SDE vs. EBITDA: which valuation method fits your deal

Buyers, sellers, and brokers in the Canadian small business market use two earnings measures more than any others when discussing price: seller's discretionary earnings, usually shortened to SDE, and EBITDA. They measure similar underlying ideas, the cash flow a business generates before certain financing and accounting choices, but they are not interchangeable, and using the wrong one, or comparing a multiple calculated one way against a multiple calculated the other way, can make two businesses look more or less comparable than they actually are.

What each measure actually shows

Seller's discretionary earnings starts from a business's pre-tax profit and adds back interest, one owner's compensation and benefits, and discretionary or non-recurring expenses the current owner ran through the business. The idea is to show the total cash flow available to a single owner-operator who works full time in the business, which is why SDE is the measure most commonly used for smaller, owner-run businesses where the buyer is expected to step into the same operating role the seller currently fills. EBITDA, earnings before interest, tax, depreciation, and amortization, does not add back owner compensation in the same way, on the assumption that the business already pays, or would need to pay, a market wage to whoever runs it, whether that is the owner or a hired manager. That makes EBITDA the more common measure for larger businesses that already have a management layer in place, or for a buyer who plans to hire a manager rather than run the business personally.

Why the distinction matters

• A multiple applied to SDE is not directly comparable to a multiple applied to EBITDA for the same business, since the earnings base itself is calculated differently
• Small, owner-operated businesses are usually discussed in terms of an SDE multiple, while larger or management-run businesses are more often discussed in terms of an EBITDA multiple
• Which figure to use can shift as a business grows, particularly once it becomes large enough to reasonably support a manager who is not the owner
• Add-backs used to calculate either figure should be reasonable and well-documented, since aggressive or unsupported add-backs are one of the more common points of pushback during due diligence

There is no fixed revenue or profit threshold at which a business switches from being discussed in SDE terms to EBITDA terms, and brokers exercise judgment based on the specific business, including whether it already has a functioning management team that would stay on after a sale. For a buyer or seller working through a specific deal, the more useful question is usually not which label applies, but whether the add-backs behind whichever figure is being used are reasonable and can be supported with documentation, since that is what a buyer's lender and accountant will ultimately scrutinize. For buyers evaluating more than one business at a time, it can help to normalize everything to the same measure before comparing them, even if that means converting a stated EBITDA-based multiple to an approximate SDE-equivalent, or the reverse, for a smaller business, though that kind of conversion is imprecise and should be treated as directional only, useful for spotting which opportunities warrant a closer look rather than for ranking businesses precisely against one another.