In the M&A roadmap, Phase 2 (Objective Valuation) is where you establish the data-driven foundation for your entire sale. But valuation is not one-size-fits-all. The metric used to value a large, scalable enterprise is different from the one used for a smaller, owner-operated agency.
While Normalized EBITDA is the gold standard for larger agencies, Seller’s Discretionary Earnings (SDE) is the most relevant, accurate, and critical metric for valuing smaller, owner-operated agencies (typically those valued under $5 million).
This guide explains what SDE is, how it is calculated, and why it is the correct metric for a vast number of agency owners looking to sell.
What is SDE (Seller’s Discretionary Earnings)?
Seller’s Discretionary Earnings is a financial metric designed to show the total financial benefit available to a single new owner-operator.
The SDE Buyer Assumption
The SDE calculation is based on a specific and important assumption: that the new buyer will step directly into your shoes as the seller. They will be the primary, hands-on operator of the business, managing the agency day-to-day.
Therefore, SDE is calculated to show the total earning potential of the business before the new owner pays themselves. It answers the buyer’s most fundamental question: If I buy this agency and run it myself, how much money will the business generate for me?
This metric is the most relevant one for smaller agencies, as this owner-operator model is the most common for that segment of the market.
How is SDE Calculated?
SDE is calculated through a process of normalization (or recasting) of your financial statements. The goal is to provide a clear picture of the cash flow available to a single, hands-on owner by removing expenses that are not essential to the core operation of the business.
The calculation begins with your agency’s net profit and then systematically adds back key owner-specific and non-operational expenses.
The SDE Add-Back Calculation
A clear, defensible SDE calculation is the key to justifying your valuation.
Your SDE = Net Profit +…
- Interest, Taxes, Depreciation, and Amortization (I,T,D,A)
- The Owner’s Entire Salary and Benefits: This is the most critical part. The calculation adds back all compensation the current owner receives (salary, benefits, 401(k) matches, health insurance, etc.).
- Owner-Specific Discretionary Perks: Any personal expenses run through the business that a new owner would not incur (e.g., personal auto leases, club memberships, personal travel).
- One-Time, Non-Recurring Costs: Specific expenses or revenues that are not expected to repeat (e.g., a major, one-time legal settlement, an office renovation, or the profit from a one-time asset sale).
The resulting SDE figure is a clear, verifiable number that communicates the total financial benefit available to an individual who purchases the business and assumes your role as the primary operator.
The Critical Distinction: SDE vs. Normalized EBITDA
While SDE and Normalized EBITDA are both core profitability metrics, they are distinct tools suited for different scales of business. Normalized EBITDA is the gold standard used in over 90% of M&A deals for established, profitable, and scalable agencies.
The distinction rests entirely on how the owner’s salary is treated, which reflects the buyer’s assumed role post-acquisition.
| Feature | Seller’s Discretionary Earnings | Normalized EBITDA |
|---|---|---|
| Primary Applicability | Smaller, owner-operated agencies (typically < $5M valuation). | Larger, established, and scalable agencies (typically > $5M). |
| Buyer Assumption | The new owner will step in as the primary, hands-on operator. | The business is a scalable enterprise that requires a professional management structure. |
| Owner Salary Treatment | Adds back the owner’s entire salary and benefits. | Adjusts the owner’s compensation to a fair market rate for a hired general manager (this market rate remains as an expense). |
| The Core Question | What is the total financial benefit for me if I run this business? | What is the sustainable profit after paying a professional manager to run this business? |
For larger agencies that are scalable, Normalized EBITDA is the correct metric because it proves profitability after accounting for management costs, demonstrating that the business is a self-sustaining enterprise. For a smaller agency where the owner is the manager, SDE is the more accurate reflection of value.
Where SDE Fits in Your Valuation (And Where It Doesn’t)
It is just as important to know when not to use SDE.
SDE is for a Full Agency Sale Only
SDE is a metric relevant only in the context of a Full Agency Sale—what buyers call a turnkey business. The buyer is acquiring your entire operational infrastructure (staff, brand, processes, etc.) and your SDE is the measure of that infrastructure’s profitability.
SDE is Not for a Book of Business Sale
If you are only selling your Book of Business (a pure revenue stream) and the buyer is not acquiring your staff, rent, or other expenses, then your SDE and EBITDA are irrelevant.
The preferred and ideal valuation method for a pure revenue stream is a Revenue Multiple (a multiple of your gross annual commissions). In this case, the buyer is simply plugging in your revenue stream to their own existing infrastructure, so your expenses do not matter to them.
Using the Right Metric for Your Agency
The M&A market speaks a specific financial language, and using the right metric is essential for a credible, data-driven valuation.
Seller’s Discretionary Earnings (SDE) is the correct and most powerful metric for smaller, owner-operated agencies (typically valued under $5 million). It is calculated by normalizing your financials and adding back your entire owner’s salary to show the total cash flow available to a new owner-operator.
It is a distinct tool from Normalized EBITDA (for large enterprises) and a Revenue Multiple (for book-only sales). By calculating a clear, defensible SDE, you arm yourself with the objective data needed to set a credible valuation and speak the financial language of your most likely buyers.
Create your free Milly Books account for an instant valuation and begin your data-driven M&A journey.
Frequently Asked Questions (FAQ)
SDE is a profitability metric tailored for smaller, owner-operated agencies (typically under $5 million). It calculates the total financial benefit available to a single new owner-operator by adding back the owner’s entire salary, benefits, and personal perks to the net profit.
The treatment of the owner’s salary. SDE adds back the entire owner salary, assuming the new buyer will be the operator and take that salary as their benefit. Normalized EBITDA only adds back the excess owner salary above a fair market rate, leaving a market-rate manager’s salary as an expense.
Because SDE is designed to show the total cash flow available to a new owner who is stepping into your shoes. That salary is not an expense to them; it is the benefit they will receive for operating the business.
SDE is the most relevant metric for smaller, owner-operated agencies (typically under $5 million). Normalized EBITDA is the gold standard for larger, more established, and scalable agencies where the buyer is an investor or enterprise, not a hands-on operator.
Glossary of Key Terms
- Asset-Based Approach: A valuation method that calculates an agency’s net value by subtracting total liabilities from the fair market value of total assets; often used only to establish a floor value.
- Book of Business: A specific list of clients and policies that represents a future stream of commission and fee revenue.
- Discounted Cash Flow (DCF) Analysis: The most comprehensive Income-Based valuation method that projects an agency’s expected future cash flows and discounts them back to their present value.
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): The gold standard metric for valuing a full insurance agency, measuring core operational cash flow and profitability.
- Full Agency Sale (Turnkey Business): The sale of an entire enterprise, including the staff, brand, processes, and operational infrastructure, valued holistically based on Enterprise Value.
- Income-Based Approach: A forward-looking valuation methodology that calculates a business’s worth based on the present value of all the income it is expected to generate.
- Market-Based Approach (Relative Value): A valuation methodology that determines an agency’s worth by comparing it to similar businesses recently sold in the current market, relying on valuation multiples.
- Normalization (Recasting): The critical process of adjusting an agency’s financial statements to remove expenses specific to the current owner (like excess salary or personal perks) and one-time, non-recurring costs, resulting in Normalized EBITDA or SDE.
- Normalized EBITDA: An adjusted EBITDA figure that reflects an agency’s true, sustainable earning power for a new owner. It is the single most important metric for buyers and lenders of established, scalable agencies.
- Revenue Multiple: A valuation metric calculated as a direct multiplier of an agency’s gross annual revenue; the preferred and ideal method for valuing a pure Book of Business sale.
- Seller’s Discretionary Earnings (SDE): A profitability metric tailored for smaller, owner-operated agencies (typically under $5 million), reflecting the total financial benefit available to a single owner-operator by adding back the owner’s entire salary and perks to net profit.
- Valuation Fog: A state of uncertainty experienced by small to medium-sized agency owners, unsure of their true market worth due to a scarcity of comparable sales data.