SDE vs EBITDA: Understanding Business Valuation Metrics

Two common metrics are often used when valuing a business: SDE and EBITDA.

Both metrics serve as proxies for earnings, but they are used in different situations and have their own advantages and disadvantages.

In this article, we will explore the differences between SDE and EBITDA, when to use them, and the pros and cons of each.

SDE vs EBITDA: What’s the Difference?

SDE (Seller Discretionary Earnings) is used for owner-operated companies. It represents the profit in the business with non-essential operating expenses added back. These are expenses not necessary to create the operating profit of the company. SDE can be more difficult to come across for specific industries than EBITDA, so a conversion to EBITDA is often done.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), on the other hand, is used for professionally managed companies. It is a measure of a company’s operating performance that excludes interest, taxes, depreciation, and amortization. In simple terms, EBITDA is a fancy word for net income with a few small adjustments to get back to the cash generated by the business.

When to Use SDE and EBITDA

SDE is typically used for smaller, owner-operated businesses where the owner’s salary is a significant part of the company’s earnings. In these cases, the buyer would need to step in and run the business or the earnings calculation would assume the owner’s salary.

EBITDA is more commonly used for larger, professionally managed companies where the focus is on the company’s overall operating performance rather than the owner’s involvement.

Advantages and Disadvantages of SDE

Advantages:

1. SDE provides a more accurate representation of an owner-operated business’s true earnings potential.
2. It accounts for the owner’s salary and benefits, which can be significant in smaller businesses.

Disadvantages:

1. SDE can be more difficult to calculate for specific industries compared to EBITDA.
2. It may not be as widely recognized or understood as EBITDA, making it harder to compare businesses across industries.

Advantages and Disadvantages of EBITDA

Advantages:

1. EBITDA is a widely recognized and accepted metric for valuing businesses, making it easier to compare companies across industries.
2. It focuses on the company’s overall operating performance, providing a clearer picture of the business’s financial health.

Disadvantages:

1. EBITDA does not account for the owner’s salary and benefits, which can be significant in smaller businesses.
2. It may not accurately represent the true earnings potential of an owner-operated business.

Conclusion

Understanding the differences between SDE and EBITDA is crucial when valuing a business.

While SDE is more suitable for owner-operated businesses, EBITDA is better suited for professionally managed companies.

By considering the advantages and disadvantages of each metric, you can make a more informed decision when valuing a business or comparing potential investments.