Do you add back owner's draw for SDE calculation?
March 18, 2024
by a searcher from Rochester Institute of Technology in Portland, OR, USA
I am analyzing an on-market deal and broker is calculating SDE by adding owners and/or shareholders withdrawal. This amount is additional of owner's salary. Do you consider owner/shareholder's drawing on retained earnings or profits from previous years as part of SDE?
from University of Pennsylvania in Philadelphia, PA, USA
SDE, or seller's discretionary earnings, is an income / cash flow concept that is a proxy for free cash flow available to the owner of a small business. A decision to pay out that cash flow as salary vs. owner distributions has no impact on the SDE figure itself.
For example, a business that makes $100 revenue that has $60 expenses (cost of goods sold, rent, sales and marketing, team members, etc.) and $10 of owner salary would have $30 of EBIT (earnings before interest and taxes*). Let's imagine also that the owner distributed $20 in an owner draw.
To calculate SDE, we would take $30 EBIT and add back the $10 of owner salary (we would add back all owner's benefits that wound up as an expense) to find that the business has $40 SDE. In their discretion, the owner decided to pay out $30 of the SDE as $10 salary and $20 owner's draw. It doesn't matter how it was distributed - the SDE remains the same.
*For now, let's ignore the impact of taxes and depreciation. Most small businesses are pass-through entities so the business itself does not have a tax burden (because it is passed on to its owners), and depreciation / capex is worthy of a separate discussion.
from Boise State University in 800 W Main St, Boise, ID 83702, USA