Key Insight
Every SDE analysis that adds back owner compensation must answer one question: what would a competent replacement actually cost? Without that number, the add-back is meaningless.
Why It Matters
Owner compensation is added back to net income in the SDE calculation because the new owner will set their own compensation. The theoretical SDE is "what's available to a new owner before they pay themselves."
But if a new owner can't run the business themselves and needs to hire a GM, the replacement manager cost reduces the true available earnings:
True Available SDE = Reported SDE − Replacement Manager Cost + Buyer's Own Compensation Target
For a self-operating buyer taking over full-time, replacement cost is their own time's market value — if the role is worth $120K/year, that's the effective cost. For a passive investor hiring a GM, it's the literal cash cost of hiring.
Estimating Replacement Cost
Replacement manager cost varies by:
- Industry (a licensed master electrician running an electrical contracting firm costs more than a retail store manager)
- Scope (revenue size, number of employees, complexity of operations)
- Geography (San Francisco vs. rural Ohio)
- Skills required (technical certifications, sales expertise, regulatory knowledge)
Sources for benchmarking: BLS Occupational Employment Statistics, industry salary surveys, job postings for comparable roles in the same market.
The SBA Lender's View
SBA lenders calculate DSCR using the business's NOI after deducting a market-rate management compensation — whether or not the buyer actually plans to pay themselves that amount. This prevents buyers from inflating DSCR by underpaying themselves during underwriting and then drawing more post-close.
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