That translation gap costs business owners millions every year.
Having worked in corporate finance at Fortune 100 companies, I've seen both sides—how institutional buyers really think versus how most business owners present their numbers.
Two Profit Metrics, Two Buyer Universes
Seller's Discretionary Earnings (SDE) captures all cash available to an owner-operator—profit plus any salary and perks they pay themselves (so one full market-salary is added back).
EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) measures profit before any owner compensation. Institutional buyers deduct a market GM salary (typically $180-250K for a $10M HVAC firm) to calculate true cash flow.
The valuation spread: 2025 data show businesses with $500K-$1M SDE typically trade at ≈ 2.5-3× SDE (median), occasionally pushing toward 4× in premium cases (BizBuySell main-street median; skewed to sub-$2M deals). Companies with clean $1-3M EBITDA average ≈ 4-6× EBITDA (GF Data, Q1 2025 LMM Report—median 3.9×, upper quartile 6.1×). Sector spreads are wide—HVAC services ≈ 5×, precision machining typically 4× (3.5×-5× band), recurring pest control ≈ 6-7× (GF Data, Q1 2025 LMM Report, Table 2).
Same cash generation, different measurement—dramatically different enterprise value.
When Does the Market Switch Metrics? The switch usually begins when adjusted EBITDA approaches $1.5M or when a professional management layer is already in place. But it's not automatic:
Bolt-ons: PE groups may use EBITDA multiples below that size if the strategic fit is compelling.
Owner-centric sectors: Specialized consulting or medical practices can remain SDE-valued far above $2M.
Tech exception: SaaS companies under $3M often price off ARR multiples or hybrid ARR + EBITDA metrics—especially when ARR is growing >20% YoY.
The question: Can the business still generate that EBITDA after paying someone else to run it?
The Valuation Bridge (Example)
Individual buyer scenario: Manufacturing firm shows $1.2M SDE × 3× multiple = $3.6M enterprise value.
Institutional buyer scenario: Two-year margin work lifts EBITDA to $2.0M → less $250K replacement CEO salary = $1.75M FCF; 5× multiple = $10.0M enterprise value.
Value delta: +$6.4M (assumes ~$150K maintenance capex already deducted).
Remember: enterprise value − net debt = equity value. A $10M EV with $1M net debt equals $9M in your pocket, not $10M.
EBITDA Add-Backs Face New Scrutiny
I'm seeing buyers push back harder on adjustments that used to slide through:
- Personal vehicle leases or family phone plans
- "One-time" marketing spends that recur annually
- Owner travel/entertainment above industry norms
- Family payroll for minimal documented work
- Personal perks like gym memberships or season tickets
Positive normalizations are factored in, too—e.g., below-market rent you charge your op-co. Document those upward adjustments just as rigorously. Working-capital normalizations (such as reducing AR days) don't change EBITDA but hit the closing true-up—track them early so a working-capital peg adjustment doesn't surprise you. A disciplined peg can work in your favor if WC comes in above target.
Clean records mean less back and forth in diligence. Plan to document or eliminate gray-area expenses 12-24 months before going to market.
A 12-Month "Graduation" Roadmap
Months 1-3: Restructure Compensation Pay a documented market salary; separate extra draws. This establishes the replacement-cost baseline for EBITDA.
Months 4-6: Upgrade Financial Systems Move to accrual-basis GAAP, close monthly, track adjusted EBITDA. Produces diligence-ready financials.
Months 7-9: Reduce Dependencies Document processes, delegate key functions, cut any >25% revenue from one customer, build KPI dashboard. Lowers key-person & concentration risk; creates management reporting.
Months 10-12: Test Your Story Commission a sell-side QoE (yes, it's expensive but worth it); practice your EBITDA story until it's second nature. Locks credibility, prevents buyer re-trades.
(Begin informal market talks with your adviser only after you have draft QoE results.)
Final Thought
Graduating from SDE to EBITDA isn't just a profit milestone—it opens doors to buyers with cheaper capital and higher risk tolerance. Engineering that transition—rather than stumbling into it—can add millions to your exit.
Multiples still depend on fundamentals: a 15%-margin job-shop and a 40%-margin SaaS firm won't trade alike. But mastering the SDE-to-EBITDA framework—and the free-cash-flow reality beneath it—gives you the foundation to maximize value.
If you'd like to schedule a time to talk, I'm offering no-cost, 30-minute valuation-readiness calls this month to identify your next steps.
For educational purposes only. I'm a registered investment adviser; this is not investment-banking advice or a solicitation to buy or sell securities.