29 Feb The Seller’s Discretionary Earnings Method (Part 2 of 2)
The following is a continuation from yesterday’s posting.
The terms used to express earnings are as follows, along with a definition of SDE:
EBDIT (EBITDA)—Earnings before depreciation (and other noncash charges), interest, and taxes.
EBDT—Earnings before depreciation (and other noncash charges), and taxes.
EBIT—Earnings before interest and taxes.
Source: Pratt et al., Valuing a Business
SDE—Seller’s Discretionary Earnings
Seller’s Discretionary Earnings: “The earnings of a business enterprise prior to the following items:
nonrecurring income and expenses
nonoperating income and expenses
depreciation and amortization
interest expense or income
owner’s total compensation for one owner/operator, after adjusting the total compensation of all owners to market value.”
Source: The International Business Brokers Association (IBBA)
The above definition of Seller’s Discretionary Earnings, although completely accurate, is a bit confusing. If you change the words “prior to the” and substitute the word “plus” it may be easier to understand. We would also suggest that the highest salary be used in the calculation of SDE. The reason is that we must assume that the buyer will replace the highest compensated employee or owner – at least for the SDE calculation. We should also add that this is our definition and not necessarily that of the IBBA.
Keep in mind that the multiples for the different earnings acronyms mentioned above will be different than the multiple of SDE, which, as mentioned, generally is a number between 0 and 4. The rules contained in the Guide are specific about what is being used. It will say 2 times SDE or 4 times EBIT, etc.