If you have browsed small businesses for sale, you have almost certainly seen the letters SDE, usually next to the price. Seller's discretionary earnings is the profit measure most small business sales are priced on, yet many first-time buyers do not know what it includes, what it leaves out, or how easily it can be manipulated. Understanding SDE is essential, because a business priced on an inflated SDE is overpriced no matter how attractive the headline multiple looks. This guide explains SDE in plain terms, with the adjustments buyers should always check.

SDE starts with the business's net profit and adds back expenses that benefited the seller personally rather than the business itself. Typical add-backs include the owner's salary, personal travel or vehicle costs run through the business, one-off legal or professional fees, and non-cash charges such as depreciation. The logic is that a new owner will not incur those personal costs, so the earnings available to a new owner are higher than the reported profit. For an owner-operated business, SDE is therefore a better guide to what the buyer can actually earn than net profit alone.

An example makes the idea concrete. Suppose a small online business reports a modest net profit after paying the owner a salary and covering personal expenses through the company. Adding back the salary and the personal expenses produces a higher SDE, which represents the total financial benefit the owner derived from the business. A buyer who will work in the business themselves can reasonably expect something close to that benefit, before paying themselves. A buyer who plans to hire a manager instead must subtract a market-rate manager's salary from SDE, because that cost will be real for them even though it was not real for the seller.

Not every add-back is legitimate, and this is where SDE is most often inflated. Genuine add-backs are personal or one-off costs that will not recur under new ownership. Questionable add-backs include regular business expenses relabelled as personal, such as marketing, software, or contractor costs that the business will still need, and one-off items that recur every year under a different label. A seller who adds back a large expense every year, each time calling it one-off, is not adjusting profit; they are hiding a cost.

Buyers should ask for a detailed add-back schedule, with each item explained and supported by documents, and should test each one with a simple question: will this cost disappear under my ownership, or will I still pay it? If the answer is that you will still pay it, it is not an add-back. Also check for missing costs: work the seller does for free, such as customer support or content creation, which you must either do yourself or pay someone to do. A business whose SDE looks strong only because the seller's unpaid labour is ignored is worth less than its SDE suggests.

Small businesses are commonly priced as a multiple of SDE, with the multiple varying by size, growth, risk, and industry. A buyer can estimate a starting price by multiplying verified, adjusted SDE by a multiple for comparable businesses, then adjusting up or down for factors such as customer concentration, owner dependence, and traffic stability. The multiple is a starting point for negotiation, not a fixed rule, and it should be applied to SDE you have verified and adjusted yourself, not to the seller's headline figure.

SDE also has limits buyers should respect. It is a backward-looking measure, based on past performance, and it says nothing about future growth or decline. It does not account for capital spending the business will need, such as rebuilding a website or replacing equipment, and it does not reflect working capital needs. For larger businesses, buyers often switch to EBITDA, which treats owner compensation differently and suits businesses with professional management. For small, owner-operated businesses, though, SDE remains the standard, and the buyers who use it well are those who rebuild it from source documents, question every add-back, and price on the result.