Normalized Earnings, SDE, and EBITDA Explained for Ontario Business Buyers

Ask a small business owner what their business earns, and the number they give you is almost never the number a buyer should actually use. Owners often run personal expenses through the company, pay themselves in ways that don't reflect a market salary, and carry one-time costs that won't repeat under new ownership. Normalized earnings exist to strip all of that out and get to a number that actually reflects what the business would earn under ordinary, arm's-length management.

This article explains the two most common versions of that number — Seller's Discretionary Earnings (SDE) and EBITDA — and why the raw figure on the seller's tax return usually isn't the one to trust.

Why the Seller's Reported Net Income Isn't the Real Number

Small business financial statements are often prepared to minimize taxable income, not to present the clearest possible picture to a future buyer — which is entirely legitimate for the owner's own purposes, but it means the bottom line understates what the business can actually support. Common distortions include:

• The owner's salary, bonuses, and benefits, which may be well above or below what it would cost to hire a manager to do the same job.
• Personal expenses run through the business — a vehicle, travel, memberships, or family members on payroll who don't work in the business.
• One-time expenses or windfalls, like a lawsuit settlement, a major repair, or a one-off grant.
• Non-arm's-length rent or fees paid to a related party at above- or below-market rates.

Normalization means adjusting for each of these, item by item, with documentation — not just accepting a seller's verbal claim that "it really earns more than this."

Seller's Discretionary Earnings (SDE)

SDE is the earnings measure most commonly used for small, owner-operated businesses — particularly where a single owner-operator is expected to replace the seller after closing. It generally starts from net income and adds back:

1. The owner's salary and personal benefits.
2. Interest, taxes, depreciation, and amortization (the same add-backs used in EBITDA, described below).
3. One-time or non-recurring expenses.
4. Personal expenses run through the business that a new, unrelated owner would not incur.

SDE is meant to represent the total financial benefit available to a single owner-operator who will work in the business full-time — it assumes that owner's own labour is part of what they're being compensated for, not a separate cost to replace.

EBITDA

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is more commonly used for larger businesses, or any business where a buyer expects to hire professional management rather than work in the business personally. Unlike SDE, EBITDA typically does deduct a market-rate cost for management — because the buyer is assumed to need to pay someone (possibly themselves) a real salary to run daily operations, rather than absorbing that role for free.

SDE vs. EBITDA at a Glance

Using the wrong measure for the size of business you're looking at can meaningfully distort your sense of what the business actually earns.

Common Normalization Adjustments to Ask About

• [ ] Owner's total compensation, including benefits and perks, compared to what a market-rate manager would cost.
• [ ] Family members on payroll and whether their pay reflects actual work performed.
• [ ] Vehicle, travel, and entertainment expenses of a personal nature.
• [ ] Related-party rent, management fees, or loans on non-market terms.
• [ ] One-time legal settlements, insurance payouts, government support payments, or major unplanned repairs.
• [ ] Discretionary charitable donations or sponsorships not required for the business to operate.

Every adjustment should be backed by documentation the seller can actually produce — an unsupported add-back is just an assertion, not a normalized number.

Frequently asked questions