Small businesses are valued based on SDE. That's why it exists, it's the most 'common' denominator that can be applied across businesses. Just don't confuse it with money that ends up in your pocket.
@@DavidCBarnett thank you for your reply, I think that is what is throwing me off, understanding the difference between sde and what will then end up in my pocket. Thank you for the clarification
Net earnings is not cash flow either. Things like depreciation are not cash expenses. Also, cash collected in earlier periods could be taken out at owner's salary in later periods. It's why you need to be looking at balance sheets as well as income statements.
I'm late to this one watching on 4/9/2024 - I thought net profit has the same definition as net earnings and both have taxes subtracted in their calculations? Hard to distinguish the nuances of these terms because they seem to sometimes be used interchangeably. Thanks and I love your content!
In my mind net income and net earnings are the same. But, this is why you sometimes need to ask when looking at a presentation about any business. Many use their own definitions that don't align with what you think.
Was there a multiple applied to the SDE to determine a sale price? I saw a newer video where you referred to a 2.0-2.2 multiple, I thought it pertained to SDE but might be wrong.
Unless you are a large company that master tax evasion, you should never ever add the tax to your net profit. This is why EBIDTA or SDE ( which includes EBIDTA) is a very dangerous metric. In my humble opinion, especially for small to medium sized company, Cach flow + owner salaries = lets call it reduced SDE, is the best metric to evaluate a companies performance for you as a buyer. Personally however, i will never add the owner salary, and just use the cash flow as the sole metric.
The reason taxes are added back is because they can be moved up or down because of management decisions about things like salaries, bonuses or depreciation elections. Taxes can be fluid in this way. I think it's best to add them back, then calculate your own tax burden when you do the buyer's cash flow forecast. Especially if you're going to be operating under a different kind of business structure or a different jurisdiction, etc.
Accounts payable is unpaid bills. If you don't pay your bills, your cash is increasing. You owe more. When you pay the bills, the A/P goes down and the cash as well. Get it?
Thanks David. Really helpful! I'm looking at a small business and the SDE is more than $200k while the net income is just $50k. In the add-backs, the broker included many items such as "COGS (personal)", "meal and entertainment", "cash (not reflected in books)" etc. Does it just mean these are all personal items? I'm really confused by the personal COGS and the cash...
Every business I get from a broker is fucked up , make sure you verify especially compensation to officers either on k1s or 1120s and make sure it’s consistent. ,cogs is bullshit watch out for husband and wife teams most of yjf business I look at is literally all add backs and ebitda is shit then asking price is 5-7 times ebitda which should be 2-3 times ebitda .
Thanks Brian, Depends on the industry. For example, if it were a restaruant or nightclub it might be worth $300K, if it was a machine shop with a lot of equipment it could be around $500-$550K. Ultimately, the buyer needs to work out a cash flow forecast to see if the debt service makes sense while leaving enough cash for them to take home and to cover 'wiggle room' if sales should decline. The more 'stuff' in the business the easier it is to finance longer term and the more of a 'plan b' that exists if things should go wrong. ie, more value if you closed and liquidated means people are usually willing to pay more. If you want to get into the weeds of cash flow forecasting, check out www.BizPlanSchool.com
Why don’t business brokers just value a business with a multiple of forward in unleveraged FCF rather than a multiple of past SDE? For example try and find the unlevered FCF ten years out, discount it with WACC, and add a multiple on it. This way all CAPEX, taxes, growth, and owners salary over the next ten years is taken into account, rather than with SDE where it isn’t. Since businesses usually sell cash free-debt free or in an asset deal the debt shouldn’t be taken into account and if the buyer plans on using debt they can just subtract that amount and come up with levered FCF. Why in your experience isn’t this the industry standard, as it makes more sense to me than using past SDE and multiples on that to value businesses, or am I getting something wrong?
Because when you buy a small business you become responsible for the leadership and management. Discounting future cash flows is used for bigger businesses with a management team in place that sticks around. In the smallbiz space, buyers ask, 'how much money do I have access to if I buy this business and run it?' If they hire a manager, it's easy to adjust to normalized EBITDA.
I'm doing a 45 minute talk on this topic for the BossUp conference later this month, you should come, it's free.. hopin.com/events/bossup-virtual-micro-m-a-conference
David, I bought your BBA course and was gong to email these questions you but figured some other ppl may have the same question. I'm actively looking at two business's right now. Two Question's: Q1) When looking at the financials I'm being sent for review, is owner cash flow the same as seller discretionary earnings? Q2) Is the owner cash flow or seller discretionary earnings SDE figures, after the Owner's salary and all expenses? Looking forward to your replay. Thank you.
Q1= Usually, yes. Q2= It's after all expenses but before the owner's salary. Definition of SDE is the total amount of money available to an owner who works full time in the business. Out of this money, the owner has to satisfy 5 things: 1. their pay, 2. debt service 3. taxes 4. replace machinery and equipment 5. get a return on the cash they put down. Hope this helps.
Because the level of interest and taxes are 'discretionary.' They are only there based on how the current owner runs the company. For example, you might have more or cheaper debt meaning your interest expense would be different. Also, if you chose to issue a big bonus to yourself, your own taxes would go up, but the company taxes would go down (if this is a corporation) meaning that the tax bill is actually under the control of the owner. We go back to SDE and then as a buyer, you need to figure out your own interest, capex, and tax situation when you forecast how you will be able to live and service debt once you're the owner. Hope this helps.
Buying a business this small is for scavengers. The amount headache after completion of a deal like this is not worth it. I am aware that headache comes with the purchase of any business, however the juice must be worth the squeeze. With small enterprises like this if you sneeze you are out of business. I wrestle with the fact that people buy businesses that have no clear management structure in place. A business with no management, and processes in place automatically makes that business not operationally sound. In my mind, this creates an astronomical devaluation of the company.
Everything you say is true. That's why they sell for such low valuations vs. mid-market and other larger and more 'organized' businesses. Some of my other videos address how many buyers of these businesses actually are the ones who bring the skills to 'organize' it better and this is what allows growth and ergo an enhancement of the value and cash flow.
The 'classification' of businesses is different based on who you're talking to. In my world, this would be a mid-market business, not a small one. To a Harvard professor, this example is a small business. It's why you always have to calibrate for the content you're consuming. ie the book HBR Guide to Buying a Small Business is about businesses this size.
Great video! At 5.20 you mentioned that the principle portion of the loan replayment is not represented as net income. Does that mean that the end of the day the income required to make payment of the principle portion is taxed? I hope that question makes sense
Yes. it does. Yes, it is. People don't often get it but when you take a bank loan, you don't get taxed on that money, so, when you pay it back, it's also a non-taxation thing. The money you earn to make the principle payment is taxable income. People get themselves trapped by this all the time with short amortization loans. They give all their cash to the lender, then have none to pay the taxes they owe.
Adjusted EBITDA assumes a manager is being paid a fair market salary for running the business. So, yes, your thinking is correct. Normally, we add back the full owner salary to get SDE, then use a FMV salary to get to EBITDA.
It is really helpful to see each of these side by side. Thank you! You always explain things in a way that is easy to understand.
Glad it was helpful Patty!
This video was a gold mine crash course, as I start my small business acquisition journey. Thank you!!!!
Thanks Steve
This was extremely helpful, thank you! Breaking the calculations into separate steps made it so easy to follow.
Glad it was helpful Creed.
This is the clearest explanation I've ever seen. Which should we use when valuing a business to buy? Net income?
Small businesses are valued based on SDE. That's why it exists, it's the most 'common' denominator that can be applied across businesses. Just don't confuse it with money that ends up in your pocket.
@@DavidCBarnett thank you for your reply, I think that is what is throwing me off, understanding the difference between sde and what will then end up in my pocket. Thank you for the clarification
The best explanation I’ve seen yet! Thanks
Wow, thanks Aaron!
Anyone know the answer:
If the Net Earnings are $85.942.34 then how does the owner pull out a $100,000 Owner's Salary? Where does it come from?
Net earnings is not cash flow either. Things like depreciation are not cash expenses. Also, cash collected in earlier periods could be taken out at owner's salary in later periods. It's why you need to be looking at balance sheets as well as income statements.
Thank u this was super helpful!! Just what I was looking for!
You're welcome
Thanks! Great information ...Subscribed
Thanks for the sub!
I'm late to this one watching on 4/9/2024 - I thought net profit has the same definition as net earnings and both have taxes subtracted in their calculations? Hard to distinguish the nuances of these terms because they seem to sometimes be used interchangeably.
Thanks and I love your content!
In my mind net income and net earnings are the same. But, this is why you sometimes need to ask when looking at a presentation about any business. Many use their own definitions that don't align with what you think.
I absolutely love the Excel details! Thank you.
Glad it was helpful!
That was just what I needed! Thanks
Glad I could help!
Was there a multiple applied to the SDE to determine a sale price? I saw a newer video where you referred to a 2.0-2.2 multiple, I thought it pertained to SDE but might be wrong.
This video talks about cash flow. not valuation.
Simply Excellent 👍🏾
Much appreciated
Unless you are a large company that master tax evasion, you should never ever add the tax to your net profit. This is why EBIDTA or SDE ( which includes EBIDTA) is a very dangerous metric. In my humble opinion, especially for small to medium sized company, Cach flow + owner salaries = lets call it reduced SDE, is the best metric to evaluate a companies performance for you as a buyer. Personally however, i will never add the owner salary, and just use the cash flow as the sole metric.
The reason taxes are added back is because they can be moved up or down because of management decisions about things like salaries, bonuses or depreciation elections. Taxes can be fluid in this way. I think it's best to add them back, then calculate your own tax burden when you do the buyer's cash flow forecast. Especially if you're going to be operating under a different kind of business structure or a different jurisdiction, etc.
im confused how accounts payable going up causes cash to go up. wouldnt that mean we have to pay more?
Accounts payable is unpaid bills. If you don't pay your bills, your cash is increasing. You owe more. When you pay the bills, the A/P goes down and the cash as well. Get it?
👌🙏
Enjoy!
COGS always trips me up.
It's just the direct cost of making the sale.
Very helpful
You're welcome
This one killed it for me!...... thank you David!
Thanks b. This fools a lot of folks.
Good video
Glad you enjoyed
Is that why they say cash flow is king?
They say 'Cash is king' because if you have cash you can buy your way out of problems.
Thank you!
You're welcome!
Aweseome vid
Glad you find it helpful.
Wow! - straight to the point, plain talk, and really, really simple to understand. Thx u
These are my goals everyday, glad you're finding these useful. Cheers.
Thanks David. Really helpful! I'm looking at a small business and the SDE is more than $200k while the net income is just $50k. In the add-backs, the broker included many items such as "COGS (personal)", "meal and entertainment", "cash (not reflected in books)" etc. Does it just mean these are all personal items? I'm really confused by the personal COGS and the cash...
I've just recorded a video answering this question... watch for it in September.
Every business I get from a broker is fucked up , make sure you verify especially compensation to officers either on k1s or 1120s and make sure it’s consistent. ,cogs is bullshit watch out for husband and wife teams most of yjf business I look at is literally all add backs and ebitda is shit then asking price is 5-7 times ebitda which should be 2-3 times ebitda .
Really great video, it was very helpful !!!
Thanks Lack.
I searched for SDE and found this- super helpful!
Yes, so many people are confused by these terms. This is one of my most popular videos.
Based on this example, what would you pay for this company?
Thanks Brian,
Depends on the industry. For example, if it were a restaruant or nightclub it might be worth $300K, if it was a machine shop with a lot of equipment it could be around $500-$550K. Ultimately, the buyer needs to work out a cash flow forecast to see if the debt service makes sense while leaving enough cash for them to take home and to cover 'wiggle room' if sales should decline.
The more 'stuff' in the business the easier it is to finance longer term and the more of a 'plan b' that exists if things should go wrong. ie, more value if you closed and liquidated means people are usually willing to pay more. If you want to get into the weeds of cash flow forecasting, check out www.BizPlanSchool.com
Why don’t business brokers just value a business with a multiple of forward in unleveraged FCF rather than a multiple of past SDE?
For example try and find the unlevered FCF ten years out, discount it with WACC, and add a multiple on it. This way all CAPEX, taxes, growth, and owners salary over the next ten years is taken into account, rather than with SDE where it isn’t.
Since businesses usually sell cash free-debt free or in an asset deal the debt shouldn’t be taken into account and if the buyer plans on using debt they can just subtract that amount and come up with levered FCF.
Why in your experience isn’t this the industry standard, as it makes more sense to me than using past SDE and multiples on that to value businesses, or am I getting something wrong?
Because when you buy a small business you become responsible for the leadership and management. Discounting future cash flows is used for bigger businesses with a management team in place that sticks around. In the smallbiz space, buyers ask, 'how much money do I have access to if I buy this business and run it?' If they hire a manager, it's easy to adjust to normalized EBITDA.
You made this so easy to understand. I always had trouble understanding cashflow. It all makes perfect sense now. Thank you! Subscribed immediately!
Thanks, glad to help.
Super simple in the best way
Glad you liked it
so sde is a sales gimmick to make it seem like business is making more $ than it actually is?
I'm doing a 45 minute talk on this topic for the BossUp conference later this month, you should come, it's free.. hopin.com/events/bossup-virtual-micro-m-a-conference
David, which column would you add back owners “benefits”?
Those are added back in all instances for most small deals. I didn't touch on that in this video.
David, this is extremely helpful and the best explanation on net
Thanks Steve
David, I bought your BBA course and was gong to email these questions you but figured some other ppl may have the same question. I'm actively looking at two business's right now. Two Question's: Q1) When looking at the financials I'm being sent for review, is owner cash flow the same as seller discretionary earnings? Q2) Is the owner cash flow or seller discretionary earnings SDE figures, after the Owner's salary and all expenses? Looking forward to your replay. Thank you.
Q1= Usually, yes. Q2= It's after all expenses but before the owner's salary.
Definition of SDE is the total amount of money available to an owner who works full time in the business. Out of this money, the owner has to satisfy 5 things: 1. their pay, 2. debt service 3. taxes 4. replace machinery and equipment 5. get a return on the cash they put down.
Hope this helps.
@@DavidCBarnett I helped immensely. Thank you for your speedy reply and clearing that up for me.
Finally… a truly helpful video. Thank you
The channel is full of them.. check it out. Thanks.
Very Informative and clear.
Thanks for watching.
Lovely. David you are an awesome tutor!
Thank you kindly!
Very helpful.
Glad it was helpful!
Great simple explanation!
Glad it was helpful!
Awesome video...as always.
Thanks
That was excellent.
Thanks Noah
Very good VDO, one question here,
why SDE is not 100K + 85,942 + 8,000, since interest,tax are things we need to pay ( not belong to owner )
Because the level of interest and taxes are 'discretionary.' They are only there based on how the current owner runs the company. For example, you might have more or cheaper debt meaning your interest expense would be different. Also, if you chose to issue a big bonus to yourself, your own taxes would go up, but the company taxes would go down (if this is a corporation) meaning that the tax bill is actually under the control of the owner.
We go back to SDE and then as a buyer, you need to figure out your own interest, capex, and tax situation when you forecast how you will be able to live and service debt once you're the owner.
Hope this helps.
Buying a business this small is for scavengers. The amount headache after completion of a deal like this is not worth it. I am aware that headache comes with the purchase of any business, however the juice must be worth the squeeze. With small enterprises like this if you sneeze you are out of business.
I wrestle with the fact that people buy businesses that have no clear management structure in place. A business with no management, and processes in place automatically makes that business not operationally sound. In my mind, this creates an astronomical devaluation of the company.
Everything you say is true. That's why they sell for such low valuations vs. mid-market and other larger and more 'organized' businesses. Some of my other videos address how many buyers of these businesses actually are the ones who bring the skills to 'organize' it better and this is what allows growth and ergo an enhancement of the value and cash flow.
Hi David,
A Biz with $18m gross $1.8 EBITDA. Is that considered a large business and is there a big differences . Do you explain it in your class?
The 'classification' of businesses is different based on who you're talking to. In my world, this would be a mid-market business, not a small one.
To a Harvard professor, this example is a small business. It's why you always have to calibrate for the content you're consuming. ie the book HBR Guide to Buying a Small Business is about businesses this size.
Great video! At 5.20 you mentioned that the principle portion of the loan replayment is not represented as net income. Does that mean that the end of the day the income required to make payment of the principle portion is taxed? I hope that question makes sense
Yes. it does. Yes, it is. People don't often get it but when you take a bank loan, you don't get taxed on that money, so, when you pay it back, it's also a non-taxation thing. The money you earn to make the principle payment is taxable income. People get themselves trapped by this all the time with short amortization loans. They give all their cash to the lender, then have none to pay the taxes they owe.
Doesn't SDE differ from adjusted EBITDA in that adjusted EBITDA adds back excess owner's salary whereas SDE adds back the full owner's salary?
Adjusted EBITDA assumes a manager is being paid a fair market salary for running the business. So, yes, your thinking is correct. Normally, we add back the full owner salary to get SDE, then use a FMV salary to get to EBITDA.
@@DavidCBarnett Thanks! Love the content.