SDE vs EBITDA: The Valuation Difference That Matters

What SDE measures and when it applies

Seller's Discretionary Earnings (SDE) is the earnings metric used for small business acquisitions - typically deals under $5M in total enterprise value and under $3M in annual revenue.

SDE is calculated by taking net income and adding back: the owner's salary and benefits, depreciation, amortization, interest expense, income taxes, and any discretionary or personal expenses run through the business. The rationale: a single owner-operator who buys the business is both the investor and the primary labor. Adding back the owner salary shows what the business generates before compensating the owner, which is the maximum available return to a buyer who replaces that owner.

SDE is the right metric when: - The business is owner-operated with one primary working owner - Annual revenue is under $2–3M - The deal is priced by the business broker or seller, not a formal M&A process - The buyer intends to work in the business full-time

Typical SDE multiples by category (U.S. SMB market, 2026): home services 2.5–3.5x, QSR franchise 2.8–3.8x, manufacturing services 3.0–4.5x, professional services 2.5–3.5x, healthcare services 3.0–5.0x.

What EBITDA measures and when it applies

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is the earnings metric used for middle-market acquisitions - typically businesses with revenue above $3–5M and enterprise values above $5M.

Unlike SDE, EBITDA does not add back the owner's salary because at middle-market scale, the business requires professional management regardless of whether the buyer is an operator. EBITDA represents earnings available to cover debt service and generate investor return - independent of who runs the company.

EBITDA is the right metric when: - The business has revenue above $3–5M - Management infrastructure exists independent of the owner - The deal is run through an investment bank, M&A advisor, or private equity process - The buyer intends to install management rather than operate day-to-day

Typical EBITDA multiples (U.S. lower middle market, 2026): 4.0–7.0x for manufacturing, 5.0–9.0x for tech-enabled services, 4.5–7.5x for healthcare services. These are substantially higher than SDE multiples because the management risk premium is lower.

Why using the wrong metric leads to mispriced deals

The most common error in small business acquisitions: applying EBITDA multiples (5–7x) to a business that should be priced on SDE (2.5–3.5x).

Example: a $500,000 SDE business that generates $600,000 EBITDA (after an implied market-rate management salary, the owner's "real" earnings are $500K). If a buyer uses 5.0x EBITDA, the price is $3,000,000. If they use 3.0x SDE, the price is $1,500,000. The difference is $1.5M - for the same business.

Sellers (and some inexperienced brokers) sometimes cite EBITDA to inflate the perceived multiple. Always ask: "Is the owner's salary added back in this number?" If the answer is yes, you are looking at SDE. If the answer is no, you are looking at EBITDA. The label on the spreadsheet does not determine which metric it actually represents.

For businesses under $3M in annual revenue, SDE is the correct earnings base. Do not let a broker or seller present SDE multiples as "low" by comparing them to EBITDA-based deals in a different market segment.

Once you have the right earnings figure, the next step is verifying it holds through closing. See Working Capital Peg: What Buyers Miss at Closing and the Business Acquisition Closing Checklist.

Frequently Asked Questions