Sellers Discretionary Earnings (SDE)-COVID-19 Normalization for Business Valuation and Bank Financing Purposes

COVID-19 has had a devastating impact on the cash flow of many small businesses.  Government restrictions and societal behavioral changes were often the cause.  Many of these businesses were classified by federal and state governments as being non-essential.    

The lending and business valuation communities have taken the position that COVID’s negative impact on businesses was in essence “An Act of God”.  Hence these communities are allowing business brokers to “normalize” SDE’s during the period of impact.  Government restrictions were often in place during this period, which is generally accepted as April 1, 2020 through June 30, 2021.

The broker’s normalization of SDE requires month by month income statements.  The negatively impacted months should be extracted from the income statement, with the corresponding months from 2019 and 2018 dropped in. 

For the purposes of Buyer, Bank Financing and Business Valuation review, the broker should assist the Seller in creating a narrative of how:

  • COVID negatively impacted financial performance
  • During restrictions, what strategic actions were taken by the Seller to mitigate the negative impacts
  • How the Seller is prepared to manage the company going forward to insulate it from future business interruptions

COVID-19 also had a positive cash flow impact on many small businesses that were often deemed essential.  This COVID improvement in cash flow is also viewed as “An Act of God” with the improved cash flow not always deemed sustainable by the lending and business valuation communities.  The broker’s normalization of SDE should follow the same process as described above.  The same Seller narrative should also be formulated.