If you ask a business broker how much your business is worth, the first question back is “what’s your SDE?” — not your revenue, not your net income, not your EBITDA. SDE is the language of small-business valuation, and most owners don’t know what their number actually is.
The simple definition
Seller’s Discretionary Earnings is the total cash benefit available to one working owner from running the business for a year. Not just the salary you draw — the salary plus everything the business pays for that benefits you personally, plus everything left over.
The base formula:
SDE = Net Income (pre-tax)
+ Owner's salary and bonuses
+ Payroll taxes on that owner compensation
+ Owner's personal benefits (health, retirement, perks)
+ Interest expense
+ Depreciation and amortization
+ One-time / non-recurring expensesThat’s it. Five buckets of add-backs on top of net income. Each bucket has nuance, but the structure is straightforward.
Why SDE exists
A buyer of your business won’t run it the same way you do. They might:
- Pay themselves a different salary
- Drop your kids from the payroll
- Cancel your truck lease
- Refinance the SBA loan you took out three years ago
- Skip the once-every-decade office renovation you did last year
If you give them tax-return net income, they’d be comparing apples to oranges. SDE strips out the things that change with ownership and reveals the earning power of the underlying business, independent of how you happen to run it.
That’s the number an industry multiple gets applied to.
The five add-back buckets, explained
1. Owner compensation
Add back everything paid to one working owner: W-2 salary, K-1 distributions, bonuses, payroll taxes the company paid on that compensation, retirement contributions, health insurance.
If you’re a sole owner, this is straightforward. If you have a partner, only one owner’s compensation gets added back (the buyer can’t extract two salaries unless they’re hiring two managers — that’s an EBITDA-style adjustment).
If you have non-working family members on payroll, their compensation also adds back.
2. Owner perks
Anything personal that runs through the business:
- Personal vehicle, gas, insurance, maintenance
- Family cell phone plans
- Country club, gym, or social club memberships
- Personal travel disguised as business travel
- Spouse’s “consulting” fees
- Family meals booked as business meals
- Home office expenses for personal residences
Be honest in your add-backs. Padding here is the fastest way to lose buyer trust in diligence.
3. Interest
Buyers will refinance or pay cash. Your existing loan structure tells them nothing about the underlying business. Add it all back.
4. Depreciation and amortization
Non-cash accounting charges. Add them back.
5. One-time and non-recurring expenses
This is where defensibility matters most. Legitimate examples:
- Legal fees from a settled lawsuit
- One-time IT system migration
- Equipment replacement the business won’t repeat for 10 years
- COVID-era bonuses or hazard pay
- Hurricane / flood / fire damage repair (above insurance recovery)
Buyers reject anything that looks like a recurring expense reframed as one-time. “Marketing campaign” doesn’t add back. “$50K spent rebuilding our website (won’t redo for 7 years)” does, with documentation.
A worked example
A landscaping company has these reported financials (single working owner):
| Line item | Amount |
|---|---|
| Revenue | $1,800,000 |
| Cost of services | ($900,000) |
| Owner salary + payroll tax | ($165,000) |
| Owner health insurance | ($18,000) |
| Owner truck lease + gas | ($14,000) |
| Family cell phones (4 lines) | ($3,600) |
| Office rent (market) | ($36,000) |
| Other operating expenses | ($550,000) |
| Interest expense | ($28,000) |
| Depreciation | ($72,000) |
| One-time settlement | ($25,000) |
| Net income (pre-tax) | ($11,600) |
Tax-return net income is essentially zero. Nobody’s buying this business based on net income — it’d look worthless.
Now SDE:
Net income ($11,600)
+ Owner salary+tax $165,000
+ Owner health $18,000
+ Owner truck $14,000
+ Family cell $3,600
+ Interest $28,000
+ Depreciation $72,000
+ One-time $25,000
= SDE $314,000Same business, $314K in real earning power. At a typical 2.5x landscaping multiple, this is roughly an $785K business — not a $0 business.
What SDE is not
- Not cash flow. Cash flow includes capital expenditures and working capital changes. SDE is an earnings metric.
- Not free cash flow. Same — FCF subtracts capex; SDE doesn’t. (Buyers and lenders evaluate capex separately.)
- Not EBITDA. EBITDA does not add back owner compensation. We cover the difference in EBITDA vs SDE.
- Not a guarantee. SDE is a calculation. The number a buyer accepts depends on the quality of your documentation and the defensibility of every add-back.
How buyers verify SDE
Expect this scrutiny in diligence:
- Tax returns for 3 years. Reported net income must reconcile to your SDE worksheet.
- Payroll records. Confirms owner W-2 and family payroll.
- Credit card statements. Confirms personal-on-business expenses.
- Bank reconciliations. Confirms revenue and expenses are real.
- Lease and loan documents. Confirms interest, rent, and any related-party transactions.
- Customer list and revenue concentration. Drives the multiple, not the SDE.
A clean SDE schedule with a documented spreadsheet for every add-back saves weeks in diligence and prevents most price reductions (“re-trades”).
What you should do now
- Pull three years of P&Ls in consistent format.
- Build an add-back spreadsheet. One row per add-back, with the dollar amount and the supporting document name (credit card statement, payroll record, invoice).
- Calculate trailing-twelve-months SDE updated monthly. This is the number buyers will ultimately price against.
- Sanity-check against industry multiples. If your SDE × industry multiple seems wildly off from peer transactions, your number is wrong somewhere.
- Get a confidential valuation if you want a real-market price range — that uses your SDE, your industry, and your specific risk factors to produce an actual estimate.
