EBITDA vs. SDE

Acquisition activity remains strong and we are getting more out of state, and even out of country, inquiries than in the most recent several years. I attribute this to the quality of our clients and the strength of the Colorado economy. As a result of this increased activity, we are looking to expand our administrative staff by adding either a full-time or part-time team member.  The candidate should have good communication skills, including social media.  If you know of someone that you think might be interested, please have them contact my Office Manager, Lynn Lage, at lynn@fbb.com.  Thank you.

We are often asked "What is SDE?" and "What is EBITDA?" by both buyers and sellers of businesses. In this month's article, I will attempt to explain the differences, and when those terms are typically applied.

SDE- Is an acronym for Seller's Discretionary Earnings, and is a metric for determining the historical cash flow of a business. It is a recasting process that starts with the net profit of a business, from either the business tax return or the yearend income statement. (We prefer to use the net profit from the tax return, as the tax return has typically been vetted by an accountant and most financing for a business that uses SDE as a metric is SBA guaranteed, which relies heavily on tax return calculations.) The owner's salary, owner's benefits, non-cash expenses, such as depreciation and amortization, and non-recurring expenses such as a move or litigation, are added back to the net profit to calculate the SDE. The SDE is usually used in smaller businesses, because many times the owners of those types of businesses aggressively expense a lot of personal benefits, such as use of automobiles and entertainment.

EBITDA - Is similar to SDE and is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization. Although the concept is similar to SDE, EBITDA calculations are typically used for larger businesses with more disciplined financial reporting. One of the big differences between the two is that, in EBITDA calculations, the manager's salary is not added back, whereas in SDE calculations, the manager's salary is added back with the assumption that the buyer is going to replace the seller as the owner/operator of the business. Private Equity Groups often use EBITDA calculations as a starting point in their initial cash flow assessments. They may also use EBIT (Earnings Before Interest and Taxes) as a metric. To complicate the process, we sometimes use an Adjusted EBITDA calculation as a hybrid method when the financials are fairly disciplined and the buyer is probably a financial buyer, such as a Private Equity Group, but the seller is taking a salary substantially hirer than the salary of a non-owner manager.

Regardless of the method used, buyers and lenders prefer, and will reward with a higher multiple of earnings, owners of businesses with fewer add backs.

Ronald V. Chernak
President

(originally published in May 2015 eNewsletter)