Question 1

What is Seller Discretionary Earnings (SDE)?

Accepted Answer

SDE is the total financial benefit flowing to a working owner-operator from a business. It equals Net Income + Interest + Taxes + Depreciation + Amortization + Owner Add-Backs. It represents what a single working owner earns from the business annually, and is the primary basis for valuing home service businesses under ~$5M in revenue.

Question 2

How is SDE different from EBITDA?

Accepted Answer

EBITDA adds back Interest, Taxes, Depreciation, and Amortization to Net Income. SDE adds all of those PLUS owner-specific add-backs (salary, benefits, personal expenses). SDE is always higher than EBITDA for owner-operated businesses. EBITDA is used for larger businesses ($5M+ revenue) where owners are replaced by management teams.

Question 3

What add-backs are legitimate in an SDE calculation?

Accepted Answer

Legitimate add-backs include: owner salary above what a replacement manager would cost, owner health insurance premiums, owner retirement plan contributions, owner vehicle expenses, owner cell phone (personal use portion), one-time non-recurring expenses (legal fees, equipment, natural disasters), and personal expenses run through the business. Each must be documented.

Question 4

What add-backs are NOT legitimate?

Accepted Answer

Illegitimate add-backs include: costs a new owner would genuinely need to incur, inflated salaries that can't be substantiated, expenses without documentation, and 'adjustments' that don't tie to your actual books or tax returns. Sophisticated buyers will reject undocumented add-backs.

Question 5

Should I use one year of SDE or an average?

Accepted Answer

Most buyers calculate a weighted 3-year average: most recent year × 3, prior year × 2, year before × 1, divided by 6. This smooths volatility. If you have a strong recent year, a trailing-12-month analysis may be more favorable. Discuss with your broker which methodology best reflects your business's true earning power.

Question 6

How does SDE translate into a sale price?

Accepted Answer

Sale Price = SDE × Multiple. If your SDE is $400K and your business warrants a 3.5x multiple, your business is worth $1.4M. The multiple is determined by recurring revenue %, owner hours, growth trend, customer concentration, and management depth. Home service multiples range from 2.0x–5.5x.

Question 7

What if I pay myself a very low salary?

Accepted Answer

If your W-2 salary is below what a replacement manager would cost, buyers will ADD the replacement cost difference back as an expense — reducing SDE. Example: you pay yourself $40K but a replacement GM would cost $90K; buyers will reduce SDE by $50K to reflect true earnings power. Always normalize owner comp to market rate.

Question 8

Can I add back depreciation if I have aging equipment?

Accepted Answer

Yes, depreciation is always added back in SDE calculations. However, buyers will separately assess equipment condition and may factor in a capital expenditure (capex) requirement or escrow for equipment replacement. High depreciation with aging equipment doesn't hide the need for replacement — it just affects how the deal is structured.

Question 9

What is a 'recast P&L' and do I need one?

Accepted Answer

A recast (or adjusted) P&L shows your reported financials alongside your SDE adjustments in a single document with explanations for each add-back. It's the standard document buyers use to evaluate home service businesses. Yes — you need one before going to market. Work with your CPA or broker to prepare it.

Question 10

How do personal expenses in the business affect SDE?

Accepted Answer

Personal expenses run through the business are legitimate add-backs — but they must be documented. If you run $30K/year of personal travel, dining, or personal vehicle through the business, that $30K is added back to SDE. Undocumented personal expenses will be questioned; documented ones with clear explanations are accepted.

Question 11

Does SDE include the owner's profit distributions?

Accepted Answer

It depends on your entity structure. In an S-Corp or LLC, owner distributions are NOT included in SDE separately — they're already embedded in net income (which flows through to the owner). In a C-Corp, the salary is the primary owner benefit. The key is ensuring all forms of owner compensation are captured.

Question 12

What happens to SDE if I have a spike year?

Accepted Answer

A single outlier year gets diluted by the 3-year weighted average. If your SDE spiked due to a one-time government contract, buyers will also remove that from normalized SDE. Present spike years with clear explanations so buyers understand the underlying business vs. the anomaly.

Question 13

Do buyers verify SDE independently?

Accepted Answer

Yes. PE buyers commission a Quality of Earnings (QoE) report from a third-party accounting firm that independently verifies SDE and every add-back. Individual buyers have their lender and CPA review. Expect all add-backs over $5K to require documentation. Clean documentation speeds the process; missing documentation causes re-trading.

Question 14

Can I include my spouse's salary as an add-back?

Accepted Answer

Only if your spouse does not provide real, ongoing value to the business that would need to be replaced. If your spouse handles bookkeeping, customer calls, or operations, a replacement would cost money — so you can't add it back. If the salary is truly non-economic, yes — but document it carefully.

Question 15

How do I present SDE to maximize my valuation?

Accepted Answer

Use a professionally prepared recast P&L with clear explanations for each add-back. Have tax returns and bank statements available to verify every line. Don't just hand buyers a raw QuickBooks printout. Businesses with clean, professional financial presentations consistently get higher offers because buyers have more confidence in the numbers.

SDE Valuation: 15 Questions Answered

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