Key Takeaways
- SDE adds back a working owner’s full salary and benefits, while adjusted EBITDA keeps a market-rate manager’s cost in the expenses, so the two numbers rarely match for the same company
- Owner-operated HVAC and plumbing businesses are typically evaluated using SDE, while companies with a management team already in place are more likely to be evaluated using adjusted EBITDA
- A worked example for a $4.5 million-revenue plumbing company shows $598,000 in SDE versus $478,000 in adjusted EBITDA, a $120,000 gap equal to the assumed cost of hiring a manager
- Add-backs need paper trails; bank statements, payroll records, tax returns, and invoices are what buyers request before accepting a seller’s adjustments
Two business owners can run companies with identical profit and still walk away from a sale with very different numbers on the table. The reason usually traces back to one line item: owner pay. Understanding how that single line separates seller’s discretionary earnings (SDE) from adjusted EBITDA can mean the difference between a valuation that holds up under scrutiny and one that falls apart during due diligence.
“Business owners sometimes focus on the highest earnings figure without considering how a buyer will evaluate it,” explains Clint Evans, founder of Core Growth Group. “Understanding the difference between SDE and adjusted EBITDA helps sellers prepare realistic financial expectations and support their valuation with the right documentation.”
The One Line That Splits Your Valuation
SDE and adjusted EBITDA are both earnings metrics used to value a business, and both rely on add-backs to normalize the numbers. Where they diverge is in how each one treats the compensation paid to a working owner.
SDE assumes a buyer will step into the owner’s shoes and keep that salary as their own earnings. Adjusted EBITDA assumes the business needs to keep paying someone, whether that’s a hired general manager or an existing leadership team, to keep running without the previous owner in the building every day. That difference is roughly the cost of replacing the owner, and it is not a number a seller gets to pick.
Many owners assume the higher figure automatically leads to a higher sale price. What actually decides the price is which metric the buyer is working from, since multiples get applied to different earnings bases. Knowing the distinction before heading into negotiations helps a seller avoid presenting a number that gets challenged, or worse, discarded.
What SDE Really Measures
SDE represents the total financial benefit a single working owner receives from the business in a given year. It starts with the bottom-line profit, then adds back everything tied to the owner’s personal benefit, built on the assumption that a buyer will take over daily operations and collect the same financial rewards.
The logic holds up well for small, owner-operated trades businesses. A plumbing or HVAC company where the owner answers calls, manages crews, and handles sales is a business where the next owner will likely do the same. SDE reflects what that next owner actually stands to earn.
Add-Backs SDE Typically Includes
SDE calculations start with net profit and layer back specific costs that reflect the owner’s personal benefit rather than the ongoing cost of running the business. Common additions include:
- Owner’s salary and the payroll taxes tied to it
- Owner’s health insurance and other personal benefits
- Depreciation and amortization
- Interest expense
- One-time, non-recurring expenses such as legal fees or emergency equipment repairs
- Personal expenses run through the business, including vehicle, travel, and phone costs
Each of these needs a paper trail eventually, but the first step is simply identifying which costs belong on the list.
What Adjusted EBITDA Really Measures
Adjusted EBITDA starts with the standard EBITDA formula, earnings before interest, taxes, depreciation, and amortization, then layers in further adjustments to strip out one-time or non-operational items that distort how the business actually performs. The adjustment that sets it apart from SDE involves owner compensation.
Rather than adding back the owner’s full pay, adjusted EBITDA assumes a market-rate salary for a professional manager is already baked into the expenses. Only the amount the owner takes above that market rate gets added back. This approach reflects a business that can keep functioning independently of whoever currently owns it, a picture institutional buyers, private equity groups, and acquisition lenders need to see before they’ll engage.
Why Below-Market Owner Pay Gets Deducted
Here’s where many owners get caught off guard. If an owner has been taking a modest salary, lower than what it would actually cost to hire a qualified manager, the adjusted EBITDA calculation doesn’t reward that frugality. Instead, it deducts the shortfall, since the business will need to pay market rate for that role once the owner is gone.
An owner who has been reinvesting profit back into the business and paying themselves conservatively might assume that choice makes the numbers look stronger. For SDE, it can. Adjusted EBITDA moves in the other direction, since the real cost of replacing that owner’s labor gets added into the expense side rather than removed from it.
Owner-Operator or Management Team?
Deciding which metric applies comes down to one practical question: how much does daily revenue generation depend on the person currently signing the checks? A business where the owner is the one answering emergency calls, quoting big jobs, and managing the technicians is read differently than one where a general manager and department leads keep things moving without daily owner involvement.
Buyers ask themselves whether the company can run without the seller, who the realistic buyer pool looks like, and whether an operations manager or similar role already exists. The answers to those questions point toward SDE or adjusted EBITDA well before any numbers get crunched.
Why Business Structure Decides the Metric, Not Size Alone
Revenue size provides a clue, but it isn’t the deciding factor. An HVAC company with a strong general manager and a working leadership team might get evaluated on adjusted EBITDA, while a larger plumbing company still leaning entirely on its founder could be read on SDE despite the bigger top line.
The operating model is what matters:
- Owner-operated trades businesses, where the owner is central to sales, scheduling, or fieldwork, are generally evaluated using SDE
- Businesses with a general manager, department heads, or a management layer already running operations are more likely to be evaluated using adjusted EBITDA
- Institutional buyers and private equity groups rarely work from SDE once a company’s earnings climb past the $1 million to $2 million range, regardless of how the business is staffed
A $4.5 Million Plumbing Company, Two Numbers
Numbers make this easier to see in action. Picture a plumbing company generating $4.5 million in annual revenue, with an owner drawing a $180,000 salary. Starting from a pre-tax net profit of $240,000, the SDE calculation adds back the owner’s salary, health insurance, personal vehicle use, depreciation and amortization, interest expense, and a one-time legal fee. That brings total SDE to $598,000.
Now run the same business through adjusted EBITDA, assuming a market-rate general manager would cost $120,000 a year. Instead of adding back the owner’s full $198,000 in salary and benefits, only the $78,000 above that market rate gets added back. The vehicle, depreciation, interest, and legal fee add-backs stay the same. The result lands at $478,000 in adjusted EBITDA.
The $120,000 Gap Explained
The difference between the two figures, $120,000, is exactly the assumed cost of hiring a manager to replace the owner. That single number captures the entire distinction between these two earnings metrics. It reflects the dollar value of the owner’s labor once a buyer has to pay someone else to provide it, not a rounding error or a disagreement over accounting method.
How 3x and 4x Multiples Change the Outcome
Multiples applied to these figures show how much the choice of metric can move a final valuation. At a 3x multiple, the SDE figure of $598,000 values the business at roughly $1,794,000, while the adjusted EBITDA figure of $478,000 comes to about $1,434,000. Push the multiple to 4x, and SDE produces roughly $2,392,000 compared to $1,912,000 for adjusted EBITDA.
Service businesses around the $5 million revenue mark generally trade in the 2x to 4x range on adjusted EBITDA, with 3x serving as a common baseline. The lower end tends to reflect a business still highly dependent on its owner with flat growth and unverifiable books, while the upper end usually requires documented year-over-year growth, recurring service revenue, a working management layer, and clean financial records. Owner-operated companies priced on SDE land in a comparable multiple band, with the same growth and documentation factors driving where a given business falls within it.
Proving Your Add-Backs Hold Up
A well-built earnings figure means little if it can’t survive a buyer’s review. Every add-back claimed, whether it’s a personal vehicle expense folded into SDE or an excess owner compensation adjustment under adjusted EBITDA, needs to be something a buyer can independently verify. Add-backs that look reasonable on a spreadsheet but can’t be traced back to actual records tend to get stripped out before a deal closes.
This is where sellers who’ve kept organized books have a real advantage. A one-time legal fee is easy to defend when there’s an invoice and a bank statement showing the payment. A personal vehicle add-back is easy to defend when mileage logs or lease documents back it up. Owner compensation add-backs need to match payroll records and W-2 filings exactly, since any mismatch raises immediate questions.
Records Buyers Request During Due Diligence
Buyers and their advisors typically ask for a specific set of documents to confirm that add-backs are legitimate, non-recurring, and unrelated to ongoing operations:
- Bank statements covering the periods in question
- Payroll records and tax filings, including W-2s for the owner and key employees
- Business tax returns for recent years
- Invoices or receipts supporting one-time or non-recurring expenses
An add-back that can’t be documented doesn’t just get questioned; it typically gets removed from the earnings calculation entirely, which lowers the number a multiple gets applied to and directly reduces the final price.
The Metric Follows the Business, Not the Seller
The earnings figure that applies to a given HVAC or plumbing company isn’t a matter of preference. It follows directly from how the business actually operates, whether an owner’s daily involvement is essential to revenue, and what kind of buyer is likely to be interested. A seller who understands this going in is better positioned to present a figure that matches what a buyer will actually calculate, rather than a number built around hope.
Getting the earnings figure right, and getting it documented well before a sale, often takes time. For owners starting to think through what their business could be worth, reviewing Core Growth Group’s business valuation calculator built around SDE and adjusted EBITDA can offer a clearer starting point than guesswork.
Core Growth Group
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