Encyclopedia
Seller's discretionary earnings (SDE)
A small business's earnings before owner's compensation and certain items, used to value owner-run businesses.
For example: A buyer verifies SDE adjustments with tax returns. (Illustration only, not a real deal.)
This is a general industry term with no single official definition. Your lease or contract wording controls.
Example only, not a real client. Say you are looking at buying a small owner-run shop. The seller’s discretionary earnings add back the owner’s salary and personal expenses to show what the business really earns for one owner. You use that to judge whether the price makes sense for you.
What I’d tell a friend
Check what has been added back in SDE. Each add-back should be supported by records.
Why it matters to you
Many small businesses are priced as a multiple of SDE, so every add-back moves the price. Buyers will want proof for each one, so keep the records that back them up.
How to use it in your deal
Sellers should prepare a clean SDE schedule tied to tax returns, with each add-back explained and documented. Expect buyers to challenge vague add-backs like "travel". If you own the building and charge your business below-market rent, adjust to market rent so the figure is honest; buyers will.
Buyers should verify SDE against tax returns, bank deposits and sales records, then subtract what you'd need to pay yourself or a manager, plus capital spending. Compare the price with SDE and with what lenders will finance. Lenders look at debt coverage on the adjusted figure. Landlords may ask for SDE or similar data when assessing a new tenant buying an existing business.
Ask for tax returns, not just the seller's summary. Ask for tax returns that match the SDE number before you rely on it.
Mistakes I see
Counting add-backs that aren't real. Ignoring rent adjustments. Treating SDE as free cash. Not adjusting for the buyer's own salary.
In BC and Vancouver
SDE is an industry measure. Taxes follow federal rules; consider advice on asset or share sale structure.
The Canada Revenue Agency (CRA) handles federal tax. Official sources: Income Tax Act (Justice Laws) · CRA Guide T4037: Capital gains
What it is
Seller’s discretionary earnings is a measure of profit for small businesses that adds back the owner’s pay, perks and one-time costs.
It is often used to value businesses with one owner-operator.
What to check
Ask for records to support each add-back.
Remember you may need to pay a manager if you will not run it yourself, which reduces the earnings available to you.
Have your accountant review the figures before you remove subjects.
Challenge the add-backs
Treat every add-back as a claim. Owner salary, one-time repairs, personal travel and family wages on the books all need records. After a big change in the business, use a run-rate for what it earns now, not only last year’s total.
Your accountant should rebuild seller’s discretionary earnings from tax returns and deposits. The multiple only means something if the base number is honest.
Questions to ask before you sign
- What add-backs are included?
- Can they be proven?
- Is rent at market?
- What must I pay myself?
- What capital spending is needed?
Keep reading
Related terms: earnings before interest, taxes, depreciation and amortisation (EBITDA), Goodwill
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General information for British Columbia only. It isn’t legal, tax, accounting or financial advice, laws and rates change, and reading it doesn’t make you my client. Any numbers or scenarios are hypothetical. Check the linked official source and talk to a lawyer, accountant or other qualified professional before you act or sign anything. See the terms and disclaimer.