Why SDE Doesn't Tell You What You'll Actually Make

You're buying a Camry with 80,000 miles. The seller points at the dashboard — purrs like new, runs great, no warning lights. You take it for a spin and yeah, it feels solid. The broker tells you it's worth $12K because it runs perfectly right now.

But here's what they're not showing you: the timing belt is due at 90K miles, the tires are at 60% tread, and the brake pads have maybe 10,000 miles left in them. That's $2,500 in work coming at you in the next 12-18 months, and none of it shows up in the "runs great today" test drive.

That's exactly what SDE and EBITDA do when you're buying a business. They tell you the engine runs — not what's about to break.

The Problem: SDE Ignores What Actually Wears Out

SDE (Seller's Discretionary Earnings) is the standard way to value businesses under $5 million. It includes owner compensation and discretionary expenses, which makes sense — you want to know what the business can throw off for an owner-operator. For companies above that threshold, buyers typically use EBITDA instead, which treats owner salary as an operating expense at fair market rates.

But here's the catch: both metrics exclude depreciation and amortization. Those are "non-cash expenses," so they get stripped out to show you the real cash the business generates. Sounds smart until you realize depreciation exists for a reason — equipment actually does wear out.

The HVAC van with 120,000 miles? It's going to need replacing. The industrial printer that's been running double shifts for seven years? The maintenance bills are about to get expensive. The point-of-sale system running on Windows 7? You're one software update away from a forced upgrade.

None of that shows up in SDE. The number looks clean, but the bills are coming.

And you can't just look at the depreciation line on the P&L and call it good. Tax incentives like Section 179 and bonus depreciation let owners write off equipment way faster than it actually wears out. A truck with a 10-year useful life can get fully expensed in year one for tax purposes. The depreciation number on the P&L tells you about the owner's tax strategy, not about what you'll actually need to spend to keep the business running.

What Smart Buyers Do Instead

Forget the P&L's depreciation line. Build your own capital expenditure reserve based on what things actually cost to replace.

Start with the major assets. What does a new delivery van cost in the future (inflation)? $45K? When was the current one purchased, and how many miles does it have? If it's got three years of useful life left, you need to be setting aside $15K per year — or $1,250 per month — to replace it when the time comes. Do that for every major piece of equipment, adjust for inflation, and add it all up.

That's your real capex reserve. Not what the tax return says, but what you'll actually need to spend to keep the business running at its current level.

Now here's why this matters in dollars: let's say the broker shows you a business with $200K in SDE and asks for a 4x multiple — that's an $800K purchase price. Sounds reasonable based on typical SDE multiples of 2-3x, with potential highs of 4x for strong businesses.

But if you dig into the assets and realize you need to set aside $40K per year for equipment replacement — money that's not factored into SDE at all — then the business only generates $160K in true discretionary cash flow. At a 4x multiple, that's a $640K business, not an $800K business. You just found $160K in overpayment before you even made an offer.

How AlphaY Helps You Get to the Real Number

This kind of analysis sounds tedious, but it doesn't have to be. AlphaY's P&L import tool uses AI to automatically extract line items from financials, so you're not manually typing in revenue and expenses from scanned PDFs. Once the data's in, the projections tool lets you layer in your capex reserve, debt service, and working capital needs, then run scenarios to see what you'll actually take home.

You go from "broker says SDE is $200K" to "here's what I'll earn after real capex, debt payments, and a manager's salary" in minutes, not days. That's the difference between buying the dashboard story and actually looking under the hood.

SDE isn't a lie — it's just incomplete. It tells you what the business made last year for the current owner under the current circumstances. What you need to know is what it'll make for you after you account for the stuff that's wearing out, the debt you're taking on, and the reality that equipment doesn't last forever.

Don't buy the Camry without checking the timing belt.

Sources:

Table of Contents

Why SDE Doesn't Tell You What You'll Actually Make

The Problem: SDE Ignores What Actually Wears Out

What Smart Buyers Do Instead

How AlphaY Helps You Get to the Real Number

Ready to accelerate your acquisition journey?