Wealth Insight: Understanding EBITDA vs. SDE

When valuing a business, two common ways to measure cash flow are EBITDA and Seller’s Discretionary Earnings (SDE). While both aim to show profitability, they serve different purposes depending on the type and size of the business.

What is EBITDA?

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is commonly used for mid-sized businesses. It standardizes earnings by removing variables like taxes and financing structures, which can vary by location and ownership.

It also assumes the business will be run by a professional manager—not the current owner—so the owner’s compensation is excluded. In simple terms, EBITDA reflects the cash flow available to an investor.

What is SDE?

SDE represents the total financial benefit to an owner-operator. It includes salary, bonuses, distributions, and personal benefits such as insurance or a company vehicle.

This measure assumes the owner is actively running the business. In short, SDE reflects the cash flow available for both ownership and day-to-day involvement.

Key Adjustments

Both measures often require adjustments to reflect true market conditions:

• Compensation: Family members or partners may be overpaid or underpaid compared to market rates, which impacts true cash flow.
• Rent: If the owner also owns the property, rent may not reflect market value and should be adjusted accordingly.

These adjustments help present a more accurate picture of the business to potential buyers.

Which One is Right?

• EBITDA is typically used for larger businesses (generally $1M+ in cash flow) and investor buyers.
• SDE is more appropriate for smaller businesses (under ~$700K) where the buyer is likely to be an owner-operator.

The Bottom Line

Both EBITDA and SDE are tools to understand business value—but the right one depends on who is buying the business and how it will be operated.