SDE versus EBITDA HVAC and Plumbing Companies for Sale

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Understanding SDE versus EBITDA for Business Valuation: Insights from HVAC and Plumbing Industry Data

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When it comes to valuing small businesses, especially in service-based industries like HVAC and plumbing, choosing the right metric to represent earnings is critical. Two popular financial metrics often used to value these types of businesses are Seller’s Discretionary Earnings (SDE) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). Both provide insights into profitability, but each serves a different purpose and is suited for different types of businesses. By examining industry data from recent transactions involving HVAC and plumbing companies, we can better understand the differences between SDE and EBITDA and how each impacts business valuation.

What is SDE?

SDE, or Seller’s Discretionary Earnings, represents the total financial benefit a business provides to its owner. SDE includes the net profit of the business along with the owner’s salary, benefits, and any discretionary expenses that a new owner might not incur. This metric is most commonly used for smaller, owner-operated businesses where the owner is directly involved in day-to-day operations.

SDE is particularly useful for businesses where the potential buyer is likely to be an individual who will also work as the manager. It provides a clear picture of the earnings the new owner can expect if they replace the current owner. For example, if the current owner of an HVAC business draws a salary and includes personal expenses or non-recurring costs in the financial statements, SDE accounts for these adjustments, offering a more accurate picture of actual owner benefit.

What is EBITDA?

EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, is a metric that provides insight into a company’s operational profitability by removing the impact of financing and non-operational expenses. EBITDA assumes that the business can be run by professional management and is therefore often used for larger businesses or businesses where the buyer is an investor rather than an owner-operator.

By focusing on the core earnings potential of the business, EBITDA is particularly relevant for businesses that are less dependent on the owner’s personal involvement. Investors and larger corporations typically use EBITDA because it standardizes earnings by removing owner-specific and non-operational factors, making it easier to compare across different businesses.

Key Differences Between SDE and EBITDA

While both SDE and EBITDA are used to measure profitability, they serve different types of buyers and businesses:

  1. Ownership and Management: SDE is best for owner-operated businesses, where the new buyer is likely to step into a hands-on role. EBITDA, on the other hand, is suited for businesses that can operate independently of the owner, appealing to investors or corporate buyers.
  2. Earnings Adjustments: SDE includes the owner’s salary, personal expenses, and discretionary spending, providing a realistic picture of owner benefits. EBITDA excludes these factors and focuses purely on operational earnings, making it ideal for businesses where the owner’s role is less central.
  3. Business Size and Complexity: SDE is often used for smaller businesses (typically with revenues under $2 million), while EBITDA is more relevant for larger, established businesses with stable management structures.

Analyzing SDE and EBITDA for HVAC and Plumbing Companies

Let’s dive into the specific data from 63 transactions involving HVAC and plumbing companies, examining key statistics such as SDE, EBITDA, and their respective multiples. This data provides insight into how each metric is valued and which might be more appropriate for these types of businesses.

Transaction Data Summary

  • Sales Price Range: $270,000 to $3,300,000, with a mean sales price of $1,166,506 and a median of $900,000.
  • SDE Range: $128,026 to $956,618, with a mean SDE of $401,290 and a median of $327,000.
  • EBITDA Range: $63,026 to $839,688, with a mean EBITDA of $305,234 and a median of $252,000.
  • SDE as a Percentage of Revenue: 6.85% to 62.52%, with a mean of 19.82% and a median of 17.50%.
  • EBITDA as a Percentage of Revenue: 4.44% to 53.32%, with a mean of 14.81% and a median of 12.87%.

This data indicates that SDE and EBITDA vary significantly across HVAC and plumbing businesses. The large range in both metrics suggests that businesses in these industries differ greatly in terms of profitability, size, and owner involvement.

Multiples of Revenue, SDE, and EBITDA

When it comes to valuing a business, one common approach is to apply multiples to revenue, SDE, and EBITDA. Here’s a breakdown of the multiples observed in these transactions:

  • Multiple of Revenue: Ranges from 0.19 to 1.72, with a mean of 0.54 and a median of 0.45.
  • Multiple of SDE: Ranges from 1.66 to 3.64, with a mean of 2.77 and a median of 2.79.
  • Multiple of EBITDA: Ranges from 2.06 to 5.52, with a mean of 3.77 and a median of 3.81.

These multiples highlight the fact that HVAC and plumbing companies generally sell at higher multiples of EBITDA compared to SDE. This is often the case for industries where EBITDA is considered a more stable measure of earnings, appealing to investors interested in operational profitability independent of owner involvement.

Applying SDE and EBITDA Multiples: Example Calculations

To better understand the practical applications of these multiples, let’s calculate potential valuations for an HVAC or plumbing business based on both SDE and EBITDA.

  1. Example Business:
    • Annual Gross Revenue: $1,000,000
    • SDE: $300,000
    • EBITDA: $200,000

Using the median multiples for SDE and EBITDA from the data:

Valuation Based on SDE

Valuation=SDE×Median Multiple of SDE=300,000×2.79=837,000

Valuation Based on EBITDA

Valuation=EBITDA×Median Multiple of EBITDA=200,000×3.81=762,000

In this case, using SDE yields a higher valuation than EBITDA, but the difference is relatively small. The choice of metric depends on the type of buyer. An owner-operator buyer might prefer the SDE-based valuation as it represents total owner benefit, while an investor or larger entity might prefer EBITDA for a more standardized view of operational earnings.

Choosing Between SDE and EBITDA for HVAC and Plumbing Businesses

When deciding between SDE and EBITDA for valuing an HVAC or plumbing business, consider the following factors:

  1. Buyer Profile: If the prospective buyer is likely to be an individual looking to run the business themselves, SDE is more relevant. It provides a clear picture of what the owner can expect to earn after stepping into the seller’s role. However, if the buyer is a corporate entity or investor, they’ll likely focus on EBITDA as it aligns more with operational profitability.
  2. Business Size and Structure: Smaller HVAC and plumbing businesses with revenues under $2 million and direct owner involvement are better suited to SDE. In contrast, larger businesses with professional management structures align better with EBITDA.
  3. Growth and Stability: Businesses that have steady, predictable cash flows and minimal owner involvement often appeal to investors, making EBITDA a more appropriate metric. Meanwhile, for businesses heavily reliant on the owner’s presence, SDE remains the preferred measure of earnings.

Conclusion: Using SDE or EBITDA for Your Business Valuation

Understanding the differences between SDE and EBITDA is crucial for valuing an HVAC or plumbing business accurately. Each metric serves a unique purpose, and the right choice depends on the business’s size, ownership structure, and the type of buyer interested in purchasing the business. Reviewing the data from comparable sales transactions helps clarify which metric may be more relevant for your business.

Ultimately, choosing between SDE and EBITDA is about aligning the valuation with the buyer’s expectations and the nature of the business. For  looking to attract corporate buyers or investors. By understanding these differences, business owners can make informed decisions that maximize the appeal and value of their business in the eyes of potential buyers.

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