What You Need to Know About the Multiple Of Seller Discretionary Earnings

Understanding seller discretionary earnings is extremely important when you are listing a website or an e-commerce business for sale.

Here at Website Closers, we have extensive experience helping you to determine the most appropriate valuation methodology so that you can charge the maximum multiple and receive a high profit from selling your company.  Many e-commerce business valuations will look at the historical earnings of the business.  This is known as the net profit of the company for a minimum of the previous 12 months. From that point, once the number is obtained, a multiplier is applied. Some calculations can put the multiplier as high as five to determine the company’s valuation.

What Does SDE Stand For?

SDE simply stands for Seller’s Discretionary Earnings.

Understanding Seller Discretionary Earnings

Seller’s discretionary earnings (SDE) represent a business’s profitability and are commonly used to assess the cash flow when valuing small businesses. It provides a standard way for buyers to evaluate and compare different companies.

How to Calculate SDE

SDE is calculated by taking the following:

• Pre-tax net income
   
• Adding compensation paid to all owners, minus the cost of replacing any additional owners
   
• Adding interest expenses
   
• Adding depreciation and amortization
   
• Including discretionary expenses like vehicle costs, smartphones, meals, entertainment, and travel
   
• Accounting for adjustments related to extraordinary or non-operating items, as well as one-time revenues or expenses, such as lawsuits or natural disasters.

SDE Multiple

The SDE multiple is used to estimate the worth of a small business through the seller’s discretionary earnings. Valuation professionals examine the SDE multiples through a comparable companies analysis to establish a reliable value range for the business being appraised.

The Role of the Multiple of SDE in Business Valuation

Each business size typically corresponds to a standard range of SDE multiples. However, some companies may not fit within these averages, either exceeding or falling below the norm.

Because businesses often deviate from these typical ranges, your broker needs to have a deep understanding of your specific company and choose the proper multiple of earnings valuation method. Accurate valuation requires a thorough review of your financials and detailed knowledge of your operations.

Multiple of SDE vs. Other Valuation Methods

SDE and EBITDA

The multiple of earnings methods, EBITDA and SDE, are different largely by one factor. SDE business valuation includes the owner’s salary and personal expenses, while EBITDA does not. Since SDE, often called “Owner Benefit,” accounts for these additional items, it generally results in a higher figure compared to EBITDA.

EBITDA, another multiple earnings approach, offers buyers and investors a way to evaluate the financial performance of various companies by excluding non-operational factors.

In contrast, SDE valuation includes the owner’s discretionary spending, providing a fuller view of the financial benefits the business generates. This measure reflects not only the company’s profits but also the owner’s salary, perks, and personal expenses tied to the business. SDE is especially relevant for small businesses where the owner’s financial involvement is critical to the company’s success.

Recognizing the difference between each multiple of earnings approach is essential for accurately valuing small businesses. While EBITDA is an earnings multiple valuation often used for larger firms, SDE gives a broader perspective of a small business’s financial health. Accounting for discretionary expenses captures the complete financial benefit the business offers its owner.

For those selling a small business, SDE gives buyers a clear insight into the cash flow they can expect, considering the owner’s compensation and personal expenses. This is particularly important for small businesses, where the owner’s role is closely linked to the overall performance.

Practical Applications of the Multiple of SDE

• Seller’s discretionary earnings (SDE) serve as a general guideline for estimating a business’s cash flow. It helps buyers make straightforward comparisons between businesses, regardless of industry.
   
• SDE offers an estimate of free cash flow, representing the amount available for covering interest, debt payments, or reinvesting in the business, such as purchasing new equipment. Once the SDE is determined, buyers assess additional factors like growth rate, margins, and customer concentration, along with other financial and operational metrics.
   
• As an initial measure of earnings, SDE helps buyers gauge a company’s financial performance when considering it for acquisition. It provides a starting point in determining whether the business is worth further investigation.
   
• SDE is also used in various valuation methods, including income-based and market-based approaches. It plays a key role in comparing earnings multiples valuation of similar businesses that have been sold, providing context for determining business value.

How We Can Help

Choosing a multiple that both you and your potential buyer agree upon can be tricky. Your business may have distinct qualities that don’t neatly fit into a typical industry category. 

At Website Closers, we sit down with you to explain how the valuation process works, as well as what you can anticipate when we help you sell your company. Every business broker on our team believes that you should be kept informed about proper valuation methodologies.

Understanding how all of these different factors can contribute to the amount of money you charge when selling your business is extremely helpful and can give you a lot of peace of mind.  Our online business brokers work hard from the moment you contact us to help explain to you what you can anticipate so that you can make an informed decision about what to do next.