Almost every small business for sale is priced off a single number, and that number is rarely net profit. It's SDE — Seller's Discretionary Earnings: what the business produces for one owner who also works in it.
Understanding how it's built is the difference between evaluating a business and reciting the seller's arithmetic back to them.
How SDE is calculated
Start from the profit the business reports, then add back the costs that exist because of this particular owner rather than because of the business:
| Component | Why it's there |
|---|---|
| Net profit, as reported | The starting point — what the business declares after every expense. |
| + The owner's salary and benefits | A new owner pays themselves. This isn't a cost of the business, it's the owner's income. |
| + Personal expenses run through the business | A vehicle, travel, phone, meals attributable to the owner rather than to operations. |
| + Genuine one-off costs | A lawsuit settled once, equipment bought once, a move that won't recur. |
| + Interest and depreciation | The buyer's financing and asset basis will differ, so the seller's are not predictive. |
The result is meant to represent the cash a single owner-operator could reasonably expect the business to generate for them.
Add-backs are where the number gets inflated
Add-backs are legitimate in principle. They are also the easiest place in an entire deal to move a number, because every one of them is a judgement the seller made about their own business.
There is one test, and it applies to every claimed add-back: does this expense actually disappear when the owner changes?
- A one-time legal settlement — yes. It happened once and won't recur.
- The owner's salary — yes, in the SDE convention, because the new owner's pay is theirs to set.
- The owner's car, if the work genuinely doesn't require a vehicle — usually.
- "Marketing we didn't really need" — almost never. If revenue depended on it, removing it removes revenue too.
- A family member on payroll who does real work — no. You'll have to pay someone to do it.
Why the number matters so much
Because the price is a multiple of it. If a business is asking a 3× multiple and the real SDE is 20% lower than stated, then roughly 20% of the asking price is unsupported — and every figure you derived from that SDE is off by the same proportion: the multiple you think you're paying, your debt-service coverage, your payback period, your return.
That's why verifying SDE against the seller's own documents is the highest-value hour in diligence. The documents to ask a seller for are, in large part, the documents that let you check this one number.
Where the figure you're quoted comes from
Any SDE in a listing, a broker's summary or an offering memorandum is a claim. It was calculated by the seller, using add-backs they selected, from records they prepared. It is not audited, and a score or a multiple computed from it inherits every assumption inside it.
Treat a strong stated SDE as a reason to ask for documents, never as a reason to skip that step.
Acquire Scout recomputes SDE from a seller's own P&L and tax returns and shows every rejected add-back — see the diligence walkthrough, or the sample report for a deal where stated SDE of $400K verified at $310K.