A broker's multiple of SDE and a lender's multiple of EBITDA are not the same price, and the gap between them is two lines of the earnings bridge.
Start from seller's discretionary earnings, take out every add-back a quality of earnings review will not accept, put back the costs the seller never paid, and then deduct a market salary for the person who will run the business. On Cedar Ridge Mechanical, the HVAC contractor in Buying a Small Business, the broker's SDE of 917,000 becomes 676,000 of adjusted EBITDA, 26.3 per cent less, and the asking price of 3.5 times SDE turns out to be 4.75 times the number the lender will actually underwrite.
Worked in full in Buying a Small Business by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
SDE and EBITDA answer different questions. SDE is what the business pays one full-time owner-operator before debt, depreciation and that owner's own pay. EBITDA is what it pays its capital once somebody, owner or not, has been paid to run it. A buyer who will run the business himself is tempted to stop at SDE. The SBA lender will not, and neither should the buyer, because the manager's salary is a real cost the moment he wants a day off, falls ill or sells.
| Line | Broker | After QoE | Removed |
|---|---|---|---|
| Reported pre-tax income | 540,000 | 540,000 | 0 |
| + Owner's salary | 180,000 | 180,000 | 0 |
| + Owner's vehicle, phone and insurance | 38,000 | 23,000 | 15,000 |
| + Depreciation | 72,000 | 72,000 | 0 |
| + Interest | 14,000 | 14,000 | 0 |
| + One-time legal settlement | 25,000 | 0 | 25,000 |
| + Spouse on payroll, non-working | 48,000 | 48,000 | 0 |
| + Employer payroll taxes and benefits on that pay | 0 | 16,000 | −16,000 |
| − Related-party rent brought to market | 0 | −36,000 | 36,000 |
| − Customer deposits booked early (cash to accrual) | 0 | −31,000 | 31,000 |
| SDE | 917,000 | 826,000 | 91,000 |
| − Market salary for a manager, with payroll burden | −150,000 | −150,000 | |
| Adjusted EBITDA | 767,000 | 676,000 | 91,000 |
The broker lists the business at 3.5 times SDE, an asking price of 3,209,500. The buyer agrees 2,600,000. Total debt service in year one, on the SBA 7(a) loan and the paying seller note, is 432,859, and the lender's minimum coverage is 1.25 times.
SDE = pre-tax income + owner's pay and perks + depreciation + interest + genuinely one-off items
Adjusted EBITDA = SDE after QoE − market salary for a manager (with payroll taxes and benefits)
In Excel, with the bridge in B2:B11 and the salary in B13: =SUM(B2:B11)-B13. Keep the broker and QoE versions in adjacent columns so that every removed dollar is visible.
Step 1, test each add-back. The owner's salary, depreciation and interest survive: they are either the owner's return or financing and accounting items a buyer replaces with his own. Of the 38,000 of vehicle, phone and insurance, the review accepted 23,000 as personal; the rest is a cost the business would carry under any owner. The 25,000 legal settlement was presented as one-off and rejected: a contractor that settles claims has to expect to settle others, so the cost is part of normal earnings.
Step 2, add back the add-back's own cost. If the spouse's 48,000 is added back, so must be the 16,000 of employer payroll taxes and benefits that came with it. Brokers often leave it out, and here the correction works in the seller's favour.
Step 3, put back costs the seller never paid. The seller owns the building and charges the business 36,000 of rent against a market rent of 72,000. The buyer will pay the market rent, so the 36,000 difference comes off. And 31,000 of customer deposits were booked as revenue when received rather than when the work was done; on an accrual basis they belong in next year.
That takes SDE from 917,000 to 826,000: 91,000, or 9.9 per cent, removed by the review.
Step 4, pay a manager. Deduct a market salary of 150,000 including payroll burden. Adjusted EBITDA is 826,000 − 150,000 = 676,000, which is 73.7 per cent of the SDE the business was marketed on.
| Earnings figure | Amount | Asking 3,209,500 | Paid 2,600,000 | Coverage of 432,859 |
|---|---|---|---|---|
| Broker SDE | 917,000 | 3.50x | 2.84x | 2.12x |
| SDE after QoE | 826,000 | 3.89x | 3.15x | 1.91x |
| Broker EBITDA | 767,000 | 4.18x | 3.39x | 1.77x |
| Adjusted EBITDA | 676,000 | 4.75x | 3.85x | 1.56x |
Only the last row is the lender's number. The 2,600,000 the buyer agreed looks like a bargain at 2.84 times SDE; it is 3.85 times the earnings that service the debt. At the asking multiple, the 91,000 the review removed was worth 318,500 of price, and the manager's salary another 525,000: together they explain more than the 609,500 the buyer negotiated off the ask.
The lender's coverage, 1.56 times, clears the 1.25 minimum. Run the same debt service against broker SDE and it reads 2.12 times, a figure that has no meaning: it pays the debt with the money that was supposed to pay the person running the company.
The salary deduction is the largest single line in the conversion and the one with no invoice to check it against. Holding the entry multiple of 3.85 times adjusted EBITDA:
| Manager salary | Adjusted EBITDA | Price at 3.85x | Change in price | Coverage |
|---|---|---|---|---|
| 100,000 | 726,000 | 2,792,308 | +192,308 | 1.68x |
| 120,000 | 706,000 | 2,715,385 | +115,385 | 1.63x |
| 150,000 | 676,000 | 2,600,000 | 0 | 1.56x |
| 180,000 | 646,000 | 2,484,615 | −115,385 | 1.49x |
Every 10,000 of salary is 38,462 of price at this multiple. A seller who argues that a general manager for an HVAC contractor costs 100,000 all-in is asking for 192,308 more. The answer is a salary survey for the role in that market, with payroll taxes and benefits on top, not the owner's view of what he would have paid himself.
Do not double count the owner's salary. The 180,000 the seller paid himself is added back in full, and the 150,000 market salary is deducted in full. Netting them into a 30,000 add-back gives the same EBITDA but hides the salary assumption from everyone who reads the schedule.
The common mistake is to apply an EBITDA multiple to SDE, or an SDE multiple to EBITDA. Small business multiples quoted by brokers are almost always on SDE; lower middle market multiples are on EBITDA. On Cedar Ridge the two earnings figures differ by 241,000, so 3.5 times one is a very different price from 3.5 times the other. Ask which earnings figure a quoted multiple is on before comparing it with anything, and do the coverage test only on adjusted EBITDA after the review.
Rebuild SDE line by line with a reason for every add-back, then deduct a market manager's salary with its payroll burden. The figure you get is the one the lender sizes the loan on and the one your price should be a multiple of. The full bridge, with the broker and QoE columns side by side and the lender's coverage built on top, is in the free workbook for this case, and the small business acquisition model template runs the same logic on your own deal. For what the seller notes that fund this price are worth, see what a seller-financed price is worth in cash.
No. SDE adds back the owner's full salary and perks; EBITDA deducts a market salary for whoever runs the business. On Cedar Ridge Mechanical the review-adjusted SDE of 826,000 becomes 676,000 of EBITDA after a 150,000 manager salary with payroll burden. Multiples quoted on one cannot be applied to the other.
Recurring costs dressed as one-offs, business expenses claimed as personal, and it adds the payroll taxes that brokers leave off genuine add-backs. It also deducts costs the seller never paid, such as below-market rent to a related party. On Cedar Ridge those adjustments removed a net 91,000, or 9.9 per cent, from a broker SDE of 917,000.
Lenders cover debt service with earnings after a reasonable salary for the owner-operator, which is adjusted EBITDA. On Cedar Ridge that gives 1.56x on 432,859 of year-one debt service, against a 1.25x minimum. The same debt measured against broker SDE would show 2.12x, which overstates what the business can carry.
This article is one calculation from Buying a Small Business. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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