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 North Carolina at Wilmington in Wilmington, NC, USA
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.