Guide · Business
Business Valuation Guide: How to Value a Business Using SDE & EBITDA
Whether you're buying a business, selling your life's work, or just tracking your net worth, understanding how businesses are valued is a critical skill.
The Basic Formula
The vast majority of profitable small and medium-sized businesses are valued using a simple formula: Valuation = Earnings Metric × Industry Multiple.
The complexity lies in defining the "Earnings Metric." You don't just look at the bottom line of the tax return, because business owners legally minimize their taxable income. Instead, you calculate the true cash-generating ability of the business by adding back certain expenses. This adjusted number is usually either SDE or EBITDA.
SDE vs. EBITDA: Which to Use?
Seller's Discretionary Earnings (SDE)is the standard metric for "Main Street" businesses—typically those under $5 million in revenue where the owner is the full-time operator. SDE represents the total financial benefit to one owner-operator.
EBITDAis used for mid-market companies. If a buyer purchases a $10M revenue manufacturing company, they aren't going to run the machines themselves; they will hire a CEO. Therefore, the CEO's salary is a real expense and is not added back.
| Line Item | Main Street (SDE) | Mid-Market (EBITDA) |
|---|---|---|
| Net Profit | $100,000 | $100,000 |
| Taxes | +$25,000 | +$25,000 |
| Interest Expense | +$10,000 | +$10,000 |
| Depreciation | +$15,000 | +$15,000 |
| Owner's Salary | +$80,000 | Not Added Back |
| Owner's Health Insurance | +$12,000 | Not Added Back |
| One-time Lawsuit | +$20,000 | +$20,000 |
| Total Earnings Metric | SDE: $262,000 | EBITDA: $170,000 |
Notice how SDE is significantly higher than EBITDA for the exact same business, because SDE assumes the buyer takes the owner's place and pockets their salary.
Applying the Multiple
Once you have your earnings metric, you apply a multiple. The multiple represents the risk of the business. A higher multiple means the business is less risky and more desirable.
Most small businesses valued on SDE trade between 2.0x and 3.5x. A business completely reliant on the founder's personal relationships might trade at 1.5x. A growing B2B service company with recurring contracts and a strong middle-management team might push 4.0x.
Enterprise Value vs. Equity Value
The formula gives you the Enterprise Value—the value of the business operations. However, most small business sales are cash-free, debt-free.
If you are calculating what you will actually walk away with (the Equity Value), you must add any cash left in the business accounts, and subtract all debts (like a SBA loan or equipment financing) that you must pay off at closing.
Frequently asked questions
What is the difference between SDE and EBITDA?
SDE (Seller's Discretionary Earnings) adds the owner's salary and perks back into the net profit. It's used for owner-operated businesses under $5 million in revenue. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) doesn't add back the owner's salary (because a replacement CEO must be paid). EBITDA is used for larger, management-run companies.
How do I choose the right industry multiple?
Multiples depend on the risk and growth profile of your business. SDE multiples usually range from 2.0x to 3.5x. EBITDA multiples are generally higher (4.0x to 8.0x+). Subscription revenue, low customer concentration, and strong management teams push multiples higher, while reliance on the owner pushes them down.
Are debts transferred to the buyer?
Most small business sales are structured as 'cash-free, debt-free' asset sales. This means the seller keeps the cash in the bank but must use the proceeds of the sale to pay off all business debts before walking away.
What are add-backs?
Add-backs are expenses that are added back to the net profit to show the true earning power of the business. Legitimate add-backs include the owner's salary, personal vehicles run through the business, one-time legal fees, and depreciation.