The Difference between Seller's Discretionary Earnings (SDE) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and True Net
By Alan Miklofsky
Updated 10/12/2024
Seller's Discretionary Earnings (SDE) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) are related concepts used in valuing businesses, but they differ in what they measure and how they are used. Here's the breakdown:
Seller's Discretionary Earnings (SDE)
Definition: SDE reflects the total financial benefit that a single owner-operator would derive from a business in a year.
Purpose: Commonly used for small businesses and businesses that are owner-operated.
Adjustments: In addition to adding back interest, taxes, depreciation, and amortization (like EBITDA), SDE also adds back the owner's salary and benefits, personal expenses run through the business, and other discretionary costs (like non-essential travel or family perks).
Formula for SDE:
SDE=Net Income+Owner’s Salary+Benefits+Interest+Taxes+Depreciation+Amortization+Discretionary Expenses\text{SDE} = \text{Net Income} + \text{Owner’s Salary} + \text{Benefits} + \text{Interest} + \text{Taxes} + \text{Depreciation} + \text{Amortization} + \text{Discretionary Expenses}SDE=Net Income+Owner’s Salary+Benefits+Interest+Taxes+Depreciation+Amortization+Discretionary Expenses
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
Definition: EBITDA measures the operating profitability of a business without accounting for interest, taxes, and non-cash expenses like depreciation and amortization.
Purpose: Primarily used for larger businesses, corporate acquisitions, and businesses with multiple stakeholders to give a sense of operating performance. It reflects profitability before financial structure or accounting decisions come into play.
Adjustments: Unlike SDE, EBITDA does not include the owner's compensation or discretionary expenses.
Formula for EBITDA:
EBITDA=Net Income+Interest+Taxes+Depreciation+Amortization\text{EBITDA} = \text{Net Income} + \text{Interest} + \text{Taxes} + \text{Depreciation} + \text{Amortization}EBITDA=Net Income+Interest+Taxes+Depreciation+Amortization
Key Differences
Use Case:
SDE: Best for small, owner-operated businesses where personal expenses and the owner’s role significantly affect profit.
EBITDA: Best for larger companies with more formal management and external investors, focusing on operational profitability.
Owner’s Compensation:
SDE: Adds back the owner’s salary, benefits, and personal expenses.
EBITDA: Does not include any adjustments for owner’s salary or personal expenses.
Perspective:
SDE gives a buyer an idea of how much cash flow they would get if they ran the business themselves.
EBITDA provides a view of how profitable the business is regardless of ownership.
In summary, SDE and EBITDA are similar in that both add back interest, taxes, depreciation, and amortization, but SDE goes further by adding back the owner’s personal compensation and discretionary expenses. SDE is more relevant for valuing small businesses, while EBITDA is the go-to metric for larger companies or when investors are involved.
Comparison of True Net and Seller's Discretionary Earnings
True Net and Seller’s Discretionary Earnings (SDE) are not exactly the same, although they can overlap conceptually, depending on the business context. Here’s a comparison to clarify the differences and how they are used:
True Net
Definition: True Net typically refers to the actual net profit of a business after accounting for all necessary expenses. It reflects the real, sustainable earnings available to the owner, excluding one-time or non-recurring items and personal, non-business expenses.
Use: It’s often used in small business valuations to provide a realistic picture of profitability, aiming to show the "real bottom line" from regular operations.
Adjustments: It excludes non-recurring income/expenses, excessive discretionary spending, or abnormal costs that wouldn’t continue with new ownership. However, it may or may not add back all owner-specific benefits, depending on the context.
Key Concept: True Net aims to show the genuine profit of a business as it would operate on an ongoing basis.
Seller’s Discretionary Earnings (SDE)
Definition: SDE reflects the total financial benefit that a single owner-operator receives from the business, including the owner’s compensation and personal benefits paid through the business.
Use: SDE is commonly used for small businesses to assess how much cash flow an owner-operator can expect to generate.
Adjustments: SDE adds back the owner’s salary, benefits, discretionary expenses, and other non-operational costs, in addition to the typical interest, taxes, depreciation, and amortization adjustments.
Conclusion
While True Net aims to present the actual ongoing profit of the business, SDE provides a more generous cash flow figure by adding back all owner-related expenses. Both metrics can be useful depending on the buyer’s goal:
SDE is more relevant when the new owner plans to operate the business actively.
True Net is useful if the buyer is looking for a realistic, operational net profit, especially for passive or investment-driven acquisitions.
In some valuations, the two can overlap if the business’s structure is simple and the owner’s compensation aligns with market standards. However, they remain conceptually different—True Net emphasizes operational profit, while SDE emphasizes total cash flow benefit to the owner.