EBITDA vs SDE: How the Metric You Choose Can Change Your Sale Price

In small-business and lower-middle-market deals, it's common for negotiations to stall over one deceptively simple question: are we valuing this business on EBITDA or SDE? Brokers, buyers, lenders, and even accountants may talk past each other"especially when the owner's compensation and perks run through the P&L.

Using the wrong metric (or not understanding how the other side will "normalize" your numbers) can swing valuation by 20–50% and create avoidable "price gap" drama in diligence.

This guide is for small-business owners preparing to sell, buyers, and founders approaching an exit, along with their advisors, who want a practical way to talk about earnings and price.

You'll get clear definitions, a worked example, and a checklist for choosing and negotiating the right metric"plus where it shows up in LOIs, purchase agreements, covenants, and tax structuring.

TL;DR – When to Use EBITDA vs SDE

• SDE (seller's discretionary earnings) is usually used for smaller, owner-dependent businesses where the owner's pay and perks are flexible.
• EBITDA (earnings before interest, taxes, depreciation, and amortization) is typically used for larger, professionally managed businesses and by financial buyers.
• SDE often produces a higher earnings number, but multiples are lower; EBITDA is usually lower per dollar but gets a higher multiple.
• Buyers, lenders, and PE funds will almost always normalize toward EBITDA; sellers should understand both to avoid sticker shock.
• The LOI and purchase agreement should clearly define which metric governs price and how it will be calculated and verified.

Understand the Core Definitions Before You Negotiate

What Is EBITDA in Plain English?

EBITDA means earnings before interest, taxes, depreciation, and amortization. It's commonly used as a proxy for operating profitability because it strips out (a) how the business is financed (interest), (b) tax profile (taxes), and (c) certain non-cash accounting items (depreciation and amortization).

Formula: EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization.

Buyers like EBITDA because it helps them compare businesses on a more apples-to-apples basis. For example, a manufacturing company with loans and heavy equipment purchases might show low net income due to interest and depreciation, but EBITDA highlights the underlying operating performance before those financing and accounting effects.

What Is Seller's Discretionary Earnings (SDE)?

SDE (seller's discretionary earnings) is the earnings available to a single full-time owner-operator. It typically starts with EBITDA and then adds back the owner's compensation and discretionary expenses that a new owner might not incur (or could choose to handle differently).

Base formula: SDE = EBITDA + Owner Salary/Comp + Owner Perks + One-time/Non-recurring Expenses − Replacement Salary (if the buyer won't be the working owner).

Many brokers use a simplified SDE that assumes the buyer will step into the owner's role. That's why SDE is common in Main Street and SBA-style deals: it answers, "How much cash can one working owner reasonably take home?"

Key Differences That Actually Matter in Deals

• SDE assumes an owner-operator; EBITDA is owner-agnostic.
• SDE is usually more subjective (because add-backs vary); EBITDA is more standardized, but most deals still use Adjusted EBITDA.
• Valuation gaps often happen when a listing is marketed on SDE but a buyer underwrites on EBITDA.
• Legal preview: the definition of "Adjusted EBITDA" or "SDE" in the LOI and purchase agreement can drive purchase price adjustments and earnout math.

How to Calculate EBITDA and SDE Step by Step

Start With a Simple Income Statement

To calculate EBITDA and SDE, start with a clean P&L that clearly separates: revenue, COGS, operating expenses (rent, payroll, marketing), owner compensation, interest, taxes, depreciation & amortization, and any one-time/unusual items. You'll typically want at least 2–3 years of financials to identify anomalies and normalize results.

Step-by-Step EBITDA Calculation

1. Start with net income.
2. Add back interest expense.
3. Add back income taxes.
4. Add back depreciation.
5. Add back amortization.

Many deals then move to Adjusted EBITDA by adding back specific items (for example, documented restructuring costs or an extraordinary legal settlement). Each adjustment should be clearly supported"buyers will test them in diligence.

Step-by-Step SDE Calculation

1. Start with EBITDA.
2. Add back all owner compensation (wages/bonuses and any comp running through expenses).
3. Add back personal or discretionary expenses (e.g., personal travel, personal vehicle, non-working family payroll).
4. Add back legitimate one-time/non-recurring expenses.
5. If the buyer won't be the working owner, subtract a fair-market replacement salary.

Sellers and brokers often stop at Step 4; sophisticated buyers usually push for Step 5.

Common Add-Backs Buyers Challenge

• "Perks" that are partly operational (e.g., a vehicle used for sales calls).
• Owner salary that's above-market versus the true cost of management.
• "One-time" marketing tests or launches that actually recur.
• Legal/consulting fees that show up every year under different labels.

When add-backs are contentious, deals slow down and buyers may respond with price chips, tighter reps and warranties, or earnout structures tied to a stricter definition of earnings.

Worked Example – How EBITDA vs SDE Change the Price

Example Company: Owner-Operated Services Business

Assume an owner-operated services business (think marketing agency or HVAC) with:

• Revenue: $1,200,000
• Net income: $150,000
• Interest expense: $20,000
• Taxes: $15,000
• Depreciation & amortization: $25,000
• Owner salary: $180,000
• Owner perks: $20,000
• One-time legal fee: $10,000

Assume the buyer will step into the owner's role (no replacement manager).

Calculate EBITDA for the Example

• $150,000 net income
• + $20,000 interest = $170,000
• + $15,000 taxes = $185,000
• + $25,000 D&A = $210,000 EBITDA

Calculate SDE for the Example

• $210,000 EBITDA
• + $180,000 owner salary = $390,000
• + $20,000 perks = $410,000
• + $10,000 one-time legal = $420,000 SDE

Same business, two very different earnings numbers: $210k EBITDA vs $420k SDE.

Show Valuation Impact Using Market Multiples

If a Main Street/SBA buyer pays ~3x SDE, that implies $420k × 3 = $1.26M. If a financial buyer focuses on ~5x EBITDA, that implies $210k × 5 = $1.05M. The choice of metric and multiple can swing price by hundreds of thousands.

Scenario: Seller Lists on SDE, Buyer Counters on EBITDA

Seller's broker markets at ~$1.3M based on ~3.1x SDE. A small PE buyer underwrites EBITDA and offers $1.05M (5x $210k). A ~$250k gap appears"and both sides feel "right." Knowing both metrics early helps you target the right buyers and structure tools like earnouts or seller financing to bridge the gap.

When EBITDA vs SDE Makes Sense for Your Deal

Choose by Business Size and Owner Dependence

SDE is usually the right primary lens when the business is owner-dependent: the owner drives sales, operations, or delivery; the company is realistically a one-owner job; and personal/discretionary expenses run through the P&L. In that world, buyers are often underwriting "what cash flow can I take home?"

EBITDA tends to fit better when the business is professionally managed (or can be) and less dependent on any one person. It's also the go-to metric when the buyer will change the capital structure, add leverage, or integrate the target"all of which makes an owner-comp-based metric less meaningful.

Choose by Buyer Type and Financing Source

Individual/first-time buyers and many SBA-backed transactions often start with SDE because underwriting is tied to debt service coverage and the buyer's ability to pay themselves. Private equity and strategic buyers almost always evaluate on (adjusted) EBITDA to model leverage, synergies, and returns. If you're courting PE or strategics, come prepared with a clean adjusted EBITDA bridge"not just an SDE add-back spreadsheet.

How Metrics Translate into Deal Terms

Deals marketed on SDE often feature lower multiples but a higher earnings base, and can feel simpler and more cash-flow-focused. Deals priced on EBITDA may carry higher multiples but also more negotiation around adjustments, accounting policies, and covenants. Either way, the metric is only as good as the definition"so lock down the chosen metric and calculation method in the LOI and purchase agreement to avoid disputes later.

Legal and Deal Implications of Picking EBITDA vs SDE

Lock the Definition in Your LOI and Purchase Agreement

The single most common "EBITDA vs SDE" failure is assuming everyone means the same thing. Your LOI should state (1) whether price is based on SDE, EBITDA, or Adjusted EBITDA, (2) the measurement period (e.g., trailing 12 months vs last fiscal year), and (3) the big-ticket add-backs/adjustments that are agreed in principle.

Then the purchase agreement should define the metric in a dedicated Definitions section and tie it directly into purchase price mechanics (including any earnout, working capital adjustment, or true-up). If the definition is vague, you've created a dispute you can predict on day one.

Earnouts and Performance-Based Payments

Earnouts can behave very differently depending on the metric. An SDE-based earnout can be distorted if the post-close owner changes salary/perks; an EBITDA-based earnout can swing based on financing decisions, capital expenditures, or aggressive "adjustments." Drafting should address what the buyer controls, what the seller controls, and how related-party transactions and extraordinary items are treated.

Reps, Warranties, and Due Diligence Risk

Sellers often represent that financial statements are accurate and prepared under a stated standard (GAAP, tax-basis, or consistently applied methods). Over-aggressive add-backs can become a misrepresentation risk. A common scenario: diligence finds personal expenses booked as business expenses; the buyer demands a price reduction, tighter indemnity terms, or walks.

Tax and 409A / Equity Considerations (High-Level)

The metric itself doesn't decide tax treatment, but it can influence valuation narratives, allocations, and (for startups) how stakeholders think about value versus what a 409A valuation supports. For background, see 409A valuation and pre-money valuation.

Practical Checklist for Sellers and Buyers

For Sellers Preparing to Go to Market

• Assemble 3+ years of P&Ls, balance sheets, and tax returns.
• Calculate both EBITDA and SDE for trailing 12 months and the last full fiscal year.
• Create an add-back schedule with documentation (invoices, receipts, contracts).
• Decide your target buyer profile (individual/SBA vs PE/strategic) and align your primary metric accordingly.
• Work with your accountant and lawyer to clean up owner perks/personal expenses in advance where possible.
• Ensure your broker, banker, and legal team use consistent EBITDA/SDE definitions in marketing materials and term sheets.

For Buyers Evaluating a Target

• Rebuild EBITDA from source documents (tax returns, financials, GL)"don't rely only on the seller's spreadsheet.
• Recreate SDE, then normalize for replacement management cost if you won't be the working owner.
• Test every add-back: is it truly non-recurring/discretionary, or part of normal operations?
• Stress-test valuation under both metrics to understand sensitivity.
• Make sure the LOI states which metric governs price and how it will be calculated and verified.

Documents and Data to Have Ready

• General ledger exports for the last 12–24 months.
• Major contracts (customers, vendors, leases) that drive expenses or restrict changes.
• Payroll reports identifying owner and family compensation.
• Prior valuation reports or lender packages (SBA/bank) if available.

Having this package ready speeds diligence, reduces "price chips," and makes it easier for both sides to agree on the earnings metric that actually governs the deal.

FAQs on EBITDA vs SDE (For Quick Answers and Snippets)

• Q: Is SDE always higher than EBITDA?
  A: Usually, yes. SDE typically starts with EBITDA and then adds back the owner's compensation and discretionary perks. But if the owner is underpaid (or if a buyer must hire a manager at market pay), the gap can shrink substantially.
• Q: Do SBA lenders use SDE or EBITDA?
  A: Many SBA-backed small-business loans are underwritten with an SDE mindset because they assume a single working owner and focus on debt service coverage. Larger SBA deals and conventional lenders often focus more on EBITDA, cash flow, and coverage ratios.
• Q: Which metric do private equity buyers prefer?
  A: Most financial sponsors think in terms of Adjusted EBITDA because it aligns with leverage and return models. They may look at SDE for very small add-ons, but will still normalize toward EBITDA.
• Q: Can we base an earnout on SDE?
  A: You can, but it's riskier because SDE depends heavily on how owner compensation and perks are handled post-close. Many buyers prefer EBITDA-based earnouts with tightly defined adjustments.
• Q: Should a startup founder care about SDE?
  A: Typically less. Venture-backed startups are usually discussed in terms of growth and revenue multiples (and sometimes adjusted EBITDA), not SDE. If you need a grounding point, see pre-money valuation and 409A valuation.

Actionable Next Steps

• Gather your last 2–3 years of financial statements and, with your accountant, calculate both EBITDA and SDE (TTM and last fiscal year).
• Decide which buyer profile you're targeting and pick a primary metric (SDE for owner-operators; EBITDA/adjusted EBITDA for institutional buyers), but stay fluent in both.
• Document every proposed add-back with clear support (invoices, receipts, contracts) so you can defend it in diligence.
• Work with a deal lawyer to lock the definitions of EBITDA/SDE into your LOI and purchase agreement and to structure earnouts or seller financing around those definitions.
• If you're a founder with complex equity, sanity-check how your valuation narrative interacts with convertible notes, your cap table, and 409A valuation expectations.
• Build a simple EBITDA/SDE calculator (using the inputs in this article) and stress-test different add-back and replacement-salary assumptions before negotiating.

If you want help translating EBITDA/SDE into clear deal terms"and avoiding valuation disputes in diligence"Promise Legal can assist with LOIs, purchase agreements, and related transaction documentation.