What is seller's discretionary earnings (SDE), and how do I calculate it?

How do I calculate SDE?

Start with net profit before income taxes from the federal return, not from the internal P&L. The return is the version a buyer's accountant and an SBA lender will reconcile to, so it is the version to build from. Then add back, in this order, with a document behind every line: interest expense; depreciation and amortization; one owner's salary, payroll taxes and benefits; personal expenses the business paid for the owner (vehicle, health insurance, phone, travel); and expenses that will not recur, such as a roof repair or a one-time legal bill. Remove anything that is not from operations, including a gain on a truck you sold, forgiven loan income and interest earned on the operating account.

Then make the deductions most owners leave out. A family member who is paid below market for work the buyer will have to pay someone to do is a deduction, not an add-back. Rent paid to your own real-estate LLC below the market rate is a deduction for the difference. Work you do for free that a buyer will have to hire for is a deduction too. The International Business Brokers Association's glossary defines discretionary earnings as the earnings of a business before "income taxes, non-operating income and expenses, nonrecurring income and expenses, depreciation and amortization, interest expense or income, one owner's entire compensation, including benefits and any non-business or personal expenses paid by the business." Every word of that definition is a line in the table below.

Which add-backs will a buyer's accountant accept, and which will they reject?

Accepted without much argument: the owner's W-2 and the payroll taxes on it, the owner's health insurance, interest, depreciation, and a one-time expense with an invoice and a plain explanation. Accepted with a schedule: the owner's vehicle, phone, travel and meals, provided the schedule ties to the general ledger and the amounts are the kind a reasonable person would call personal. A documented add-back schedule takes about 30 days to build and it is the single cheapest thing an owner can do before a sale.

Rejected, or argued down, in most Chicago deals we see. A spouse or child on payroll who actually works in the business is not an add-back; the buyer will replace that person at a market wage, so the right adjustment is the difference, and it often runs the other way. A second owner's salary is not an add-back either, because SDE is a one-owner number by definition; the second owner is replaced by a manager at market. A "one-time" repair that shows up in each of the last three returns is maintenance. The truck and phone the buyer will also need are an operating cost, not a perk. Rent to your own LLC at $8,000 a month when the market lease will be $10,000 costs you $24,000 of SDE a year, not the other way around. And cash sales that never reached the return are never added back. A buyer will not pay for income they cannot verify, and a lender cannot finance it. Every one of these is on the list of seven things a buyer's accountant finds first, which is why we build the schedule before the listing rather than defend it in diligence.

What is the difference between SDE and EBITDA?

One owner's pay. EBITDA is earnings before interest, income taxes, depreciation and amortization, with a market-rate manager already in the cost base. SDE adds one working owner's full compensation back on top of that. So for a business with a single working owner, SDE equals EBITDA plus what that owner takes out, and EBITDA equals SDE minus what it would cost to hire the person who replaces them. The IBBA and M&A Source Market Pulse survey prices deals under $2 million in transaction value on SDE and deals from $2 million up on EBITDA (Q1 2026), because below that line the buyer is usually going to run the company and above it they are usually going to hire someone.

The mistake this causes is predictable. SDE multiples look lower than EBITDA multiples because the base is bigger, and an owner who applies a 4 or 5 times EBITDA multiple they read about to their SDE prices the company a third high. That is most of the gap BizBuySell reports for the Chicago metro, where listings in the third quarter of 2025 were asking 3.26 times cash flow and 2024 sales closed at 2.43 times. BizBuySell describes SDE as the preferred measure of cash flow for owner-operated businesses, so those multiples are SDE multiples. The size bands and the industry ranges are on how much is my business worth.

A worked example: a Cook County machine shop

The company is hypothetical and every assumption is stated so you can swap in your own. A job shop in the southwest suburbs does $3.2 million in revenue. The owner runs the front office and quotes the work, his son runs second shift, and the building belongs to the owner's real-estate LLC.

Owner-run manufacturing businesses under about $2 million in transaction value commonly sell for 2.7 to 3.1 times SDE, so this shop prices at roughly $1.43 million to $1.64 million before the equipment appraisal, the customer list and the lease terms move it inside that range. The owner's own math, done the week before he called, skipped the deductions for the son and the rent and applied 3.5 times, which is $2.0 million. The buyer's accountant would have taken that number apart in the first week of diligence, and the price would have been renegotiated at the LOI instead of set correctly at the listing.

If you want the EBITDA view of the same company, assume a plant manager who replaces the owner costs $150,000 with payroll taxes and benefits. EBITDA is then about $378,000. Nobody prices a shop this size on EBITDA, but when a buyer does, the multiple has to be higher to land in the same place, and the lender will run the same arithmetic either way. What this looks like for shops specifically is on selling a manufacturing business in Chicago.

How does SDE turn into a price?

Multiply it by the range for your size and industry, then let the five things buyers examine move the number inside the range. Owner-operated businesses under about $2 million in value trade at roughly 1.6 to 3.6 times SDE depending on industry; manufacturing and distribution run 2.7 to 3.1; the trades sit around 2.3 to 2.6 at the median. A company with one customer over about 20 percent of revenue, cash-basis books or an owner who holds every relationship prices at the bottom of its range, and the same SDE with a manager, maintenance agreements and a monthly close prices at the top. The lender then tests that the price can be serviced out of the earnings, which is why an inflated SDE fails at the bank even when a buyer has accepted it. The lenses are on what buyers look for and the multiples with their sources are in what Chicagoland businesses actually sell for.

What documents prove the number?

Three years of federal returns and the year-to-date P&L with the same period of the prior year beside it. Twelve months of bank statements, because the buyer's accountant will trace revenue to deposits before they read your add-backs. The payroll register, so the owner's compensation and the family members on it are what you said they are. The add-back schedule itself, one line per item, each tied to a ledger account and a receipt. The lease or, if you own the building, a market-rent opinion. The fixed-asset schedule that matches what is on the floor. Those seven items are most of the data room, and the Exit-Readiness Review builds the SDE schedule from them in two weeks for a flat $4,500, credited against our fee if we later list the business.