How to Leverage SDE Seller’s Discretionary Earnings in Negotiations
A deep understanding of how to play the SDE Seller’s Discretionary Earnings (SDE) game during negotiations is critical…. Buyers and sellers often use this financial metric to help determine a business’s value, providing insights into the company’s profitability. This post will discuss the tactics for winning an SDE bid, which can be your best offer.
What is SDE (Seller’s Discretionary Earnings), and how can it be calculated?
But before I get to the topic of negotiation tips, first things first… we need a clear understanding of SDE Seller’s Discretionary Earnings. SDE stands for seller discretionary earnings, representing the total cash flow that an owner can utilize. The line item takes the business’s net income before taxes, interest, depreciation, and amortization (a figure sometimes called TIDAS) but also adds any one-time or discretionary expenses the owner has deliberately incurred to that number. This is probably the most important metric for small and mid-sized businesses to determine purchase price potential under new ownership.
The Importance of SDE in Biz Sales
SDE is the number that many use to start valuation discussions when selling a business. The multiple of its SDE that a company goes for—Buyers value businesses by multiplying the figure with which I sell my firm to reach this. Fig. As such, having a well-documented and accounted-for SDE can provide sellers with the ability to negotiate from a more informed position. This is less about proving the current profitability of the business; it’s more about communicating your vision and potential upside in this opportunity for a buyer.
Getting Your SDE Ready for Negotiation
Preparation is the proper way to utilize SDE in negotiations. — First and foremost, ensure that your SDE calculation is accurate, transparent there (due diligence) for a reason, and defensible. Discrepancies or unknown costs may put prospective buyers on edge and compromise your negotiation position. An SDE Prep Guide: If you have the budget, work with an accountant or financial advisor experienced in business sales to help prepare a proper presentation of your SDE.
Spot Those Optional Costs
How to Prepare Your Statement of Discretionary Expenses One of the first steps in creating an SDE is identifying and segregating discretionary expenses. These include costs the current owner has spent, which are superfluous and will not need to be covered for the business’s continued operation. These could be things such as leisure and recreational travel or nonessential luxuries. Listing all these costs helps elucidate the scale of a business’s actual profit. Buyers are typically keen to know how much of the SDE is discretionary and which forms part of core operating earnings.
Owner Compensation Adjustment
Another essential part of SDE is the add-back for owner compensation. The owner’s salary is only one example and could be reasonable by market standards for a small business. For the sake of negotiation, you will also need to adjust the SDE to get it as close as possible to what any new owner would reasonably pay himself. The adjustment lets buyers visualize what the business could earn under their stewardship and gives you a stronger negotiating position.
Document One-Time Expenses
SDE can also be affected by one-time expenses. These are the costs that will stay the same under new ownership. Examples include:
Costs of bringing a lawsuit to an end
Expenses for moving the business
One-off marketing campaign costs
In many of these cases, you can also attribute some of that $200K owner benefit to one-off expenses. By mapping out those costs and explaining why they are not recurring, you will be able to represent a better SDE number for potential buyers.
Spot Potential Areas for Growth
Beautiful machinery. You know what — SDE is not only a thing of the past; if anything, it is more important for demonstrating future potential. Have answers ready to the possibilities of growth that a new owner could leverage during negotiations. This may mean entering new markets, introducing new products or services, or improving operations more effectively. This is a potential argument for a higher valuation when you frame SDE regarding future growth.
Justify Your Asking Price with SDE
The Perfect Way to Use SDE in Your Exit Strategy When negotiating your final sale price, one of the most beneficial relative measures you can use is Seller’s Discretionary Earnings (SDE). Again, buyers will likely bring their valuation models, but sellers can start anchoring bids on multiples of a well-supported SDE. Expect to be ready to explain how your SDE represents the business’s real earning potential and why this justifies your asking price. This strategy will protect against super-lowball offers and keep the conversation rooted in what you can provide.
Negotiation Tactics Using SDE
Once you have set up your SDE, now using it at a very strategic time during negotiations will work. Below are a few key tactics you should potentially try:
Begin with SDE: Grounding the Negotiation — Introduce your site’s SDE and show how it backs up your request. Anchoring the discussion around this economic number starts with a ping of value in your valuation.
Highlight Adjustments and Their Impact: Such Analysis of the Highlighted Adjustments and their Impact on SDE e provided (Tonally: taking of some discretionary expenses and one-time costs). Demonstrate how these changes increase profits for the business and argue why it should be valued higher.
Show Recent Sales: If applicable, show recent sales that have gone for a few times SDE. A comparison like this can bolster your position, showing that you are asking an appropriate price based on market moves.
Expect Your SDE to Be Challenged and Prepare: Any buyer who asks you will likely question the math behind calculating your Seller’s Discretionary Earnings (SDE) number and how that figure was derived. The negotiation process needs transparency and honesty to maintain trust and credibility.
Earn-Outs or Contingent Payments: On occasion, buyers are unwilling to pay your requested total purchase price at closing. You could use SDE to bargain earn-outs or contingent payments rooted in the business’s later performance. This can help offset the difference between where you value the property and what price a buyer will ultimately pay.
Work flexibly: SDE is a fantastic tool, but you must be adaptable in your negotiations. You should also be ready to discuss the other deal structures, allowing you to partner with the buyer and ensure the seller is paid correctly based on his SDE.
Do Not Fall into Common SDE Traps
While SDE can be helpful to its negotiations, beware of common pitfalls that may sabotage your efforts:
Bloating SDE: Resist the urge to pad your SDE through zero-cost non-discretionary items or understating actual business costs. This will be found in due diligence, and trust will be lost between the parties, creating a material adverse effect.
Failure to Account for Market Conditions: Substantial Discretionary Earnings are crucial in business valuation, but it’s not only that. The state of the market, industry trends, and the overall economic environment are also important. Remember this and set reasonable expectations for yourself based on your situation.
Not Documenting Adjustments: An excellent adjustment to the SDE should be documented with notes on how it was calculated and why. Not doing so clearly will likely promote skepticism and weaken your negotiation posture.
SDE Acquisitions — Professional Advisors Play a Key Role
SDE negotiations can be complicated and daunting if you need to learn more about financial metrics or valuation techniques. This is where professional advisors can be a huge help. Work with an experienced business broker, accountant, or attorney. They should be able to help create a solid SDE story for the seller and point out red flags during due diligence that can make negotiating easier. An accountant can help you land the sale of your business in a cleaner way.
Conclusion
Utilizing only an SDE seller’s discretionary earnings in a speaking engagement is an excellent method of sales ability, which can assist you in obtaining beautiful results when selling your business. Realizing how critical the SDE metric is and preparing an open and honest calculation that you can use during negotiations effectively becomes a crucial factor in determining the value of your business and negotiating to successfully close out on ensuring all parties win. If you remember to deal with the few aspects of flexibility, transparency, and realistic earning potential ideas at heart, this shall follow your development expectations most successfully.