News & Insights

When business owners begin thinking about selling their company, one of the first questions they ask is, “What is my business worth?” While there are several methods used to value a business, one of the most common—particularly for small and owner-operated companies—is Seller’s Discretionary Earnings (SDE). Seller’s Discretionary Earnings represents the true economic benefit a single owner receives from operating the business. It is different from the net income figure at the bottom of your profit & loss statements (P&Ls), which is the basis for income taxes, so smaller is better.  SDE is basically a readjustment of your P&L that intends to show a potential buyer how much discretionary income your business generates, so for SDE bigger is better. 

At its core, SDE starts with the business’s net profit and then adds back certain expenses that are considered discretionary or non-essential to ongoing operations. These typically include the owner’s salary and payroll taxes, personal benefits paid through the business, non-recurring or one-time expenses, and sometimes depreciation and amortization. The idea is to show how much cash flow is available to a potential buyer if they purchase your business.

Why does this matter? Well, most small businesses are purchased by individual buyers, not large corporations. These buyers are usually acquiring both a business and a job. SDE helps them understand how much income they can reasonably expect to earn by owning and operating the company themselves. A potential buyer will look at the SDE, will research various sources that report on sales of similar businesses, and will develop a “multiple” that they are willing to apply to your SDE. Perhaps similar businesses are selling for an average of “2 times SDE”. The buyer will consider if your business is more or less attractive than average and may apply a higher or lower multiple accordingly.

It’s important to note that SDE is not a standardized accounting term. The specific add-backs included can vary depending on the business, the industry, and the quality of the financial records. This is why careful documentation and support for each adjustment are critical when preparing a business for sale. Overstated or poorly supported add-backs can undermine buyer confidence and derail negotiations.

For business owners considering a sale, or structuring an exit or succession plan, understanding Seller’s Discretionary Earnings is essential. Properly calculated SDE can significantly impact valuation, buyer interest, and ultimately, the success of the transaction. Working with experienced legal, accounting, and valuation professionals can help ensure your SDE is accurate, credible, and positioned to maximize value. If you have any questions about buying or selling a business, or about exit or succession plans, contact RC Kelly by phone at 215-896-3846 or by email at help@rckelly.com.