If you've spent any time researching business valuation, you've encountered two metrics that seem to perform the same function but are used in very different contexts: EBITDA and SDE (Seller Discretionary Earnings). For owners of businesses in the $10–$100 million revenue range, understanding the difference, and knowing which one a sophisticated buyer will actually apply, is a practical prerequisite for understanding what your business is worth.
The short answer: buyers of lower middle market businesses, whether PE sponsors, strategic acquirers, or well-advised individual buyers, use EBITDA. SDE is a useful metric for smaller, owner-operated businesses typically valued below $2–3 million. If your company generates $1 million or more in annual earnings and you're using SDE as your basis for expectations, you may be creating a meaningful mismatch with the market. Our in-depth guide on what EBITDA is covers every component in detail.
What Each Metric Measures
SDE adds back the standard EBITDA components plus the full compensation package of a single owner-operator, on the premise that a new owner stepping in personally would capture that whole economic benefit. This works well for a business a buyer will personally operate, a restaurant, a small service business, a retail location.
EBITDA strips out interest, taxes, depreciation, and amortization, but normalizes compensation to market rate rather than adding it back wholesale: what would a professional manager hired to replace the owner actually cost? This is the metric PE sponsors use in their LBO models, that strategic acquirers apply across their portfolio, and that QoE analysts scrutinize in diligence.
Using SDE to set your valuation expectation for a $20M business is like quoting a house price in square footage when the buyer is measuring in acres. The units don't convert, and the conversation goes nowhere.
Why the Distinction Matters at $10-$100MM
As businesses grow, the economics of owner-operator replacement change. A company generating $2 million in EBITDA probably needs a CEO, CFO, and senior operations leader, a management stack that might cost $600,000–$800,000 annually. SDE adds back all or most of that; EBITDA builds market-rate replacement compensation into the expense base. If your SDE is $3 million but your EBITDA is $2.2 million, an SDE-based 6x valuation implies $18 million; the market, applying 6x EBITDA, arrives at $13.2 million. That gap isn't a negotiating point, it's a fundamental misunderstanding of how the business will be valued.
EBITDA multiples in the lower middle market, typically 4–8x, assume a clean, institutional-grade earnings figure. SDE multiples are lower, typically 2–3x, because they embed assumptions about an owner who is both investor and operator. A business cleaned up to present EBITDA rather than SDE benefits from the higher institutional multiple.
Normalizing EBITDA: The Practical Steps
The most consequential normalization is owner compensation. If the owner earns $600,000 in a business a replacement CEO would manage for $250,000, the add-back is $350,000, the excess above market. If the buyer is an individual taking over the owner's role personally, a fuller add-back may be defensible; if the buyer is PE or a strategic acquirer hiring a professional manager, market-rate replacement applies.
Beyond compensation, normalized EBITDA adds back genuine non-cash charges and excludes truly non-recurring expenses, each requiring documentation and written rationale.
What sophisticated buyers check: QoE analysts will reconstruct your EBITDA from the ground up, examine every add-back, and test whether the compensation normalization reflects realistic market rates. Our article on 11 tax breaks small business owners miss explores deductions that, used strategically, can actually improve your normalized EBITDA presentation.
EBITDA Margin: The Metric Within the Metric
Beyond the absolute figure, buyers watch EBITDA margin, the percentage of revenue converting to operating earnings. A $10 million revenue business at $2 million EBITDA (20% margin) tells a different story than $20 million revenue at the same $2 million (10% margin). Margin trajectory matters as much as the current level: a margin that expanded from 15% to 20% signals something different than one that contracted from 25% to 20%.
From Valuation to Transaction
Understanding your EBITDA is only one chapter. Once a buyer submits an LOI, real leverage shifts, and sellers who aren't prepared can give back significant value during exclusivity. Our post on 5 LOI "gotcha" clauses that can hurt sellers walks through five provisions that have cost sellers millions after signing.
Your EBITDA gets you to the table. Knowing what you are signing in the LOI keeps the value there.