Small Business Valuation: EBITDA Vs SDE

Income, Assets, and Market are the three most popular approaches used to value a business. This article will focus on the different types of income used within the income methodology. Under the income approach, companies are valued based on the profits that the company generates. Buyers are more concerned with the amount of income that would be available to them if they acquired the business. Net ordinary income, reported in profit and loss statements for tax purposes, does not represent the actual profits of the company based on non-monetary, discretionary and non-recurring items recorded as expenses by the owner of the company. Earnings are intentionally kept low to achieve the goal of mitigating income taxes. Therefore, to determine the true earning capacity of the company, profit and loss statements must be reissued during the valuation process to derive SDE or EBITDA. Re-casting standardizes (or normalizes) business earnings by excluding discretionary, non-recurring, and variable items, allowing for an accurate and objective comparison between two or more businesses. Then, the commercial value is calculated by applying a multiple, consistent with the industry and a weighting of the factors that affect the business, to the amount of SDE or EBITDA.

Seller Discretionary Earnings (SDE):

Seller’s discretionary earnings (also known as discretionary earnings) are generally used for companies with less than $ 1 million in adjusted earnings. These businesses typically have the owner operating and receiving a salary through the business. With these small businesses, it is important to determine what is the “owner’s profit” as opposed to the “profit” of the business. This is accomplished through a series of profit and loss adjustments called “additions” that are made to business earnings before taxes. In certain circumstances, there are negative additions as in the case of a business that owns the building where the owner pays himself a below-market rent or a family employee performing a critical business function who receives a below-salary. From the market. In both cases, an adjustment is made to normalize the expense to a fair market value.

The most common adjustments in the recast process are as follows:

• Complete an owner’s total compensation

– Salary

– Payroll taxes

– Sure

– 401K / Retirement Contributions

– Benefits (club memberships, etc.)

• Additional non-monetary expenses

– depreciation

– Amortization

• Additional interest expense

• Additional discretionary expenses (not necessary in the operation of the business)

– Owner’s vehicles

– Travel and entertainment

– Non-essential phones

– donations

• Additional non-recurring expenses

– Sanctions / Fines

– Attorney’s fees (for example, related to the sale of businesses)

• Adjust rent / lease to fair market value

Income before amortization of interest tax depreciation (EBITDA):

Larger companies, generally with adjusted revenues greater than $ 1 million, use EBITDA to define company profits. In most cases, the owner / investor does not actively direct the operations of the business and must pay a general manager to perform that function. Therefore, the EBITDA calculation will differ from the SDE as it includes the manager’s compensation in the profit calculation as an expense. EBITDA is a non-GAAP measure used to determine profitability and to make comparisons between businesses and sectors because it eliminates the effects of accounting and financial decisions. An easy way to determine EBITDA is to subtract the owner’s compensation and benefits from the SDE. Although the EBITDA number will be lower than the SDE, the multiple used in the valuation is usually higher, often 2 to 2.5 times the SDE multiple. Therefore, as you might expect, the market value of the same business calculated using either method should be close to each other. If not, a determination of why and which (or what other methods) should be undertaken.