When talking about market values in general terms, you will hear a lot of references to “multiples” of EBITDA and SDE. Lookup a company for sale on the internet and you’ll see that SDE (Seller’s Discretionary Earnings) reference. What’s the difference? What do they mean? How do they relate to the multiple?
Both of these formulas are used by buyers* to approximate the cash flow without the specifics that are attached to the present owner’s situation. The Buyer applies their own tax situation their own way to calculate depreciation their own cost of money for interest, etc. Which of the two to use has a lot to do with the size of the company to start with. Adjusted EBITDA is usually used to estimate the market value of a company with revenues of $2-3 million and above. It is the figure most investors (Private Equity, Family Office, etc.) and large buyers will use. SDE assumes that an owner/operator will be buying the company, so that salary and expenses are left in the calculations (for one owner, not all owners.)
To get EBITDA – Earnings before Interest, Taxes, Depreciation and Amortization. Start with Earnings, (Net Income) and add Interest, Taxes, Depreciation and Amortization.
To get Adjusted EBITDA
Take the EBITDA number and add Owner Addbacks (excess expenses that may be run through the business as a result of the fact that it is a privately-owned company). This might include luxury autos, autos for kids, excess health insurance premiums, landscaping for family members travel expenses for family members, etc.) special consulting fees, charitable contributions and other similar expenses. These would also include one-time expenses. Depending on the buyer, some things will be accepted as add-backs and some will be up for debate.
To get Seller’s Discretionary Earnings
Begin with the Pre-Tax Net Profit which is the cash available. Assume the expenses of one working owner. Add non-cash items back to pre-tax net profit. Discretionary items that are personal benefits can be eliminated (like those listed in Adjusted EBITDA). Financing costs (interest) will be added back because the business’ earning power is independent of the business’ financing plan.
Business appraisers source relevant comparables to the seller’s business, compile all of that data and interpret that data. Usually, in the casual conversations we are talking about, you will hear multiples based on size, business type and mix (residential, commercial, maintenance, design-build, etc.), region and other business success factors.
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*and for some extra light reading for those interested in finance, there are a lot of brilliant discussions/writing out there about the wisdom of using this type of metric in the first place. But for our purposes, this is what you are most likely to hear.