SDE vs EBITDA: What Buyers Need to Know Before Valuing a Business
Buying a business is hard enough without confusing financial jargon. Two of the most misunderstood terms are SDE and EBITDA. They both try to answer the same question: how much money does this business really produce? But they are not interchangeable, and using the wrong one can lead to serious overpaying or walking away from a great deal.
This article is written so you can send it directly to buyers who are confused about SDE and EBITDA. It explains what each metric means, when to use it, and how to translate one into the other in a practical, buyer-friendly way.
What is SDE?
SDE stands for Seller's Discretionary Earnings. It is most common in smaller, owner-operated businesses where the owner is deeply involved in day-to-day operations.
In plain language, SDE is the total financial benefit that a single full-time owner-operator takes out of the business in a year. It includes salary, perks, and some personal or one-off expenses run through the company.
A simple formula for SDE looks like this:
SDE = Net Income
+ Owner's salary and payroll taxes
+ Owner's benefits and personal expenses
+ One-time or non-recurring expenses
+ Interest expense
+ Depreciation and amortization
SDE assumes one owner working full time in the business. If you are buying a business where you plan to replace the owner and take their role, SDE helps you understand what you can reasonably pay yourself while still covering all expenses.
SDE is most often used for businesses with less than about 2 million dollars in EBITDA and heavy owner involvement. Above that level, most sophisticated buyers expect to see EBITDA instead.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It is the standard metric for valuing larger, more institutional grade businesses and is widely used by private equity firms, corporate buyers and lenders.
The basic formula for EBITDA is:
EBITDA = Net Income
+ Interest
+ Taxes
+ Depreciation
+ Amortization
EBITDA is meant to approximate the operating performance of the business independent of financing decisions, tax structure and non-cash accounting charges. Buyers like it because it is closer to the cash flow available to all capital providers, not just the owner.
Important: EBITDA is not the same as free cash flow. EBITDA does not include capital expenditures, working capital swings, principal repayments, or other cash items that affect how much money actually lands in the bank. It is best thought of as an earnings proxy that makes it easier to compare similar businesses, and even different industries, on a common basis.
In most transactions in the Lower Middle Market, buyers often talk about Adjusted EBITDA, which is EBITDA plus certain agreed add-backs such as one-time legal fees, non-recurring consulting projects or other unusual items. The goal is to normalize earnings for what the business would look like in a "steady state" going forward.
SDE vs EBITDA: Why the Difference Matters for Buyers
If you confuse SDE and EBITDA, you can easily misread the true earning power of a business.
For example:
If a broker presents a business with "500,000 earnings" and that number is SDE, it almost certainly includes the owner's salary.
If you treat that same 500,000 as EBITDA and then plan to add your own salary on top, you will overestimate cash flow and may overpay.
Think of it this way:
SDE is best for one full-time owner operator.
EBITDA is best for professional buyers, financial sponsors, or companies that will hire managers and separate ownership from management.
If you are a buyer who plans to hire a general manager or keep existing leadership rather than work full time in the business, you should think in EBITDA terms, not SDE.
If you are an individual buyer stepping into the owner's role, SDE can help you see what you can reasonably pay yourself and still service debt.
How to Convert SDE to EBITDA (and Back)
In many lower middle market deals, brokers present SDE, while serious buyers underwrite value using EBITDA. You can translate between the two with simple logic.
Starting from SDE, a common conversion is:
EBITDA ≈ SDE
– Market-based salary for a full-time CEO or general manager
– Any personal or non-operating add-backs that will not continue
+ Any missing expenses that you will incur (for example, professional accounting)
In other words, to get to EBITDA:
Remove the owner's "excess" compensation and perks.
Replace it with a realistic market salary for the role.
Remove any add-backs that are actually recurring, not truly one-time.
If SDE is 600,000 dollars and a realistic market salary for the owner's role is 200,000 dollars, a rough starting point for EBITDA might be around 400,000 dollars before further adjustments.
This is why applying an "EBITDA multiple" to an SDE number can be dangerous. You may end up paying a price that only makes sense if you work full time in the business and pay yourself below market.
Churn and Net Revenue Retention (NRR)
In the subscription economy, keeping a customer is just as important as acquiring a new one. Buyers will look closely at your Net Revenue Retention (NRR).
NRR measures how much revenue you retain from existing customers, including upsells and expansion, minus churn. Data from ChartMogul’s SaaS Benchmarks indicates that best-in-class companies in the $1M–$10M ARR range consistently achieve NRR rates between 100% and 110% .
NRR < 90%: This is a leaky bucket. Your valuation will be discounted because the buyer knows they have to spend heavily on marketing just to stay flat.
NRR 100%: You are retaining your base. This is the baseline expectation for a healthy B2B SaaS.
NRR > 110%: Your product is "sticky." Existing customers are spending more over time by upgrading seats or adding features. This is a massive value driver and can increase your multiple by 1–2 turns.
The Technical Debt Discount
For founder-led SaaS companies, "Technical Debt" is often the silent deal killer. You built the product to work, often scraping by with spaghetti code in the early days to get to market.
When a buyer brings in a technical team to review your code, they are looking for scalability. If the code needs to be completely rewritten to support the next 1,000 customers, the buyer will deduct that cost from your purchase price.
Before you go to market, document your architecture. Be honest about what needs to be refactored. Transparency here builds trust, whereas hiding it destroys deals.
How Deal Structure Affects Your "Take Home"
A $5 million offer is not always $5 million in your bank account on closing day. In the lower middle market ($1M–$5M ARR), deals are rarely 100% cash at close.
You should expect a structure that looks something like this:
60–70% Cash at Close: The guaranteed money.
10–20% Seller Note: A loan you give the buyer, paid back over 3–5 years with interest. This keeps you invested in the transition.
10–20% Earn-out: Performance-based payments tied to retaining key customers or hitting growth targets in the first year post-sale.
Preparing for a 2026 Exit
If you are eyeing an exit in 2026, you cannot wait until the month you want to sell to start preparing. The market is active, but it favors the prepared.
To get the highest multiple, you must focus on three areas. First, clean up your financials. Move from cash accounting to accrual accounting and ensure your ARR is clearly separated from one-time revenue. Second, audit your churn. If NRR is below 90%, focus your team on customer success immediately. Third, document your IP. Ensure all developers, including contractors from three years ago, have signed IP assignment agreements.
Selling a SaaS business is different from selling a traditional service company. The multiples are higher, but the scrutiny on metrics is more intense. By understanding the levers of Growth, Rule of 40, and NRR, you can position your business not just to sell, but to exit at a premium.
FAQ: SDE vs EBITDA for buyers
Q: Why do small business brokers use SDE instead of EBITDA?
A: In many owner-operated businesses, the owner’s salary, perks, and discretionary expenses are intertwined with the business. SDE is a simple way to show the total financial benefit to one full-time owner-operator.
Q: When should I think in EBITDA instead of SDE?
A: If you plan to hire a manager, keep existing leadership, or run the business as part of a larger platform, you should think in EBITDA terms. EBITDA better reflects the earnings available to all capital providers, not just the owner.
Q: How do I sanity-check a broker’s SDE number?
A: Ask for the detailed add-back schedule. Look for personal expenses, one-time items, and aggressive adjustments. Then subtract a realistic market salary for the role you or a hired manager will perform.
Q: Can a business be priced on SDE but financed on EBITDA?
A: Yes, and this is common. Sellers and brokers may talk in SDE multiples, while lenders and sophisticated buyers underwrite the deal on EBITDA and debt service coverage. Your job as a buyer is to bridge the two.
Q: What if the owner is underpaying themselves?
A: In that case, SDE may overstate the true earnings. You will need to adjust for a fair market salary, which will reduce the EBITDA you can reasonably rely on for valuation and debt service.
Recommended reading
Section 4: Marketing Your Business - Getting in Front of the Right Buyers
Selling a Services Business? Read This Before You Sign Anything
If you want a second set of eyes on a specific deal, you can share the broker package and financials with your advisor and ask them to walk through the SDE-to-EBITDA bridge with you.
Key takeaways
SDE represents the total financial benefit to a single full-time owner-operator, including salary, perks, and discretionary expenses.
EBITDA represents the operating earnings of the business before interest, taxes, depreciation, and amortization, and is the default language for institutional buyers and lenders.
EBITDA is not free cash flow. It is an earnings benchmark that helps you compare businesses and industries on a like for like basis, but it does not tell you how much cash the business actually produces after investments and debt service.
Treating SDE as if it were EBITDA can cause you to overestimate cash flow and overpay for a business.
To convert from SDE to EBITDA, you must subtract a market salary for the owner’s role and remove any non-operating or non-recurring add-backs.
Serious buyers should always clarify whether a broker’s “earnings” number is SDE or EBITDA before applying a valuation multiple.
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