SDE is Seller’s Discretionary Earnings. SDE is a common financial metric used in both business and website valuation calculations.
The purpose of SDE is to determine the total financial benefit a website produces for its owner. To do so, you take the net profit from the business, and add back to that number things such as the owners salary or any personal expenses that are being run through the business. For example, let’s say a website owner pays himself a $50,000 annual salary, and the websites net income after the owners salary is $50,000. The owners total financial benefit from the website is $100,000.
It’s important to calculate an accurate SDE number for your website before selling it. If you do not take advantage of adding back numbers, you are leaving money on the table! If your website is a 3x multiple business, if you forget to addback $10,000 of personal expenses per say, that’s $30,000 less you will receive when you sell your site.
How to calculate SDE
First, we are going to start with net income. Then we want to addback any non-cash expenses from the business such as depreciation or amortization. Next, addback any interest expense. From there, we need to addback any salary or personal expenses the owner is running through the business, or any random or non-recurring one-time expenses.
SDE = Net Income + Depreciation & Amortization + Interest expense + Owner’s salary + Owner personal expenses + Non-recurring or one-time expenses
What can you addback to SDE?
The most important addback to SDE is an owner’s salary. However, this can get more complicated if you have multiple owner’s who receive a salary. The common rule is to only addback one owner’s salary, but this isn’t always the rule.
If you have two owners and each spend 40 hours per week on the business, then you can only add one salary back. The reason for this is that we make the assumption that the new owner will need to use those salary dollars to hire someone to take over the one owner’s workload. Now if each owner only spends 5 hours on the business per week, then you can add both salaries back to SDE.
If you pay yourself in the form of distributions and do not run the distribution as an expense through the P&L, then you can’t add it back.
Owner’s personal expenses
Most website and business owners run personal expenses through their P&L for tax purposes. Common expenses are phone bills, home office “rent”, utilities, car expenses, meals, etc. Unless operating the website requires a separate phone, its own office, its own car, etc. then all of these items should be added back.
One-time & non-recurring expenses
SDE should reflect the amount of money the business generates that can be spent at the discretion of the owner. But it should also reflect business profitability at a steady state. Expenses that are truly non-recurring in nature can be added back as they are one-time expenses that the business will not occur going forwards in the future.
A good example is website re-development. If an owner pays $10k to get his website redesigned and refreshed, this number should be added back because it will not need to happen again the following year. Now, if the website requires $10k of annual website maintenance, then it should not be added back.
SDE does not always equal Cash Flow
SDE is a good proxy for cash flow, but not all the time. 95% of the time, SDE will represent cash flow that the new owner could expect. However, this isn’t always the case.
In eCommerce, if the owner buys the products in bulk and ships them out manually, then SDE might not equal cash flow. In this instance, if the business is growing at a steady rate, then cash flow will need to be used to buy additional inventory. And if the website is running accrual accounting, this will not be reflected in SDE. You could run into the scenario where you bought an ecommerce store and think you’re going to be pocketing $100k per year, but it turns out the actually number is $50k because the other $50k needs to be spent to buy inventory. This is called working capital.
Additionally, if you have a business that capitalizes expenses and depreciates them, rather than expensing them, SDE will not equal cash flow.
How to accurately calculate SDE
If my above commentary is a bunch of jargon to you, then reach out to someone for help! Having an SDE that is lower than what it actually should be results in you getting a lot less money in your pocket, since the effect is multiplied by whatever your business’ valuation multiple is.
Ultimately, reach out to an online business broker for help.