SDE vs EBITDA for Earnings Calculation

When valuing a business based on its earnings, the specific metric used—Seller Discretionary Earnings (SDE) or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)—depends on the size and management structure of the company.

Seller Discretionary Earnings (SDE)

• What it is: SDE is the total financial benefit that a single owner-operator derives from the business. It is calculated by taking the company's profit and adding back the owner's salary and any personal benefits run through the company.
• Formula: SDE = (Revenue - Operating Expenses - Cost of Goods) + Owner's Compensation
• When to use it: SDE is the standard for valuing small businesses where the owner is central to the day-to-day operations. It represents the true earnings potential for a new owner who would step into that role.

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

• What it is: EBITDA is a measure of a company's overall profitability, excluding non-operating expenses. It treats the owner's or CEO's salary as a real operating expense because a new owner would need to hire someone to fill that role.
• When to use it: EBITDA is the standard for larger businesses that have a management team in place and are not dependent on a single owner-operator. It provides a clearer picture of the company's operational profitability.

The choice between SDE and EBITDA is a critical first step in The Core Formula for Startup Valuation, as it establishes the earnings baseline to which a multiple will be applied.