2. Understanding Seller’s Discretionary Earnings (SDE)

Seller’s Discretionary Earnings (SDE) is a key metric used in small business valuation. It represents the total financial benefit a full-time owner-operator derives from the business. SDE is calculated by starting with net income and adding back items like owner salary, non-recurring expenses, interest, taxes, depreciation, and personal perks. Understanding and maximizing your SDE is crucial because most small businesses are valued using a multiple of SDE.

Once you tell a business broker or business valuation consultant, “sell my business,” their first step should be to determine your company’s Seller’s Discretionary Earnings (SDE). If they skip this critical step, it’s a red flag—consider finding a more qualified professional who understands how to properly value and position your business for sale.

To present a clear and compelling SDE, it’s essential to provide full documentation and justification for each add-back. The more verifiable and justifiable your SDE, the higher the perceived value by buyers and lenders. Properly understanding SDE also helps set realistic price expectations and supports your asking price during negotiations. For sellers, optimizing SDE before going to market can result in tens or even hundreds of thousands more at closing.