What Is SDE — And Why Every Seller Hides Behind It

What Is Seller’s Discretionary Earnings?

Seller’s Discretionary Earnings (SDE) is a normalized earnings metric that shows what a full-time owner-operator could reasonably take home from the business each year. It’s the number most small business listings lead with — and the number most buyers misread.

Almost 60% of failed deals trace back to bad or inflated earnings numbers. SDE is often ground zero.

Why SDE Matters

SDE isn’t just an accounting footnote — it’s the number that drives pricing, negotiations, and how fast buyers write checks.

• Valuation anchor: SDE is the starting point for most small-business valuations.
• Apples-to-apples comparison: It lets buyers line up wildly different businesses on the same metric.
• Debt & cash flow planning: Lenders and buyers use it to model deal serviceability.
• Seller leverage: It’s the number brokers massage to make mediocre deals look irresistible.

Get this number wrong, and your offer price, your debt plan, and your ROI all fall apart before closing day.

The SDE Formula (Unpacked)

This simple formula is why SDE is so widely used — and why it’s so easy to inflate.
Every “+” in that equation is an opportunity to either clarify reality or dress it up like a parade float.

Why SDE Exists — and Why It’s Flawed

SDE gives buyers a shorthand estimate of how much money they could walk away with — if they stepped in and ran the business full-time.

But it’s also where sellers and brokers sprinkle in a little fairy dust:

• Add-backs that stretch the truth
• Personal expenses that don’t fully go away
• Non-recurring revenue still counted as “normal”

How Brokers Inflate SDE (Without Technically “Lying”)

We unpack how brokers inflate SDE in detail, but here’s the short version:

Brokers don’t usually invent numbers out of thin air — they just shine a flattering light on them.
Common plays include:

• Double-counting perks: Personal car, cell phone, travel. All magically “go away” in pro formas, even when they’re actually part of how the business runs.
• Calling recurring costs “one-time”: That annual marketing push or software renewal? Not a one-time expense.
• Owner salary sleight of hand: Adding back too much of the owner’s comp, or using an unrealistically low replacement cost.
• Including soft revenue: Counting COVID booms, seasonal spikes, or contracts that aren’t locked in.
• Stacking non-recurring adjustments: One or two adjustments can make sense. Five or six is story time.

When buyers don’t tear into the add-backs line by line, they end up underwriting a fantasy — not a business.

Used right, SDE is a clean signal.
Used wrong, it’s noise that can cost you six figures.

Common SDE Mistakes Buyers Make

1. Confusing SDE with Profit

SDE isn’t what the business made — it’s what the owner pulled out.
That’s a massive distinction.

When you buy a business, you’re either stepping into their shoes or paying someone else to.
If the seller was wearing five hats — operator, salesperson, bookkeeper, janitor — that SDE number is packed with free labor that disappears the second you take over or hire someone else to do it.

2. Blindly Trusting Add-Backs

Not every add-back is legit.

Add-backs can dramatically influence your business valuation, but only if they’re valid, justifiable, and strategically handled.

3. Forgetting to Budget for a Manager

If you’re not running the business yourself, subtract what it’ll cost to replace the seller.
That $180K SDE can shrink fast.

Buyers forget this step all the time — then wonder why their “six-figure cash flow” feels like a $60K job.

4. Ignoring Spikes and Flukes

A one-time windfall isn’t a growth story.
If last year’s revenue came from a lucky contract or one big client, don’t count on that SDE sticking around.

How to Vet SDE Like a Pro

Step 1: Start with tax returns — not just the seller’s P&L.
Step 2: Verify each add-back. If it isn’t documented or explained, it doesn’t count.
Step 3: Compare SDE to industry benchmarks.
Is a 40% margin realistic for a restaurant? Probably not.
Step 4: Adjust for your role. If you’re not doing the owner’s job, back out that “free” labor.

Case Study: The HVAC “Cash Cow” That Wasn’t

On paper, this small HVAC company looks like a dream:

• Net Profit: $300,000
• Owner’s Salary: $120,000
• Owner Perks: $40,000 (truck lease, phone, “training trips”)
• “One-time” Expenses: $40,000 (equipment purchases, marketing blitz)

Claimed SDE = $500,000

But here’s what happens when you pop the hood:

• That “one-time” marketing blitz? It’s their annual spring tune-up campaign.
• The trucks aren’t going anywhere. The next owner still needs vehicles on the road.
• The owner is the lead estimator and closer. Replacing them means hiring a sales manager at $100K+ and likely losing some goodwill with repeat customers.
• Those “equipment purchases” aren’t optional — they’re part of the replacement cycle every year.

Realistic Adjustments:

• Subtract $40K marketing (recurring)
• Subtract $40K truck perks (core ops)
• Subtract $100K to replace owner’s role
• Subtract $40K equipment replacement

True SDE: $300K + $120K − $220K = $200K

Buyers typically question the reliability of future earnings, and aggressive add-backs are among the top reasons for valuation misalignment.

SDE vs EBITDA vs Net Profit

Understanding the difference between SDE, EBITDA, and Net Profit is like knowing the difference between a trailer, a highlight reel, and the full damn movie.
Brokers love showing you the highlight reel. Smart buyers watch the whole game tape.

Example: The “$500K SDE” HVAC Business

Remember the example we just went over? Let's illustrate the difference between these different figures for the HVAC business.

Limitations of SDE

SDE is useful — but it’s not gospel. It’s a shorthand earnings metric that strips out noise, but it also glosses over real costs and can make fragile businesses look healthy. If you stop your analysis at SDE, you’re basically buying the highlight reel.

1. Ignores Real Operating Costs

SDE adds back owner perks and one-time expenses, but it doesn’t account for:

• The cost of replacing the owner’s labor
• Market-rate salaries for critical roles
• True capital expenditures and working capital requirements

2. Overstates Cash Flow

SDE is not actual free cash flow. It ignores:

• Taxes
• Required reinvestments (equipment, vehicles, buildouts)
• Financing costs and loan servicing

A business showing $500,000 in SDE may realistically deliver far less to a new owner after debt, payroll, and reinvestment.

3. Creates a False Sense of Stability

SDE can smooth over messy realities, making shaky businesses look stable:

• Seasonal revenue swings
• One-off contracts
• Owner-operator heroics that can’t be replicated

4. Easy to Manipulate

Every add-back is a judgment call. Without disciplined verification, sellers can pad:

• “One-time” costs that actually recur
• Owner perks that are operational in disguise
• Non-operating adjustments that don’t hold up post-sale

Red Flags to Watch For

Not all SDE numbers are created equal. If it looks too good to be true — it usually is.

Financial Shenanigans

• “Other Expenses” that bury vague or unexplained costs
• Add-backs with no supporting documentation or receipts
• Mysterious one-time expenses that recur every year
• Owner perks that are operational in disguise (e.g., vehicles, insurance, phone plans)
• Revenue trending down while SDE magically goes up
• SDE margin way above industry benchmarks with no clear reason
• Sudden “clean” books right before listing
• Unusually low payroll for a labor-heavy business

Operational Dependency

• Owner is the key salesperson, estimator, or operator
• No second-in-command or documented processes
• Customer relationships tied directly to the owner
• “Team” is mostly family members or 1099 contractors with no contracts
• No clarity on how the business actually runs day to day

Timing Tricks & One-Offs

• Seasonal revenue spikes presented as stable cash flow
• PPP or government aid included in earnings
• Temporary COVID-era demand baked into “normal” numbers
• Expiring contracts or key customer concentration not disclosed up front

Structural Gaps

• Incomplete or sloppy financial statements
• No formal accounting system (Excel is not a ledger)
• Inventory or WIP (work-in-progress) not reconciled with financials
• Add-backs that rely on “trust me” explanations
• No tax return tie-outs to verify actual profit

Final Take

SDE is the seller’s headline number.
But your job as a buyer is to reverse-engineer it line by line until you know exactly what’s real and what’s noise.

• Trust, but verify.
• Adjust for your role.
• If it doesn’t make sense, walk.

Bottom line: Inflated SDE isn’t just misleading — it becomes your paycheck.

Want to See a Real SDE Breakdown?

👉 Use Acquidex to spot inflated numbers before you waste time on a dud.

FAQ

Is SDE the same as profit?

No. SDE is not the same as profit. Profit is what’s left after all expenses. SDE adds back the owner’s salary, perks, and “one-time” adjustments — it’s a padded number, not a pure bottom line.

How do you calculate Seller’s Discretionary Earnings?

Start with net profit, then add one owner’s salary, perks, and non-recurring expenses. The result is SDE — the number brokers love to headline.

What’s the difference between EBITDA and SDE?

EBITDA is the clean, standardized metric used by investors. SDE is EBITDA plus owner perks and salary, often making the business look richer than it really is.

Is SDE real or just marketing?

SDE is real — but often dressed up. Treat it as a starting point, not gospel.

What’s a good SDE multiple?

Most small businesses sell for 2×–4× SDE, depending on industry, size, and risk. Don’t fall for high multiples on shaky numbers.

Why do brokers use SDE instead of profit?

Because it inflates the headline earnings number and makes deals look more attractive. SDE sells stories. Profit tells the truth.

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