TL;DR: Business value is typically based on normalized cash flow (SDE or EBITDA) × a risk-adjusted multiple, with adjustments for debt, working capital, and deal structure. This glossary explains each term in plain English.
Plain-English Definitions for SDE, EBITDA, Add-Backs, Multiples, and M&A Terms
If you’re selling (or buying) a business, the fastest way to make better decisions is to understand the language buyers, lenders, and brokers use every day.
This business valuation glossary defines the most common terms you’ll see in:
- valuation discussions (SDE, EBITDA, multiples)
- offers and LOIs
- due diligence
- deal structure and closing
How to Use This Glossary
- If you’re a seller, focus on: SDE, add-backs, multiple, customer concentration, owner dependence, working capital, LOI, due diligence.
- If you’re a buyer, focus on: EBITDA, quality of earnings, run-rate, CAC, retention, earn-out, seller note, reps & warranties.
For the full valuation walkthrough, see: how buyers value cash flow
For buyer behavior and mechanics, see: how buyers value small businesses
Core Valuation Terms
Seller’s Discretionary Earnings (SDE)
Definition: SDE is the cash flow available to one full-time owner-operator after adding back owner compensation and discretionary expenses.
Why it matters: Most small businesses are priced as SDE × multiple.
Example: Net income $120k + owner salary $80k + add-backs $30k = SDE $230k.
EBITDA
Definition: EBITDA is earnings before interest, taxes, depreciation, and amortization, typically used for larger, management-run businesses.
| Category | SDE (Seller’s Discretionary Earnings) | EBITDA |
|---|---|---|
| Used For | Owner-operated small businesses | Larger, management-run businesses |
| Includes Owner Salary? | Yes (added back) | No |
| Primary Buyer Type | Individual buyers / owner-operators | Strategic buyers / private equity |
| Business Size | Typically under ~$1–3M earnings | Larger companies with management teams |
| Purpose | Shows total cash flow available to one working owner | Shows operating performance independent of ownership |
| Common Valuation Method | SDE × Multiple | EBITDA × Multiple |
SDE is used when a single owner will replace the seller. EBITDA is used when the business operates with independent management in place.
Why it matters: Bigger deals often price as EBITDA × multiple.
Example: EBITDA $600k × 4.0 = implied enterprise value $2.4M (before adjustments).
Add-Backs
Definition: Add-backs are expenses that are non-recurring, discretionary, or not required for a new owner to operate the business.
Why it matters: Add-backs raise normalized earnings, which can raise value.
Examples: Owner personal auto, one-time legal settlement, non-recurring marketing spend.
Normalized Earnings
Definition: Normalized earnings reflect the business’s true ongoing cash flow after removing one-time items and adjusting owner compensation.
Why it matters: Buyers price the business based on normalized earnings, not “best year” results.
Valuation Multiple
Definition: A multiple is the number applied to earnings (SDE or EBITDA) to estimate value, reflecting risk and market demand.
Why it matters: The multiple often creates larger value differences than earnings alone.
Related: valuation risks that lower offers
Risk-Adjusted Multiple
Definition: A risk-adjusted multiple increases when cash flow is predictable and transferable, and decreases when risk is higher.
Why it matters: Two businesses with the same earnings can sell for very different prices.
Enterprise Value (EV)
Definition: Enterprise value is the value of the entire business operations before subtracting debt and before adding excess cash.
Why it matters: EV is the starting point for many deal structures.
Equity Value
Definition: Equity value is what the seller receives after debt is paid off and cash/excess assets are considered.
Why it matters: Sellers care about net proceeds, not just the headline price.
Fair Market Value (FMV)
Definition: FMV is the price a willing buyer and willing seller would agree to, with neither under compulsion and both informed.
Why it matters: FMV supports defensible pricing discussions.
Market Approach
Definition: A valuation method using comparable sales (like similar businesses sold) and market multiples.
Why it matters: Buyers often anchor to market comps.
Income Approach
Definition: A valuation method based on the business’s expected future cash flow (often through capitalization or discounted cash flow).
Why it matters: It connects value to earnings power and risk.
The Income Approach estimates value based on projected future cash flow, often through capitalization or discounted cash flow analysis. Formal valuation standards and methodologies are commonly guided by professional accounting frameworks such as those outlined by the American Institute of Certified Public Accountants (AICPA).
Asset Approach
Definition: A valuation method based on the value of assets minus liabilities (more common for asset-heavy or underperforming businesses).
Why it matters: Relevant when the business is worth more “in pieces” than as a going concern.
Deal Terms and Process Terms
Letter of Intent (LOI)
Definition: An LOI is a non-binding agreement outlining the key deal terms before due diligence and final contracts.
Why it matters: It sets price, structure, timeline, and major contingencies.
Learn more: what an LOI means in a business sale
Indication of Interest (IOI)
Definition: An IOI is an early expression of interest that is typically less detailed than an LOI.
Why it matters: Helps narrow serious buyers before heavy diligence.
Due Diligence
Definition: The buyer’s process of verifying financial, legal, and operational claims after LOI.
Why it matters: This is where many deals slow down or fail.
Related: why deals collapse in due diligence
Confidential Information Memorandum (CIM)
Definition: A detailed document describing the business, financials, operations, and growth opportunities provided after an NDA.
Why it matters: A strong CIM speeds up buyer decisions.
NDA (Non-Disclosure Agreement)
Definition: A legal agreement requiring a buyer to keep business information confidential.
Why it matters: Protects employees, customers, vendors, and the seller.
Purchase Price Allocation
Definition: The accounting/tax allocation of the purchase price across assets like equipment, inventory, goodwill, etc.
Why it matters: Affects taxes for both buyer and seller.
Asset Sale vs Stock Sale
Definition:
- Asset sale: buyer purchases business assets and may leave liabilities behind.
- Stock sale: buyer purchases ownership shares and assumes liabilities.
Why it matters: Taxes, liability, and complexity differ significantly.
Working Capital
Definition: Current assets minus current liabilities needed to run the business (often excluding cash/debt).
Why it matters: Working capital targets can change seller proceeds at closing.
Working Capital Adjustment
Definition: A true-up at closing if actual working capital is above or below an agreed target.
Why it matters: It can change the final check the seller receives.
Seller Financing (Seller Note)
Definition: A portion of the price paid over time, with interest, by the buyer to the seller.
Why it matters: Can increase buyer pool and support price, but adds seller risk.
Earn-Out
Definition: A portion of the price paid only if future performance targets are met.
Why it matters: Bridges valuation gaps but increases complexity and uncertainty.
Contingencies
Definition: Conditions that must be satisfied for the deal to close (financing, lease assignment, diligence approval, etc.).
Why it matters: More contingencies can reduce deal certainty.
Reps and Warranties
Definition: Legal statements by the seller about the business (financial accuracy, legal compliance, ownership, etc.).
Why it matters: Misstatements can create post-closing liability.
Non-Compete / Non-Solicit
Definition: Agreements restricting the seller from competing or soliciting customers/employees for a period of time.
Why it matters: Often required to protect goodwill value.
Transition Period
Definition: The agreed time the seller helps train the buyer and support handoff.
Why it matters: Reduces operational risk for the buyer.
Buyer “Risk” Terms That Influence Multiples
Customer Concentration
Definition: When a small number of customers represent a large percentage of revenue.
Why it matters: High concentration usually lowers multiples and increases diligence scrutiny.
Recurring Revenue
Definition: Revenue that repeats predictably through contracts/subscriptions/maintenance agreements.
Why it matters: Predictability supports higher valuation multiples.
Churn
Definition: The percentage of customers or revenue lost over time.
Why it matters: High churn increases risk and compresses value.
Owner Dependence (Key Person Risk)
Definition: When revenue or operations rely heavily on the owner’s relationships, skills, or daily involvement.
Why it matters: Buyer risk increases → multiple often decreases.
Moat
Definition: A competitive advantage that protects profits (brand, location, contracts, switching costs, etc.).
Why it matters: Strong moats support stronger pricing and terms.
Barriers to Entry
Definition: Factors that make it hard for competitors to replicate the business (licenses, expertise, contracts).
Why it matters: Higher barriers usually support higher multiples.
Gross Margin
Definition: Revenue minus direct costs, divided by revenue.
Why it matters: Higher margins often indicate pricing power and operational efficiency.
Job Costing
Definition: Tracking profitability by job/service line to understand true margins and performance drivers.
Why it matters: Strong job costing improves buyer confidence and can reduce diligence friction.
Run-Rate
Definition: A forward-looking estimate based on recent performance, often annualized.
Why it matters: Buyers may discount run-rate if it isn’t supported by history.
Quick Reference: The Buyer Valuation Framework
Most small business buyers start here:
- Normalize earnings (SDE/EBITDA)
- Assess risk factors (concentration, owner dependence, documentation)
- Apply a risk-adjusted multiple
- Confirm structure (cash, seller note, earn-out)
- Validate in due diligence
If you want the full process view: sell a business preparation guide
What is the difference between SDE and EBITDA?
SDE is used for owner-operated businesses; EBITDA is used for larger businesses with management in place.
What add-backs are acceptable?
Acceptable add-backs are typically documented, non-recurring, or discretionary items that a new owner would not need to continue.
What is a typical multiple for a small business?
Multiples vary widely by industry and risk profile, but many small businesses trade within a broad SDE multiple range depending on stability and transferability.
Why do deals fall apart during due diligence?
Common reasons include financial surprises, unclear add-backs, customer concentration, and financing issues.
See: https://i-sell-businesses.com/why-business-deals-fall-apart/
For Business Owners
If you’re considering selling, the most valuable first step is understanding your true normalized cash flow and your risk profile, because that’s how buyers price businesses.
Request a Confidential Valuation ReviewFor Buyers
If you’re evaluating acquisitions, use this glossary to interpret earnings, multiples, and deal structure so you can compare opportunities properly.
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