Adjusted EBITDA

EBITDA vs. SDE: Which to Use

The threshold is roughly $2M in annual earnings:

• Below ~$2M: Use SDE. The owner is typically working full-time in the business, their comp is the biggest variable, and SDE normalizes for it.
• Above ~$2M: Use Adjusted EBITDA. At this scale, there's typically a management layer, the owner may not be operating, and EBITDA gives a cleaner picture of the enterprise's earnings power.

SBA acquisition loans use SDE for smaller deals. Private equity and institutional buyers use EBITDA almost exclusively.

The Standard Adjustments

Start with EBITDA (Net income + Interest + Taxes + D&A), then adjust for:

• Owner compensation above market — if the owner pays himself $500K but a replacement CEO costs $250K, add back $250K
• Non-recurring revenue or expenses — one-time legal settlements, COVID relief, unusual insurance recoveries, non-recurring consulting revenue
• Rent normalization — if the owner pays rent to a related entity above or below market rate
• Pro-forma adjustments — for acquisitions completed during the measurement period, annualized for the full period

Why "Adjusted" Matters

Raw EBITDA is easy to manipulate. Sellers push aggressive adjustments — particularly pro-forma revenue from new contracts that haven't actually materialized. A rigorous Quality of Earnings report independently tests each adjustment.

Adjusted EBITDA Multiples

Multiples expand significantly with scale. A business earning $500K SDE might trade at 3-4x. A business earning $3M Adjusted EBITDA in the same industry might trade at 7-9x. This multiple expansion is one of the fundamental value creation strategies in acquisition entrepreneurship: buy at a small-business multiple, operate to scale, exit at a larger multiple.