Before selling your business in California, ensure you maximize its value through SDE adjustments and revised financial statements that will attract buyers and yield a better return on your investment.
Adjusted SDE Definition
SDE is an acronym that stands for Seller’s Discretionary Earnings. It represents a company’s net income before factoring in the listed expenses. Take a look at an example of how to calculate adjusted SDE:
| The ABC Company | (in thousands) |
| Net Income | $800 |
|
$830 |
|
$40 |
|
$1550 |
| SDE | $3220 |
An adjusted SDE takes the SDE and adjusts it to account for factors such as non-recurring or irregular expenses. We call this normalizing the income. Doing this with the same information as our first example, we get the following:
| The ABC Company | (in thousands) |
| Net Income | $800 |
|
$830 |
|
$40 |
|
$1550 |
|
$30 |
| Adjusted SDE | $3250 |
An adjusted SDE enables entrepreneurs to compare similar companies within the same industry.
10 Smart SDE Adjustments
Let’s look at some standard SDE adjustments.
1) Owner’s Salary and Bonuses
Your salary may differ from that of your managers. It is also common for an owner to declare one or more bonuses to reduce income taxes for the year. These expenses should be added back and would more often than not result in an increased adjusted SDE.
Picture a family-owned company that pays family members more than third-party owners. A Buyer wouldn’t need to continue to pay them as generously, so you could add the estimated difference back.
2) Property Rental Costs
If your business rents property owned by a separate legal entity and doesn’t pay market-level rent, you should adjust your Standard Deduction for Employment (SDE).
This may be done when a potential Buyer determines that a non-assumable lease is under market price, and they will adjust their SDE assessment accordingly.
3) Non-Arm-Length Revenue
The category of non-arm’s-length revenue refers to expenses that a company has with third parties that differ from the market price.
For instance, if a supplier that a company shareholder owns sells you supplies at a price above the market value, then you should adjust the SDE to reflect the market value.
4) Start-up Costs
If you invested in a start-up and are interested in selling it, you should be aware that the start-up costs are typically considered a one-time expense.
Since these expenses are no longer required to run the business moving forward, you can add back the start-up costs to the SDE.
5) One-Time Professional Fees
If you have ever hired someone for a specific, non-recurring job, then you can adjust your SDE.
For example, if you hired an accounting company for a one-time inventory audit, you could add back that cost.
6) Insurance Claims, Lawsuits, and Other Disputes
Any one-time disputes, claims, or lawsuits can be subtracted or added back to the SDE depending on the scenario.
If you had to go to court and reach a legal settlement as part of a situation involving an accidental slip and fall, this would be an example of a non-recurring expense that you could add back.
7) Redundant Assets
Any asset that is not required to run the business is considered redundant, and you can adjust your SDE to reflect its expense.
Picture a scenario where you award the employee of the month using a company-owned car. A Buyer doesn’t need the car to run the business. You can add any expenses the company paid for the vehicle to the (SDE).
8) Inventories are essential when performing SDE adjustments
If you carry an inventory and have an allowance for its expenses, consider adjusting your (SDE). Estimate your inventory level at the time of the business sale and adapt accordingly.
If you have a company with an inventory allowance of $5,000 and you’re carrying an excess with a value of $1,000, then that means you can add that excess back to your allowance.
9) Maintenance and Repairs
You can add one-time repair costs, such as those for repairing a wall damaged by water, back to the SDE. If you have categorized any past capital expenses as repairs or maintenance, go back and reassess them.
You may have done so to help lower taxes, but applicable expenses should be separated and added to the SDE.
10) Other Income and Expenses
You most likely use this category on your financial statements to encompass many different expenses that are not easily assigned to other categories. Typical examples are one-time employee bonuses or charitable donations made by the business.
Review all the expenses you have in this category for anything that is non-recurring. Such expenses most likely can be added back to the SDE.
Final take on SDE adjustments
If you’re concerned about maximizing the sale of your business, consider hiring a qualified business broker with experience in business valuation to help you make these SDE adjustments and enhance the business value of your California-based business. They will help you get the best return on your investment.
See how to calculate a business valuation for a manufacturing company.
Get started by determining the value of your company. To learn more, what is my business worth?