Know what your business earnings really show.
If you’re thinking about selling your California business, Seller’s Discretionary Earnings, usually shortened to SDE, is a number you’ll likely hear from buyers, brokers, and lenders. It can help describe the cash flow an owner-operator may receive from the business. But only when the number is calculated clearly and backed by records.
Get SDE wrong, and buyers may question your financials, lower their offer, or lose confidence. Get it right, and you can explain your earnings with greater clarity and prepare for a more informed sale process.
WHAT SDE MEANS
SDE estimates the financial benefit available to one full-time owner-operator before personal income taxes, financing costs, and certain expenses that may not continue under new ownership.
A simple starting formula is:
Pretax business profit + interest + depreciation and amortization + one owner’s compensation and benefits + supported adjustments = SDE
“Adjustments” are expenses included in the business’s books that a seller believes will not continue for a buyer. Each one needs to be evaluated, not simply labeled an add-back.
SDE is commonly used for smaller, owner-operated businesses. It helps a buyer consider what the business might provide if they personally take an active role. It is not the same as cash in your pocket after a sale, and it does not automatically account for the buyer’s loan payments, taxes, equipment needs, or replacement labor.
COMMON ADD-BACKS, AND THE PROOF THEY NEED
Some expenses may be appropriate to add back when they are documented and genuinely won’t continue, or when the SDE calculation specifically accounts for them.
- One working owner’s compensation and benefits: SDE typically adds back the compensation of one owner who works in the business. Keep in mind that a buyer may need to hire someone to take on those duties.
- Business-paid personal expenses: A personal-use portion of a vehicle, insurance, or travel might qualify. Records should show the personal use and separate it from legitimate business use.
- Non-cash expenses: Depreciation and amortization are common SDE adjustments. These accounting expenses reduce reported profit, but do not represent a cash payment in the same way as payroll or rent. Still, don’t assume every non-cash item can be ignored: the buyer may need to replace equipment or invest in the business.
- Genuinely one-time expenses: A documented, unusual cost, such as a specific legal settlement or an isolated storm-related repair, may be considered if it is unlikely to recur.
- Discretionary spending: An expense that is truly personal or optional may be considered. The fact that you chose to spend money does not, by itself, make the expense an add-back.
Use invoices, payroll records, tax filings, bank statements, mileage logs, and accounting records to support each adjustment. An experienced California business broker can help organize the explanation, but buyers and their advisors will still want to verify it.
For a more detailed overview, see BizBuySell’s guide to Seller’s Discretionary Earnings.
WHAT SHOULD STAY IN THE NUMBERS
A new owner will still have to pay the business’s ordinary operating costs. Rent, insurance, utilities, normal repairs, and wages for employees who are needed to keep the business running generally remain part of the financial picture.
A replacement manager’s salary is a particularly important example. If you perform essential daily work and a buyer plans to hire a manager to take over, that future cost should not be hidden by adding back your pay without considering the replacement role. The buyer needs to understand the earnings after paying for the work the business still requires.
This is also why not every owner’s compensation is automatically an add-back. SDE is generally presented around one working owner’s role. If multiple owners work in the business, their duties and the cost of replacing them need careful review.
The key question is practical: Will this expense truly disappear for the buyer, or will the buyer need to pay for the same function another way?
SDE VS. EBITDA
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is often used for businesses with management already in place, or for larger businesses where buyers are evaluating ongoing operations rather than stepping into the owner’s job.
The main difference is how owner compensation is treated:
- SDE typically adds back one working owner’s full compensation and benefits to estimate the earnings available to an owner-operator.
- EBITDA does not automatically add back the owner’s pay. If the owner performs necessary work, a buyer’s analysis may include a reasonable cost for replacing that role.
That distinction matters. Comparing an SDE figure with an EBITDA figure without accounting for owner duties can give you a misleading impression of the business’s earnings. A buyer comparing an owner-operated California company with a similar business in Dallas needs to know whether each figure reflects the same staffing assumptions.
Neither measure is a guaranteed offer price. Buyers use earnings alongside their own review of the business, and lenders may recalculate cash flow using their underwriting standards. The SBA 7(a) loan program provides financing for eligible small businesses, but a seller’s SDE figure alone does not establish whether a buyer will qualify or whether a loan can be repaid.
A SIMPLE CALIFORNIA EXAMPLE
Imagine a small California plumbing business with $140,000 in pretax profit after paying its working owner. Its records also show:
- $95,000 in the owner’s compensation and benefits
- $8,000 in interest expense
- $12,000 in depreciation
- $6,000 in documented personal vehicle costs
- $4,000 in a supported, one-time repair expense
If each item is substantiated and accepted, the illustrative SDE calculation is:
$140,000 + $95,000 + $8,000 + $12,000 + $6,000 + $4,000 = $265,000 SDE
Now suppose a buyer won’t perform the owner’s daily work and expects to pay a manager $70,000. The buyer may view the earnings after that replacement cost as closer to $195,000, before debt payments, taxes, and other considerations.
That does not mean the business is worth a particular amount. It shows why an SDE calculation needs to explain what the owner does, and what a buyer may need to spend to replace that work.
WHY UNSUPPORTED ADD-BACKS CAN HURT
An aggressive add-back might make your business look more profitable on paper, but it can weaken a buyer’s confidence if the records don’t support it. Buyers may request documentation, challenge the adjustment, or become more cautious about the rest of the financial information.
Lenders may also scrutinize adjustments when deciding whether a buyer’s projected cash flow can support financing. A broker’s SDE presentation is not a substitute for the lender’s own review.
A clear, reasonable SDE schedule can do the opposite: help buyers understand the earnings, make questions easier to answer, and keep discussions grounded in the records.
IF YOUR ADD-BACKS ARE MESSY, START HERE
You don’t need perfect books to begin preparing your business for sale. You do need a clear path to explain them.
- Start with your financial statements and tax filings. Identify the reported profit and confirm the period being reviewed.
- List every proposed adjustment separately. Include the amount, year, reason, and accounting entry.
- Gather supporting records. Attach invoices, payroll reports, bank records, and other documents that help verify the expense.
- Check whether the cost will continue. Identify recurring expenses, replacement labor, and equipment or operating needs that a buyer may still face.
- Ask your CPA and sale advisor to review the schedule. Get questions addressed before a buyer or lender raises them.
If you’re searching for “business brokers near me,” look for an advisor who can explain how earnings are presented and help keep a confidential business sale organized. Business brokerage in California should include more than presenting a headline number. You deserve a clear explanation of what supports it.
SDE is one part of how to sell a business, not a shortcut to a guaranteed value. As a business broker in California, I help owners understand the earnings behind a potential sale and the documentation that can help support them. A sale-focused valuation and an early review of your financials can help you prepare your business for sale and shape an exit strategy for business owners that fits your goals.
GET CLEAR BEFORE YOU DECIDE
If you’re considering a sale, start by learning exactly where your numbers stand. I offer a free, sale-focused valuation to help you understand your company’s position before you decide what comes next.
Explore business sale services, schedule a confidential conversation, or contact David. I’ll help you make sense of the details, answer your questions, and take the next step without pressure.
ABOUT DAVID
David Mayfair is a Business Sales Advisor at SD Business Advisors. David Mayfair and his team have sold over 850 businesses since 2007. He learned about the industry when he became a business buyer in 2000. He offers a free, sale-focused valuation and a confidential, no-pressure process. Contact him at 650-304-1138.
