When valuing a small business, most buyers and lenders focus on a metric called Seller’s Discretionary Earnings (SDE). This figure reflects the true earning power of the business after adjusting for certain expenses. It is the most commonly used valuation metric for small businesses, while larger businesses tend to rely on EBITDA.
Add backs are central to calculating SDE. These are adjustments for non essential, one time, or personal expenses that do not reflect the ongoing operations of the business. Common examples include the full owner’s salary, personal vehicle use, discretionary travel, non recurring legal fees, or pandemic related income and expenses. The goal is to isolate the earnings a new owner could reasonably expect.
Well documented add backs improve transparency and build buyer trust. They also give a more accurate picture of profitability and can help justify a higher valuation. In contrast, unclear or unsupported adjustments may lead to lower offers or increased scrutiny during due diligence.
If you’re preparing to sell, work with a broker or accountant to identify and clearly explain all valid add backs. A thorough and honest financial picture makes your business more appealing to serious buyers.
