Most business owners have never heard of Seller's Discretionary Earnings until they start thinking about selling. Then it becomes the single most important number in their financial life. SDE is the normalized cash flow available to a working owner-buyer. It is what the business would put in your pocket if you owned and ran it yourself. Everything else in a business valuation flows from this number.
What Is Seller's Discretionary Earnings
SDE is not the number on your tax return. It is a reconstructed picture of what your business actually earns when you strip out the decisions you made for tax purposes and add back the real economic value you extracted from it.
The formula: SDE equals net profit, plus owner's salary and draws, plus personal expenses run through the business, plus one-time or non-recurring costs, plus depreciation, plus amortization, plus interest. Each of these line items is called an "add-back." Together they adjust the reported income to reflect what the business truly earns.
This matters because most small businesses are run to minimize taxable income. Owners take large salaries, run personal vehicles through the P&L, and expense things that are technically personal. None of that is wrong. But it means the tax return dramatically understates the business's actual earning power. SDE corrects for that.
How SDE Is Calculated
Here is a real-world example. A business shows $80,000 in net income on its tax return. The owner paid himself a $120,000 salary. A personal vehicle costs the business $12,000 per year. There was a one-time legal expense of $8,000 related to a dispute that is now resolved. Depreciation on equipment adds another $15,000.
Add those together: $80,000 net income plus $120,000 salary plus $12,000 vehicle plus $8,000 one-time legal plus $15,000 depreciation equals $235,000 SDE.
That $235,000 is the actual earning power of the business. A buyer who purchases this company and steps into the owner role can expect to generate approximately $235,000 in annual economic benefit, before debt service on any acquisition financing. The tax return showed $80,000. SDE shows $235,000. That difference is why understanding add-backs matters.
How SDE Affects Your Valuation
Most small businesses in Texas sell at a multiple of SDE. That multiple typically ranges from 2.5x to 5x depending on the quality of the business. Apply that math to the example above: at 3x, a $235,000 SDE business is worth $705,000. At 4x, it is worth $940,000.
That $235,000 difference between those two outcomes comes from a single multiple point. The multiple is determined by factors like recurring revenue, owner dependency, financial cleanliness, customer concentration, and churn rate for subscription-based businesses. Improving those factors moves the multiple. Improving the add-back documentation increases the SDE. Both levers matter.
To understand what your business is worth today, start with a free valuation that walks through your specific SDE and likely multiple range.
SDE vs EBITDA
You will hear both terms during a sale process. SDE is used for businesses generating roughly under $500,000 in annual earnings where the owner is actively working in the business. It includes the owner's compensation because a buyer stepping in would earn that compensation themselves.
EBITDA (earnings before interest, taxes, depreciation, and amortization) is used for larger businesses where professional management is already in place and the owner's compensation is reflected in normal market-rate management salaries. EBITDA does not add back owner compensation because the owner is not the primary operator.
Both frameworks are valid. Buyers use the one appropriate for the deal size. For most Texas small businesses selling below $5 million in enterprise value, SDE is the relevant metric.
Common SDE Mistakes Texas Sellers Make
The first and most costly mistake is failing to identify all legitimate add-backs. Owners routinely leave money on the table by not documenting personal expenses run through the business. Every dollar of undocumented add-back reduces the SDE, and every dollar of reduced SDE reduces your sale price by a multiple of that amount.
The second mistake is commingling personal and business expenses in a way that makes add-backs difficult to defend during buyer scrutiny. If you cannot produce receipts and clear documentation for what was personal versus operational, buyers will either discount the add-back or walk away.
Third, inconsistent owner salary year over year creates confusion in the normalization process. Buyers want to see a consistent, defensible pattern. Wild swings in owner compensation raise questions.
Fourth, many sellers do not get a proper SDE analysis done before listing, and they end up surprised during due diligence when their number does not hold up. By then, the buyer is already using the discrepancy as leverage to renegotiate price.
Anchorpoint works with sellers to calculate and present SDE correctly before going to market. Getting this right directly affects the final sale price. Start with a free valuation to see where your business stands today.