Key Insight
Owner compensation is always added back in SDE — but the add-back only creates value if a replacement operator costs less. When the replacement costs more, the add-back is negative and SDE shrinks.
Components of Owner Compensation
W-2 wages: Formal salary paid to the owner as an employee of the business
Distributions: Profit distributions to the owner (for LLCs and S-corps)
Benefits: Health insurance, dental, life insurance, disability insurance premiums paid by the business for the owner
Retirement contributions: SEP-IRA, SIMPLE IRA, 401(k) matches funded by the business
Payroll taxes: Employer portion of FICA on the owner's W-2 wages
Other perks: Vehicle allowance, cell phone, education, meals and entertainment that are personal in nature
The Replacement Manager Problem
Owner compensation is added back because the new owner sets their own compensation. But the add-back is only economically valid if a replacement operator costs the same or less.
If the owner pays himself $75,000 but it costs $130,000 to hire a replacement general manager with the same skills, the effective add-back is negative $55,000 — the new owner either does the work themselves (worth $130K) or pays more than the seller did.
This is the most frequently abused element of SDE marketing. Sellers show high SDE by paying themselves below-market compensation; buyers who don't model replacement cost overpay.
Single Working Owner Assumption
SDE assumes one working owner. If the business has two owners both working full-time and both drawing compensation, only one owner's compensation is added back in standard SDE — the second is a required labor cost. Both are added back in EBITDA (which strips all owner comp), but SDE is a single-owner metric.
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