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EBITDA vs SDE: What's the Difference? | A Business Lawyer Explains - YouTube
Channel: Brett Cenkus
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Hi this is Brett Cenkus I'm a business
lawyer and an M&A advisor so M&A
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is mergers and acquisitions and as a lawyer
and as an advisor I do a lot of work in
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this space so businesses buying and
selling each other so I help them with
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the legal side and also help sellers
market and sell their businesses terms
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that come up commonly in M&A are EBITDA and sellers discretionary earnings and
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these terms aren't restricted well sellers
discretionary earnings really is an M&A
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term but EBITDA shows up in other
places it shows up in finance and things
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like that but in M&A these are really
important terms so EBITDA E-B-I-T-D-A is an
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acronym and it stands for earnings before
interest taxes depreciation and
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amortization so it's the net earnings of
a business adding back in the interest
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the business paid on loans the taxes the
business paid the depreciation that
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reduced its income the depreciation to
assets is an accounting term accounting
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construct calculation that reduces
earnings and then amortization which is
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similar to depreciation depreciation is
on sort of hard assets so if you buy a
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huge piece of equipment for your
business you might depreciate it over
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time you write that off you reduce your
earnings because the asset is losing
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value over time it could be a couple
years could be 15 years and amortization
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is on intangible assets like goodwill
and other things like that
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so we add all these things back in so
if a business makes a million dollars in net
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earnings but they had a hundred thousand
dollars in paid a hundred thousand
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dollars in interest they pay two hundred
thousand dollars in taxes that's three
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hundred and then they had a hundred of
depreciation and amortization we add
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that back in that's a total add back
total add backs of four hundred thousand
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so EBITDA's 1.4 million seller
discretionary earnings is a similar idea
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but it shows up really it doesn't show
up in finance it shows up in mergers and
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acquisitions or just business brokerage
in the Main Street part of the market
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which I define as less than two million
dollars so businesses that are trading
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hands for less than two million dollars
and it's it's similar to EBITDA
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we're adding certain things back in but
it's sellers discretionary earnings or SDE
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actually other words you might hear for
it are recast earnings or owners benefit or
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adjusted earnings all mean the same
thing what we're doing is we're adding
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back in a couple other things we're
adding back in the compensation of the
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owner-operators in small businesses
owners tend to take money out of their
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business in a lot of different ways I
mean some will pay themselves some
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salary some will have distributions there's all
sorts of things going on and we're
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adding that back in because the idea is
that that owner/operator you know what
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they take out of the business how they
pay themselves can be wildly different
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in small businesses some take hardly
anything out they're building everything
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up in terms of building the worth of
their business some suck it all out
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every year right so we're trying to sort
of normalize for unique decisions of
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different owners and then we add back in
discretionary expenses things that an
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owner might run through the business
that are defensible that you can deduct
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as a necessary business expense that
really aren't really necessary
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so maybe certain travel certain
entertainments certain dues professional
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dues research periodicals you know stuff
like that
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maybe it's home office it's things like
that totally necessary but it is really
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something that you need necessarily to
run the business or that a new owner
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would need and one-time expenses we
would also put back in to say hey that
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was a one-off there was a crazy
litigation matter last year that's not
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gonna happen again there's no history of
that we're gonna add that back in here's
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what we're doing okay so that's what
these things are EBITDA and SDE why do
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they exist they exist so that so that
people looking at the business from an
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investment or a purchase standpoint can
compare apples and apples one business
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to another so there could be two exactly
similar businesses I mean exactly the same
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same revenue same industry same type of
customer same net earnings but one
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business is highly levered that has tons
and tons of loans and the other business
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has none well so the net earnings of
the one with a lot of loans is gonna be
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way down here right it's gonna be you
know it's gonna be a lot less than the
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other business but from a buyer's
perspective
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that's the same business because most
buyers are gonna require all the debt be
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paid off at closing so in the hands of
the new buyer those are identical
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businesses they're not in the existing
hands of the sellers but we're trying to
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normalize we're trying to get apples and
apples comparisons so with SDE the
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reason you put back in those one-time
charges is what you're trying to say is
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look I mean that's not normal we're
trying to give you an idea a new buyer
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of what this business will produce for
you next year and here's why we think
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you shouldn't count that thing and
here's why we're gonna add back in the
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owners salaries because those two
businesses are exactly the same but this
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owner is letting a lot of money build up
and this owners taking it all out what
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do you care I mean they both produce the
same amount of really truly the same
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amount of SDE so that's why we use these
terms in the industry that's what they
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mean if you have questions about EDBITDA
or SDE or anything about mergers and
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acquisitions reach out to me thanks
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