SDE Add-Backs in Arizona Business Valuations: the full guide
Eddy Roche, Associate Broker, HUB AZ Brokers
What SDE is
Seller's Discretionary Earnings is the cash a full-time owner-operator would take from the business after we put owner pay and discretionary spending back on a clean line. Buyers price most Arizona owner-operated files on that number. They do not price on last year's revenue.
SDE is not EBITDA. SDE is the language on owner-operated Main Street deals. EBITDA shows up more on larger or manager-run companies. I use the measure that matches the buyer pool sitting in front of the file.
I rebuild SDE from the tax returns and the P&Ls. Net income is the start. What remains should be a number a buyer and a lender can sit with.
How to calculate SDE
The formula is short. Net income, plus the owner's salary or draw, plus the discretionary add-backs. The work is in the adjustments, because a tax return is built to minimize tax.
- From the tax return
- Net income
- One full-time owner
- Owner pay
- Documented ones
- Add-backs
- What a buyer prices on
- SDE
Net income comes off the tax return. Owner pay goes back on because a buyer will either pay themselves for that work or hire someone to do it. One full-time owner's pay goes back in full. A second owner or a working family member only comes back above what a replacement at a market wage would cost, and only when I can show what that wage is.
Then the add-backs. Interest goes back because the buyer will carry their own debt. Depreciation and amortization go back because they are not cash. Personal expenses run through the company and true one-time costs go back when the paper supports them. Normal cost of goods, rent, utilities, payroll for the staff the business needs, and loan principal stay in. They are the cost of running the place.
I run the same worksheet on each year of returns, then read the trend. The most recent year carries the most weight, but a buyer and a lender look at all of them. A business that peaked three years ago and has slid since is priced on where it is. Keep the accounting basis consistent across the years, too. A cash-basis return next to an accrual-basis P&L creates gaps that a buyer's CPA will find first.
What usually qualifies as an add-back
An add-back is an expense in the historical P&L that a new full-time owner would not need to pay, or that is discretionary. We add it back when we estimate SDE. That is the definition. It is not a promise that every line you hope to add will survive.
What Arizona buyers usually accept, when the paper supports it: documented owner compensation above a market manager wage. One-time, non-recurring costs. Clearly personal expenses run through the company.
I do not treat any category as automatic. Soft stories without an invoice, a tax-return line, or a recurring pattern get cut. I will tell you which add-backs I will defend and which ones I will not.
What gets challenged
Recurring "one-time" costs get challenged. So do lifestyle expenses mixed into COGS, and add-backs that disappear when the tax returns are compared to the P&L. Diligence is where weak add-backs die.
Inflated add-backs do not raise the asking price. They waste a listing term. A buyer, a CPA, and a lender will rebuild the same worksheet. If I cannot show why the dollar comes out, it stays in the expense column.
How that review runs on the seller side is on seller due diligence in Arizona.
The add-backs buyers quietly discount
A buyer's CPA does not always argue. Sometimes they allow the line and discount the file instead. These are the add-backs that cost more than they are worth.
A salary for a family member who barely works in the business. The payroll was real, but the buyer reads it two ways: the relative may expect to stay on after closing, or the business leans on that person more than you admit. Either way the buyer models the wage as a cost.
Discretionary spending that blurs personal and business. The truck that goes home every night, the club membership, the home office. Some of it is technically defensible. All of it signals that the P&L was padded, and from that point the buyer questions every other line.
A "normalized" expense with no recent history. If the business has not paid for that consultant in years, a buyer asks why the number is coming back now. That add-back needs a paper trail and a reason it matters to the buyer's own forecast. Without both it gets cut.
Here is the real cost. A long list of soft adjustments makes a buyer and a lender doubt the baseline. They dig into inventory, customer concentration and the lease, and they build a bigger haircut into the offer or the multiple. A short list of adjustments that each survive a receipt test does the opposite. The CPA signs off in an afternoon, the number holds, and the deal moves. Five add-backs I can defend beat ten I have to argue.
Before a line goes on the worksheet I ask three questions. Was the expense real. Will a new owner face it. Can we prove it. If any answer is fuzzy, we document it better or we leave it in the expense column.
Why tax returns still matter
Buyers and lenders start with the returns. The P&L is useful. It is not the last word. If an add-back is not on a return line, or the two statements do not tell the same story, the add-back is the first thing that gets cut.
Typically I want three years of returns for a serious valuation. Thin history makes the multiple and the add-backs harder to defend. I will not invent a multiple to fill a thin file.
Messy books also sit on the clock. See how long a sale takes in Arizona.
How this feeds the valuation
This page is the add-back conversation. The method lives on Business Valuation in Arizona. I rebuild SDE, then I price to what a buyer, a landlord, and a license transfer can support. No automated PDF. No teaser range from a form.
The form that starts that conversation is Value My Business. There is no obligation to list.
Start with a valuation
Send the basics. I look at the returns, walk the add-backs, and tell you which ones I will defend. No padded worksheet. No obligation to list.
Across Arizona
I work across Arizona. Restaurants, bars, service businesses, and contractors. I set the add-backs on the file in front of us.
More answers
The questions owners ask next.
- How do I start?
- Free valuation worksheet conversation at bizsalesguy.com/value-my-business or (480) 405-3200. Eddy Roche, Associate Broker. Deeper method: business valuation Arizona.
Walk the add-backs on your file
No obligation. I look at the numbers and call you. Across Arizona.