Earnings Multiples for Small Business
Depending on their size, businesses are valued based on a multiple of earnings. But which earnings number is utilized? The earnings multiple for a small business is applied to seller’s discretionary earnings (SDE). The earnings multiple for larger businesses is applied to EBITDA. The approximate cutoff, although it can vary with circumstances, for our definition of a small business vs. a larger business is seller’s discretionary earnings of $1,000,000.
EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization and is used for larger businesses. In general terms, Seller’s Discretionary Earnings is equal to EBITDA plus owner’s compensation and owner perks. SDE is an effort to identify all owner benefits available to the new owner of a business. Clearly, because SDE is a larger number than EBITDA, the earnings multiple applied to SDE is less than the earnings multiple applied to EBITDA.
Adjusted EBITDA and Add Backs
The example above is fairly simplistic. There are many other types of adjustments and add backs that must be considered. For instance, often Adjusted EBITDA is used to account for excess owner’s compensation (above fair market value to replace the owner’s services) or excess facility lease payments to an owner (when the owner personally owns the facility the business operates in). To see an example of Adjusted EBITDA read Adjusted EBITDA Calculation. To learn more about other add backs read Add Backs for Business Valuation.
