When small business owners start thinking about selling, one of the first questions they ask is, “How much is my business worth?” 

The answer isn’t always simple, but understanding Seller’s Discretionary Earnings (SDE) is one of the most important steps in getting it right.

At Baton, we’ve seen firsthand how clear, well-prepared financials—especially SDE—can make or break a sale. Whether you're years away from listing or ready to hit the market tomorrow, knowing how to calculate and present SDE properly can dramatically improve your business valuation and help close deals faster.

This isn’t about throwing numbers on a spreadsheet and hoping for the best. SDE is the story of your business’s financial performance. When told well, it helps potential buyers see the true earning power of your company—and feel confident about making an offer.

Here’s what you need to know about Seller’s Discretionary Earnings, why it matters so much in small business sales, and how to get it right from day one.

What Is Seller's Discretionary Earnings (SDE)?

Seller’s Discretionary Earnings (SDE) is one of the most common methods for valuing small businesses, especially those under $10 million. 

Simply put, SDE is the total financial benefit the current owner takes from the business. It tells a potential buyer what they might reasonably expect to earn if they step into the owner’s shoes.

The basic formula looks like this: Net Profit + Owner’s Salary + Discretionary Expenses + Non-Recurring Expenses = SDE

Let’s break it down:

• Net profit: Your bottom-line earnings after all standard business expenses have been paid.

• Owner’s salary: What the owner pays themselves as compensation.

• Discretionary expenses (add-backs): Personal expenses that the business paid but aren’t essential to operations (think personal travel, a vehicle, or health insurance premiums).

• Non-recurring expenses: One-time costs that won’t apply to the new owner—like legal fees for a specific lawsuit or a one-off marketing campaign.

For example, say your landscaping business shows a net profit of $100,000. You pay yourself $80,000 as salary. The business also covers $10,000 in personal vehicle expenses and had a $5,000 one-time legal fee this year. Your SDE would be $195,000.

This number gives buyers a clearer view of cash flow and helps them understand the business's true earning potential, not just what appears on the tax return.

How SDE Fits into Small Business Valuation

Discretionary earnings are a cornerstone of business valuation for small businesses because they account for many of the nuances that go into running a smaller operation. Unlike EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), which is more commonly used for larger businesses or corporations with complex financials, SDE is designed specifically for owner-operated companies.

What are discretionary earnings? The term “discretionary” refers to cash that isn’t tied up in fixed business obligations or money the owner can use at their discretion.

For example, an owner’s salary and personal expenses can have a big impact on cash flow, but these aren’t always visible in traditional accounting. SDE adds back these owner-related expenses.

This allows a prospective buyer to compare businesses on an “apples-to-apples” basis. Two companies in the same industry might have the same revenue, but owners often pay themselves differently or run the business in unique ways. By normalizing these financials, SDE shows the true earning potential of the business, regardless of the current owner’s personal decisions.

What is the difference between SDE and EBITDA? At a high-level, while EBITDA strips out interest expense, income taxes, depreciation, and amortization, it ignores the nuances of owners’ compensation and discretionary spending. 

This is especially important when determining the value of a service business, where much of the profitability often depends on the owner’s involvement and discretionary spending. For small business deals, these details can be the most critical factors in determining value.

Valuation multiples—such as 2x or 3x SDE—are typically applied to this figure to calculate the overall business value. This approach ensures the valuation reflects the true earning potential of an owner-operated business, rather than just the surface-level profit.

Why Small Business Buyers Pay Attention to SDE

Buyers look beyond the P&L to answer the question: “What will this business pay me once I run it?”

In other words, buyers, brokers, and lenders rely on SDE because it accounts for the reality of how money moves in an owner-operated company. It helps buyers estimate owner income, assess future performance, and gauge whether the business aligns with their financial goals.

What’s Included in SDE (and What’s Not)?

Getting your SDE calculation right means understanding exactly what belongs and what doesn’t.

Included in SDE:

• Owner’s salary or owner’s benefits

• Personal expenses run through the business (travel, vehicle, phone, etc.)

• Non-recurring expenses like one-time legal fees or equipment purchases

• Certain payroll taxes tied directly to owner compensation

• Bad debt write-offs (if clearly documented as one-off events)

Not included in SDE:

• Normal business expenses required to operate the company

• Employee wages (unless they’re family members paid above market rate)

• Interest expense, income taxes, and depreciation (those are handled separately)

• Non-cash expenses like depreciation and amortization, unless tied to one-time events

One of the most common mistakes sellers make when calculating SDE is double-counting expenses or failing to document add-backs clearly. Every add-back needs to be defensible—not just to the buyer but often also to lenders and other stakeholders involved in the sale.

Transparency is everything. Overcomplicating the list of add-backs can erode trust quickly.

How to Maximize Your SDE Before Selling

If you’re preparing to sell, optimizing your SDE well before going to market is one of the smartest moves you can make. This isn’t about manipulating numbers—it’s about presenting an honest, compelling financial picture that makes your business attractive to potential buyers.

1. Clean up your bookkeeping.
Make sure your financials are accurate and up to date. Clear, organized records are the foundation for a reliable SDE calculation.

2. Separate personal and business expenses.
Many owners write off personal expenses to reduce taxable income, but when selling, you’ll likely want to rework your records to highlight SDE instead. This helps buyers see the true profitability of your business. (You can still use your tax-optimized books when filing taxes.)

3. Document every add-back.
Keep receipts, invoices, and notes for discretionary or non-recurring expenses. One-time business costs—like building an office addition—can often be treated as add-backs, since these optional projects are unlikely to happen again. Including these adjustments ensures your SDE reflects the normalized earnings a new owner could expect.

4. Present a clear SDE story.
Experienced buyers want to see a clear, defensible presentation that builds confidence and reduces risk. Key elements buyers and lenders look for include clean books, transparent add-backs, consistency across years, and ensuring every add-back is defensible. 

5. Work with an advisor.
Outside expertise can help ensure your SDE calculation is accurate and defensible, giving buyers confidence in your financials.

Think of it as financial modeling for valuation purposes. The better prepared your numbers are, the easier it is to defend your asking price and keep the sale process moving smoothly.

What if You Don’t Have a Clear SDE Yet?

Here’s the good news: You’re not alone. Many small business owners haven’t tracked SDE consistently—or at all—before starting the sale process.

That’s why Baton Market offers a free, accurate business valuation upfront. We help sellers understand their numbers, clean up their books, and present their business earnings clearly and confidently.

Even if you’re a year (or more) away from selling, getting clarity on your SDE today can save you headaches tomorrow. And if you’re already in the process, having expert guidance ensures you’re putting your best foot forward with any new buyer.

SDE Is More Than a Number. It’s the Story Buyers Believe

You’re not alone. Many small business owners haven’t tracked SDE consistently—or at all—before starting the sale process.

That’s why Baton offers a free, accurate business valuation upfront. We help sellers understand their numbers, clean up their books, and present their business earnings clearly and confidently. Even if you’re a year (or more) away from selling, getting clarity on your SDE today can save you headaches tomorrow. And if you’re already in the process, having expert guidance ensures you’re putting your best foot forward with any new buyer.