Measuring the value of your business with EBITDA and SDE

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is an accounting term used to measure the profitability of a business before expenses for interest, taxes, depreciation and amortization. I am often asked by business owners, “What multiple of EBITDA should I use to determine how much my business is worth?” If your business is an owner-operator enterprise, the answer is generally, “EBITDA should not be used in the valuation of your business; SDE (seller’s discretionary earnings) is the figure that matters.”

SDE is the historic, normalized cash flow available to pay an owner-operator and service debt. Two different businesses could each have the same annual EBITDA of, say, $250,000. Business #1 because of stronger cash flow pays generous compensation and perks to the owner-operator, and as such the company has a SDE of $500,000. Business #2 has a less robust cash flow, and pays the owner-operator more modestly, and as a result only generates a $350,000 SDE.

If a multiple of EBITDA is used exclusively for valuing the two businesses, both would have exactly the same value. If the same multiple of SDE is correctly used for both businesses, business #1 is valued 43% higher than business #2. This certainly makes sense given the fact that business #1 generates more cash to pay the owner-operator and service debt than business #2.

While many other factors (in addition to SDE) contribute to a detailed valuation of a business, a multiple of SDE is the best place to start a discussion of what your business is worth..

Contributed by Michael Greengard, Praxis Business Brokers.