SDE is seller's discretionary earnings: roughly EBITDA plus one full-time owner's total compensation. It measures the entire financial benefit a single working owner takes from a business, and it is the convention buyers use for smaller, owner-operated companies where one person is central to how the business runs.
What is SDE trying to capture?
The idea that a buyer of a small owner-operated business is purchasing a job as well as an asset.
Such a buyer will step into the owner's role personally. The salary the previous owner paid themselves therefore becomes money available to the new owner, not a cost the business must keep bearing. Treating that compensation as an operating expense would understate what the buyer actually receives.
EBITDA makes the opposite assumption: that management is a genuine ongoing cost, because the buyer intends to install someone. Both conventions are trying to describe transferable earnings. They differ on whether the owner's own labour is a cost of the business or a benefit of owning it.
How is SDE calculated?
In two stages, and keeping them separate is what stops the arithmetic double-counting.
The first stage is normalization, which every valuation does regardless of convention: strip out the items that will not recur. The second stage is the one specific to SDE: add the owner layer on top.
| Step | Running figure | |
|---|---|---|
| Reported operating profit | $420,000 | |
| Add depreciation and amortization | +$60,000 | $480,000 |
| Reported EBITDA | $480,000 | |
| Add a one-time legal settlement | +$30,000 | $510,000 |
| Normalized EBITDA | $510,000 | |
| Add the owner's salary | +$180,000 | $690,000 |
| Add payroll taxes and benefits on that salary | +$25,000 | $715,000 |
| Add personal vehicle and travel run through the business | +$18,000 | $733,000 |
| SDE | $733,000 |
The figures are illustrative, but the shape is what matters. One-time items belong to the normalization stage, not the SDE stage. Adding them in both places is a common error and it inflates the result.
The second stage is where SDE and EBITDA part company. Everything above the normalized line is identical between the two conventions; everything below it exists only in SDE.
For which adjustments survive a buyer's scrutiny at the normalization stage, see which add-backs buyers accept and reject. For the underlying earnings measure, see what EBITDA is.
Why does only one owner count?
Because a buyer replaces one person, and has to pay for everyone else.
This is the constraint owners most often get wrong, and it is worth stating plainly: a business with three active owner-operators does not add back three salaries. It adds back one. The other two represent work that still has to happen after the sale, so the business must carry a market-rate cost for those roles.
The same logic applies to an owner who works part-time. If you draw a full-time salary for what is genuinely a two-day-a-week role, the add-back is limited to what the business would actually save, not what appears on the payroll.
The test is not who holds equity. It is whose job disappears when the buyer arrives.
What exactly gets added back?
The full cost of employing that owner, plus the personal spending the business absorbs.
- Total compensation, not base salary. Payroll taxes, health insurance, retirement contributions, and any other benefit attached to the role. For an owner with a substantial benefits package the difference between base pay and total cost is material.
- Genuinely personal expenses. A personal vehicle, family travel, a relative on payroll who does not work in the business. The word doing the work is genuinely: a cost that is partly personal and partly operational gets apportioned, not claimed in full.
- Not anything the business would still have to spend. A legitimate operating cost does not become discretionary because the owner chose it.
The distinction that decides most of these is whether the cost disappears when you do. If it survives your departure, it is an operating expense and it stays in.
When does SDE apply rather than EBITDA?
When a buyer would step directly into your role rather than hire someone to fill it.
That is the short answer, and the honest one: the dividing line is owner involvement rather than revenue alone. A larger business whose owner holds every key relationship may still be assessed on SDE, and a smaller one that genuinely runs without its owner may be assessed on EBITDA.
Which convention applies to you, how buyers decide, and what happens to your headline number when the two get mixed up are covered properly in EBITDA vs SDE: which applies to your business. It is the better page for that question.
Our valuation calculator uses EBITDA throughout. If you are in SDE territory, read its output as a directional ceiling rather than a midpoint, and treat it as a starting point for a more specific conversation rather than a formal appraisal.