I keep seeing small businesses advertised in a way that makes them look
almost absurdly profitable.
A company is listed for $600,000 and produces $200,000 of “cash flow.”
Three times earnings. Great.
Then another company is listed for $2.5 million and produces $500,000
of EBITDA. Five times earnings. Expensive.
The obvious conclusion is that the first business is the bargain.
It may be.
It may also be a much more expensive business.
The problem is that the two earnings numbers are not measuring the same
thing.
The $200,000 may be Seller’s Discretionary Earnings, or SDE:
essentially the economic benefit available to one working owner before
paying that owner a market salary. The $500,000 EBITDA business, by
contrast, may already be paying a general manager, salespeople and
everyone else required to make the company function.
One number can include the value of a full-time job.
The other is supposed to measure earnings after the business has paid
people to do the work.
That difference sounds like accounting trivia until you are about to
wire several hundred thousand dollars into an acquisition.
Then it becomes one of the most important distinctions in the deal.
I touched this in Digital Business vs Physical Business
Acquisition
and again in Buying a Business vs Buying Real Estate: Where Would I Put
$500,000?.
But it deserves its own treatment because SDE versus EBITDA is not
really an accounting question.
It is an ownership question.
What exactly am I buying — an investment, a job, or some combination
of the two?
That is what I want to figure out before I ever argue about the
multiple.
Start With the Definitions
EBITDA stands for:
Earnings Before Interest, Taxes, Depreciation and Amortization.
At a simplified level:
Net income\
- interest\
- income taxes\
- depreciation\
- amortization
= EBITDA
It is intended to give a cleaner view of the operating earnings of a
business before financing structure, taxes and certain non-cash
accounting charges.
BDC describes EBITDA as a measure used by businesses, valuators and
lenders to assess operating performance, compare companies and evaluate
debt capacity. It also makes an important point that gets lost in
acquisition listings: EBITDA is not the same thing as net income, and it
is not automatically cash flow. BDC’s EBITDA
guide
is a useful Canadian starting point.
SDE starts from a different question.
The International Business Brokers Association defines discretionary
earnings as earnings before taxes, interest, depreciation and
amortization, non-operating and non-recurring items, plus one owner’s
total compensation, benefits and personal expenses paid by the
business. The IBBA uses Seller’s Discretionary Earnings, Seller’s
Discretionary Cash Flow and similar terms for this concept. Its
business-broker
glossary is worth
bookmarking if you spend any time reading acquisition listings.
In practical terms, I think of it like this:
EBITDA asks: what does the business earn from operations?
SDE asks: what economic benefit could one owner-operator potentially
take out of this business?
Those are useful questions.
They are not interchangeable questions.
The Owner’s Salary Is the Bridge
Imagine a business with the following economics:
Item Annual Amount
Revenue $1,500,000
Gross profit $600,000
Employee wages and operating expenses ($390,000)
Owner salary ($100,000)
EBITDA $110,000
Assume for simplicity that there are no other normalization adjustments.
If the owner is working full time, we can add that $100,000 owner
salary back to calculate SDE:
Calculation Amount
EBITDA $110,000
Add owner’s compensation $100,000
SDE $210,000
Same company.
Same customers.
Same bank account.
Same year.
But I can now advertise it as either a business producing $110,000 of
EBITDA or $210,000 of SDE.
That is not necessarily dishonest.
The $210,000 is genuinely available to an owner who buys the company,
replaces the seller personally and performs the same work.
But if I want to own the business without doing the seller’s job,
$210,000 is not my economic return.
I need to pay someone.
And that is where the conversion works in reverse.
SDE
— market replacement cost for the working owner
= normalized EBITDA
If replacing the seller costs $100,000, I am back at $110,000.
If replacing the seller actually costs $140,000, normalized EBITDA is
only $70,000.
That one assumption can completely change what the business is worth to
me.
A Three-Times-SDE Business Can Be More Expensive Than a Five-Times-EBITDA Business
This is the part I wish every acquisition marketplace put in a warning
box.
Consider two businesses.
Business A — the “cheap” one
- Asking price: $600,000
- SDE: $200,000
- Asking multiple: 3× SDE
- Owner works 50 hours per week
- Market replacement salary for the owner’s role: $120,000
Normalized EBITDA:
$200,000 — $120,000 = $80,000
So the apparent 3× business is actually priced at:
$600,000 ÷ $80,000 = 7.5× normalized EBITDA
Business B — the “expensive” one
- Asking price: $2,500,000
- EBITDA: $500,000
- General manager already included in operating expenses
- Owner works five hours per week on oversight
- Asking multiple: 5× EBITDA
Business B looks expensive because the multiple is five instead of
three.
But Business A costs 7.5 times the earnings that remain if I replace the
owner.
Business B costs five times earnings and already has management.
Which is cheaper?
It depends on what I want to do with my life after closing.
If I genuinely want Business A’s job and would otherwise need to earn
$120,000 somewhere else, the SDE framework is completely legitimate. I
am buying an $80,000 investment return plus a $120,000 job.
But I cannot compare that 3× SDE multiple with Business B’s 5× EBITDA
multiple and conclude that Business A is cheaper.
I would be comparing different products.
SDE Is Not Fake — It Is Just Buyer-Specific
I do not want to overcorrect here.
There is a tendency among sophisticated buyers to sneer at SDE as broker
math.
That is too simplistic.
SDE is genuinely useful for a small owner-operated business because a
buyer often is replacing the seller.
Imagine a profitable plumbing company where the owner spends his day
estimating jobs, supervising technicians and managing customers.
If I am a licensed plumber who wants to leave employment and own the
company, his salary is not necessarily an expense I need to retain.
I may perform that job myself.
The economic benefit available to me could therefore be much closer to
SDE than EBITDA.
The same can happen with a digital business.
If I buy a content site where the owner spends ten hours per week
managing writers and I intend to do that myself, adding the owner’s
compensation back can make sense.
The problem begins when I interpret SDE as investment income.
It isn’t.
SDE is closer to:
return on capital + compensation for the owner-operator’s labour +
legitimate discretionary benefits.
That is why the number is so useful to a working buyer and so dangerous
to a passive one.
My Labour Has a Value Even If I Don’t Pay Myself
This is the conceptual mistake I see most often.
Suppose I leave a $150,000 corporate job and buy a business for
$750,000.
The business produces $225,000 of SDE.
I work full time in it and take $225,000 out.
It is tempting to say:
I invested $750,000 and now make $225,000. That’s a 30% return.
No.
Not unless my labour is worth zero.
Suppose a competent replacement for me would cost $125,000.
Then the economics are closer to:
- Compensation for my labour: $125,000
- Return to ownership: $100,000
- Capital invested: $750,000
The owner-independent return is roughly 13.3%, before considering
acquisition debt, taxes, capital expenditure and changes in working
capital.
Still potentially excellent.
But it is not 30%.
And if I was previously earning $150,000 with benefits, pension
contributions and no capital at risk, the personal economics need
another layer of analysis.
I may still prefer ownership.
I may have more control.
I may be able to grow the company.
I may create equity through debt amortization.
I may eventually install management and remove myself.
Those are all powerful reasons to buy.
But I want to know whether I am earning money because my capital owns
a good business or because I showed up for work Tuesday morning.
The distinction becomes especially important if the entire point of the
acquisition is greater independence.
The Owner Replacement Salary Is Not Whatever the Seller Pays Himself
This is where the analysis gets messier.
The seller’s actual salary tells me surprisingly little.
A seller may pay himself $60,000 because that is what his accountant
recommended.
He may pay himself $250,000 because the company has plenty of cash.
He may take no salary and live on dividends.
His spouse may be on payroll.
His truck may be in the business.
His phone, insurance and travel may run through the company.
None of that tells me what it costs to replace what he does.
I need a job description.
Does he:
- sell?
- quote?
- supervise production?
- approve purchases?
- maintain customer relationships?
- troubleshoot technical problems?
- recruit?
- schedule employees?
- handle bookkeeping?
- manage cash?
- work on the tools?
- hold a licence or certification the company requires?
- own intellectual property that is mostly sitting in his head?
Now ask what it would cost to replace those functions.
Sometimes one general manager can do it.
Sometimes the owner is really doing three jobs.
That $90,000 “replacement salary” in the broker’s normalization may
need to be:
- $110,000 general manager,
- plus $40,000 of sales support,
- plus outsourced bookkeeping,
- plus a vehicle.
Suddenly the add-back collapses.
This is why owner dependence is not just an operational-risk issue. It
is a valuation issue.
The more of the company’s economic engine resides in the seller, the
less of the advertised SDE actually belongs to the business.
Family Payroll Can Distort the Number in Either Direction
Family businesses make normalization particularly entertaining.
Suppose the seller’s spouse earns $80,000 doing ten hours per week of
bookkeeping.
A broker may add back $50,000 because a competent bookkeeper could
perform the role for $30,000.
That can be reasonable.
Now flip it.
Suppose the spouse works forty hours per week handling accounting,
payroll and administration but is paid only $25,000.
The business is understating the true labour cost.
A buyer may need to subtract another $45,000 or $55,000 to
normalize that role to market compensation.
Add-backs are not automatically additions.
Normalization can go both ways.
That is a theme I would keep in mind every time a seller hands me
“adjusted” earnings.
The goal is not to maximize adjusted EBITDA.
The goal is to estimate what the business will earn under my
ownership.
Sometimes that number goes up.
Sometimes it goes down.
Adjusted EBITDA Is Where the Negotiation Really Starts
Raw EBITDA is only the beginning.
In a private-company acquisition, buyers and sellers usually care about
normalized or adjusted EBITDA.
BDC describes adjusted EBITDA as EBITDA modified for items that are not
representative of core ongoing operations, including things such as
non-recurring expenses, non-cash losses, legal settlements and
non-market rent.
That makes sense.
If a company spent $75,000 on a one-time lawsuit last year and the
issue is genuinely finished, I should not necessarily assume the
business will incur that cost every year forever.
But adjusted EBITDA has an obvious problem.
Everybody wants to adjust it.
And the seller has a financial incentive to adjust it upward.
If a business is being sold for five times EBITDA, every additional
$10,000 of accepted add-backs can theoretically support another
$50,000 of purchase price.
A $50,000 questionable adjustment can become $250,000 of valuation.
That is why I do not think of add-backs as accounting footnotes.
They are purchase-price negotiations.
The Add-Back Test
I would put every proposed adjustment through a simple test:
Will this expense actually disappear after I own the company?
Not:
Was it unusual?
Not:
Does the seller dislike it?
Not:
Can the broker explain it?
Will the cash expense disappear?
If yes, there may be a legitimate adjustment.
If no, it stays.
A second test is:
If it disappears, will another expense replace it?
That catches a lot of nonsense.
The seller’s $160,000 salary may disappear at closing.
Wonderful.
But if I need to hire a $130,000 general manager, the correct
adjustment is not +$160,000.
It is +$30,000.
The seller’s vehicle lease may disappear.
But if the new sales manager needs a vehicle, some or all of that
expense remains.
The seller’s daughter may leave payroll.
But if she handled customer service, someone else still has to answer
the phone.
The old owner’s life can disappear from the P&L.
The work rarely does.
Add-Back #1: Owner Compensation
This is the big one.
For SDE, adding back one working owner’s compensation is fundamental to
the metric.
For EBITDA, owner compensation needs to be normalized to the market cost
of the actual work.
Suppose:
- Owner salary and benefits: $220,000
- Market general-manager replacement: $140,000
A reasonable normalization might add back the excess:
+$80,000
Not the full $220,000.
If the owner is underpaid relative to the role, the adjustment goes the
other way.
Suppose:
- Owner salary: $60,000
- Replacement manager: $140,000
Normalized EBITDA should fall by roughly:
-$80,000
That is not the add-back a seller wants to discuss.
It may be the one that matters most.
Add-Back #2: Personal Expenses
Private companies can legitimately contain expenses that a new owner
would not incur.
Personal travel.
A family member’s cellphone.
An owner’s luxury vehicle beyond what the business requires.
Club memberships.
Life insurance benefiting the owner.
Personal professional fees.
These can be legitimate adjustments if they are truly discretionary and
properly documented.
But I would distinguish between personal and pleasant.
The owner may enjoy taking customers to hockey games.
That does not mean customer entertainment disappears when I take over.
The owner may drive a nice pickup.
That does not mean the business needs no vehicle.
The owner may travel to a trade show in Las Vegas and stay an extra
three nights.
The extra nights may be personal.
The airfare and trade-show cost probably are not.
I want the underlying invoices, not a round number labelled “owner
perks.”
Add-Back #3: One-Time Professional Fees
This is usually more defensible.
A business may incur:
- litigation costs,
- a one-time consulting project,
- unusual accounting fees,
- transaction expenses,
- a failed acquisition cost,
- extraordinary recruiting fees.
If the event is genuinely non-recurring, adjusting for it can give a
better view of normalized operations.
But “one-time” expenses have a funny habit of occurring every year under
different names.
2023: ERP implementation.
2024: lawsuit.
2025: consultant.
2026: recruitment.
Individually, each may be unusual.
Collectively, perhaps a company of this size simply incurs $75,000 of
unusual things every year.
I would look at five years, not one.
A business is not normalized to a world in which nothing ever goes
wrong.
Add-Back #4: Repairs and Maintenance
This is one of my favourites because it reveals the difference between
accounting earnings and economic earnings.
Suppose the seller spent $100,000 replacing a major machine component
and calls it a one-time repair.
Maybe it is.
If the machine now has another fifteen years of life, perhaps the
current year’s earnings really are unusually depressed.
But if this is a manufacturing company with ten major machines,
something may need rebuilding every year.
The specific repair is one-time.
The category is recurring.
Adding the entire cost back can overstate sustainable earnings.
This is why I would rather understand normalized maintenance capital
than debate whether one invoice technically qualifies as extraordinary.
Add-Back #5: Rent
Related-party rent creates another trap.
The seller may own the building personally and charge the operating
company $60,000 of annual rent when market rent is $120,000.
The P&L looks fantastic.
After I buy the business and lease the building at market rates, EBITDA
falls by $60,000.
The opposite can happen too.
The owner may charge the company above-market rent to extract cash into
a separate real-estate corporation.
Normalize it.
But again, the question is not whether the rent is “related party.”
The question is:
What will a market participant actually pay for this space after
closing?
If I am buying the building too, then the analysis changes again.
Add-Back #6: Growth Spending
This one requires judgment.
Suppose the seller hired two salespeople last year to expand into a new
territory. They have not yet generated much revenue, so the seller wants
to add their $180,000 cost back because it is “growth investment.”
No.
Not automatically.
If I plan to keep the salespeople, the expense continues.
The fact that management voluntarily chose to spend the money does not
make it discretionary in the acquisition sense.
Likewise:
- marketing,
- software development,
- R&D,
- employee training,
- preventive maintenance,
- cybersecurity,
- website rebuilds.
A seller may describe these as discretionary because he could have
chosen not to spend them.
I care whether the business can maintain its current earnings and
competitive position without them.
A company can increase EBITDA beautifully by starving itself.
That does not make it more valuable.
EBITDA Is Not Cash Flow
This deserves its own section because EBITDA gets treated like cash far
too casually.
Imagine a company with $500,000 of EBITDA.
Looks excellent.
Now subtract:
- $100,000 of annual equipment replacement,
- $75,000 of additional inventory and receivables needed to support
growth, - $40,000 of cash taxes,
- $180,000 of acquisition debt service.
The amount available to me is nowhere near $500,000.
EBITDA ignores depreciation and amortization by definition.
That can be reasonable for comparing operating performance, but
depreciation is often trying to tell me something real: assets wear
out.
The accounting charge may not equal the actual annual replacement cost,
but setting it to zero does not make the equipment immortal.
A software company has the same issue in a different costume.
It may have little physical capex but require continuous development
just to keep the product competitive.
Either way, I want to know what the business must spend each year to
remain the business I am buying.
I care about EBITDA.
I care more about normalized free cash flow after the expenses the
business actually requires.
Working Capital Can Eat the Rest
Then comes working capital.
A growing company can report excellent EBITDA and consume cash.
Suppose revenue rises rapidly.
Great.
But customers pay in 60 days.
Inventory must be purchased before products ship.
Employees are paid every two weeks.
Suppliers want payment in 30 days.
The company can become more profitable on paper while requiring
additional cash from the owner.
That is not a contradiction.
It is working capital.
For an acquisition, this matters twice.
First, I need to understand how much working capital normally has to
remain in the business at closing.
Second, I need to understand how much additional capital growth will
require afterward.
A company that generates $500,000 of EBITDA but needs $250,000 of
additional inventory and receivables every time it grows is a very
different asset from a company that generates $500,000 and gets paid in
advance.
This is why a dedicated working-capital article is in the
Business Ownership innCanada roadmap.
Purchase price is only the first cheque.
Debt Service Is Below EBITDA — But Very Much Above My Bank Account
EBITDA deliberately removes interest because financing structures
differ.
That is useful when comparing companies.
It is less useful when I am the person who just borrowed money to buy
one.
Suppose:
- Normalized EBITDA: $500,000
- Purchase price: $2,000,000
- Acquisition debt: $1,400,000
- Buyer equity: $600,000
The company’s EBITDA does not fall because I borrowed $1.4 million to
acquire it.
But my cash available after debt service certainly does.
This is one reason lenders care so much about normalized EBITDA. They
are trying to determine how much operating cash flow exists before
financing, then whether that cash flow can support the financing being
layered onto the company.
BDC’s business-acquisition financing guide describes how senior debt, vendor debt and buyer equity can combine in an acquisition.
The buyer needs to take the analysis one step further:
EBITDA
— cash taxes
— maintenance capex
— working-capital needs
— debt service
= cash potentially available to ownership
And if I still have to work in the business:
cash available to ownership
— fair compensation for my labour
= something closer to the return on my invested capital
Now we are getting somewhere.
The Multiple Is Meaningless Until I Trust the Denominator
Business buyers spend enormous energy debating multiples.
Three times.
Four times.
Five times.
I think that is backwards.
The denominator matters first.
A business at 4× $500,000 of genuinely normalized EBITDA costs $2
million.
A business at 3× “adjusted EBITDA” of $600,000 costs $1.8 million.
The second business looks cheaper.
But suppose $150,000 of its adjustments are aggressive and sustainable
EBITDA is really $450,000.
I am actually paying:
$1.8 million ÷ $450,000 = 4×
Same multiple.
Now suppose the company needs $100,000 more annual maintenance capex
than the first company.
The economic difference gets wider.
This is why I would rather pay five times a number I believe than three
times a number I don’t.
The multiple is the easy part.
The earnings are the diligence.
A Full Example: From Broker SDE to What I Actually Earn
Let’s build the kind of small business listing I regularly see.
The listing
Asking price: $1,000,000
Revenue: $2,200,000
SDE: $325,000
Multiple: 3.08× SDE
That looks compelling.
Now pull it apart.
Seller’s SDE reconciliation
Item Amount
Reported EBITDA $155,000
Owner salary and benefits +$120,000
Owner vehicle/personal expenses +$18,000
One-time legal expense +$20,000
Owner spouse payroll +$12,000
Advertised SDE $325,000
Nothing there is automatically unreasonable.
Now I ask what happens under my ownership.
The seller currently handles sales, key accounts, hiring and operations.
A replacement GM with enough commercial experience costs $135,000 plus
perhaps $15,000 of employer costs and benefits.
The spouse actually handles ten hours per week of useful administration.
Replacing that work costs $15,000.
The owner vehicle is partly required for customer visits. A reasonable
business vehicle allowance costs $10,000.
The legal expense really was one-time.
Now normalize it.
Buyer normalization
Start with reported EBITDA: $155,000
Owner salary disappears: +$120,000
But replacement management appears: -$150,000
Owner vehicle/personal expense disappears: +$18,000
Replacement business vehicle cost: -$10,000
One-time legal cost: +$20,000
Spouse payroll disappears: +$12,000
Replacement administration: -$15,000
Normalized EBITDA:
$150,000
The business advertised at 3.08× SDE is effectively priced at:
$1,000,000 ÷ $150,000 = 6.67× normalized EBITDA
That does not automatically make it a bad business.
Maybe I want to run it myself.
If I replace the seller personally, perhaps I really can capture most of
the $325,000 SDE.
But now I know what I am buying.
I am paying $1 million for:
- a business generating roughly $150,000 before financing, taxes and
capex after professional management, plus - a management/sales job worth roughly $150,000.
That is a much more useful description than “3.08× cash flow.”
Now Compare It With a Bigger Business
Suppose another company is listed for $2.4 million.
It has:
- Revenue: $4.5 million
- Normalized EBITDA: $480,000
- General manager already employed
- Sales manager already employed
- Owner involved mainly in strategy and major capital decisions
- Asking multiple: 5× EBITDA
The first business:
- $1 million price
- $325,000 SDE
- $150,000 normalized EBITDA
- 6.67× normalized EBITDA
- requires a full-time owner if I want the SDE
The second:
- $2.4 million price
- $480,000 normalized EBITDA
- 5× EBITDA
- management already included
- much less owner dependence
The bigger business is not just more business.
It may be a fundamentally different kind of asset.
This is the same paradox I found in the $500,000 capital-allocation
exercise: a larger business can sometimes be more owner-independent than
a small one because it has enough earnings to afford the people required
to run it.
The smaller company may be easier to buy.
The larger company may be easier to own.
When Should I Use SDE?
I would use SDE when the buyer is reasonably expected to replace one
working owner.
That usually means smaller businesses where:
- the owner works materially in operations,
- the buyer intends to work in the business,
- management is not already fully staffed,
- the owner’s compensation is a significant part of total economic
benefit.
SDE is particularly useful for answering:
What can this business economically provide to one owner-operator?
That is a legitimate question.
If I am buying a $400,000 service company and intend to become its
full-time general manager, EBITDA alone can make the economics look
worse than they actually are because it treats my future compensation as
though it must be paid to someone else.
I am allowed to work in my own company.
I just should not call the wages for that work passive investment
return.
When Should I Use EBITDA?
EBITDA becomes more useful when I want to understand the business as an
organization independent of one particular owner.
That generally becomes more important as:
- the company gets larger,
- management depth increases,
- the buyer is financial rather than purely owner-operator,
- acquisition debt becomes meaningful,
- multiple shareholders or investors are involved,
- the owner wants to become less operational,
- institutional or strategic buyers become plausible future acquirers.
BDC’s business-valuation guide
describes applying a multiple to EBITDA as a common valuation approach
while emphasizing that assets and comparable transactions should also be
considered.
For me, the deeper point is simpler.
SDE tells me what I might earn if I become the owner.
Normalized EBITDA helps tell me what the company earns if I am not the
employee.
If my goal is eventually to own rather than operate, I care enormously
about the second number.
The Transition Zone Is More Interesting Than a Hard Cutoff
There is no magical revenue level where a company wakes up one morning
and switches from SDE to EBITDA.
The distinction is economic, not ceremonial.
A $700,000 revenue business with a passive owner and a competent
manager may already make more sense on EBITDA.
A $5 million company where the founder personally sells 60% of the
revenue may still require substantial owner-dependence normalization.
The metric follows the business.
That is why I would be skeptical of rules like:
Under $1 million, use SDE. Over $1 million, use EBITDA.
Useful shorthand, perhaps.
Not diligence.
I care about who does the work, what that work costs, and whether the
earnings survive the seller’s departure.
Normalized EBITDA Is Still Not “The Truth”
Even after all this work, I would resist treating normalized EBITDA as
an objective fact.
It is an estimate.
Two intelligent buyers can look at the same company and reach different
normalized EBITDA figures because their ownership plans differ.
A strategic buyer may eliminate duplicate accounting, HR and management
costs.
That buyer can justify synergies I cannot.
A hands-on owner-operator may replace the seller personally.
A passive investor needs full management.
A competitor may move production into an existing facility and eliminate
rent.
I cannot.
The same company can therefore have different economic values to
different buyers without anyone being irrational.
This is another reason “the business is worth four times EBITDA” is too
simplistic.
Whose EBITDA?
Under whose ownership?
With which people?
In which building?
After which adjustments?
At what required reinvestment?
Those questions come before the multiple.
What I Would Ask the Seller for
Before I accepted an SDE or adjusted EBITDA number, I would want enough
information to rebuild it myself.
At minimum:
- Three to five years of financial statements and corporate tax
returns. - Year-to-date financials compared with the same period last year.
- General ledger detail behind material add-backs.
- Payroll records for owners, family members and management.
- A written description of what each working owner actually does.
- Related-party transactions, including rent and management fees.
- Capital-expenditure history.
- Repair and maintenance history for major equipment.
- Working-capital history: receivables, inventory and payables.
- Customer concentration and revenue by major customer.
- Any expenses the seller says are personal, discretionary or
non-recurring. - Any costs I will incur that the seller currently does not.
Then I would build three numbers.
Number 1: Seller’s SDE
What economic benefit has historically been available to one working
owner?
Useful.
Number 2: Buyer-normalized EBITDA
What should this company earn after paying market rates for all labour
required to operate it under my intended structure?
More useful.
Number 3: Buyer-normalized free cash flow
After maintenance capex, normal working-capital requirements, cash taxes
and eventually acquisition debt service, what cash is actually left?
That is the number I ultimately have to live with.
The Three Numbers Can Tell Completely Different Stories
Imagine:
- SDE: $400,000
- Normalized EBITDA: $230,000
- Normalized pre-debt free cash flow: $170,000
A broker can honestly advertise a $400,000 cash-flow business.
A buyer can honestly conclude the underlying owner-independent business
only generates $170,000 of recurring cash before acquisition financing.
Both numbers can emerge from the same company.
The gap is the story.
What creates it?
Owner labour?
Capex?
Working capital?
Personal expenses?
Deferred maintenance?
Family payroll?
That gap tells me more about the acquisition than the headline multiple.
A Low SDE Multiple Can Be a Warning, Not a Bargain
Why would a business generating $300,000 of SDE sell for only
$750,000?
Sometimes because it is cheap.
Sometimes because the market understands the earnings better than the
buyer does.
Maybe:
- the owner works seventy hours per week,
- one customer is 55% of sales,
- the lease expires next year,
- the equipment is tired,
- the owner’s licence is essential,
- revenue has been declining,
- the business needs $250,000 of inventory,
- the owner’s relationships are the sales pipeline,
- the industry is shrinking,
- the company has no second layer of management.
The multiple is not just a price.
It is often the market’s compressed opinion of risk.
That does not mean the market is always right.
Small private businesses are inefficiently priced. That is part of their
appeal.
But before I congratulate myself for finding a 2.5× SDE business, I want
to understand why nobody else has paid 3.5×.
The Bigger Business Can Deserve the Higher Multiple
Now reverse it.
Why might I willingly pay 5× EBITDA?
Because the company has:
- a general manager,
- recurring or repeat customers,
- low customer concentration,
- clean financial statements,
- stable margins,
- useful equipment,
- a defensible local or technical moat,
- low owner dependence,
- good employees,
- manageable capex,
- strong cash conversion.
I am not paying more because I like expensive things.
I am paying more because more of the earnings belong to the company
rather than to the seller’s personal effort.
That distinction is central to how I think about business quality.
The ideal acquisition is not merely a company with high SDE.
It is a company where the cash flow survives the transfer of ownership.
The Metric I Actually Care About: Owner-Independent Earnings
If I had to reduce this entire article to one idea, it would be this.
I want to know the business’s owner-independent earnings.
That is not an official accounting term.
It is simply the question I care about as a buyer:
What does this company earn after paying fair market compensation for
everyone required to operate it, including the work currently
performed by the seller?
That gets me much closer to the asset I am actually purchasing.
Then I can make a conscious choice.
Maybe I decide to perform the owner’s role for three years.
Great.
If the business generates $250,000 of owner-independent earnings and
the job is worth another $150,000, I may take $400,000 out while I am
actively operating it.
But I know that $150,000 disappears from my personal economics when I
hire a replacement.
That allows me to plan the transition rather than experience it as an
unpleasant surprise.
It also makes growth targets more honest.
If I want to hire myself out of the company without reducing my cash
flow, I know exactly how much incremental EBITDA I need to create first.
This Changes How I Think About the First Few Years After Acquisition
Suppose I buy a business with:
- $350,000 SDE
- $220,000 owner-independent EBITDA
- $130,000 replacement cost for the seller
I decide to operate it personally.
For the first three years, I capture the full $350,000 before debt
service, tax and reinvestment.
But mentally I split it:
$130,000 = my job
$220,000 = my business
Now suppose I grow owner-independent EBITDA from $220,000 to $350,000.
I can hire a manager for $130,000 and still retain the same $220,000
of business earnings I started with.
I have effectively converted my labour into enterprise value.
That is a much more interesting target than simply “grow revenue 20%.”
The goal is not merely to make the business bigger.
The goal is to make the business less dependent on me while preserving
or increasing the return on my capital.
That is sovereignty.
SDE Is Useful for Buying the Business; EBITDA Is Useful for Escaping It
That may be the cleanest way I can put it.
SDE helps an owner-operator understand the total economic opportunity.
It says:
If I own this company and perform the seller’s work, what might the
business provide me?
EBITDA — properly normalized — pushes the analysis toward:
What does this organization earn after paying for the people required
to operate it?
If my ambition is to buy a company, work in it forever and enjoy being
the owner-operator, SDE may remain the more personally relevant number.
There is nothing wrong with that.
A good owner-operated company can provide excellent income, control and
wealth.
But if my ambition is to build an asset that eventually operates without
me, the migration from SDE toward owner-independent EBITDA becomes part
of the strategy.
I am not just trying to increase earnings.
I am trying to move the earnings out of my own hands.
The Acquisition Checklist I Would Use
When a broker sends me an offering memorandum showing SDE or adjusted
EBITDA, I would work through this in order:
- Reconcile the number to the actual financial statements. If I
cannot get from reported profit to advertised SDE or EBITDA, stop. - Identify every add-back. No miscellaneous bucket.
- Verify every material add-back. Invoice, payroll record,
contract or general-ledger detail. - Write down what the seller actually does. Hours are less
important than responsibilities. - Price the seller’s replacement at market. Not at the seller’s
salary. - Normalize family payroll and related-party transactions.
- Separate one-time expenses from recurring categories of unusual
expense. - Estimate maintenance capex. Equipment eventually sends invoices.
- Understand normal working capital.
- Calculate owner-independent EBITDA.
- Calculate free cash flow before acquisition financing.
- Layer in the actual debt structure.
- Stress-test a 10% and 20% revenue decline.
- Then discuss the multiple.
Not before.
Then I can finally ask whether the price makes sense.
What a Canadian Buyer Is Actually Buying
This is where the accounting question comes back to the bigger Sovereign
Canadian question.
A business acquisition can be one of the most powerful wealth-building
moves available to someone with capital, operating skill and a
willingness to accept concentration.
But the word business hides several different things.
At one end, I can buy a tiny company where the seller is the
salesperson, manager, technician and institutional memory.
I am largely buying his job, customer relationships and equipment.
At the other end, I can buy an organization with management, systems,
employees and customers that produces earnings before I arrive in the
morning.
I am much closer to buying an asset.
SDE is often the language of the first world.
EBITDA is often the language of the second.
Neither metric tells me whether the company is good.
Neither tells me whether the price is fair.
Neither tells me whether the customers will stay.
Neither tells me whether the debt is safe.
And neither tells me what the business will be worth after I own it.
But the difference between them tells me something extraordinarily
important:
How much of the advertised earning power belongs to the company, and
how much belongs to the person currently standing inside it?
That is the question I want answered before I buy.
Because I am perfectly willing to buy a job if it is a good job attached
to a great asset with a path to becoming independent of me.
What I do not want to do is pay an investment multiple for my own future
salary.
Disclaimer: This article is for general informational purposes and
documents how I think about business acquisitions. It is not business
valuation, accounting, tax, legal, lending or investment advice. SDE,
EBITDA and normalized earnings are non-standardized measures that can be
calculated differently depending on the business, transaction and
analyst. Any acquisition should be reviewed using the company’s
underlying financial records and appropriate professional advice.