Seller's Discretionary Earnings (SDE): the profit number buyers actually use

Ask a broker what your business earns and they will not quote your tax return. They will compute SDE. If you plan to sell within a decade, or just want to know your real score, this is the number to understand.

What SDE is

Seller's Discretionary Earnings is the total annual financial benefit available to one full-time owner-operator. The logic: small-business buyers are usually buying themselves a livelihood, so they want to know everything the business puts in one owner's pocket, however it is labelled.

The computation starts from pre-tax profit and adds back:

• Your compensation. Salary, dividends, and payroll costs for one owner.
• Personal expenses run through the business. The car, the phone, the travel that is really personal. Legitimately added back, if provable.
• One-time costs. A lawsuit, a refit, a flood. Things a new owner would not face again.
• Interest, depreciation, and amortisation. Financing and accounting charges, not operations.

What does NOT get added back

This is where sellers lose credibility. A buyer, and their accountant, will strike:

• A market-rate manager's salary, if you claim the business "runs itself" while paying yourself nothing for managing it. You cannot have it both ways.
• Recurring "one-offs". If equipment breaks every year, it is a cost, not an exception.
• Family members on payroll who do real work the new owner would have to pay someone for.
• Anything you cannot document. An add-back without a paper trail is a discount waiting to happen.

SDE vs EBITDA

EBITDA is the equivalent measure for larger businesses that run under professional management: it does NOT add back a manager's pay, because the buyer expects to employ a manager rather than work in the business. Somewhere around the point a business can afford a full-time general manager and still show a healthy profit, buyers switch from SDE to EBITDA, and multiples change with the measure. For most owner-operated businesses, SDE is the honest yardstick.

Why this matters years before a sale

Because the habits that maximise SDE-at-sale are the opposite of the habits that minimise tax this year. Cash kept off the books saves tax now and destroys 2 to 3 times its value at sale, since it cannot be counted. Undocumented perks are invisible earnings. The earlier the books show reality, the more years of provable SDE you carry into a negotiation. Our guide on clean books covers exactly this trade.

To see what your SDE implies for price, put it through the valuation calculator. And to see the whole valuation picture beyond profit, start with what is my business worth.