When a buyer evaluates your independent insurance agency, their primary question is simple: How much cash does this business really generate?
To answer this, they look past the net income on your tax return to find the true, sustainable earning power of your operation.
Two key metrics are used to measure this power: Seller’s Discretionary Earnings (SDE) and EBITDA. While similar, these metrics are used for different types of agencies. Understanding which one applies to your business is the first step in a professional valuation and is crucial for speaking the same language as your potential buyer.
The Goal: Finding Your Agency’s True Earning Power
Both SDE and EBITDA are profitability metrics designed to normalize your earnings. This process involves taking your reported net income and adding back certain owner-specific and non-operational expenses.
The goal is to reveal the core cash flow the business generates. This gives a buyer a clear, apples-to-apples picture of the financial potential they are acquiring, free from your personal tax or financing decisions.
Normalization is the process of finding the true profit of the business, which is the starting point for any serious valuation.
Defining SDE: The Metric for the Owner-Operated Agency
Seller’s Discretionary Earnings (SDE) is the valuation metric most relevant for smaller independent agencies, typically those valued under $5 million.
What It Is
SDE represents the total financial benefit available to a single owner who actively runs the business day-to-day.
The Key Calculation
It is calculated by taking your net profit and adding back:
- The owner’s entire salary and benefits.
- Discretionary perks (like a personal vehicle run through the business).
- Standard items: Interest, Taxes, Depreciation, and Amortization.
Its Purpose
SDE is designed to show a potential buyer how much money they would make if they stepped directly into your shoes as the new owner-operator.
Think of SDE as the total owner’s paycheck. It combines the company’s profit and the owner’s salary into a single number.
Guide to Seller’s Discretionary Earnings (SDE)
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.
Defining EBITDA: The Gold Standard for Larger Businesses
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the gold standard for professional buyers and is the preferred metric for larger, more established agencies (used in over 90% of M&A deals).
What It Is
EBITDA also measures operational profitability, but with one critical difference from SDE.
The Key Calculation
It is calculated by taking net profit and adding back only:
- Interest
- Taxes
- Depreciation
- Amortization
It also includes add-backs for the owner’s personal perks, but it treats the owner’s salary very differently.
EBITDA is a measure of the business’s profit as a standalone enterprise, separate from the owner’s compensation.
EBITDA: The Metric That Drives Your Agency’s Valuation
What is EBITDA, and why has it become the gold standard for buyers and sellers? Understanding the why behind this metric is the key to unlocking and maximizing your agency’s value.
The Critical Difference: What About the Owner’s Salary?
The only significant difference between SDE and EBITDA is how they treat the owner’s salary. This single difference explains why they are used for different-sized agencies.
How SDE Treats Salary
SDE adds back 100% of the owner’s salary.
Why? Because in a small, owner-operated agency, the buyer is assumed to be buying a job. They will run the agency themselves, so the owner’s salary is considered part of the profit they are acquiring.
How EBITDA Treats Salary
EBITDA does not add back the owner’s salary.
Why? Because in a larger agency, the buyer is not buying a job. They are buying a scalable business that they will not run themselves.
They will have to hire a General Manager to run it. Therefore, the owner’s salary is normalized to a fair market rate (e.g., $120,000) for that GM. This $120,000 is left in as a real expense, and only the excess salary (if any) is added back.
SDE values the business including the owner’s job. EBITDA values the business excluding the owner’s job, as it must pay for a professional manager.
Which Metric is Right for Your Agency?
The answer provides a clear line of demarcation for how your agency will be valued by a professional buyer.
You are an SDE Agency if…
- You are the primary owner-operator.
- Your agency is smaller (typically valued under $5 million).
- A buyer would likely replace you directly and run the business themselves.
- Your value is based on the total cash flow you, as the owner, get to keep.
You are an EBITDA Agency if…
- Your agency is larger and more scalable.
- You already have a management structure in place.
- A buyer would not run the business themselves and would need to hire a General Manager to replace you.
- Your value is based on the profits after paying for all staff, including a manager.
Using the correct metric is the first step to a credible valuation. It shows buyers that you are a serious seller who understands your business’s position in the market.
Using the Right Metric for a Credible Valuation
Understanding your agency’s true earning power is the foundation of a successful sale. Using the right metric—whether SDE for a smaller, owner-operated business or Normalized EBITDA for a scalable enterprise—is essential.
It allows you to set a credible valuation, build buyer confidence, and speak the same financial language as the sophisticated acquirers in today’s market.
Let your data tell the story. Create your free Milly Books account for an instant, sophisticated valuation that analyzes your agency’s unique characteristics to provide an objective, data-driven assessment of its worth.
Frequently Asked Questions (FAQ)
SDE is a profit metric used for smaller, owner-operated businesses. It’s calculated by taking net profit and adding back interest, taxes, depreciation, amortization, and the owner’s entire salary and personal perks. It represents the total financial benefit to one owner.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is the profit metric used for larger, professionally managed businesses.
The owner’s salary. SDE adds back the entire owner’s salary. EBITDA does not; instead, it leaves in a market-rate salary for a General Manager to run the business, making its profit number lower than SDE.
As a general rule, SDE is used for smaller agencies (e.g., under $5M value) where the new owner will likely run the business themselves. EBITDA is the gold standard used for larger agencies that a buyer will run with a hired manager.
Glossary of Key Terms
- SDE (Seller’s Discretionary Earnings): The total profit available to one owner-operator. Calculated as: Net Income + Interest + Taxes + Depreciation + Amortization + One Owner’s Total Salary & Benefits + Personal Perks.
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): The operational profit of a business before financing, tax, and accounting decisions.
- Normalized EBITDA (Adjusted EBITDA): The gold standard for larger agencies. It is EBITDA adjusted for owner’s perks and normalizing the owner’s salary to a fair market rate for a replacement manager.
- Normalization (Recasting): The process of cleaning up a profit & loss statement by adding back owner’s personal expenses and one-time costs to find the true, sustainable profit.
- Add-Back: An expense that is added back to your profit during normalization to find the true earning power (e.g., owner’s auto lease, one-time legal fees).