--- title: "Seller's discretionary earnings (SDE) | Ledgerbrook" source: https://ledgerbrook.com/blog/seller-discretionary-earnings/ description: "Seller's discretionary earnings: the SDE formula from your P&L, add-backs buyers accept, and how messy books cut the price." --- [Blogs](/blog/) # Seller's discretionary earnings (SDE) ![](/_astro/omkar-moraye.BHiWb4KG_xH3b5.webp) [Omkar Moraye](/about/) · November 2, 2026 [](https://www.linkedin.com/sharing/share-offsite/?url=https%3A%2F%2Fledgerbrook.com%2Fblog%2Fseller-discretionary-earnings%2F%3Futm_source%3Dlinkedin%26utm_medium%3Dsocial%26utm_campaign%3Dshare)[](https://x.com/intent/post?url=https%3A%2F%2Fledgerbrook.com%2Fblog%2Fseller-discretionary-earnings%2F%3Futm_source%3Dx%26utm_medium%3Dsocial%26utm_campaign%3Dshare&text=Seller's%20discretionary%20earnings%20\(SDE\))[](https://www.facebook.com/sharer/sharer.php?u=https%3A%2F%2Fledgerbrook.com%2Fblog%2Fseller-discretionary-earnings%2F%3Futm_source%3Dfacebook%26utm_medium%3Dsocial%26utm_campaign%3Dshare)[](mailto:?subject=Seller's%20discretionary%20earnings%20\(SDE\)&body=Seller's%20discretionary%20earnings%20\(SDE\)%0A%0Ahttps%3A%2F%2Fledgerbrook.com%2Fblog%2Fseller-discretionary-earnings%2F%3Futm_source%3Demail%26utm_medium%3Dsocial%26utm_campaign%3Dshare) ## What is seller's discretionary earnings? Seller's discretionary earnings is the total yearly benefit one owner-operator gets from a business: net profit plus that owner's salary and benefits, interest, depreciation, and personal or one-time costs. Main Street businesses sold at a median 2.0 to 3.1 times SDE in mid-2026, so every add-back must be provable from the books. Seller’s discretionary earnings is the number a small business is priced on, and it is built from the bookkeeping. An owner who plans to sell in a year or three usually hears it first from a broker: “your SDE is about $300,000, and businesses like yours go for two and a half to three times that.” What the broker does not say is that the buyer, the buyer’s lender and possibly an accountant hired by the lender will rebuild that figure from the profit and loss, the tax returns and the bank statements, and every dollar they cannot prove comes off the price at the same multiple. This post works through one SDE calculation from a sample profit and loss, with the evidence a buyer asks for behind each add-back. Then what SBA lending rules require of the seller’s numbers, as of the SBA’s October 2026 rules, and what in the books lowers SDE during due diligence. It is about the bookkeeping behind the number. It is not valuation advice; a broker or a credentialed business appraiser prices the business. ## What is seller’s discretionary earnings? Seller’s discretionary earnings (SDE) is the total financial benefit that one full-time owner-operator takes out of a business in a year. It starts with net profit and adds back the owner’s own pay and benefits, the costs that depend on how the current owner financed or accounts for the business (interest, depreciation and amortization), personal costs run through the business, and one-time costs that will not recur. The question it answers is the buyer’s: if I buy this business and run it myself, the way the seller does, how much cash does it produce for me before I pay for the loan I took to buy it? That is why it is used for owner-operated, Main Street businesses. The International Business Brokers Association’s Market Pulse survey prices deals under $2 million as a multiple of SDE, and deals above that as a multiple of EBITDA ([IBBA and M&A Source Market Pulse, Q2 2026 highlights](https://www.ibba.org/wp-content/uploads/2026/08/mp-highlights-q2-2026.pdf)). ## The seller’s discretionary earnings formula > **SDE** = Net income before income tax + One owner’s salary, payroll taxes and benefits + Interest + Depreciation and amortization + Personal expenses run through the business + One-time expenses − One-time income Three parts of it trip people up: - **One owner, not every owner.** SDE adds back the compensation of one working owner, the one a buyer will replace. If two partners both work in the business, the second one’s pay stays in as a cost, at what it would cost to hire someone to do that job. - **Income tax only where the business pays it.** An S corporation, partnership or LLC taxed as either usually pays no federal income tax itself, so its net income is already before income tax. A C corporation adds back its income tax expense. - **One-time works in both directions.** A one-time insurance payout or the gain on selling a truck is subtracted, for the same reason a one-time legal bill is added. ## A worked example: SDE from a sample P&L A residential HVAC service company, an S corporation with one owner who works in it full time, closed 2026 with this profit and loss on the accrual basis: | Line | 2026 | | --- | ---: | | Service revenue | 1,450,000 | | Equipment and materials | 520,000 | | Technician wages and payroll taxes | 310,000 | | **Gross profit** | **620,000** | | Owner’s salary | 90,000 | | Payroll taxes on owner’s salary | 6,885 | | Office wages | 68,000 | | Rent | 42,000 | | Vehicles | 54,000 | | Insurance | 38,000 | | Advertising | 31,000 | | Legal and professional | 19,000 | | Phones and software | 12,615 | | Utilities, supplies and other | 80,000 | | Depreciation | 22,000 | | Interest | 8,500 | | **Total operating expenses** | **472,000** | | **Net income** | **148,000** | The broker’s add-backs, and what each one has to be proven with: | Item | Amount | Where it is in the P&L | What a buyer’s diligence asks for | | --- | ---: | --- | --- | | Net income | 148,000 | Bottom line | The 2026 return (Form 1120-S), tying to this P&L | | Owner’s salary | 90,000 | Owner’s salary | W-2 and payroll reports for the owner | | Payroll taxes on that salary | 6,885 | Payroll taxes on owner’s salary | Payroll register: 7.65% of $90,000 | | Owner’s health insurance | 14,400 | Insurance | Premium invoices naming the owner and family, and the owner’s W-2, which must include them for an S corporation owner of more than 2% | | Depreciation | 22,000 | Depreciation | Fixed asset register and depreciation schedule tying to the return | | Interest | 8,500 | Interest | Loan statements, and confirmation the loan is paid off at closing | | Settlement of a former employee’s claim | 12,000 | Legal and professional | Settlement agreement and the legal invoices, showing it was one claim | | Owner’s personal vehicle | 6,200 | Vehicles | Lease and fuel card statements, mileage log showing no business use | | Family members’ phone lines | 1,800 | Phones and software | Carrier bill showing the lines and who uses them | | **SDE** | **309,785** | | | Add-backs total $161,785, and SDE is $309,785. On a P&L that shows $148,000 of profit, the owner-operator’s real yearly benefit is about twice that. That is the number a buyer prices, and every line in it has to survive the evidence column. One year is not enough. A broker usually builds this table for each of the last three years and the trailing 12 months, and a buyer looks at the trend before agreeing which figure, or which average, the multiple applies to. A year that jumps above the ones before it gets questioned, not paid for. Two of those add-backs deserve a note: - **Depreciation is added back, but the trucks still wear out.** A buyer who sees $22,000 a year of depreciation on a fleet of service vans knows they will need replacing. SBA lending rules list “unfunded capital expenditures” among the adjustments a lender can make to cash flow, and a buyer often argues the price down for them. - **Personal costs are added back only if they really were personal.** The $6,200 vehicle and $1,800 of phone lines are costs the business paid that a new owner will not. Whether they belonged in the tax return as business deductions is a separate question, and one the buyer may raise. Ask the CPA before listing them. ### SDE vs EBITDA vs net income The difference between the three is what each adds back. For the same company: | | Net income | EBITDA | SDE | | --- | ---: | ---: | ---: | | Starting point | 148,000 | 148,000 | 148,000 | | Interest, depreciation and amortization added back | No | 30,500 | 30,500 | | Income tax added back | Not applicable for an S corporation | Not applicable | Not applicable | | Personal and one-time costs added back | No | 20,000 if adjusted | 20,000 | | Owner’s salary, payroll taxes and health insurance added back | No | No; a market salary stays in as a cost | 111,285 | | **Result** | **148,000** | **178,500, or 198,500 adjusted** | **309,785** | EBITDA treats the business as something an owner holds while paying a manager to run it, so the manager’s salary stays in as a cost. SDE treats it as a job plus a return: the buyer is also the manager. That is why EBITDA is used for larger companies with a management team, and SDE for businesses the owner runs day to day. The gap between them in this example is the owner’s $111,285 of salary, payroll taxes and health insurance. Would your books survive a buyer rebuilding your SDE from the bank statements? That is a cleanup, not a one-off fix: $99 per month of backlog (20% off 6+ months), one fixed price agreed before any work starts. [Send the file for a free 48-hour review](/contact/?from=blog%2Fseller-discretionary-earnings). ## How much is a business worth that makes $300,000 a year? First, which $300,000. If it is revenue, there is no answer without the expenses. If it is net income, the SDE is higher once the owner’s pay is added back. If it is SDE, the median multiples give a starting range. In the IBBA and M&A Source Market Pulse survey for the second quarter of 2026, published in August 2026, the median multiples of SDE by deal size were: | Purchase price | Median multiple, Q2 2026 | Q2 2025 | | --- | ---: | ---: | | Under $500,000 | 2.0 × SDE | 2.3 × SDE | | $500,000 to $1 million | 2.8 × SDE | 2.8 × SDE | | $1 million to $2 million | 3.1 × SDE | 3.0 × SDE | | $2 million to $5 million | 4.0 × EBITDA | 3.9 × EBITDA | At the 2.8 median for its size band, the example company’s $309,785 of SDE points to a price of about $867,000. Medians are the middle of a wide spread. Industry, how much of the revenue repeats, customer concentration, how dependent the business is on the owner, and the condition of the books all move a business above or below them. A broker’s opinion of value or a formal valuation sets the asking price; the multiple only shows what is at stake in the number it multiplies. What is at stake is easy to see. If a buyer rejects $20,000 of the add-backs because the evidence is not there, SDE drops to $289,785, and at 2.8 the price falls by $56,000. ## What lenders verify: SBA rules for buying a business Many buyers of a business this size borrow through an SBA 7(a) loan, so the SBA’s rules for lenders decide how hard the seller’s numbers are tested. They are in [SOP 50 10 8.1](https://legacy.sba.gov/document/sop-50-10-lender-development-company-loan-programs), effective October 1, 2026, with the rules for buying a business in Appendix 15, “7(a) Changes of Ownership.” - **Three years of history.** The lender’s analysis of the business being bought “must be based on the three most recent year-end historical financial information using the highest level of financial reporting available,” in the order audited, reviewed, CPA-compiled, then tax returns, plus the latest interim statement and the same period a year earlier. - **The seller’s numbers are checked against the IRS.** For a change of ownership, the lender “must verify the seller’s financial data, including a selling sole proprietor’s Schedule C,” using IRS tax transcripts. The financial information the business valuation relied on is also verified against the seller’s transcripts. - **An independent valuation.** Every SBA-financed purchase of a business needs a business valuation prepared for the lender by an accredited appraiser. If the price is above the valuation, the buyer covers the difference with equity. - **A quality of earnings report at $3 million.** For a purchase price of $3 million or more by a new owner or an expanding business, the lender must also get a quality of earnings report. It reconciles the accountant-prepared statements, tax returns, internal statements and IRS transcripts, includes a cash proof that rebuilds receipts and payments from the bank statements for the trailing 12 months and the last two fiscal years, and must “identify and document all add-backs and adjustments to the seller’s reported earnings.” The lender then uses the report’s earnings, not the broker’s, to test repayment. - **Unsupported add-backs do not count.** The lender may adjust cash flow for items including “seller discretionary expenses” and owner compensation, but must explain in the credit memo why each adjustment is prudent and supportable. “Adjustments to cash flow without the Lender’s supporting analysis and justification will be ineligible.” The SBA measures repayment on EBITDA, not SDE: a new owner’s acquisition loan needs debt service coverage of at least 1.25 to 1, on historical EBITDA or on cash flow after the adjustments the lender has justified. The SDE add-backs still matter, because they are the adjustments a lender works from, and because the price the lender is financing was set on them. What lenders generally test a profit and loss against is in [a year-to-date P&L for a loan](/blog/year-to-date-profit-and-loss/). ## What lowers SDE in due diligence Buyers rarely argue with the formula. They argue with the evidence. These are the things in the books that turn an add-back into a negotiation: - **Personal spending mixed into business accounts.** Every add-back for a personal cost has to be found in the books, line by line. When personal and business spending run through the same card and are coded to the same accounts, the owner cannot show which $6,200 was personal, and the buyer will not take a round number on trust. [Commingling funds](/blog/commingling-funds/) covers how to separate them, and doing it a year before a sale gives a clean year to point to. - **Cash sales not in the books.** “There’s another $40,000 in cash jobs” is the add-back no buyer can accept. It is not in the tax return, the lender verifies the return through IRS transcripts, and a quality of earnings cash proof starts from the bank deposits. Income that was never reported cannot be counted, and claiming it creates a tax problem for the seller. - **Missing or unreconciled months.** A P&L with months not reconciled to the bank cannot be tied to anything. Buyers either discount the year or ask for the business to be valued on the tax returns alone, which carry none of the add-backs. - **Profit and loss that does not match the tax return.** Small differences need a written reconciliation. Large ones end the conversation until they are explained. - **Inventory that does not match the shelves.** An inventory balance that was never tied to a count overstates profit, and the buyer will count the stock before closing. The adjustment belongs in the books first, as in [writing off inventory](/blog/journal-entry-for-inventory-write-off/). - **Cash basis books with big timing swings.** A year that looks strong because December invoices were collected early, or bills were paid late, gets normalized. Accrual-basis books, or at least a clean year-end accrual of receivables and payables, make the year comparable to the one before it. - **Recurring costs labeled one-time.** A legal bill every year is not non-recurring. The buyer reads three years of the general ledger, and an add-back that shows up every year is an operating cost. ## How to prepare the books 1 to 3 years before a sale The three years a lender reviews are the three before the sale, so the work starts that early: 1. **Bring the books current and reconcile every month** of the last three years, including the current one. If the file is behind, that is a [catch-up](/quickbooks-catch-up-bookkeeping/); the [catch-up bookkeeping cost](/blog/catch-up-bookkeeping-cost/) post gives the per-month price. 2. **Stop running personal costs through the business,** or code each one to its own clearly named account so the add-back is a report, not a reconstruction. 3. **Keep a running add-back list,** with the evidence for each item filed as it happens: the settlement agreement, the one-time repair invoice, the owner’s insurance premiums. 4. **Make the books match the return,** and keep the reconciliation between them for each year. 5. **Tie inventory, receivables and payables to real balances** at each year end, so the balance sheet the buyer inherits is the one in the books. 6. **Close monthly from then on,** so the interim statements a lender asks for exist on the day the buyer’s diligence starts. ## Common questions about seller’s discretionary earnings ### Is SDE the same as profit? No. Profit, or net income, is what is left after every expense, including the owner’s salary. SDE adds back that salary, the owner’s benefits, interest, depreciation and amortization, and personal and one-time costs. For an owner-operated business, SDE is usually well above net income: in the example, $309,785 against $148,000. ### What is the difference between seller’s discretionary earnings and net income? Net income measures the business as a company. SDE measures the benefit to the one owner who runs it. The difference is the add-backs, and each of them needs evidence in the books for a buyer to accept it. ### Does SDE include the owner’s salary? Yes. SDE adds back one working owner’s salary, the employer payroll taxes on it, and owner benefits paid by the business, such as health insurance and retirement contributions. A second working owner’s pay is not added back, or is replaced with a market wage. ### Is the owner’s salary included in EBITDA? EBITDA keeps a salary for running the business as a cost, at market rate. If the owner pays themselves well above or below market, adjusted EBITDA changes their pay to the market figure; it does not remove it. ### Is a business worth 3 times profit? It depends which profit. The median Main Street sale in mid-2026 was 2.0 to 3.1 times SDE, depending on size, according to the IBBA survey above, and SDE is higher than net income. Three times net income is a different, and usually higher, price than three times SDE. ### What qualifies as an add-back? A cost the business paid that a new owner-operator will not pay, provable from the books and records: one owner’s pay and benefits, interest on debt the seller pays off at closing, depreciation and amortization, documented personal costs, and genuinely one-time expenses. Recurring operating costs, wages a replacement would need, and income that was never recorded do not qualify. ## When the books are not ready for a buyer The add-backs in this post depend on books that are current, reconciled, separate from the owner’s personal spending, and in agreement with the tax returns for three years. When they are not, the first step is a catch-up of the missing months and a cleanup of the coding, so the profit and loss a broker starts from is one the buyer’s lender can verify. Then a monthly close, so every month until the sale adds to the record instead of the backlog. $99per month of backlog20% off 6+ months > **When to hand this off:** if any of the last three years has months that are not reconciled to the bank, or personal and business spending share accounts, the add-backs cannot be proven yet. A [free file review](/contact/?from=blog%2Fseller-discretionary-earnings) shows how much of the record needs rebuilding before a broker sees it. 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[Add on Google](https://www.google.com/preferences/source?q=ledgerbrook.com) Continue Reading[All blogs →](/blog/) [ Previous BlogNovember 2, 2026 ### Journal entry for an inventory write-off Inventory write-off journal entry: debit cost of goods sold, credit Inventory Asset, plus write-downs and QuickBooks steps. Read previous post → ](/blog/journal-entry-for-inventory-write-off/)[ Next Blog November 3, 2026 ### Property management trust account bookkeeping Property management trust account bookkeeping: what goes in trust, the monthly three-way reconciliation, and fixing a gap. Read next post → ](/blog/property-management-trust-account/)