SDE addbacks (Owner salaries)

by a searcher from The University of Chicago - Booth School of Business

9 months ago

Hi all,

Reaching out to tap into the wisdom of this community. How the owner salary should be treated for SDE calculation, when the owner is 100% involved in the deal?

In the last 30 days, 3 deals i looked at, had SDE calculations where the owner(s) salary was added back, although the owners are 100% involved in the business, but no  market wages for equivalent positions were considered to replace those positions. All these were with business brokers (not that sophisticated in my opinion), and when I mentioned that's not the right way to calculate SDE, you need to consider market wages to replace those positions (even if smaller amounts), they become defensive.

What should I do, is it even worth mentioning this? Why would they do this? What am I missing here?

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intermediary from University of Pennsylvania - The Wharton School

If you're relying on DealStats (formerly Pratt's Stats) for valuation multiples, there is a FAQ (https://www.bvresources.com/products/faqs/dealstats) that includes definitions of all the terms used in the database.

Discretionary Earnings (also referred to as Seller's Discretionary Earnings or SDE) is defined as Operating Profit + Depreciation/Amortization + Owner’s Compensation. The definition also states that "If the business has more than one working owner, generally, the highest-paid partner's compensation is added back and the lesser paid partner's compensation is normalized. Typically, brokers who sell businesses try to indicate the highest earnings available to one working owner."

BVR also publishes a more detailed DealStats Companion Guide that is available for free at https://www.bvresources.com/docs/default-source/free-downloads/dealstats-companion-guide.pdf.

1 month ago | like reply | 2 likes

searcher from Arizona State University

I typically add back the seller’s salary, benefits, and expenses but then deduct the fair market cost of replacing that role. Whether you hire a general manager or take on the role yourself, that expense is an essential business cost that must be accounted for. I base this adjustment on my understanding of the owner’s role, their contributions, weekly hours, and the qualifications required to replace them—which may involve multiple positions. I also confirm these details with the broker to ensure a shared understanding. Ultimately, you can choose to include it as they are doing and simply apply a lower multiple, aligning with what you would have used if it were excluded.

1 month ago | like reply | 0 likes

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