EBITDA vs SDE: How to Value a Business for SBA Loan Approval

When you’re buying a business with SBA financing, the valuation determines everything: your purchase price, your loan amount, your down payment, and whether lenders will approve the deal at all.

Two metrics dominate small business valuation: EBITDA and SDE. Understanding the difference—and knowing which one applies to your deal—is essential for structuring acquisitions that lenders will finance.

Quick Definitions: EBITDA vs SDE

SDE (Seller’s Discretionary Earnings)

SDE represents the total financial benefit available to a single owner-operator. It’s the cash flow a new owner would have if they ran the business themselves.

Best for: Owner-operated businesses under $5M revenue where the buyer will replace the seller as the primary operator.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)

EBITDA measures operating profitability independent of the owner. It assumes the business has professional management and the owner isn’t critical to daily operations.

Best for: Larger businesses ($5M+ revenue) with management teams in place, or businesses where the owner’s role can be replaced with a salaried manager.

When to Use Each Metric

Gray Area: The $3M-$7M Range

For businesses in the $3M-$7M purchase price range, either metric may apply. The deciding factors:

• If buyer will be the operator: Use SDE
• If buyer will hire a GM: Use EBITDA (deduct manager salary from SDE)
• If the business has a GM already: Use EBITDA

How to Calculate SDE: Step-by-Step

Start with Net Income

Begin with the net income figure from the business’s tax return. This is the most defensible starting point because it’s what the IRS accepted.

Add Owner’s Compensation

Include all forms of owner compensation:

• W-2 salary
• Guaranteed payments (for partnerships/LLCs)
• Health insurance premiums
• Retirement contributions
• Personal auto expenses run through business
• Other personal benefits

Add Non-Cash Expenses

• Depreciation
• Amortization

Add Interest Expense

Interest on existing debt is added back because the new owner will have different debt structure.

Add One-Time/Non-Recurring Expenses

• Legal settlements
• Major repairs (roof replacement, equipment overhaul)
• Moving expenses
• One-time consulting projects

Example SDE Calculation

How to Calculate EBITDA

Standard EBITDA Calculation

Adjusted EBITDA

“Adjusted EBITDA” adds back non-recurring items and normalizes owner compensation to market rate. This is more comparable to how SDE is used:

Valuation Multiples by Industry

Business valuation typically uses a multiple of SDE or EBITDA. Multiples vary by industry, size, and business quality.

Typical SDE Multiples (Small Businesses)

Factors That Increase Multiples

• Recurring or contractual revenue
• Growing year-over-year
• Diversified customer base
• Low owner dependency
• Strong management team
• Real estate included
• Proprietary products or processes

Factors That Decrease Multiples

• Customer concentration
• Declining revenue
• Heavy owner dependency
• Commodity business
• Industry headwinds
• Deferred maintenance

What SBA Lenders Look For in Valuations

Third-Party Valuation Requirement

For SBA loans, lenders typically require an independent business valuation when the purchase price exceeds $250,000-$500,000 (varies by lender). The lender orders this valuation; the borrower pays for it.

Purchase Price vs. Valuation

If the third-party valuation comes in below your purchase price, expect problems:

• Lender may cap loan at valuation amount
• You’ll need to cover the gap with additional equity
• Deal may need restructuring or renegotiation

If the valuation comes in above purchase price, you’re in good shape—you’re buying at a discount.

Common Add-Backs and Adjustments

Add-Backs Lenders Accept

• Owner’s salary and benefits: Always accepted
• Depreciation and amortization: Standard adjustment
• Interest on debt being refinanced: Accepted
• One-time legal or professional fees: With documentation
• Non-recurring repairs or expenses: With documentation
• Rent above market (to related party): Adjusted to market rate
• Personal expenses clearly run through business: With documentation

Documentation Requirements

For each add-back, be prepared to provide:

• Written explanation of the expense
• Supporting invoices or receipts
• Confirmation it won’t recur
• CPA or seller confirmation letter

Valuation Pitfalls That Kill Deals

Pitfall 1: Tax Returns Don’t Support the SDE

Problem: Seller claims $500K SDE but tax returns show $250K net income and only $100K owner salary.

Reality: The “missing” income isn’t verifiable and won’t be used for valuation or DSCR.

Pitfall 2: Aggressive Add-Backs Without Documentation

Problem: $200K in add-backs, but only $50K can be documented.

Reality: Lender uses $50K; your DSCR falls below minimum.

Pitfall 3: Paying a Premium Based on Growth Projections

Problem: Buyer offers 4x on projected SDE, which is 5x on historical.

Reality: Lender values based on historical; deal doesn’t get financed.

Pitfall 4: Ignoring Quality of Earnings

Problem: SDE looks good but includes non-recurring project revenue.

Reality: Third-party valuation adjusts for this; value comes in lower.

The Third-Party Valuation Process

Who Does the Valuation?

SBA lenders typically order valuations from:

• Certified Business Appraisers (CBAs)
• Accredited Senior Appraisers (ASAs)
• Qualified third-party valuation firms

Cost ranges from $3,000-$10,000+ depending on business complexity.

What They Analyze

• 3 years of tax returns
• Financial statements
• Industry comparables
• Asset values
• Management interviews
• Market conditions

Timeline

Typically 2-4 weeks from engagement to final report.

Frequently Asked Questions