The multiple gets the attention, but the SDE it multiplies decides the price, and the result has to survive the debt service before it is a value.
Value a small business by multiplying verified seller's discretionary earnings (SDE) by a multiple, then check that the price, once financed, still leaves the buyer a living. In the illustrative case below, the broker's SDE of 520,000 verifies at 450,000, so at 2.8x the business is worth 1,260,000, not the 1,456,000 the listing implies. Financed at 90 per cent over ten years, that price leaves the owner 236,380 a year before tax.
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 →
Most of the argument in a small-business purchase is about the multiple. Most of the money is in the SDE. Every 1 of earnings removed in diligence takes 2.8 off the price at this multiple, and the add-backs in a broker's listing are where the removable earnings live.
| Input | Value |
|---|---|
| SDE in the broker's listing | 520,000 |
| Multiple of SDE | 2.8x |
| Buyer's equity | 10% |
| Loan: term and rate (monthly payments) | 10 years, 10.5% |
| Recurring capital spending a year | 30,000 |
| Market salary for a manager to replace the owner | 90,000 |
SDE is pre-tax profit plus one owner's salary and benefits, interest, depreciation and genuinely one-off or personal costs. The listing's 520,000 includes two add-backs that do not survive diligence:
| Line | Amount |
|---|---|
| SDE in the listing | 520,000 |
| Spouse's salary added back, but the spouse runs scheduling and must be replaced | −45,000 |
| "One-time" vehicle repairs that appear in each of the last three years | −25,000 |
| Verified SDE | 450,000 |
The disallowed 70,000 is 13.5 per cent of the broker's figure. The test for every add-back is simple: will the cost still be there the day after closing? If yes, it is not an add-back. A full quality of earnings bridge, with costs the seller never paid put back as well, is worked on the book's case in how to convert SDE to EBITDA; this piece takes the verified figure from there to a price.
Value = verified SDE × multiple = 450,000 × 2.8 = 1,260,000
Listing basis = 520,000 × 2.8 = 1,456,000. Difference: 196,000
In Excel: =(SDE_listed-SUM(Disallowed))*Multiple. Keep the disallowed add-backs as separate rows so the seller can see each one priced.
Seen the other way, paying the asking price of 1,456,000 for 450,000 of real earnings is paying 3.24x, not 2.8x. The multiple did not change; the earnings under it did.
A value is only a price the buyer can live with if it survives the financing. With 10 per cent down, the buyer borrows 1,134,000 over ten years at 10.5 per cent.
Annual debt service = PMT(10.5%/12, 120, −1,134,000) × 12 = 183,620
Left for the owner = SDE − debt service − capital spending = 450,000 − 183,620 − 30,000 = 236,380
Lender's coverage = (SDE − manager salary − capital spending) ÷ debt service = 330,000 ÷ 183,620 = 1.80x
| Price basis | Price | Loan | Debt service a year | Left for owner | Coverage |
|---|---|---|---|---|---|
| Verified SDE at 2.8x | 1,260,000 | 1,134,000 | 183,620 | 236,380 | 1.80x |
| Listing SDE at 2.8x | 1,456,000 | 1,310,400 | 212,183 | 207,817 | 1.56x |
At the verified price, debt service takes 40.8 per cent of SDE and the owner keeps 236,380, which is 146,380 more than the market salary of a manager. That excess is the return on the buyer's 126,000 of equity and on the risk of running the business. At the listing price the buyer pays 196,000 more for the same 450,000 and keeps 28,563 a year less for ten years.
Two items sit outside this test and both make it harder, not easier. The price of a small business usually assumes a normal level of working capital is left in it, so a buyer who has to fund receivables after closing needs cash beyond the 126,000 of equity. And the owner's 236,380 is before income tax and before any reserve for a bad year. A plan that only works if every year is as good as the last one is not a plan, which is why lenders test coverage after a market salary rather than on the full SDE.
| Multiple | Price | Debt service a year | Left for owner | Coverage |
|---|---|---|---|---|
| 2.4x | 1,080,000 | 157,388 | 262,612 | 2.10x |
| 2.8x | 1,260,000 | 183,620 | 236,380 | 1.80x |
| 3.2x | 1,440,000 | 209,851 | 210,149 | 1.57x |
| 3.6x | 1,620,000 | 236,082 | 183,918 | 1.40x |
Each 0.4 turns of multiple costs the owner 26,231 a year for a decade. A lender requiring 1.25x on this definition of cover, which deducts capital spending as well as the manager's salary, would finance up to 4.03x, a price of 1,811,572. That is the bank's ceiling, not a value: at that price the cushion above the lender's minimum is gone and one weak year breaches it. Many lenders test cover before capital spending, which gives a higher ceiling still; how that maximum is solved, with an SBA loan and a seller note, is worked in what purchase price a 1.25x DSCR supports.
The common mistake is to negotiate the multiple and accept the SDE. A buyer who talks the seller from 3.0x down to 2.8x on the listing's 520,000 saves 104,000 and still pays 1,456,000; challenging the two add-backs saves 196,000 at the seller's own multiple. The second mistake is to apply an EBITDA multiple to SDE. SDE still contains the owner's salary, so its multiple must be lower, and the two must never be mixed in one comparison.
Verify the SDE line by line, multiply, then finance the result and see what is left: here 450,000 at 2.8x is 1,260,000, with 236,380 a year for the owner and coverage of 1.80x. If the price only works on the broker's SDE, it does not work. The free workbook for this case takes a listing from broker SDE to adjusted EBITDA and sizes the loan, and the small business acquisition model runs your own deal.
There is no single figure: multiples depend on size, sector, owner dependence and how much of the earnings will survive the sale. In the illustrative case 2.8x on 450,000 of verified SDE gives 1,260,000. The test is not whether the multiple looks normal but whether the price, once financed, leaves a market salary and covers debt service; here coverage is 1.80x and the lender's 1.25x would allow up to 4.03x.
Anything that will continue after the sale. A spouse's salary for real work has to be paid to whoever replaces them, and 'one-time' repairs that recur every year are an operating cost. In the illustrative case disallowing 45,000 of spouse salary and 25,000 of recurring repairs takes SDE from 520,000 to 450,000, and at 2.8x removes 196,000 from the price.
No. SDE adds back one owner's full salary and benefits; EBITDA deducts a market salary for the manager. That is why SDE multiples are lower than EBITDA multiples. Applying an EBITDA multiple to SDE overpays. In the illustrative case, deducting a 90,000 market salary and 30,000 of capital spending leaves 330,000 to cover 183,620 of debt service, a coverage of 1.80x.
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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