SDE (Seller's Discretionary Earnings)
SDE (Seller's Discretionary Earnings) is the earnings metric that reflects what an SME generates for its owner-operator: reported profit plus the founder's salary, discretionary benefits, personal expenses charged to the business, and adjustments for non-recurring items. In small, founder-dependent businesses — retail, services, franchises — it is the standard valuation base instead of EBITDA, because the buyer assumes it will replace or normalize the seller's compensation. An SDE multiple is applied to estimate enterprise value in Main Street transactions and in owner-operator markets in Mexico.
How does SDE differ from EBITDA?
| Metric | What it measures | When it is used |
|---|---|---|
| SDE | Cash flow available to the owner-operator, including total compensation and discretionary adjustments. | Small SMEs, Main Street businesses, single founder-operator, informal accounting. |
| EBITDA / Normalized EBITDA | Operating profit before interest, taxes, depreciation, and amortization, with market compensation. | Companies with formal finances, management team, corporate structure, mid-market transactions. |
In a sale, the metric chosen defines the base for the multiple. An institutional buyer applies normalized EBITDA; a Main Street buyer or business broker works with SDE. Mixing metrics without converting the base creates misalignment in negotiation.
How is SDE calculated?
The typical calculation follows a bridge from net income (or reported EBITDA) to normalized SDE:
- Base line: Net income or EBITDA from the most recent full fiscal year (preferably a 2–3 year average).
- Additions: Owner-operator salary, bonuses, and benefits; personal expenses deducted (vehicle, travel, memberships); rent paid to owner entities above market; non-recurring items that reduced profit.
- Subtractions: Non-operating extraordinary income (asset sales, one-off grants, non-recurring revenue).
- Result: Normalized SDE — the figure on which the multiple is applied in valuation.
Each adjustment is documented and negotiated in due diligence, as in an EBITDA normalization.
When is SDE used to value an SME in Mexico?
SDE is standard in businesses with lower annual revenue, operations centralized in the founder, and finances that mix personal and business expenses: restaurants, workshops, solo consultancies, owner-operated franchises, retail stores. In these cases the buyer is not buying assets alone: it is buying a cash flow that depends on replacing the current operator.
When the company has auditable finances, a management team, and several non-operating shareholders, the market shifts to normalized EBITDA. The transition between metrics occurs in the revenue range where the operation ceases to be single-person; it is advisable to agree the base before receiving or issuing an LOI.
What do buyers and sellers ask about SDE?
- How does SDE differ from EBITDA?
- EBITDA measures operating profit before interest, taxes, depreciation, and amortization, assuming corporate structure and market-level compensation. SDE starts from net income or EBITDA and adds total owner-operator compensation, personal expenses deducted from the business, and discretionary adjustments. In SMEs where the founder mixes personal and business finances, SDE better captures the cash flow available to a buyer replacing the operator.
- How is SDE calculated in an SME?
- Start from net income (or EBITDA) and add: owner salary and bonuses, personal benefits paid by the company (car, insurance, memberships), deducted family expenses, rent paid to owner entities above market, and non-recurring items that reduced profit. Subtract non-operating extraordinary income. The result is normalized SDE — the figure on which the buyer applies a multiple.
- What SDE multiple is typical in Mexico?
- In Main Street businesses and founder-dependent SMEs, SDE multiples typically range from 2.0× to 4.0× depending on sector, customer concentration, owner dependence, and quality of records. Businesses with delegated operations, diversified revenue, and clean finances can reach higher ranges; those highly dependent on the founder or with informal accounting tend toward the low end. The multiple is negotiated in the LOI and validated in due diligence.
- When should SDE be used instead of EBITDA for valuation?
- When the business is small, the owner runs day-to-day operations, accounting mixes personal and business expenses, and there is no independent management team. In companies with formal finances, several non-operating shareholders, or mature corporate structure, the buyer will prefer normalized EBITDA. The metric chosen defines the multiple base and should be agreed before negotiating enterprise value.
In this glossary:
EBITDA — alternative metric in formal companies.
Normalized EBITDA — base in mid-market transactions.
EBITDA multiple — multiple logic applicable to SDE.
Business valuation — methods and valuation context.
LOI — where multiple and earnings base are set.
Sources
Choosing SDE or EBITDA as the valuation base defines the starting point of the entire negotiation; documenting each adjustment with support reduces friction in due diligence. To compare valuation methods applicable to SMEs in Mexico, see the valuation methods guide.
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