One of the biggest mistakes business owners make when talking about valuation is assuming there is one financial metric that determines what their business is worth.

You’ll hear people say:

“You need to use EBITDA.”

Or:

“Main Street businesses are valued on SDE.”

Both statements can be correct.

But neither tells the entire story.

The better question is:

Who is going to buy your business?

Because the buyer determines what economic benefit they are actually purchasing.

A business being purchased by an owner-operator is fundamentally different from a business being purchased by a management team, strategic buyer, private equity group or larger company.

That distinction can change how the financial performance of the business is analyzed.

What Is SDE?

Seller’s Discretionary Earnings, or SDE, is commonly used when evaluating smaller Main Street businesses where the owner is actively involved in operating the company.

SDE generally attempts to capture the total economic benefit available to one owner-operator.

It can include:

Business profit
Owner salary or compensation
Certain legitimate discretionary expenses
Certain non-recurring expenses
Other appropriate add-backs

The concept is relatively straightforward:

What economic benefit would an owner-operator receive from owning this business?

Imagine a business generating:

$1.5 million in revenue

and:

$350,000 in SDE.

If a buyer is planning to purchase the business, step into the owner’s shoes and operate it themselves, that $350,000 may be a very important number.

But what happens if the buyer isn’t going to operate the business?

That’s where the analysis changes.

What Is EBITDA?

EBITDA—Earnings Before Interest, Taxes, Depreciation and Amortization—is generally used to evaluate the operating performance of a business before financing and certain accounting decisions.

It is particularly useful when analyzing businesses that have:

Professional management
Multiple employees or departments
Less owner dependence
Larger operating structures
Institutional or strategic buyers
Opportunities for a buyer to achieve additional scale

The underlying question becomes different.

Instead of:

“What does this business provide to the owner who operates it?”

we’re asking:

“What operating earnings does this business generate independent of the financing and ownership structure?”

That distinction is extremely important.

The Buyer Changes the Equation

Let’s use a simplified example.

Suppose a company has:

$3 million in revenue
$500,000 in SDE
$300,000 in EBITDA

An owner-operator might look at the $500,000 SDE and ask:

“What return can I generate by owning and operating this company?”

A strategic buyer or financial buyer may focus much more heavily on the $300,000 of EBITDA.

Why?

Because that buyer may need to replace the existing owner’s responsibilities with management or additional personnel.

The $200,000 difference between SDE and EBITDA isn’t necessarily “extra profit.”

It may represent compensation for the owner’s labor and management function.

If the buyer has to replace that function, the economics change.

The Owner Is Often Part of the Business

This is one of the most important concepts for Main Street business owners to understand.

Let’s say you own a $2 million service business.

You:

Answer the phone
Sell the jobs
Schedule employees
Handle major customers
Resolve problems
Review estimates
Manage vendors
Handle payroll
Supervise employees

Your financial statements may show substantial SDE.

But a buyer is going to ask:

“Who is going to do all of those things after closing?”

If the answer is:

“I am.”

then the buyer may be purchasing a business and a job.

That’s not necessarily bad.

In fact, that may be exactly what an owner-operator buyer wants.

But it matters when determining which earnings metric best describes the economic opportunity.

The Owner-Operator Buyer

For many smaller businesses, the likely buyer is an individual who wants to own and operate a business.

Examples might include:

Cleaning companies
Landscaping businesses
Pool service companies
Small restaurants
Automotive businesses
Specialty contractors
Home services
Small professional service companies
Route-based businesses

For these businesses, SDE can be particularly useful because the buyer is often stepping directly into the owner’s role.

The buyer isn’t necessarily trying to build a corporate management structure.

They’re buying an income-producing business that they expect to operate.

In that situation, the economic benefit to the owner-operator can be more relevant than EBITDA alone.

The Strategic Buyer

Now consider a different buyer.

Suppose a larger company wants to acquire your business.

They already have:

Accounting
HR
Sales management
Operations
Marketing
Purchasing
Administrative infrastructure

They may be able to eliminate duplicate expenses or integrate your company into their existing organization.

Their analysis can be very different from that of an individual buyer.

They may care more about:

EBITDA, recurring revenue, margins, customer concentration, operational scalability and strategic fit.

The buyer isn’t simply asking:

“How much money can I make running this company?”

They’re asking:

“How does this company improve my existing operation?”

Private Equity and Institutional Buyers

At larger transaction sizes, EBITDA becomes increasingly important because institutional buyers generally evaluate businesses based on their ability to generate operating earnings independent of a particular owner’s personal involvement.

They may examine:

EBITDA
Adjusted EBITDA
Recurring revenue
Customer retention
Organic growth
Management depth
Gross margins
EBITDA margins
Working capital requirements
Capital expenditures
Debt capacity
Scalability
Industry concentration
Customer concentration

The business is increasingly being evaluated as an enterprise, rather than simply as a source of income for one owner.

The Gray Area Is Where Things Get Interesting

The real world isn’t divided neatly into:

SDE = small business

and

EBITDA = big business.

There is a large middle ground.

Consider a company doing $4 million in revenue with $800,000 of SDE.

The owner has a strong management team and spends only 10 hours a week in the business.

That company may have characteristics that make an EBITDA analysis much more meaningful than you might expect from its size alone.

Now consider a $6 million company where the owner personally generates 60% of the sales and manages virtually every major customer.

The revenue may be large.

But the buyer’s analysis has to account for the owner’s role.

Size alone doesn’t tell the whole story.

This Is Why Add-Backs Matter

This also explains why sellers should be careful when talking about add-backs.

A seller might say:

“I have $200,000 of add-backs, so my SDE is $700,000.”

That’s only the beginning of the conversation.

A buyer may ask:

“Which expenses are actually eliminated when I buy the company?”

And:

“Which expenses will I have to incur to replace what the owner currently does?”

Those are two very different questions.

An owner’s personal automobile expense might legitimately be discretionary.

But replacing an owner who works 60 hours a week may require a $100,000 manager.

That isn’t simply an accounting adjustment.

It’s an economic reality.

Don’t Pick the Metric That Makes Your Business Look Better

This is where I think sellers can get themselves into trouble.

The goal shouldn’t be:

“Which number gives me the highest valuation?”

The goal should be:

“Which financial metric most accurately represents the economic value of this business to the type of buyer who is most likely to purchase it?”

That’s a much better question.

Because sophisticated buyers, lenders and advisors will eventually work through the numbers anyway.

Trying to make the business look more profitable on paper doesn’t solve the underlying economics.

Think About the Buyer Before You Think About the Multiple

Here’s the framework I use:

Owner-operator buyer

Think more heavily about:

SDE

The buyer is purchasing the business and expects to operate it.

Management-backed buyer

Think increasingly about:

EBITDA

The business needs to support management independent of the current owner.

Strategic buyer

Focus on:

EBITDA + strategic synergies + recurring revenue + operational fit

The buyer may be able to create value through integration.

Private equity / institutional buyer

Expect significant attention to:

Adjusted EBITDA, recurring revenue, margins, working capital, management depth and scalability.

The business is being evaluated as an enterprise.

The Same Business Can Have Different Economics for Different Buyers

This is an important point that business owners sometimes miss.

The business hasn’t changed.

The buyer has.

An owner-operator may look at your company and see an opportunity to earn $400,000 personally.

A larger company may look at the same company and see $250,000 of EBITDA after accounting for the management required to operate it.

Neither number is necessarily “wrong.”

They are answering different questions.

That’s why valuation isn’t simply:

Revenue × Multiple = Value

or even:

SDE × Multiple = Value

or:

EBITDA × Multiple = Value

The real process is much more nuanced.

You have to understand the business, the financials, the market, the risk, the buyer universe and the economic benefit being transferred.

What Should a Business Owner Do?

If you’re thinking about selling someday, don’t wait until you’re ready to list the business to figure this out.

Start by asking:

What is my true SDE?
What is my true EBITDA?
How much of my earnings depend on my personal involvement?
What would it cost to replace me?
Could the business operate without me?
Who is the natural buyer for this company?
Would that buyer be an owner-operator, strategic buyer or financial buyer?
What would that buyer actually be purchasing?

Those questions can reveal more about your future valuation than simply looking at revenue.

The Bottom Line

SDE and EBITDA aren’t competing answers. They are different ways of looking at the economics of a business.

SDE can be highly relevant when an owner-operator is buying a business and stepping into the owner’s role.

EBITDA becomes increasingly important as the business becomes more management-driven, less owner-dependent and more attractive to strategic or institutional buyers.

And sometimes a business needs to be analyzed through both lenses.

That’s why I tell business owners:

Don’t start with the multiple. Start with the buyer.

Then determine which earnings metric best describes what that buyer is actually purchasing.

If you understand that several years before you sell, you have something valuable:

time to change the business.

You can reduce owner dependence, improve margins, strengthen management, clean up financial reporting, diversify customers and create more predictable earnings.

That’s what real exit planning is about.

It’s not just figuring out what your business is worth today.

It’s figuring out what you can do to make the business more valuable—and more transferable—before you sell it.

Michael Shea represents the Tampa Florida Transworld office. In business since 2005, he has established a reputation as a trusted business broker across Florida’s key markets- from Tampa to Orlando, Melbourne, and more. Over the past two decades, Michael and his team have closed over $1 Billion in sold business volume and presided over more than 476 transactions. His credentials include the IBBA Certified Business Intermediary®, and most recently, the prestigious Certified Exit Planning Advisor® (CEPA) credential. He is also a Florida Licensed Real Estate Broker and Business Brokers of Florida Board Certified Intermediary . Shea is a member of the VRMA and a recognized expert in property management and vacation rental management business sales