In this episode, Peter Kang and Sei-Wook Kim tackle one of the most confusing aspects of agency financials: how to properly calculate profitability. They break down the critical difference between SDE (Seller's Discretionary Earnings) and EBITDA, explaining why these metrics can paint vastly different pictures of the same business.

Using concrete examples and spreadsheet walkthroughs, they demonstrate how owner salary calculations can dramatically impact reported profitability margins…sometimes swinging from 15% to 40% depending on how compensation is structured. This episode is essential for any agency owner who wants to understand their true financial performance and how acquirers evaluate businesses.

You'll learn why a "normalized" view of profitability matters, how replacement cost thinking changes valuation conversations, and why scale affects the relationship between owner compensation and overall margins.

Key Moments
1. Defining SDE vs. EBITDA and why the distinction matters for agency owners
2. Breaking down a sample P&L to show real-world profitability calculations
3. How owner salary manipulation can inflate or deflate EBITDA percentages
4. The "replacement cost" framework for normalizing owner compensation
5. Why these calculations become less volatile as agencies scale to $10M+ revenue
6. How Barrel Holdings adjusts for owner salary when evaluating acquisitions
7. The importance of understanding your true role and replacement value

Real Talk Takeaways
1. SDE includes owner compensation; EBITDA doesn't - know which metric you're using
2. Owner salary swings can create 10-20% margin differences in smaller agencies
3. Replacement cost thinking is key…what would you pay someone to do your job?
4. Scale reduces volatility - larger agencies see smaller percentage swings from owner comp
5. Normalize before you negotiate. Buyers will adjust your numbers anyway
6. 40% "profit" might actually be 25% EBITDA when properly calculated
7. Context matters. Highly involved owners need higher replacement cost estimates

Timestamps
00:00 – Welcome to Agency Habits
00:18 – Why profitability discussions often aren't apples-to-apples comparisons
00:44 – Defining SDE (Seller's Discretionary Earnings) vs. EBITDA
01:12 – The importance of understanding these different calculation methods
01:59 – Walking through concrete spreadsheet examples
02:11 – Sample P&L breakdown: $1M revenue agency with $500K COGS
02:35 – What constitutes COGS in an agency business
03:10 – SG&A expenses and how owner salary factors into calculations
03:56 – SDE calculation: adding back owner salary for 40% margin
04:26 – Why owners might take distributions instead of fixed salaries
05:18 – EBITDA scenarios: how different owner salaries create different margins
06:11 – The "too low" scenario: $65K salary inflating EBITDA to 33.5%
06:40 – The "too high" scenario: $250K salary depressing EBITDA to 15%
07:48 – How Barrel Holdings normalizes owner salary for fair comparisons
08:23 – The replacement cost framework for owner compensation
09:27 – Adjusting EBITDA calculations based on realistic replacement costs
10:38 – Why Barrel Holdings requires 15% EBITDA using their calculation method
11:22 – How these calculations change dramatically at scale
11:56 – $10M revenue example: why percentages converge at larger scale
12:57 – When owner salary becomes negligible in large, structured agencies
13:26 – The importance of understanding owner role and replacement cost
13:43 – Practical advice for agency owners on calculating true profitability

Notable Quotes
"It's not always clear what they mean. Are they talking about their profit after paying them a market salary? Are they excluding their comp? Is that inflating their numbers?"
"We're really thinking about what is the replacement cost of that person and making sure that's accurately reflected in the EBITDA."
"Just because your SDE is 400K doesn't mean you're pocketing 400K because there is something to be paid to Uncle Sam."

Links & Resources
Peter Kang on LinkedIn: https://www.linkedin.com/in/peterkang34/
Sei-Wook on LinkedIn: https://www.linkedin.com/in/seiwookkim/
AgencyHabits Website: https://www.agencyhabits.com/
AgencyHabits on LinkedIn: https://www.linkedin.com/company/agencyhabits/
Barrel Holdings Website: https://www.barrel-holdings.com/
Barrel Holdings LinkedIn: https://www.linkedin.com/company/barrel-holdings/