Owner's Earnings vs. EBITDA: What Your Business Is Really Worth
Understanding valuation metrics for different buyer types.
Key Takeaways
- •Different buyer types use different valuation metrics—know your likely buyer
- •SDE (Seller Discretionary Earnings) is used for smaller owner-operated businesses
- •EBITDA is standard for PE and larger strategic buyers
- •The metric you optimize for should match your target buyer profile
When valuing a business for sale, the earnings metric used depends on the buyer type. Small business buyers use Seller Discretionary Earnings (SDE). PE firms and larger strategics use EBITDA. Understanding the difference—and which applies to you—is critical for setting expectations and maximizing value.
Seller Discretionary Earnings (SDE)
SDE represents the total financial benefit available to a single owner-operator. It's used for businesses where the buyer will likely replace the owner as the primary operator.
SDE Calculation
Net Income
+ Owner's Salary and Benefits
+ Personal Expenses Run Through Business
+ Depreciation and Amortization
+ Interest Expense
+ Non-Recurring Expenses
= Seller Discretionary Earnings
When SDE Is Used
- Transaction size: Typically under $5M
- Buyer type: Individual buyers, search fund operators, owner-operators
- Business profile: Owner-dependent, single location, lifestyle businesses
- Typical multiples: 2x-4x SDE depending on industry and size
Why SDE Includes Owner Salary
SDE adds back the owner's entire compensation because a buyer will either work in the business (earning that income themselves) or hire a replacement (whose salary becomes an operating expense deducted from EBITDA). It represents the total economic benefit to a hands-on owner.
EBITDA for Larger Transactions
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the standard metric for PE and larger strategic transactions. It assumes professional management will run the business.
EBITDA Calculation
Net Income
+ Interest Expense
+ Taxes
+ Depreciation
+ Amortization
= EBITDA
Adjusted EBITDA
In practice, buyers use Adjusted EBITDA, which normalizes for one-time items and owner-related expenses:
Common Adjustments
EBITDA
+ Owner Compensation Above Market Rate
+ Personal Expenses
+ Non-Recurring Professional Fees
+ One-Time Litigation Costs
- Below-Market Owner Compensation (if applicable)
= Adjusted EBITDA
When EBITDA Is Used
- Transaction size: Typically $10M+ (EBITDA $2M+)
- Buyer type: PE firms, strategic acquirers, family offices
- Business profile: Management team in place, scalable operations
- Typical multiples: 4x-8x+ EBITDA depending on size, growth, and industry
SDE vs. EBITDA Comparison
| Factor | SDE | EBITDA |
|---|---|---|
| Owner Salary Treatment | Added back entirely | Only excess above market rate |
| Assumption | Buyer operates the business | Professional management runs business |
| Typical Multiple Range | 2x-4x | 4x-8x+ |
| Transaction Size | <$5M typically | $10M+ typically |
| Buyer Type | Individuals, search funds | PE, strategic, family offices |
Example Comparison
$8M Revenue Business
Owner takes $400K salary; market rate is $200K
Net Income: $600K
+ D&A: $100K
+ Interest: $50K
EBITDA: $750K
+ Owner salary add-back: $200K
Adjusted EBITDA: $950K
Same Business, SDE Basis
Sold to individual owner-operator
Net Income: $600K
+ D&A: $100K
+ Interest: $50K
+ Full owner salary: $400K
+ Personal expenses: $50K
SDE: $1.2M
Same business, different metrics. The SDE is $1.2M while Adjusted EBITDA is $950K. But the multiples differ: at 3x SDE, value is $3.6M. At 5x EBITDA, value is $4.75M. The larger transaction brings a higher multiple despite a lower earnings base.
Maximizing Your Business Value
Understanding which metric applies helps you optimize for the right outcome.
If You're Selling to an Individual Buyer (SDE Basis)
- Document all personal expenses run through the business
- Identify all discretionary spending that wouldn't continue
- Show the full economic benefit of ownership
- Demonstrate that the business can be operated by one owner
If You're Selling to PE or Strategic (EBITDA Basis)
- Build management depth so business isn't owner-dependent
- Document only legitimate, defensible adjustments
- Focus on recurring, sustainable earnings
- Demonstrate scalability and growth potential
- Invest in systems and processes that enable professional management
The Transition Zone ($5M-$15M Revenue)
Businesses in this range can attract either buyer type. The strategic choice of building management depth and positioning for PE can dramatically increase value—moving from 3x SDE to 5x+ EBITDA. But it requires investment in people and systems before going to market.
Warren Buffett's Owner Earnings
Worth noting: Warren Buffett uses "Owner Earnings," a different concept than SDE. Buffett defines owner earnings as:
Net Income
+ Depreciation and Amortization
+ Other Non-Cash Charges
- Maintenance Capital Expenditures
= Owner Earnings
This represents the true cash that owners can extract from a business after maintaining its productive capacity. It's more conservative than EBITDA because it accounts for required reinvestment. While not commonly used in lower middle market M&A, it's a useful framework for understanding true business value.
Related Resources
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