Glossary
Seller’s Discretionary Earnings (SDE): What a Buyer Should Check
Seller’s discretionary earnings (SDE) describes earnings before the compensation and benefits of one working owner, together with supported adjustments for financing, tax, non-cash and non-operating items. It can help a prospective owner-operator understand the earnings attached to both owning and working in a business. It is not the cash a buyer can automatically take home.
The first question is practical: who will do the owner’s work after the acquisition? A number that looks attractive before owner compensation can tell a different story once the buyer budgets for a replacement manager.
How the SDE bridge works
A typical analysis starts with reported net income, adds back interest, income tax, depreciation and amortization to reach EBITDA, and then shows each proposed adjustment separately. One working owner’s compensation and benefits are treated differently from the ongoing cost of a management team.
Adjustments are not automatically acceptable because the seller labels them personal or one-time. Costs the business still needs should remain in the analysis. Non-operating income may also need to be removed. CFI’s overview of SDE describes these categories and the disagreements that can arise over replacement costs.
Keep the starting figure visible. If an expense is already excluded from adjusted EBITDA, adding it back again when calculating SDE double-counts the benefit.
The owner-replacement test
In our QoE work, we review the owner’s role when distinguishing SDE from adjusted EBITDA. A management replacement salary changes the interpretation of the result, not simply the label on the earnings schedule.
| Buyer question | Evidence to request | Effect on the decision |
|---|---|---|
| What compensation was actually recorded? | Payroll records, benefits and the relevant ledger entries | Establish the amount before debating its treatment. |
| What work does the departing owner perform? | Responsibilities, time commitment and the post-close organization plan | Identify work the buyer must absorb or replace. |
| Will another person perform that work? | A documented replacement role and compensation assumption | Evaluate earnings after that ongoing cost, not only SDE. |
| Is a seller consulting payment temporary? | Transition terms and the intended end date | Separate temporary transition cash needs from ongoing management costs. |
| Is an alleged personal expense needed to operate? | Supplier purpose, invoices and expected post-close use | Challenge the add-back rather than accepting its account label. |
This is a qualitative review framework, not a claim about how frequently these issues occur. It draws on anonymized Treewalk transaction discussions; it does not reproduce a client’s figures or establish the treatment for a particular acquisition.
What supporting an add-back looks like
An owner-compensation adjustment should reconcile to the records. Related employer costs should be considered consistently with the salary treatment. The buyer should be able to distinguish the seller’s proposed amount, the amount supported by records, and any unresolved difference.
The same discipline applies to discretionary spending. An online service booked to an owner-related account may still support revenue generation. Ask what the supplier does and whether the business will keep using it. Our EBITDA normalization guide explains the broader adjustment review.
Frequently asked questions
Is SDE the same as EBITDA?
No. SDE includes the benefit associated with one working owner’s compensation. For a buyer who needs paid replacement management, normalized earnings after that cost may be more relevant. The SDE versus EBITDA comparison covers that distinction.
Can I add back every owner’s salary?
Not as an automatic rule. The one-owner view does not make the work performed by other owners disappear. Identify the roles that must continue and the cost of covering them.
Does SDE tell me how much acquisition debt I can afford?
Not by itself. Debt payments, working capital, capital spending and the buyer’s own needs require a separate cash-flow assessment. Confirm financing assumptions with the lender and transaction advisers.
Where to next
Bring the seller’s earnings schedule and a description of the owner’s role to a transaction advisory discussion. The useful starting point is which adjustments need support and what work must continue after close.
