M&A Terminology

The following is a list of important "transaction" terminology a business owner should understand before selling a business.

In a merger & acquisition transaction, add-backs represent excessive owner salaries and perks, one-time expenses, non-recurring expenses, compensation for family members whose positions will be eliminated and are not needed going forward, etc.  Add-backs receive sharp scrutiny from buyers.

Adjusted EBITDA
Represented EBITDA adjusted to reflect the impact of add-backs. It is sometimes referred to as normalized earnings.

Asset Sale
A type of merger and acquisition transaction where the acquirer purchases certain assets and may assume certain liabilities leaving the seller with the remaining assets and liabilities.  The seller retains the corporate entity.

A sell-side transaction situation where merger & acquisition intermediaries approach numerous buyers (both financial and strategic) and accept bids.  The intermediary manages the business sale process by encouraging buyers to bid and re-bid until the seller receives an offer that meets its valuation and other business sale goals.

Book Value
The value of individual assets less allowances in certain cases for depreciation or amortization.  Book value can be more or less than the asset's market value.

The sum of a corporation's long-term debt, stock and retained earnings.

Capitalization Rate
The discount rate used by a buyer or investor to determine the present value of a stream of future earnings or cash flow.

An acronym for capital expenditures.  Money spent to acquire or upgrade physical assets such as buildings, machinery and equipment.

Discounted Cash Flow
A method of determining the value of a company by discounting the future cash flow to arrive at present value.

Due Diligence
A thorough investigation of another party's business in order to confirm that the information and representations made are accurate and to uncover unknown information.

A part of the purchase price where payment to the seller is contingent upon the achievement of pre-determined future financial benchmarks (e.g., sales, gross margin, or EBITDA, etc.)

An acronym for earnings before interest and taxes.

An acronym for earnings before interest, taxes, depreciation and amortization.

Enterprise Value
Represents the market value of a business' equity plus the market value of the interest-bearing debt less cash.

An acronym for Employee Stock Ownership Plan.

Exit Plan
An exit plan is a blueprint to successfully exit a privately held business.  It asks and answers all the business, personal, financial, legal, and tax questions involved in selling a privately held business.

Fair Market Value
The price at which an asset, product or service(s) passes from a willing seller to a willing buyer.  Prior to a business sale transaction, fair market value is often determined by a qualified appraiser.

Financial Buyer
A buyer that typically does not own a company in the seller's industry. Financial buyers calculate how much profit they can make, or how much free cash flow can be generated (or both), and evaluate the possibility of buying a business according to this criterion.

An acronym for Generally Accepted Accounting Principles.

In a business sale transaction goodwill represents the difference between, (i) the purchase price and the value of the assets and liabilities acquired /assumed as shown on the balance sheet and (ii) the value assigned to the non-compete agreement.

A provision in the Purchase and Sale Agreement that places a negotiated amount of money due the seller in an escrow account to protect the buyer in the event the seller did not disclose the existence or magnitude of certain penalties and liabilities at closing.

Protection for the buyer from penalties and liabilities that become known after the closing from the incomplete or inaccurate representations and warranties of the seller.

Junior Debt
Debt that is either unsecured or has a lower priority than that of another debt claim on the same asset or property. Junior debt is also called subordinated debt.

Letter of Intent (LOI)
A mostly non-binding more formal proposal sent from a buyer to seller indicating the buyer's intentions. The LOI is usually drafted and sent after conducting preliminary due diligence and meeting the seller.   It sends the message that the buyer has a strong interest in proceeding with a transaction. Key provisions include purchase price consideration, terms, timing, and exclusivity, etc.

Leveraged Buyout
The purchase of a company using debt often secured by the assets of the company being acquired.

An acronym for mergers and acquisitions.

A type of merger and acquisition transaction where one company absorbs the corporate structure (assets and liabilities) of another company so that one company survives as a legal entity.

Mezzanine Financing
Represents the "middle" layer of financing that bridges the gap between senior debt and equity. Mezzanine financing, a type of junior debt, is typically more expensive than senior debt and often includes warrants.

Middle Market
Represents businesses with revenue between $5 million and $250 million.

Normalized Earnings
See definition of Recast EBITDA.

Off Balance Sheet Items
Usually means an asset or debt or financing activity that is not on the company's balance sheet.

Private Equity Firm
A private equity firm is an investment manager that typically makes majority control or buyout investments in the equity of private operating companies. Often described as a financial sponsor, each private equity firm will raise funds that will be invested in accordance with one or more specific investment strategies.

The reconstruction of an income statement to determine what the true earnings power of a company should be when excessive salaries and perks are eliminated, along with one-time and non-recurring expenses, etc.

Representations and Warranties
Specific assurances in a merger and acquisition purchase and sale agreement stating that certain statements are true. The purchase and sale agreement also includes specific remedies should assurances made turn out to be false or inaccurate.

Seller Financing
A purchase price payment component whereby the seller extends a note to a buyer in lieu of receiving cash at the closing of the transaction.  

Senior Debt
Debt that takes priority over other unsecured or otherwise more "junior" debt owed by the company.  Examples are revolving lines of credit or term notes issued by banks in a business acquisition transaction.

Stock Sale
A type of merger and acquisition transaction where the buyer acquires the selling company's shares and, as a result, assumes all the assets and all the debt of the company at closing.

Strategic Buyer
Represents a potential acquirer that operates in the same business or industry of the targeted company.  Strategic buyers typically can afford to pay more than a financial buyer because of potential synergies and available cost reductions (e.g., eliminating duplicate back-office expenses).

Subordinated Debt
Transaction loan financing that is given a lower preference to debt offered by other lenders. Subordinated debt, also known as junior debt, is usually unsecured and often includes warrants.

Term Sheet
A high level summary document outlining the material terms or conditions of a proposed merger or business sale.  A term sheet is typically a non-binding document.

Working Capital Adjustment
In a merger and acquisition transaction, a working capital adjustment typically represents a pre- determined amount of working capital the selling company must have on the books as of the closing date.  If the actual amount is more than the pre-determined amount, the purchase price is increased by the excess.  If it is less, the purchase price is decreased.