Seller's Discretionary Earnings (SDE)
Seller's Discretionary Earnings (SDE) is a pre-tax cash-flow metric measuring the total annual financial benefit one full-time owner-operator derives from a business: reported net income plus income taxes, interest, depreciation, amortization, that owner's entire compensation and benefits, and any discretionary or non-recurring expenses that would not continue under new ownership. SDE nets non-operating income and any related-party shortfall to market back out, and it is the basis most Main Street and lower-middle-market businesses are priced on, because their buyer is acquiring a job and a return on capital at once.
Also called Seller's Discretionary Cash Flow, SDCF, Discretionary Earnings, Owner Benefit, Adjusted Cash Flow · Last updated 2026-08-07 · All 24 terms
The SDE build-up, with real numbers
SDE starts at the bottom of the income statement and works upward. The business below is a distribution company taxed as an S corporation, so there is no entity-level income tax to add back; a C corporation would add its income tax expense back as well, which is what makes SDE a pre-tax measure.
Reported figures for the year: revenue $2,400,000; cost of goods sold $1,320,000; gross profit $1,080,000; operating expenses $900,000; operating income $180,000; interest expense $34,000; reported net income $146,000.
Inside that $900,000 of operating expense and that $34,000 of interest sit seven lines a buyer will not inherit in the same form:
- Owner's W-2 salary: $150,000
- Owner's payroll taxes, health insurance and retirement match: $28,000
- Depreciation, a non-cash charge: $65,000
- Interest expense on the seller's own debt, which will not transfer: $34,000
- Owner's personal vehicle lease and fuel: $9,600
- Family cell phone plan and a personal travel line: $6,400
- One-time settlement of an employment claim: $22,000
Total add-backs are $315,000. SDE = $146,000 reported net income + $315,000 = $461,000. Against $2,400,000 of revenue that is a 19.2 percent SDE margin.
Adjustments run in both directions. Non-operating income the buyer will not receive — interest earned on the owner's cash reserve, rent from an unrelated property parked inside the entity — is subtracted from SDE rather than added, for the same reason the owner's salary is added: the figure is meant to show what the business itself produces for its next owner. Related-party arrangements are repriced rather than added back, and they move SDE in whichever direction the owner set the terms. Where the business pays an owner-controlled entity below-market rent, normalized earnings fall by the shortfall to market, because the buyer will sign a lease at the market rate; where the rent is above market, only the excess comes back. See related-party transaction.
Note what did not move. Rent, insurance, wages for the four non-owner employees, freight and software all stayed in the expense base, because the buyer will pay every one of them next year. A recast removes costs that end at closing, not costs the seller wishes were smaller.
One owner, one salary
SDE compensates exactly one working owner. If two spouses both work full time and both draw $150,000, only one of those salaries is an add-back; the other is a real cost the buyer must replace with a hired employee. The logic runs the other way too: an owner who has been paying themselves $40,000 while working sixty hours a week gets an add-back of the $40,000 actually recorded, not a notional market salary.
This is the most common point of disagreement in a lower-middle-market recast, and it is worth settling in writing before the buyer's accountant finds it. The discriminating question is not who sits on the cap table. It is how many full-time roles the business would have to fill on the day after closing.
A related trap is the productive family member. A child on payroll at $45,000 who runs the warehouse is not an add-back at all unless the pay exceeds the market rate for that work, in which case only the excess qualifies.
How a buyer actually uses the number
A buyer does not spend SDE. A buyer spends what is left of SDE after taking a living wage, servicing acquisition debt and funding replacement capital expenditure. That last item matters because the depreciation added back into SDE stands in for real equipment that eventually wears out.
Run the $461,000 business through an illustrative SBA 7(a) acquisition structure. At a 3.0x multiple the price is $1,383,000. SBA requires a minimum 10 percent equity injection on a complete change of ownership, and up to half of that injection can be a seller note on full standby (see seller financing), leaving a loan of $1,244,700. Amortized over the 10-year maximum term SBA allows for a goodwill-heavy business acquisition, at an illustrative 10.5 percent, debt service is about $16,800 a month, or roughly $201,500 a year.
If the buyer draws a $120,000 market salary, $341,000 of the $461,000 remains to cover that debt service — a coverage ratio of about 1.7x. SBA's own credit standard in SOP 50 10 is a debt service coverage ratio of at least 1.15x; individual lenders commonly underwrite to 1.25x or higher. Rates, terms and coverage tests move, so treat the arithmetic as a worked illustration rather than current lending terms, and see dscr for how lenders construct the test.
On pricing, SDE-based Main Street and small lower-middle-market businesses were commonly quoted in a 1.5x to 4.0x band as of 2026, clustering between 2.0x and 3.0x, with the smallest and most owner-dependent businesses at the bottom and earnings quality, customer concentration and recurring revenue moving a specific deal within it. That band is orientation only; price against current comparable transaction data. See SDE multiple.
Other names, and where SDE stops
Brokers and appraisers use several labels for SDE: Seller's Discretionary Cash Flow (SDCF), Discretionary Earnings, Owner Benefit and Adjusted Cash Flow. Treat them as the same measure, but read the underlying schedule rather than the heading, because two documents carrying the same label can still differ on whether interest, a second owner's salary or a non-cash charge was included.
The real boundary is the manager-cost line. EBITDA is stated after whatever the business actually paid the person running it, and Adjusted EBITDA restates that pay to the fully loaded market cost of the role — salary, payroll taxes and benefits. SDE is stated before any owner pay at all. Converting between them is one subtraction: if a hired manager for the distribution company above would cost $120,000, its adjusted EBITDA is $341,000, and the $1,383,000 price that reads as 3.0x SDE reads as 4.1x EBITDA. Neither multiple is high or low until the basis behind it is named.
Buyers switch from SDE to EBITDA when the business runs without its owner, not at a fixed size. As a rough 2026 marker the switch tends to happen somewhere between $1,000,000 and $2,000,000 of normalized earnings, but a $700,000-SDE business with a full management team will be quoted on EBITDA and a $1,500,000-SDE business that depends on its founder will not.
Where this shows up in CastBack
CastBack computes SDE as reported net income plus every confirmed add-back, treats income tax as an add-back the broker confirms rather than one the engine applies automatically, and shows the full walk from reported net income through interest, depreciation and amortization, owner compensation and other add-backs in an SDE Bridge view. See how a recast is produced.