04 May SDE – Seller’s Discretionary Earnings – Total Owner Benefits
WHAT IS SDE?
SDE stands for Seller’s Discretionary Earnings. It is the Total Owner Benefit a business produces and is generally used for evaluating businesses with gross annual sales that are under $1,000,000. For larger business, EBITDA is more frequently use.
It is assumed with SDE that there is one (1) and ONLY one (1) full time, working manager in the business.
If, in realty, the owner is not working in the business, then the money spent on labor that could be saved with a full-time working owner should be added back to the Net Profit to get the SDE. In contrast, if multiple partners are working in the business, only one partner would be considered.
The amount a capable employee (or employees) would be paid to replace the additional partner(s) would be subtracted from the reported earnings. Other items, such as Interest and Depreciation, are also added back.
See formula below:
Profit on Income Taxes
+ Nonrecurring Expenses
– Nonrecurring Income
+ Non-operating Expenses
– Non-operating Income
+ Interest Expense
+ One Owner’s Total Compensation
*Note: Legacy Venture Group uses the terms as defined in the International Business Broker’s Association Business Brokerage Standards to inform Buyers and Sellers. Other people define Seller’s Discretionary Earnings (Owner Benefit, Adjusted Net…) in different ways. The formula above is generally used but some sellers will insist on their own calculations.
When looking at tax returns, remember to request the copy of the tax returns FROM the IRS and NOT a copy the seller has lying around. Ask for a vetted Profit and Loss Statement. You can use this general formula to help you make your decisions but ask the seller for specifics as to how he or she defined their numbers.
Try to consistently use this formula when comparing seller profits and owner benefit. Examine each item carefully and decide if the add-back applies to all people. For example, a Buyer might not get the same “low” price a seller is getting for a key product that she or he buys from a relative.
Make sure all buyers are also comparing apples to apples. Often times, sellers or their brokers are making things look as good as they can.
Beware, be thoughtful, be careful.