Glossary · underwriting

Seller's Discretionary Earnings SDE

Also called SDE, owner benefit, discretionary cash flow, adjusted cash flow.

A small-business cash-flow measure that adds one working owner's compensation and non-recurring or personal expenses back to pre-tax profit, used to price main-street business sales and to size acquisition debt.

Drafted with AI assistance. Not yet independently checked. Nobody has verified the claims on this page against a source, so treat the figures and legal points as a starting point rather than as settled, and confirm anything you are about to act on. How we check things.

What it means

The premise is that a small business's reported profit is a tax-planning artefact. One owner runs it, takes a salary set for tax reasons, runs a vehicle and a phone through the company, and expenses things a subsequent owner would not. SDE strips that out to show what the business generates for one working owner-operator before financing and taxes.

The build-up

Start with pre-tax net income from the tax return, then add back:

  • One owner's total compensation, including payroll taxes and benefits paid on their behalf
  • Interest expense on debt that will not transfer
  • Depreciation and amortisation
  • Genuinely non-recurring items, in either direction
  • Discretionary and personal expenses run through the business

SDE against EBITDA

EBITDA does not add back owner compensation. SDE does. That single difference makes the two numbers non-comparable, and it is why the same business is quoted at one multiple of SDE in a main-street listing and a different multiple of EBITDA in a lower-middle-market one. Larger deals move to EBITDA precisely because a buyer at that size will pay a manager, so the owner's salary is a real ongoing cost, not an add-back.

Where you meet it

A business listing, a broker's confidential information memorandum, and the lender's spread on a change-of-ownership loan. Lenders re-do the arithmetic and remove add-backs they cannot document.

Where this one catches people

Add-backs are where the price is set and where the loan is lost. A seller adds back the truck, the family member on payroll who did not work there, the "one-time" legal fee that also appears in the two prior years, and a rent figure that will change when the building is leased at market. The multiple is then applied to the inflated figure, so a $50,000 add-back at a three times multiple adds $150,000 to the asking price.

Then the lender arrives. It removes what has no documentation, adds back a market-rate salary for whoever will actually run the business, includes the debt service on the new loan, and recomputes coverage. Two things move at once: the valuation the deal was priced on, and the coverage ratio it has to clear.

Ask for the add-back schedule line by line with a source document for each line, before you agree a price. Every line you cannot evidence is a line the lender will strike.

Worked through

Illustrative only.

Pre-tax net income $180,000. Add back: owner salary $95,000; owner health insurance $18,000; interest $22,000; depreciation $35,000; a legal settlement described as one-time $15,000; personal vehicle $9,000.

SDE = 180,000 + 95,000 + 18,000 + 22,000 + 35,000 + 15,000 + 9,000 = $374,000.

The buyer will not work in the business and must hire a manager at $70,000. Acquisition debt service is $13,600 a month, or $163,200 a year.

Coverage: (374,000 − 70,000) ÷ 163,200 = 1.86.

Now the lender examines the add-backs. The "one-time" legal settlement appears in three consecutive years and is disallowed; so is the vehicle, which has no log. SDE falls to $350,000.

Recomputed coverage: (350,000 − 70,000) ÷ 163,200 = 1.72. And at a three times multiple, the disallowed $24,000 of add-backs is $72,000 of purchase price the buyer has now paid for earnings the lender does not accept exist.

Figures in the example are illustrative. They show the arithmetic, not a quote — what any one lender would charge is on that lender's page, where it is published at all.

Where you will meet this term

Term Loan SBA Loan

Read next

Cash flowThe actual movement of money in and out of the business over a period, which is what funding is repaid from a… Change of OwnershipA transaction in which the ownership of a business changes hands — financed as an acquisition loan on the tar… Debt service coverage ratio (DSCR)Cash available for debt payments divided by the payments due in the same period; above 1.0 means the cash cov… EBITDA (EBITDA)Earnings before interest, taxes, depreciation and amortization: a rough proxy for operating cash generation, … Global cash flow analysisAn underwriting method that adds the owner's personal income and personal debt to the business's, on the theo… GoodwillThe part of an acquisition price that exceeds the fair value of the identifiable assets acquired — the intang… Net MarginWhat is left of revenue after every cost including overhead, interest and tax, expressed as a percentage — th… SBA 7(a) loan (7(a))The SBA's main guaranteed loan program, usable for working capital, equipment, real estate, business acquisit… Seller noteA promissory note the seller of a business accepts as part of the purchase price, paid out of the acquired bu…

Seller's Discretionary Earnings — common questions

What does seller's discretionary earnings mean?

A small-business cash-flow measure that adds one working owner's compensation and non-recurring or personal expenses back to pre-tax profit, used to price main-street business sales and to size acquisition debt.

Where does seller's discretionary earnings catch people out?

Add-backs are where the price is set and where the loan is lost. A seller adds back the truck, the family member on payroll who did not work there, the "one-time" legal fee that also appears in the two prior years, and a rent figure that will change when the building is leased at market. The multiple is then applied to the inflated figure, so a $50,000 add-back at a three times multiple adds $150,000 to the asking price.

Is seller's discretionary earnings the same as an interest rate?

Seller's Discretionary Earnings is defined above; if you are comparing it against a rate, check whether the two measures share a time dimension before you put them side by side.

Which products does seller's discretionary earnings apply to?

Term Loan, SBA Loan.

Is there a worked example of seller's discretionary earnings?

Yes, on this page, and it is labelled illustrative. It shows the arithmetic, not a quote from any lender.

What else should I read alongside seller's discretionary earnings?

Cash flow, Change of Ownership, Debt service coverage ratio, EBITDA, Global cash flow analysis.

Has this definition been checked?

Not yet. This entry is drafted and live, and the notice at the top says so. Confirm anything you are about to act on.

Is this legal advice?

No. It is a definition. What a clause does in your contract, in your state, is a question for a lawyer licensed where you are.

Can I suggest a term?

Yes — [email protected]. The glossary grows from what people are actually shown in contracts.