Executive summary
Small private businesses are often priced as a multiple of seller's discretionary earnings (SDE) or EBITDA. The headline multiple matters less than the quality of the earnings it is applied to. This note explains the common metrics, typical normalisation adjustments, and a disciplined sequence for early diligence.
Key findings
- 1SDE adds back the owner's compensation and discretionary expenses; EBITDA treats a market-rate manager salary as a cost.
- 2Every add-back should be documented; undocumented add-backs inflate the price.
- 3Customer concentration, owner dependence and working-capital needs are frequent sources of overpayment.
Two common earnings measures
- Seller's discretionary earnings (SDE): pre-tax earnings plus owner's salary, owner's benefits, interest, depreciation, amortisation and one-time or discretionary expenses. Common for owner-operated businesses.
- EBITDA: earnings before interest, taxes, depreciation and amortisation, after paying a market-rate salary for management. Common for larger businesses with professional management.
A hypothetical normalisation
| Item | Amount |
|---|---|
| Reported pre-tax profit | $180,000 |
| + Owner salary | $120,000 |
| + Depreciation | $25,000 |
| + One-time legal expense (documented) | $15,000 |
| SDE | $340,000 |
| – Market-rate general manager | ($110,000) |
| Adjusted EBITDA | $230,000 |
The same business looks very different depending on which measure a multiple is applied to.
Early diligence sequence
- Reconcile financial statements with tax returns and bank statements.
- Test every add-back against documentation.
- Analyse revenue by customer, product and year.
- Identify what depends personally on the owner.
- Estimate normal working capital and capital expenditure needs.
Investment considerations
Engage qualified accounting and legal advisors for any acquisition. Use quality of earnings work for transactions of meaningful size.
Risks and limitations
Small business data is private and frequently unaudited. Valuation conventions differ by market and broker.
Methodology
Hypothetical example constructed to illustrate definitions. Multiples vary by industry, size, geography and time and are not provided here.
Facts, assumptions, estimates and opinions
TIC labels the nature of each material claim so you can weigh it appropriately.
- Verified factSDE includes the owner's compensation; EBITDA as used here deducts a market-rate manager salary.
- EstimateAll figures in the table are hypothetical.
- OpinionThe quality of earnings matters more than the headline multiple.
Sources and references
- 01Buy an existing business or franchise — U.S. Small Business Administration
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