SDE vs EBITDA and How Much the Business Earns

SDE vs EBITDA and How Much the Business Earns

Posted on July 10, 2018
Whether you want to call it EBITDA, SDE or Seller Cash-Flow, everyone wants to get down to the brass tacks and find out, “how much money is the business generating?”  If there are verified tax returns why does the buyer, seller and banker have different numbers?

To answer thoroughly but not lose anyone in the details, there are many angles from every perspective.  EBITDA is as simple as NOI plus adding back the non-cash expenses of Amortization, Depreciation and Interest.  SDE is the sum of:  1)Business Profits, 2)Seller’s Personal Salary, 3)Non-Recurring Expenses, 4)Non-Cash Expenses and 5)Discretionary Expenses.  Examples of Non-Recurring Expenses are a new roof on a building, a machinery purchase, (some) new company vehicles or a new HVAC system.  Things the business owner expensed in one year to reduce tax burden and the expense won’t happen again.  Discretionary Expenses are life/health insurance policies, bonuses, (some) company vehicles, ‘business’ trips and extraordinarily high wages for an employee that’s a relative of the owner. 

Now, EBITDA would be a great guage of cash-flow except it doesn’t consider Officer Compensation and perks small business owners enjoy.  As a result, some companies have dramatic differences between EBITDA and SDE.  The owner of one manufacturer with 16 total employees and less than $4,000,000 in sales had a $200,000/year salary, company car and satellite phone.  Seven other family members received $41,000/year each (a total of $287,000/year) in compensation for being on the board of the company.  The NOI was only $100,000/year with no Non-Cash Expenses.  In that company, EBITDA was only $100,000/year but SDE was (at least) $587,000.

Buyers and sellers sometimes detach on their difference in how frivolous, or how necessary, each expense is.  It makes perfect sense to a seller to add back ‘Contributions’ made to non-profit organizations, however, when that ‘Contribution’ is being made to a non-profit organization that accounts for 10% of company sales the buyer might feel it’s not actually a ‘Contribution.’  Banks scrutinize expenses to ensure the ‘benefit’ of those expenses will transfer from one owner to the next. 

From year to year, NAGGL, the National Association of Government Guaranteed Lenders, amends guidelines of what expenses are ‘encouraged’ to be added back and what is prohibited.  Lenders are required to adhere to NAGGL’s guidelines.  It takes a common sense look at addbacks to determine what expenses will continue and will the new business owner benefit from them. 

Tom Stayanoff is a Senior Broker with Indiana Equity Brokers and specializes in serving small and medium-sized businesses in Northern Indiana.