Two advisors can value the same company on the same financials and arrive at numbers that are millions apart. Often the disagreement is not about the multiple at all. It is about what the multiple is being applied to.
Seller’s discretionary earnings and EBITDA are two different measures of what a business earns, and they carry two different sets of multiples. Confusing them, or applying an EBITDA multiple to an SDE figure, produces a valuation that is not merely imprecise. It is wrong by a wide margin, and always in the flattering direction.
What SDE Measures
Seller’s discretionary earnings is the total financial benefit a single owner-operator takes out of a business in a year. It starts with pre-tax profit and adds back interest, taxes, depreciation and amortisation, then adds back the owner’s full compensation, benefits, and any personal or discretionary spending run through the company.
The logic is that a buyer stepping into the owner’s role will also step into that income. SDE answers a specific question: how much can one working owner expect this business to pay them? That makes it the right measure for businesses where the buyer will be the operator.
What EBITDA Measures
EBITDA answers a different question: how much does this business earn as an operating entity, independent of whoever owns it? Critically, EBITDA treats management as a cost. The owner’s compensation is not added back — it is replaced with a market-rate salary for whoever will do that job after closing.
That single difference is why the two numbers diverge so sharply. A business with $1.2 million of SDE where the owner draws $300,000 and the replacement cost of their role is $200,000 does not have $1.2 million of EBITDA. It has roughly $1 million, and that is the figure a financial buyer will price.
Where the Line Falls
There is no statutory threshold, but the market behaves consistently. Businesses with earnings up to roughly $1 million are generally valued on SDE and sold to individual buyers, often using SBA financing. Above roughly $2 million, the buyer pool shifts to private equity, family offices and strategic acquirers, and the conversation is entirely in EBITDA terms.
Between those figures sits a band where both measures are in play, and where the smartest owners prepare both. A business at $1.5 million of adjusted earnings may attract an individual buyer thinking in SDE multiples and a fund thinking in EBITDA multiples, and the two will structure very different offers.
The Multiples Are Not Interchangeable
Because SDE is the larger number, SDE multiples are lower. Owner-operated businesses typically transact between 2x and 4x SDE. EBITDA multiples in the lower middle market are higher, commonly 4x to 8x, precisely because management cost has already been deducted from the base.
Apply a 6x EBITDA multiple to an SDE figure and you will produce a number the market will not support, then spend months learning why. This is the most common self-inflicted valuation error in the lower middle market, and it usually surfaces after an owner has already anchored on the wrong expectation.
Once you know which base applies, sector benchmarks become useful. Our reference table of EBITDA valuation multiples by industry sets out where each sector currently trades, and the ranges assume a properly adjusted EBITDA figure rather than an owner-benefit number.
Add-Backs Behave Differently in Each
Both measures rely on adjustments, and both invite disagreement in diligence. Under SDE, the owner’s salary and personal expenses are legitimate add-backs. Under EBITDA, only genuinely non-recurring and non-operating items are, and a buyer will strike anything they believe the business will still need to spend.
The practical consequence is that an aggressive add-back schedule survives less well the further up market you go. Institutional buyers test every adjustment against the question of whether the expense disappears after closing, which is why disciplined preparation of the numbers matters more than the length of the list.
Which One Will Your Buyer Use?
Ultimately the buyer decides, and the buyer is determined by the size and structure of the business. An owner-operated company with $700,000 of discretionary earnings will be sold on SDE whatever its owner would prefer. A company with $4 million of EBITDA and a management team will be sold on EBITDA.
What an owner can influence is which side of the line they are on when they go to market. Building a management layer, formalising the financials and removing personal expenses from the company well ahead of a sale moves a business from the SDE world into the EBITDA world, and the multiple expansion that comes with that shift is often larger than any operational gain achieved in the same period.
With the right base established, the next question is what your number should be. That comes down to the risk and growth profile a buyer sees, and what separates a strong multiple from an average one is worth understanding before you set an expectation.
