What the business really pays its owner

Why the tax return understates the business

A well-run small business is managed to show as little taxable profit as legally possible: the owner takes a salary, the truck and the phone run through the books, equipment depreciates, the acquisition loan charges interest. None of that money is gone — most of it is going to the owner, one way or another — but the bottom line hides it. Seller's discretionary earnings reverses the disguise. It answers the question a buyer, a broker and an SBA lender all actually have: if one working owner ran this business, what would it pay them in total? That is the number main-street businesses are priced on.

How the number is built

Start with pre-tax net income — a loss is allowed, and the add-backs often turn it positive, which is precisely the point. Add back one working owner's full cost: salary, payroll taxes, benefits. Add interest, because the buyer arrives with their own financing; depreciation and amortization, because they are accounting entries rather than cash; genuinely one-time expenses, because the buyer will not repeat them; and the personal spending the business absorbed, because the buyer will not inherit it. The total is SDE, and the margin — SDE over revenue — is the fast health read: main-street service businesses commonly run 10–25%, and a margin far outside the industry's norm invites the diligence that finds out why.

Where SDE ends and EBITDA begins

SDE assumes the buyer is the manager; EBITDA assumes the buyer hires one. Add back a single owner's compensation and you have SDE; instead deduct a market salary for the general manager the business requires and you have adjusted EBITDA. The crossover matters because multiples are quoted per basis — SDE multiples for owner-operator businesses, EBITDA multiples once management stays with the company — and pricing one basis on the other's multiple misvalues the business by roughly the owner's pay times the multiple. If a second family member works unpaid or underpaid, the honest SDE charges their replacement cost before anything is added back.

Common mistakes

Add-backs fail diligence in predictable ways. "One-time" expenses that appear every year are operating costs wearing a costume. Two owners' salaries added back with no replacement cost for the second pair of hands overstates SDE by a full wage. Rent below market — usually because the seller owns the building — flatters earnings that a buyer paying real rent will never see; adjust to market rent, and value the building separately as the real estate it is. And every add-back needs paper: the buyer's accountant will rebuild this exact schedule from the general ledger, so a figure you cannot document is a figure the deal will lose. When the business and its premises are both yours, an honest schedule of each — the company here, the property on a Schedule of Real Estate Owned — is what keeps the two values from blurring into one optimistic number.

Once the SDE is honest, pricing it is one multiplication away — the business valuation calculator turns this page's answer into a value range at the multiples businesses like yours actually trade at.