Sellers in healthcare practice transactions frequently anchor their asking price to Seller’s Discretionary Earnings. SDE is a useful starting point for a valuation conversation. It is not a lending standard, and it does not determine what a particular lender will approve.

The gap between a seller’s adjusted earnings and the cash flow a lender is willing to credit can be significant. When that gap is not identified before price is set, it shows up later as a delayed approval, a revised loan amount, an added equity requirement, or a deal that cannot close on the financing the parties assumed.

Two Different Measures, Built for Different Purposes

SDE typically starts with business earnings and adds back owner compensation, interest, taxes, depreciation, and expenses or events the seller characterizes as discretionary or nonrecurring. The purpose is to estimate the economic benefit available to a single owner-operator.

Lenders are underwriting a different question: whether the borrower and the practice will generate reliable cash flow to meet debt service after recognizing ongoing operating needs and appropriate normalization. That analysis also weighs the buyer’s experience, liquidity, equity contribution, loan structure, and projected post-closing costs. Lenders do not automatically accept every add-back a seller wants credited. A seller may claim that reported supply or inventory expense is inflated by personal spending run through the practice, and ask that the difference be added back to earnings. A lender will not accept that characterization on its own. This gap between what a seller characterizes as adjustable and what a lender will credit is a primary driver of the difference between SDE and financeable cash flow. Debt-service-coverage requirements and normalization standards also differ by lender and loan program, which is exactly why a number that looks defensible in a valuation report does not automatically clear underwriting.

Why Add-Backs Are the Recurring Friction Point

Add-backs are not improper on their face. They hold up when they are specific, documented, and reflected consistently across the tax returns, financial statements, bank activity, payroll records, and any valuation or quality-of-earnings work behind the deal.

Underwriting typically tests each one against the same questions: was the expense actually incurred as recorded, is it genuinely nonrecurring or unrelated to ongoing operations, and will the buyer face a replacement cost after closing, whether for clinical coverage, management, or benefits the seller was absorbing personally.

The clarity of the add-back matters as much as its legitimacy. A seller-owned vehicle run through the practice is a straightforward add-back, easy to isolate and verify against the records. A personal item buried in a supply or miscellaneous expense line is a different problem, and a much harder one for a lender to credit.

The dispute rarely comes from the existence of add-backs. It comes from the seller’s presentation and the lender’s normalization analysis running on different assumptions, discovered after an LOI has already been signed at the seller’s number.

Documentation Is What Makes Cash Flow Defensible

Clear records do not guarantee financing, but they give a lender a basis to evaluate repayment capacity without defaulting to the most conservative read of the numbers. That means reconciled tax returns and financial statements, general ledger detail, bank statements, payroll records, receivables and payables aging, and documented support for every proposed adjustment.

Deal size affects how much effort a lender will put into that evaluation. On a smaller transaction, a lender has little incentive to spend time sorting through minor personal expenses buried in the financials. Rather than investigate and render a judgment on each line item, the lender will simply decline to credit anything it cannot verify quickly. On a larger transaction, a lender is more inclined to dig into the detail behind proposed add-backs, not out of greater flexibility, but because the loan size makes that effort worthwhile for the bank.

For a healthcare practice specifically, the record extends to the operational detail that explains whether revenue is sustainable under new ownership: provider production and compensation, payer mix, referral concentration, staffing, and lease terms. The goal is a set of records a lender can reconcile against reported revenue and proposed adjustments without having to take the seller’s characterization on faith.

This Gap Behaves Differently by Deal Size

The SDE-to-financeable-cash-flow gap is largely a smaller-deal problem. A doctor-to-doctor acquisition typically involves a single owner whose personal expenses can move through the practice without another party reviewing or challenging them, which is what creates the disputed add-backs described above.

In larger, multi-partner practices, the financial statements are generally clear and accurate and reflect only true business expenses. If they did not, partners would be in constant disagreement over the accuracy of compensation and distributions.

Larger, multi-provider or platform transactions still introduce their own variables, including provider retention, compensation structures, management costs, overhead allocation, and working capital needs, all of which affect whether reported earnings hold up post-closing. But the specific SDE dispute this piece addresses is far more likely to surface in a smaller, single-owner practice than in a larger one with multiple partners.

Rule-of-Thumb Pricing Is a Reference Point, Not a Financing Commitment

Multiples of revenue, SDE, or EBITDA are useful for framing an early conversation. They are not a substitute for diligence, a proper valuation analysis, or the lender’s own credit decision. In a financed transaction, price, buyer equity, any seller financing, and working capital needs all have to work together under the lender’s standards, not just the seller’s math.

The Takeaway

The parties who avoid late-stage renegotiation are the ones who reconcile the earnings story to the underlying records, and get lender feedback, before price is fixed rather than after. That does not eliminate underwriting risk. It identifies which assumptions the price actually depends on, while there is still time to address them.

Contact Morgan Advisory Group

Morgan Advisory Group represents healthcare professionals and investors in practice acquisitions, partnership structures, and healthcare platform development. To discuss how this applies to a specific transaction, contact the firm to schedule a consultation.