Seller Discretionary Earnings and Business Sales Price

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Understanding Seller Discretionary Earnings  (SDE) in Business Valuation 

Seller Discretionary Earnings (SDE) play a critical role in determining the fair  market value of a small business. As a fundamental financial metric, SDE  provides valuable insights into a company’s financial health and  attractiveness to potential buyers. Additionally, the predictability of cash flow  significantly influences valuation. 

Business brokers typically analyze financial data from the past three years to  assess trends and determine a company’s trajectory. Below are two  illustrative examples: 

Example 1: Business with Growth 

Year  Gross Revenues SDE 

2024 $1,500,000 $375,000  

2023 $1,200,000 $300,000  

2022 $1,000,000 $225,000  

This business demonstrates consistent revenue and SDE growth—key  indicators of stability and future potential, making it an attractive prospect  for buyers. 

Example 2: Business with Declining Performance

Year  Gross Revenues SDE 

2024 $1,500,000 $375,000 

2023 $1,900,000 $500,000 

2022 $2,200,000 $550,000 

Despite having the same SDE in 2024 as the first business, this company’s  declining revenue and SDE signal potential risks. Buyers may perceive it as a  higher-risk investment, leading to hesitancy or lower offers. 

SDE Multiples and Business Valuation 

Several methods exist for determining a business’s value, but for owner operator buyers—who often require financing—lender perspectives are  crucial. Key valuation considerations include: 

• Small businesses typically sell for 2.0 to 3.5 times their SDE. • SDE is often calculated using a weighted average to emphasize  recent performance. 

For a growing business like Example 1, a possible weighting method might  be: 

70% for 2024 

20% for 2023 

10% for 2022 

Using this method, the weighted SDE is approximately $345,000. Applying  a 3x multiple, the estimated sale price would be $1,035,000. If strong  growth trends continue, valuation might be based solely on 2024 SDE,  leading to a $1,125,000 sale price at a 3x multiple. 

For Example 2, the declining financial trend raises concerns. Buyers may  choose to use only the 2024 SDE and apply a lower multiple to account for  increased risk, resulting in a lower valuation compared to a stable or  growing business. 

Final Considerations 

Numerous factors influence the SDE value and the multiple applied. An  experienced business broker provides essential guidance by thoroughly  analyzing financial trends and market conditions to ensure accurate pricing  and maximize business value. Properly evaluating these variables leads to  fair negotiations and successful transactions for all parties involved.

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