Business Valuation

If you’ve started researching what your business is worth, you’ve probably come across the term Seller’s Discretionary Earnings, commonly abbreviated as SDE. It’s one of the most important concepts in small business valuation, and understanding it can give you a significant advantage when it comes time to sell.

Let’s break it down in plain language.

What Is SDE?

Seller’s Discretionary Earnings is a measure of the total financial benefit an owner-operator receives from running a business each year. It’s calculated by taking your net profit and adding back certain expenses that reduce your taxable income but don’t represent real ongoing costs to a future buyer.

In other words, SDE is the answer to this question: “If I buy this business and run it myself full-time, how much money will it put in my pocket each year?”

How Is SDE Calculated?

Start with your net profit (after all expenses), then add back:

• Owner’s salary and benefits: What you pay yourself, including health insurance, retirement contributions, and any other owner-specific compensation
• Personal expenses run through the business: Vehicle expenses, phone bills, certain meals, travel, or other costs that are for your personal benefit and wouldn’t continue under new ownership
• Depreciation and amortization: These are non-cash accounting expenses that don’t represent actual money leaving the business
• Interest expense: Financing costs that are specific to your current debt structure and won’t carry over to the buyer
• One-time or non-recurring expenses: Costs that happened in a particular year but won’t repeat, major repairs, legal fees for a one-time issue, startup costs

The sum of all these additions gives you your SDE, and it’s almost always significantly higher than the net profit shown on your tax return.

A Simple Example

Let’s say you own an HVAC service company in Northeast Florida. Here’s a simplified example of how SDE might look:

• Net profit (as reported): $80,000
• Add: Owner salary (paid through payroll in an S corporation), $90,000
• Add: Owner health insurance, $12,000
• Add: Personal vehicle expenses, $8,000
• Add: Depreciation, $15,000
• Add: One-time equipment repair, $7,000
• SDE: $212,000

That’s a dramatically different number, and it’s the number a buyer will use to evaluate what your business is worth.

Recasting: How Your Tax Return Becomes SDE

Recasting, also called normalizing, is the work of turning the profit on your tax return into SDE. Your return is built to keep taxes low, which is legal and normal. A buyer needs to see what the business earns for one full-time owner, so every legitimate add-back has to be identified, explained, and backed up.

I prepare a recast for every seller before a business goes to market, because buyers, their CPAs, and their lenders will rebuild your numbers on their own. A recast never changes your filed returns; it explains them, and your CPA should review it before it goes to a buyer.

Normalizing Works in Both Directions

Most owners only think about add-backs, but a recast also subtracts costs a buyer will face that you don’t carry today:

• Related-party rent: if you lease the building from your own real estate entity, rent is adjusted to market. Rent above market is added back; rent below market is deducted, because the buyer will sign a real lease.
• Family payroll: a relative paid more than the job is worth creates an add-back for the difference. A spouse or child who works for little or nothing creates a deduction for the cost of replacing them.
• A second job you do: SDE assumes one owner. If you also work full time as the bookkeeper or lead technician, the cost of hiring for that second role comes out.

Build an Add-Back Schedule You Can Defend

Every adjustment belongs on a schedule that shows the year, the amount, what it was, and where the proof is: general ledger detail, an invoice or receipt, a bank or card statement, and the tax return line it sits in. A personal expense should be one the business won’t need to keep running. A one-time expense shouldn’t show up again the next year.

Two kinds of add-backs rarely survive. The first is cash sales that never made it into the books, because buyers and lenders can only rely on income you reported. The second is a “one-time” cost that appears every year.

What Buyers and SBA Lenders Accept

Many buyers finance with an SBA 7(a) loan, and SBA rules shape how your add-backs are treated. Under the SBA’s current lending procedures (SOP 50 10 8.1), the lender:

• Verifies the business’s tax returns against IRS tax transcripts, so the starting point is always the return you filed
• Must justify each adjustment or add-back in its credit memo, and adjustments without that supporting analysis don’t count toward the loan’s cash flow test
• Relies on a business valuation prepared for the lender, not one prepared for you or the buyer, and checks the financial data behind it against your IRS transcripts
• On acquisitions priced at $3 million or more, also requires a quality of earnings report that reconciles bank statements to the income statement and tax returns

The same rules require the buyer’s own pay to cover their living expenses, so lenders account for a salary the new owner can live on before deciding whether the business can carry the debt. An add-back the lender rejects shrinks the loan a buyer can get, and that usually shows up in the price.

If your books need work first, start with my guide to cleaning up your financials before a sale, and read how a quality of earnings report works if your deal is headed that way.

Where Your Pay Shows Up Depends on Your Entity

Owner pay is usually the biggest add-back, but where it sits on your return depends on how the business is set up. Getting this wrong is an easy way to overstate SDE.

Sole Proprietors and Single-Member LLCs Filing Schedule C

On a Schedule C you can’t deduct pay to yourself as wages, and your own health insurance and retirement contributions are deducted on your personal return, not on Schedule C. That means your Schedule C net profit already includes your compensation. There’s no owner salary to add back, and adding one anyway counts the same dollars twice.

S Corporations

An S corporation has to pay a working shareholder reasonable compensation as wages before taking distributions, and those wages are an expense on the corporate return. Your wages, the employer’s share of payroll taxes on them, and health insurance the company pays for you are the usual add-backs. Distributions are not an expense, so they’re already inside the profit and never get added back.

Partnerships and Multi-Member LLCs

Partners aren’t paid wages. A working partner’s fixed payments for services are guaranteed payments, which the partnership deducts as a business expense, so the working owner’s guaranteed payments are added back the way a salary would be.

Two Working Owners, One Add-Back

SDE assumes one full-time owner. If you and a partner both work in the business, only one owner’s pay is added back. The other role stays in as an expense at what it would cost to hire someone for that job, because one buyer can’t do both.

How SDE Is Used in Valuation

Buyers and lenders look at SDE together with what makes it more or less reliable: how steady it has been over three years, how much depends on you, customer concentration, the lease, and the condition of equipment. Two businesses with the same SDE can sell for very different prices for those reasons.

Why This Number Matters

SDE is the foundation of any business valuation for a small to mid-sized company. Getting it wrong, either too low or too high, leads to problems. Too low, and you leave money on the table. Too high, and buyers (or their lenders) can’t verify the number and the deal falls through.

That’s why it’s important to work with a professional who can help you accurately calculate your SDE and build a well-documented add-back schedule that buyers and lenders can verify.

Why the Trend Matters as Much as the Number

Buyers don’t price off one good year. Show SDE for each of the last three years and the trailing twelve months side by side, because that’s how buyers and their lenders will read it. If the most recent year is lower, have the reason documented before anyone asks.

SBA lenders make the trend concrete. Under SOP 50 10 8.1, the lender tests whether the business can cover the buyer’s debt using either the most recent fiscal year or an average of the last two, and it can’t rely on the buyer’s projections to pass that test. A strong year three years ago won’t carry a weak last year. My article on how SBA loans affect your sale covers the rest of the lender’s review.

Depreciation Isn’t Free Money

Depreciation is added back because it’s a non-cash expense, but equipment still wears out. If trucks, ovens, or machines will need replacing soon, expect buyers to account for that cost; SBA rules list unfunded capital expenditures among the cash flow adjustments a lender can make. A record of maintenance and replacements helps that add-back hold up.

If you’d rather hear it explained, watch my video on SDE and add-backs.

Frequently Asked Questions

What is the difference between SDE and EBITDA?

SDE adds back the full pay and benefits of one working owner, so it fits businesses where the buyer will run the company day to day. EBITDA assumes a paid manager is already in place and does not add back that salary, which is why it is used more for larger companies. Which measure fits depends on who the likely buyer is.

Can I add back cash income I didn't report?

No. Buyers rely on the income you reported, and SBA lenders verify tax returns against IRS transcripts. If you want credit for revenue when you sell, it needs to be on your books and your returns, ideally for several years before you list.

How many years of financials will buyers review?

Plan on at least three years of tax returns and profit and loss statements, plus the current year to date. SBA lenders base their analysis on the three most recent year-end statements and compare the latest interim period with the same period a year earlier.

Are S corporation distributions added back to SDE?

No. Distributions aren’t an expense on an S corporation’s return, so they’re already included in the profit you start from. The owner’s wages, the employer payroll taxes on them, and owner benefits the company pays are the add-backs. Adding back distributions would count the same money twice.

I file a Schedule C. Do I add back my owner draws?

No. Draws aren’t deducted on Schedule C, so your net profit already includes them. You can still add back documented personal expenses, depreciation, interest, and true one-time costs that ran through the business.

Does SDE account for the buyer's loan payments?

No. SDE is measured before any acquisition debt, because every buyer finances the purchase differently. Buyers and lenders subtract the new loan payments and a living salary for the new owner to see whether the deal works, which is why a well-supported SDE matters for financing.

Find Out Your SDE Estimate

Curious what your SDE might look like? Start with my free business valuation calculator for a realistic estimate of your business’s market value. Or request a free, confidential valuation or call (904) 789-1276, and we can walk through your actual numbers together.

When business owners start thinking about selling, the first question is almost always: How much is my business worth?

It sounds simple enough. But business valuation is more nuanced than most owners expect. The answer depends on your industry, your financials, your growth trajectory, and what buyers in your market are currently willing to pay. Let’s break it down in plain language.

What a Valuation Actually Measures

A valuation estimates what a ready, informed buyer would pay and a ready, informed seller would accept, with neither one forced into the deal. It is not a measure of the years you’ve put in, the money you’ve invested, or the number you need to retire. Buyers pay for future cash flow and for how confident they are that it will keep coming after you leave.

That’s why two owners with the same sales can get very different answers. Revenue tells a buyer how big the business is. Earnings, and the risk attached to them, tell the buyer what it’s worth.

Why Your Number Matters Even If You Aren’t Selling

Most owners ask this question only when they’re ready to sell, and by then it’s late. Knowing your value two or three years ahead shows you what is holding the price down while there’s still time to fix it: owner dependence, a concentrated customer list, messy books, or a short lease.

A current number also helps with decisions that have nothing to do with selling. Bringing in a partner, setting the price in a buy-sell agreement, planning your estate, or deciding whether to open a second location all go better when you know what the business is worth today. And if a competitor calls with an offer, you’ll know whether it’s serious.

The Starting Point: Seller’s Discretionary Earnings

For small to mid-sized businesses, which covers most businesses in Florida, valuation typically starts with Seller’s Discretionary Earnings, or SDE. This is the total financial benefit an owner-operator receives from running the business each year.

SDE adds back to net profit: your owner salary, personal expenses run through the business, depreciation, amortization, interest, and any one-time costs that won’t continue after the sale. In short, it reflects the real earning power of the business under your ownership.

Once you have your SDE, the price depends on how confident a buyer is that those earnings will continue. That judgment is shaped by several factors:

• Industry: Service businesses, retail, restaurants, and healthcare all have their own typical ranges
• Business size: Larger businesses generally draw more buyers and stronger pricing
• Revenue stability: Recurring revenue and long-term contracts significantly increase value
• Transferability: Can the business run without you? The more it can, the more it’s worth

For most main street businesses in Florida, this is where quality shows up: two businesses generating the same $200,000 in SDE can sell for very different prices depending on quality, industry, and current market conditions.

How I Recast Your Financials

SDE starts with your tax returns and profit and loss statements, then adjusts them so a buyer can see what the business really earns. This is called recasting, and I work through it in this order:

1. Gather three years of tax returns and profit and loss statements, plus the current year to date.
2. List everything the business pays for you: salary, payroll taxes on that salary, health insurance, retirement contributions, and any vehicle or phone it covers.
3. Identify true one-time costs, such as a lawsuit settlement or the cost of moving locations, and keep the paperwork that proves each one.
4. Remove personal expenses that ran through the business, with statements showing they were personal.
5. Tie the final numbers back to your bank deposits and tax returns.

Buyers accept add-backs they can verify. They push back on cash sales that never reached the books, “one-time” costs that show up every year, and claims that a new owner could simply raise prices. If the buyer finances with an SBA 7(a) loan, the lender must check the seller’s financial information against IRS tax transcripts, so income that isn’t on your returns generally can’t support your price. My guide to seller’s discretionary earnings has more examples.

Larger Businesses: EBITDA

As a business grows and a management team takes over the owner’s role, buyers often shift to EBITDA, Earnings Before Interest, Taxes, Depreciation, and Amortization. This metric looks at the business as a more independent entity, separate from what the owner pays themselves.

These larger deals tend to attract private equity groups and strategic buyers who compete for strong businesses, which supports stronger pricing.

What Pushes Your Value Up

• Consistent year-over-year revenue growth
• A diversified customer base, with no single client driving a large share of revenue
• Documented processes and systems that reduce owner dependency
• Recurring revenue or long-term service contracts
• A strong online reputation and positive customer reviews
• Clean, well-organized financial records going back at least three years
• A stable, trained team that would likely stay after the sale

What Brings Your Value Down

• Heavy owner dependency, revenue that exists because of your personal relationships
• Customer concentration risk
• Inconsistent or declining revenue trends
• Disorganized financials or personal expenses mixed with business ones
• A short remaining lease term with no guaranteed renewal
• Deferred maintenance or aging equipment that needs replacement

Other Valuation Approaches

Beyond earnings-based methods, appraisers and brokers also look at comparable sales and at the value of the assets. The right approach depends on your situation, and I can walk you through which method fits your business.

Comparable Sales

Brokers and appraisers use databases of closed small business sales. I look for deals in the same industry, at a similar size, and as recent as possible, then see how buyers priced businesses with similar earnings, growth, and risk. Comparable sales keep a valuation tied to what buyers actually paid, not what sellers hoped for. The limit is that every deal has its own terms, so the data is a guide, not an answer.

Future Earnings

The income approach asks what the business’s future cash flow is worth today, after accounting for risk. A steady business with loyal customers and a team that runs without you gets more credit for its future earnings than one that depends on you or on a single contract. Credentialed appraisers often use this method alongside comparable sales.

Assets as a Floor

When earnings are thin, value falls back to what the assets would bring: equipment, vehicles, inventory, and sometimes the customer list. A profitable business is worth more than its assets because the buyer is paying for the earnings those assets produce. If your earnings barely cover a fair wage for running the business, expect buyers to focus on the assets.

What the Price Usually Includes

Most main street sales in Florida are asset sales. The price usually covers the equipment, furniture, fixtures, business name, phone numbers, website, customer lists, and goodwill. Cash and accounts receivable typically stay with the seller, and the seller pays off business debts at closing. Inventory is often counted near closing and added to the price at cost.

Real estate is appraised separately from the business. Terms matter as much as the headline number, too. A price paid partly over time through seller financing, or tied to future results, is worth less to you than the same price in cash at closing, and buyers know it.

Why the Buyer’s Lender Tests Your Price

Many buyers finance with an SBA 7(a) loan, and the lender doesn’t take your asking price on faith. Under SBA’s current lending rules, the business valuation must be ordered by and prepared for the lender, not the buyer or the seller. When the purchase price is above $350,000, it must come from an independent appraiser who holds a recognized business valuation credential.

If the price is higher than that valuation supports, the difference has to be covered by the buyer’s own cash, not by more borrowing. In practice, an overpriced business either loses its buyer or gets renegotiated late in the deal. Pricing to a value you can defend from the start avoids both. I explain the rest of the lender’s review in how SBA loans affect your sale.

Valuing a Business in St. Augustine and Northeast Florida

Local conditions show up in the numbers. Many St. Augustine and Northeast Florida businesses have a seasonal rhythm tied to visitors, beach traffic, or part-year residents, so buyers study the trailing twelve months and how much cash the business keeps through the slow months. A strong season helps only if it carries the quiet ones.

Location and lease carry real weight here. A good spot with a long lease and renewal options is part of what a buyer is paying for, and so is a strong review profile in a market where many customers find you online first. For coastal locations, buyers and lenders will also ask about flood zones and insurance costs. My guide to selling a seasonal business in Northeast Florida covers how to present those swings.

Mistakes That Distort an Owner’s Number

• Pricing to what you need for retirement instead of what the business earns.
• Counting effort and years invested as value. Buyers pay for earnings that will transfer to them.
• Listing high to leave room to negotiate. Overpriced listings sit, and buyers start to wonder what’s wrong.
• Treating an online calculator result as the final answer. It’s a starting range, and it can’t read your lease, your customer list, or your books.
• Waiting until burnout or a health problem forces the sale, when there’s no time left to fix what’s holding value down.

Frequently Asked Questions

What is the difference between revenue and SDE?

Revenue is everything the business takes in. SDE is what is left for one full-time owner after normal operating costs, with your own pay, benefits, and verified personal or one-time expenses added back. Buyers and lenders price a business on earnings, not revenue, so two businesses with the same sales can be worth very different amounts.

Do I need a certified appraisal to sell my business?

Usually not to list it. A broker’s opinion of value based on your financials and comparable sales is the normal starting point for a main street sale. If your buyer uses an SBA loan, the lender orders its own valuation, and situations like estate planning, gifting shares, divorce, or a partner dispute often call for a credentialed appraiser. Confirm with your CPA or attorney what your situation requires.

What documents do I need for a business valuation?

Start with three years of business tax returns and profit and loss statements, a current year-to-date statement, and a balance sheet. Add your lease, a list of major equipment with its condition, payroll by position, and a short note on any personal or one-time expenses the business paid. The cleaner the package, the faster and more accurate the valuation.

How often should I update my business valuation?

Once a year is a good habit if you are within five years of selling, and any time something big changes, such as losing a major customer, signing a new lease, or adding a manager. Value moves with your earnings and your risk, so an old number can mislead you.

Can I find out what my business is worth without anyone knowing?

Yes. My valuations are confidential, and getting one doesn’t commit you to selling. Your employees, customers, and competitors don’t need to know you asked.

Find Out What Your Business Is Worth

You don’t have to guess. Use our free business valuation calculator to get a quick estimate based on your actual numbers. Or if you’d like a deeper analysis of your specific business, reach out for a free consultation. Knowing your number is the foundation of any smart exit plan.