EBITDA vs SDE: Understanding the Critical Differences

Understanding the difference between EBITDA and SDE is fundamental for business owners navigating M&A transactions. These two metrics—EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and SDE (Seller's Discretionary Earnings)—serve different purposes and apply to different business sizes. Using the wrong metric can result in significant valuation errors.

What Is EBITDA?

EBITDA represents a company's earnings before interest, taxes, depreciation, and amortization. It measures operational profitability by removing the effects of financing decisions, accounting methods, and tax environments. EBITDA provides a clearer picture of a company's core operating performance.

EBITDA is the preferred metric for larger businesses with professional management teams because it reflects the earnings available to all stakeholders—debt holders, equity holders, and the tax authority—before capital structure decisions.

EBITDA vs SDE: The Key Differences

When to Use EBITDA vs SDE

Use EBITDA When:

• Business has professional management that will remain post-sale
• Annual revenue typically exceeds $10 million
• Owner is not required for day-to-day operations
• Targeting strategic or institutional buyers
• Company has multiple locations or business units

Use SDE When:

• Single owner-operator runs the business
• Annual revenue is typically under $10 million
• Owner actively works in daily operations
• Buyer will replace owner's labor and management
• Marketing to individual buyers or small family offices

Why the Difference Matters for Valuation

The critical distinction affects business value significantly. Consider this example:

Common Mistakes in EBITDA vs SDE

Mistake #1: Using SDE Multiples with EBITDA

Some business owners calculate EBITDA but then apply SDE multiples from comparable sales. This dramatically undervalues the business because EBITDA multiples are typically 2-3x higher than SDE multiples for the same business.

Mistake #2: Adding Back Owner Salary to EBITDA

EBITDA assumes a professional manager's salary stays in the business. Adding back the owner's entire salary to EBITDA overstates earnings because a replacement manager salary must still be paid.

Mistake #3: Using EBITDA for Owner-Operated Businesses

For businesses where the owner is essential to operations, EBITDA understates the earnings available to a working buyer, making SDE the more appropriate metric.

The Transition Zone: $5M-$15M Revenue

Businesses in the $5-15 million revenue range often straddle both worlds. The choice between EBITDA and SDE depends on:

• Management depth: Strong team suggests EBITDA
• Owner involvement: Heavy owner dependency suggests SDE
• Buyer profile: Who you're marketing to determines the metric
• Industry norms: Some industries use EBITDA at lower revenue levels

Industry-Specific Considerations

Different industries transition from SDE to EBITDA at different revenue levels:

• Technology/SaaS: Often use EBITDA even at lower revenues due to scalability
• Professional Services: Typically SDE-based until $10M+ revenue
• Manufacturing: Transition to EBITDA around $5-7M revenue
• Healthcare: Often EBITDA-based at $3M+ revenue with proper management
• Retail: Usually SDE until $10M+ revenue

Conclusion

Understanding EBITDA vs SDE isn't just academic—it directly impacts how you value your business, who you market to, and what price expectations are realistic. As a business owner in Knoxville or throughout the Southeast, working with M&A advisors who understand these distinctions ensures your business is properly valued and marketed to the right buyers.

Whether your business calls for EBITDA or SDE valuation depends on size, management structure, owner involvement, and target buyer profile. Getting this right from the start sets the foundation for a successful transaction.