EBITDA is one of those business terms that sounds complicated but is actually pretty straightforward once you break it down. The acronym stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. But what does that actually tell you about a business?
EBITDA is a profit metric, similar in spirit to SDE. It’s showing you what a business is earning, stripped of certain accounting and financing decisions that don’t reflect operational performance. But it’s used primarily for larger businesses, while SDE is the metric for smaller ones.
The Difference Between EBITDA and SDE
Both metrics are trying to show you cash-generating profit. But they measure it differently.
SDE (Seller’s Discretionary Earnings) starts with net income and adds back owner salary, owner perks, and one-time expenses. It’s designed for small businesses because it accounts for the fact that many owners take salary plus profit, and a new owner might have different compensation preferences.
EBITDA starts with net income and adds back interest (cost of debt), taxes, depreciation, and amortization. It’s designed to show operating earnings without the noise of capital structure (how much debt a company has) or accounting decisions (how fast assets are depreciated).
Here’s a practical difference. Imagine two businesses, both with $1 million in net income. Business A has $100,000 in interest expense and $50,000 in depreciation. Business B has no debt and no depreciation. Their net income is the same, but their EBITDA is different: Business A’s EBITDA is $1.15 million ($1M + $100K interest + $50K depreciation). Business B’s EBITDA is $1 million. Same bottom line, different operational reality when you strip out financing and accounting effects.
SDE doesn’t care about interest or depreciation because it’s looking at the profit available to the owner. EBITDA is trying to isolate the profit generated by the business’s operations, separate from how the business is financed or how assets are accounted for.
When Do You Use Each?
Under $3 million in annual revenue: Use SDE. Most small businesses use SDE because it’s the standard metric buyers expect, and it accounts for owner compensation in a way that matters for small businesses.
$3 million to $5 million: You might see both. Larger service businesses or small manufacturing might use SDE. Businesses that are more capital-intensive or are preparing for a larger institutional buyer might use EBITDA.
Over $5 million: Use EBITDA. This is where institutional buyers (private equity, larger strategic acquirers) enter the picture, and EBITDA is their standard metric.
Why Does This Matter for Valuation?
EBITDA multiples are different from SDE multiples. A small business might sell for 2-4x SDE. But a business sold on EBITDA might be 6-10x, or even higher for fast-growing businesses.
This isn’t because EBITDA generates more profit than SDE. It’s because larger, institutionally-backed buyers have different valuation approaches. They’re looking at businesses that generate strong cash flow, and they’re less concerned about owner compensation because the new owner will be a corporation or investor, not an individual taking a salary.
An Example
Let’s say you own a contracting business with $2 million in annual revenue. Your tax return shows $300,000 in net income. You’ve been paying yourself a $100,000 salary, and you’ve had $50,000 in one-time expenses. Your SDE is $450,000.
At 3x SDE, your business is worth roughly $1.35 million.
Now imagine that same business but with $5 million in revenue and $800,000 in net income. You’re still paying yourself $100,000 and you’ve had $50,000 in one-time expenses. Your SDE is $950,000, and at 3x SDE, you’re looking at $2.85 million.
But wait. If you’re at the $5 million revenue mark, a strategic buyer might look at your EBITDA instead. Your EBITDA is around $900,000 (net income plus add-backs). At 8x EBITDA, that’s $7.2 million. Much higher.
This is why understanding which metric applies to your business matters. If you’re in the small business range, SDE is your anchor. If you’re scaling toward institutional buyers, EBITDA becomes increasingly relevant.
The Transition
As your business grows, you’ll transition from SDE thinking to EBITDA thinking. This usually happens naturally around the $3-5 million revenue range. At that point, you might have a professional accountant recast your financials to show both metrics, which gives potential buyers flexibility in how they think about your valuation.
The key insight: don’t just memorize a metric. Understand what it’s measuring (owner profit vs. operational profit) and when it applies to your business. SDE is simpler and more common for small business sales. EBITDA is more sophisticated and used for larger deals. Know which one your business should be valued on, and make sure you’re comparing apples to apples when you evaluate offers.