Understanding Seller's Discretionary Earnings
Dylan Gans
May 5, 2025 ⋅ 7 min read
When small business owners start thinking about selling, one of the first questions they ask is, “How much is my business worth?”
The answer isn’t always simple—but understanding Seller’s Discretionary Earnings (SDE) is one of the most important steps in getting it right.
At Baton Market, we’ve seen firsthand how clear, well-prepared financials—especially SDE—can make or break a sale. Whether you're years away from listing or ready to hit the market tomorrow, knowing how to calculate and present SDE properly can dramatically improve your business valuation and help close deals faster.
This isn’t about throwing numbers on a spreadsheet and hoping for the best. SDE is the story of your business’s financial performance. When told well, it helps potential buyers see the true earning power of your company—and feel confident about making an offer.
Here’s what you need to know about Seller’s Discretionary Earnings, why it matters so much in small business sales, and how to get it right from day one.
What Are a Seller's Discretionary Earnings (SDE)?
Seller’s Discretionary Earnings (SDE) is one of the most common methods for valuing small businesses, especially those under $10 million.
Simply put, SDE is the total financial benefit the current owner takes from the business. It tells a potential buyer what they might reasonably expect to earn if they step into the owner’s shoes.
The basic formula looks like this: Net Profit + Owner’s Salary + Discretionary Expenses + Non-Recurring Expenses = SDE
Let’s break that down:
Net profit: Your bottom-line earnings after all standard business expenses have been paid.
Owner’s salary: What the owner pays themselves as compensation.
Discretionary expenses (add-backs): Personal expenses that the business paid but aren’t essential to operations (think personal travel, a vehicle, or health insurance premiums).
Non-recurring expenses: One-time costs that won’t apply to the new owner—like legal fees for a specific lawsuit or a one-off marketing campaign.
For example, say your landscaping business shows a net profit of $100,000. You pay yourself $80,000 as salary. The business also covers $10,000 in personal vehicle expenses and had a $5,000 one-time legal fee this year. Your SDE would be $195,000.
This number gives buyers a clearer view of cash flow and helps them understand the business's true earning potential—not just what appears on the tax return.
How SDE Fits into Small Business Valuation
Discretionary earnings are a cornerstone of business valuation for small businesses. Unlike EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), which is more commonly used for larger businesses or corporations with complex financials, SDE is designed specifically for owner-operated companies.
In many small businesses, the owner’s salary and personal expenses are significant factors in the company’s cash flow. These aren’t always visible in traditional accounting methods, which is why SDE often gives a more accurate reflection of what a new owner can expect.
Valuation multiples (like 2x or 3x SDE) are typically applied to this figure to determine the overall business value. This approach ensures that the company's valuation reflects the true earning power of an owner-operated business, not just surface-level profit.
Buyers, brokers, and lenders rely on SDE because it accounts for the reality of how money moves in an owner-operated company.
Comparing SDE vs. EBITDA helps illustrate why SDE stands out in this space. While EBITDA strips out interest expense, income taxes, depreciation, and amortization, it ignores the nuances of owners’ compensation and discretionary spending.
This is especially true when determining the value of a service business, where much of the profitability may depend on the owner’s involvement and discretionary spending.
That’s often where the most critical financial details live for small business deals.
SDE is one of the small businesses' most common valuation methods, mainly because it accounts for the unique ways owners structure their compensation and expenses.
What’s Included in SDE (and What’s Not)?
Getting your SDE calculation right means understanding exactly what belongs—and what doesn’t.
Included in SDE:
Owner’s salary or owner’s benefits
Personal expenses run through the business (travel, vehicle, phone, etc.)
Non-recurring expenses like one-time legal fees or equipment purchases
Certain payroll taxes tied directly to owner compensation
Bad debt write-offs (if clearly documented as one-off events)
Not included in SDE:
Normal business expenses required to operate the company
Employee wages (unless they’re family members paid above market rate)
Interest expense, income taxes, and depreciation (those are handled separately)
Non-cash expenses like depreciation and amortization, unless tied to one-time events
One of the most common mistakes sellers make when calculating SDE is double-counting expenses or failing to document add-backs clearly. Every add-back needs to be defensible—not just to the buyer but often also to lenders and other stakeholders involved in the sale.
Transparency is everything. Overcomplicating the list of add-backs can erode trust quickly.
Why Buyers Pay Attention to SDE
Buyers aren’t just looking at your profit and loss statement—they’re asking, “What will this business pay me if I take it over?”
That’s why a seller’s discretionary earnings are so critical. It helps buyers estimate owner income, assess future performance, and gauge whether the business aligns with their financial goals.
Here’s what experienced buyers want to see:
Clean books: Well-organized financials with minimal unexplained add-backs.
Transparent add-backs: Every adjustment is documented and justified.
Consistency across years: Stable earnings without wild fluctuations.
If your SDE presentation looks messy or unclear, expect delays. Buyers often consult multiple lenders, each asking detailed questions about the add-backs. When sellers can’t explain these clearly, deals fall apart slowly or entirely.
When your books are clean and the story is simple—like only adding back your salary and personal vehicle expenses—it builds trust. Deals close faster. Lenders underwrite more confidently. Potential buyers feel like they’re making a smart, informed decision.
How to Maximize Your SDE Before Selling
If you’re preparing to sell, optimizing your SDE well before going to market is one of the smartest moves you can make. This isn’t about manipulating numbers—it’s about presenting an honest, compelling financial picture that makes your business attractive to potential buyers.
Here’s how:
Clean up your bookkeeping: Make sure your financials are accurate and current. Good bookkeeping is the foundation for reliable SDE.
Eliminate unnecessary personal expenses: Start separating personal and business expenses at least a year or two before selling.
Document every add-back: Keep receipts, invoices, and clear notes on any discretionary or non-recurring expenses.
Work with an advisor: Getting outside expertise can help ensure your SDE calculation holds up to scrutiny.
Think of it as financial modeling for valuation purposes. The better prepared your numbers are, the easier it is to defend your asking price and keep the sale process moving smoothly.
What if You Don’t Have a Clear SDE Yet?
Here’s the good news: You’re not alone. Many small business owners haven’t tracked SDE consistently—or at all—before starting the sale process.
That’s why Baton Market offers a free, accurate business valuation upfront. We help sellers understand their numbers, clean up their books, and present their business earnings clearly and confidently.
Even if you’re a year (or more) away from selling, getting clarity on your SDE today can save you headaches tomorrow. And if you’re already in the process, having expert guidance ensures you’re putting your best foot forward with any new buyer.
SDE Is More Than a Number—It’s the Story Buyers Believe
A seller’s discretionary earnings aren’t just a math formula. They’re a way to tell the story of your business: How it earns, where it spends, and what a buyer can expect to take home.
When that story is clear, deals close faster, prices stay stronger, and buyers feel confident. Understanding your SDE early helps protect the value of a small business by presenting accurate, defensible financials that buyers can trust.
Ready to understand your SDE and see what your business is really worth?
Get your free valuation today and see how Baton Market makes selling simple.