EBITDA and Seller’s Discretionary Earnings measure the same business and produce different numbers because they make different assumptions about who runs it. SDE assumes the owner works in the business and adds their compensation back. EBITDA assumes management is a real cost and leaves it in. For a small ecommerce business the gap between the two is often the owner’s entire salary, which is why a seller and a buyer can look at identical books and disagree about profit by six figures.
The definitions
EBITDA is earnings before interest, taxes, depreciation, and amortization. Start with net income and add back those four items. The logic is that interest reflects how the company is financed, taxes reflect its jurisdiction and structure, and depreciation and amortization are non-cash allocations of past spending. Strip all four and you get something closer to operating cash generation that can be compared across companies with different capital structures.
Seller’s Discretionary Earnings starts from EBITDA and adds back one owner’s total compensation plus genuinely discretionary or non-recurring expenses. The logic is that a small business buyer will step into the owner’s role, so the money currently paid to that owner is available to the new owner.
The formal difference is one line: owner compensation. In practice that line is enormous relative to the profit of a small business.
A worked example
Take an ecommerce business with $2,400,000 in annual revenue selling across Amazon and Shopify.
Its income statement:
- Revenue: $2,400,000
- Cost of goods sold: $1,080,000
- Gross profit: $1,320,000
- Marketplace and payment fees: $432,000
- Advertising: $288,000
- Owner salary: $140,000
- Staff wages, two people: $118,000
- Software and subscriptions: $31,000
- Warehouse rent: $54,000
- Professional fees: $22,000
- Owner’s vehicle lease and insurance: $14,000
- Legal settlement, one-time: $35,000
- Depreciation: $19,000
- Interest on an inventory line of credit: $26,000
Total operating expenses below gross profit come to $1,179,000, leaving net income of $141,000.
Calculating EBITDA
Net income of $141,000, plus interest of $26,000, plus depreciation of $19,000. There is no amortization and the business is a pass-through entity so no corporate tax line.
EBITDA = $186,000.
Calculating SDE
Start at EBITDA of $186,000 and add:
- Owner salary: $140,000
- Owner’s vehicle, a personal benefit run through the business: $14,000
- One-time legal settlement, not expected to recur: $35,000
SDE = $375,000.
Same business, same twelve months, same books. EBITDA says $186,000. SDE says $375,000. The business did not change. The question changed.
Which one applies to you
The rough dividing line in small business acquisitions is whether the buyer will operate the business themselves.
SDE is used for owner-operated businesses, generally under about $5M in revenue or $1M in earnings, sold to individual buyers or small acquirers who will run it. Business brokers quote SDE multiples almost exclusively in this range.
EBITDA is used for businesses large enough to have a management layer that survives the sale, and by private equity or strategic acquirers who are buying a company that runs without them. If the seller already has a general manager and does not work in operations, the owner add-back is not real and EBITDA is the honest measure.
The ambiguous zone is a business doing $3M to $8M where the owner still works but there is a partial management team. Both numbers get presented. The useful clarifying question is what it would cost to hire someone to do what the owner actually does, and then subtract that from SDE rather than adding back the full salary.
Where add-backs go wrong
Three recurring problems, all of which damage credibility more than they add value.
Adding back a second owner’s salary. SDE permits one owner’s compensation. A business run by two working partners that adds back both is claiming it can be operated by one person, and a buyer will test that claim.
Calling recurring costs one-time. A legal settlement in a single year is a fair add-back. Legal settlements in three consecutive years are a cost of doing business. Buyers look at multi-year patterns specifically to catch this.
Adding back growth investment that is actually maintenance. Advertising is the usual battleground. A seller may argue that some ad spend is growth investment a buyer could cut. A buyer will argue that on a marketplace, advertising is closer to a distribution cost than a discretionary one, and cutting it reduces sales. The buyer is usually right on marketplaces.
Why ecommerce complicates both numbers
Both calculations start from net income, which means both inherit whatever is wrong with the books. Marketplace businesses have a specific weakness here.
A settlement deposit is gross sales minus referral fees, fulfillment, storage, advertising, refunds, and reserve movement. Sellers who record the deposit as revenue understate sales and omit the expenses inside it. Gross profit is then wrong, net income may be roughly right by accident, and every add-back calculated on top of it is built on a number nobody can verify.
This is why diligence on ecommerce acquisitions spends so much time on settlement reconciliation before anyone discusses multiples. Tools in the ecommerce accounting category, ConnectBooks and A2X among them, exist to push settlement detail into the general ledger so the income statement reflects actual transaction components. A seller planning an exit within two years benefits from having that in place well before a buyer asks, because the history cannot be reconstructed convincingly under deadline.
The practical summary
Calculate both. Know which one your likely buyer uses. Document every add-back with a bridge from reported net income to the adjusted figure, so a buyer can follow the path rather than reconstruct it.
And do not confuse either number with cash flow. Neither EBITDA nor SDE accounts for working capital, which in a product business is the money tied up in inventory. A company showing $375,000 in SDE while adding $200,000 of inventory every year is generating far less cash than the number suggests, and that gap is where a lot of acquisitions go wrong.
Valuation and deal structure carry tax consequences that vary by entity type and state. Those are conversations to have with a transaction-experienced accountant and an attorney, not decisions to make from a definitions article.
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