I was recently talking to an Amazon seller who wants to get more out of her business. She wants to get more profitable now and she ultimately wants to sell her business for as high a price as possible. What should she focus on? Answer: SDE (Seller’s Discretionary Earnings). But why and what does this mean?
Does it mean building systems for her company? Should she launch a new product line? Should she open another selling channel? The answer is maybe.
The right tactical focus depends on her timeline, the current health of her business and what her core strengths are. There isn’t a cookie cutter answer because all businesses and owners are different but every goal should be aimed at increasing SDE regardless of if she wants to sell soon or not. I’ll tell you why below and I’ll give you some tips on setting the best goals for your business but first let’s define SDE.
What is SDE?
Seller’s Discretionary Earnings (sometimes called Adjusted Cash Flow, or Adjusted EBITDA) is a profitability measurement that shows how much cash the business generates that can be either distributed to the owner or reinvested in the business. The reason SDE is more important than Net Profit is that SDE excludes any income or expenses that are not directly associated with the core business. SDE allows you to view your profitability as though you were an investor looking to buy your business. An investor wouldn’t be interested in paying you extra for consulting income that will disappear when you disappear and an investor doesn’t care what your accounting fees or travel expenses are unless those fees directly impact sales.
SDE is the core profitability of your business when all the fluff is cut away. As a seller, you should care about SDE in both of the following circumstances:
You’re Ready to Sell –
This is obvious. If a buyer will be measuring you by your SDE then you need to understand it and work to improve it.
You’re Not Ready to Sell –
This is less obvious but just as important. Clear away the fluff and make a plan to improve your profitability. Yes doing this will improve the value of your company but more importantly, you got into this business to make money and it is time to get paid! Looking at SDE forces you to see the difference between what your business is producing and what it should be producing. If your SDE is dramatically higher than what you actually bring home then something is wrong and you need to take a hard look at where your money is going.
In other words, you must care about SDE in all circumstances! Don’t wait until you are about to sell your business to care about profits!
Why is SDE so Important if I want to Sell my Business?
If your goal is to sell your e-commerce business someday a lot of factors will determine how much interest and money you will get. Factors like the quality of your products, listings, systems, team, intellectual property, SKU-diversity, number of competitors, compliance concerns and the list goes on and on. But the most important factor is Seller’s Discretionary Earnings.
Basic Formula for Valuing an E-Commerce Business
Value = (SDE X Multiple) + Good Inventory
Let’s look at each of these terms:
The Multiple –
This is the number of years worth of your SDE that a buyer is willing to pay for your business based on all relevant market and risk factors. A buyer will pay a higher multiple if your business is larger, safer, stronger, more consistent, more compliant, more diversified, more automated, etc… On the other hand, a buyer will only offer a lower multiple if there are risk factors or inconsistencies that make the SDE less solid or predictable.
There are literally hundreds of different things you could do to improve your risk profile and therefore your price multiple. The challenge with focusing all of your energy on just improving risk factors is that the market will only support price multiples up to a certain level depending on the industry.
SAAS players and tech startups can sometimes get 30 times SDE but in e-commerce, multiples are almost always in the 1-5X range. This doesn’t mean that you shouldn’t invest significant energy into improving the risk profile of your business but it does mean that there is a ceiling to how high you can drive a multiple and market conditions are just as important as anything you might do.
Simply put, if the market for e-commerce businesses in your category is 3X SDE you might get 5X for an amazing operation but you will never get 20X no matter what kind of processes or track record you have. Just understand this and make your investment decisions accordingly.
Good Inventory –
Let’s talk about inventory that you already own when you sell. The good news is that your business is worth more if you have inventory ordered and ready to go where the buyer can hit the ground running when he purchases you. The bad news is that you only get credit for sellable inventory. If you have inventory that is close to expiring or obsolete or isn’t moving then a buyer won’t pay more for that inventory.
The most important thing is to clear out bad inventory and have your inventory management system set up so that as much of your inventory as possible is “good inventory”.
Seller’s Discretionary Earnings –
This brings us back to our focus which is SDE. Manage your inventory well and deal with the biggest risk factors associated with your business BUT spend most of your time improving your profitability. There are only two ways to improve SDE: Increase Sales or Decrease Expenses. You might try…
- Launching new products
- Improving listings and ad conversions
- Building a brand so you can raise prices
- Investing in better inventory management
- Exploring a new channel
- Renegotiating leases and contracts
- Cutting unnecessary expenses
At the end of the day, the best use of your time as the CEO of your business is to take concrete steps that will help you increase your SDE. Period.
Kill 2 Birds with One Stone!
Here’s where you need to be strategic! It is possible to increase your SDE while you decrease the risk profile of your business. Select a goal (i.e Launch a new product) that will increase your SDE while diversifying your portfolio. Better yet select a new product that has different peak sales times then your original product so that you improve cash flow throughout the year. Or launch a product that has stronger IP protection. This allows you to see higher profits while lowering the risk profile of your business.
How To Set Goals
Here’s my advice: Each year set a (that means one!) clear, measurable profitability goal for your business that is better than last year’s but is also realistic. For some coaching on how to set great goals, check out one of my favorite books, “The 4 Disciplines of Execution” by McChesney and Covey.
Every quarter set shorter-term priorities that will lead to you achieving your annual goal. It is critical to build your team, culture and meeting rhythm around achieving these goals. For some coaching on how to do this, I highly recommend the book “Traction” by Wickman.
Seller’s Discretionary Earnings is not unique to Amazon sellers but it is the most important number for you as a seller to wrap your head around and improve so that your business will flourish now and so that it will sell for more down the road. It is critical to include profitability in your annual and quarterly goals and to prioritize projects that increase SDE while decreasing the risk profile of your business. Do these things and you will get more out of your business!
At Seller Accountant, we excel at helping companies understand profitability, set the best goals and execute toward those goals. We’d love to talk to you if you have any questions about getting the most out of your business!
-Written by Tyler Jefcoat, CEO of Seller Accountant