When you buy a small business, you are really buying a stream of cash. Seller’s Discretionary Earnings (SDE) is the industry’s best attempt to measure that stream for a single owner-operator, and it is the figure almost every Main Street business is priced on.
The formula
Start with net income from the tax return or P&L. Add back the owner’s total compensation, then interest, taxes, depreciation, and amortization. Finally, add back genuinely discretionary or one-time expenses — the owner’s personal car, a family member’s no-show salary, a one-off legal bill. The result is what the business would earn for a new owner who runs it themselves.
Where deals go wrong
Add-backs are where sellers and brokers get creative. Every dollar of add-back raises SDE, and at a 3× multiple, a single questionable $20,000 add-back raises the asking price by $60,000. Treat each add-back as a claim to be verified in diligence, not a fact. Recurring expenses dressed up as “one-time,” aggressive owner-benefit add-backs, and missing normal manager pay are the classic traps.
Run the numbers yourself with the free SDE worksheet, then pressure-test the add-backs before you fall in love with a price.