When to use Seller’s Discretionary Earnings versus EBITDA

When you are looking at the financial performance of a small business that is owner-operated, one of the most relevant metrics is Seller’s Discretionary Earnings (SDE).

Here’s what SDE is, why it matters, and how it differs from EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization).

What is SDE?

SDE is the total financial benefit a full-time owner-operator can derive from the business in a year. It is calculated by taking the business’s net income and adding back a number of items that reflect either the owner’s personal benefit, discretionary spending, or non-operating/one-time items. It is calculated as follows:

• Net income plus

• Owner’s compensation including salary and benefits

• Owner’s perks/personal expenses paid through the business

• Discretionary expenses

• Depreciation and amortization

• Interest paid (add) and earned (subtract)

• Taxes

• Non-recurring expenses (add) or income (subtract)

Why SDE matters

For small businesses (typically owner-operated, lower revenue), SDE is extremely useful because it reflects:

• The owner’s involvement is a key part of operations.

• The business’s financials may include personal or discretionary expenses.

• How much a business buyer can make from the business if they own it and run it.

• A way for business brokers and valuation experts to value the business using a multiple of SDE.

What is EBITDA?

Our blog “Why is EBITDA Important for Small Business Owners” explained the definition of EBITDA:

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This financial metric provides a clear picture of a company’s profitability by focusing on its core operating performance. Essentially, EBITDA isolates the business’s earnings from the influence of financial decisions (like debt interest) and accounting practices (such as depreciation or amortization).

Why is EBITDA used for small businesses?

• It makes operating performance clearer by excluding the impacts of financing (interest), tax structure (taxes), and non-cash accounting items (depreciation & amortization).

• It makes it easier to compare businesses in different tax jurisdictions or with different capital structures, as well as businesses in the same industry.

• Multiples of EBITDA are often used in valuations for larger companies.

Seller’s Discretionary Earnings versus EBITDA - Key Differences

Here are the main ways SDE and EBITDA differ, and when each is most appropriate.

Feature	SDE	EBITDA
Reflects Ownership involvement	Strongly. For owner-operated businesses that likely have owner personal costs flowing through the business.	Minimally. For businesses that may have professional management and distinct owner compensation. The owner’s perks are less likely to flow through the business.
Adjustments included	More addbacks: owner’s compensation, perks/personal items, discretionary expenses, non-recurring items, plus interest, taxes, depreciation, and amortization.	Adds back interest, taxes, depreciation, and amortization.
Intended business size / type	Used for small owner-operator businesses. The value of the business is heavily tied to the owner’s involvement.	More common in larger businesses where the operations are less dependent on the owner-operator and where the focus is on operating performance.
What it shows	The cash-flow benefit available to a single owner-operator; what they can “take out” of the business.	The operating earnings from the business before financing, tax, and non-cash accounting effects.
Use in valuation	Multiples of SDE are often used when valuing smaller service-based businesses that are highly owner-dependent.	Multiples of EBITDA are often used in larger small business purchases with less owner dependence.
Limitations	May overlook working capital needs and significant capital expenditures.	May ignore capital expenditures, working capital needs, or owner perks. Doesn’t show what the owner actually makes. Can be misleading in small owner-operated businesses.

A simple comparison summary

Here is a short way to consider Seller’s Discretionary Earnings versus EBITDA.

• Think of SDE as: “If I buy this business and I run it; how much can I reasonably take out in a year?”

• Think of EBITDA as: “Here’s how much cash the business generates from operations, ignoring how it’s financed or how the owner is paid.”

Practical considerations & when to use each

• If you run an owner-operated business (you are the primary operator, you take a salary or draw, you have perks, your personal expenses may be run through the business), then SDE is likely the more relevant metric for valuation or business sale planning.

• If your company has grown beyond that (multiple managers, less direct owner involvement, more formal structure, higher revenue), then EBITDA may become the more relevant figure.

• Even when using SDE or EBITDA, always remember that neither is perfect. Both require careful adjustments/normalizations.

• When preparing for a sale or a valuation: get clarity on what metric buyers in your industry typically use; understand how your business’s structure, owner involvement, and financials shape which metric is best; and make sure your financials are “recast” or “normalized” with add-backs clearly documented. (Website Closers)

Conclusion

• SDE is the go-to metric for smaller, owner-run businesses—it tells you how much the owner is getting (or could get) out of the business.

• EBITDA is a broader metric showing operating performance—less about the owner’s personal benefit, more about business earnings before financing/tax/accounting effects.

P.S. If you need help evaluating a small business purchase or sale, contact us!