Industry jargon used by M&A professionals may not be familiar to everyone. PCE compiled this glossary of terms to introduce this language to business owners contemplating a transaction. We hope that these brief definitions provide context to understanding the process of selling a business.
An employee benefit plan whereby the owner sells the company to an ESOP trust, which holds the company stock on behalf of the employees.
A sale of a minority or majority equity interest in a mature company looking for capital to facilitate growth or expansion of the company.
Leveraged Buyout (“LBO”)
An acquisition financed with a significant amount of debt that is secured and repaid with the company’s cash flows. LBO is a common strategy among financial buyers who seek to increase returns by employing high leverage.
When the management team acquires majority or minority ownership in the company it manages. Management teams often partner with a private equity group to finance the deal.
The combination of two or more companies that come together and become a new business, usually with a new name.
A reorganization involving a substantial change in a company’s capital structure.
The reorganization of a company that has filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code.
Parties Involved in the Transaction
A person who serves as the legal shareholder responsible for managing the assets and valuing the stock price of the ESOP Trust.
The corporate financial advisor who helps companies raise and sell debt and equity capital. The investment banker is responsible for developing marketing materials and finding a suitable buyer for a company. The investment banker will also advise in negotiations and on the transaction structure that will maximize proceeds for the seller.
A lawyer who is focused on corporate M&A and will advise on the legal and regulatory requirements and filings related to the transaction. Legal counsel is responsible for drafting and reviewing closing documents.
The targeted list of companies that may be interested in acquiring your company. The investment banker will build this list of potential buyers to market your company to.
Strategic Buyer – A company in the same or a tangential business that is interested in acquiring a company to fit in its long-term business plan.
Financial Buyer – An institutional investor interested in the return it can achieve by acquiring a business. Financial buyers target a five-to-seven-year holding period per investment.
Family Office – A financial buyer that invests the assets of one or many families. A family office is a “hybrid” in its flexibility to make strategic investments due
A professional who supports the transaction team by advising on the tax ramifications of the transaction.
An independent person who may be engaged to prepare a fairness opinion on the transaction. The valuation advisor will analyze the transaction price and terms, and will determine the fairness of the deal terms for the selling shareholders.
The Valuation Process
EBITDA adjustments for one-time, irregular, and non-recurring items. Examples include non-business-related expenses such as owner expenses run through the business and discretionary expenses.
EBITDA adjusted for add backs for the purpose of normalizing performance. This removes any distortion caused by non-business-related expenses.
Capital Expenditure Requirements
Estimated future capital expenditures required to maintain existing property, plant, and equipment and to invest in upgraded technology. Capital expenditure requirements are excluded from free cash flows available to shareholders.
Cash-Free, Debt-Free Basis
The company pays off its debt at the time of the transaction, and the seller keeps any remaining cash. Most M&A deals are structured with consideration on a cash-free, debt-free basis.
Comparable Company Analysis
A market approach to valuation that estimates the value of a company based on metrics of publicly traded companies operating in a similar line of business.
Discount for Lack of Marketability
A discount applied to the valuation of a closely held company to account for the illiquid nature of the investment.
Discount for Minority Interest
A discount applied to the valuation of minority interest to account for a minority shareholder’s lack of control of the business operations.
Discounted Cash Flow Analysis
An income approach to valuation that estimates the value of a company based on the net present value of its future free cash flows.
Earnings Before Interest, Taxes, Depreciation and Amortization – a measure of a company’s financial performance. Interest expense, tax expense, and depreciation/amortization expenses are removed to isolate operational performance. This metric allows better comparability between companies with different capital or tax structures.
Enterprise Value (“EV”)
The entire firm value of a company. The following formula calculates EV:
Market Value of Equity + Market Value of Net Debt
The value of the company that is owned by the equity shareholders. The following formula calculates Equity Value:
Enterprise Value + Cash – Debt Outstanding +/- Working Capital Adjustment
Net Working Capital
The difference between a company’s current assets and current liabilities. Commonly, net working capital is calculated on a cash-free, debt-free basis:
A market approach to valuation that estimates the value of a company based on recent prices paid for companies operating in a similar line of business.
A financial metric used as part of the market approach to valuation. Commonly used transaction multiples are EV/EBITDA, EV/Revenue, EV/EBIT, and Price/Earnings.
Working Capital Adjustment
A purchase price adjustment based on a negotiated working capital requirement. This adjustment prevents manipulation of working capital at the time of closing that could impact company value.
The Sales Process
When all closing conditions are satisfied, the deal is legally recorded and funds are exchanged. This is the moment the transaction is completed.
Obligations specified in the purchase agreement that must be satisfied for the transaction to close. Closing conditions vary but could include transaction approval from government authority, provisions that representations and warranties are valid as of the closing date, and other deal-specific conditions that must be addressed prior to closing.
Corporate Information Memorandum (“CIM”) aka Corporate Profile
A detailed marketing document prepared by an investment banker and provided to potential acquirers who have executed NDAs. The CIM offers key investment considerations, a company overview, financial statements, and other critical details.
Definitive Purchase Agreement
An agreement between a buyer and a seller that finalizes terms and conditions related to the sale of the company’s stock or assets. Negotiations focus heavily on the specific details of this agreement.
A fact-finding investigation performed by a potential acquirer to confirm information about the investment opportunity. A potential acquirer will submit a due diligence request list to the target company after sending an LOI.
A professional report, prepared by an independent investment banker or valuation advisor, that provides the seller an opinion as to whether the proposed transaction price is fair to the selling company.
Indication of Interest (“IOI”)
A letter provided by potential acquirers expressing conditional, non-binding interest in buying the company. The IOI will outline a preliminary value range and high-level transaction terms, due diligence requirements, and other conditions required to be met prior to finalizing the transaction.
Letter of Intent (“LOI”)
A more formal term sheet submitted by a potential acquirer after an initial period of due diligence has been completed. An LOI will typically specify an exclusivity period during which the potential acquirer may complete due diligence and other conditional requirements before finalizing the transaction.
Non-Disclosure Agreement (“NDA”)
A legal document required to be signed by potential acquirers to assure confidentiality is maintained. A potential acquirer must sign the NDA before gaining access to secured company information.
Quality of Earnings (“Q of E”)
A financial due diligence report, prepared by a third-party professional, that examines the accuracy and sustainability of EBITDA and earnings. The Q of E provides buyers confirmation that financial information is not skewed due to aggressive accounting policies.
After the purchase agreement has been negotiated and agreed upon, the documents are signed by the buyer and the seller. Signing and closing can be two separate events if certain closing conditions must be completed after signing.
A brief marketing document prepared by an investment banker that is circulated to potential acquirers to introduce the investment opportunity but without mention of the company name to maintain confidentiality.
The Transaction Structure
The seller remains the legal owner of the company while the acquirer purchases the assets of the company. The seller typically retains cash and must repay long-term debt at the close. An asset sale is advantageous to the acquirer, who may “step up” the tax basis of assets and obtain depreciation tax deductions.
The threshold amount of losses that a buyer must incur before being entitled to any indemnification from the seller.
The upper dollar limit of a seller’s indemnification obligations to the buyer – i.e., the total amount of losses and damages a buyer is entitled to recover from the seller. Fundamental indemnification claims are normally excluded from the cap.
Consideration contingent on the future performance of the company. The contractual provision will state financial goals the business must achieve for part of the purchase price to be paid to the seller at a specified time.
Fundamental Reps and Warranties
Representations defined in the purchase agreement that are so material, the buyer would not have agreed to the transaction if false. Often included as fundamental reps and warranties are seller’s ownership of the securities or assets, seller’s power and authority to transact, and title to securities or assets, among others. Losses incurred due to a breach of a fundamental rep are subject to a separate cap, often equal to the aggregate amount of the purchase price.
A portion of the purchase price is placed in a third-party escrow account to serve as security for the acquirer for potential security claims against the seller. Holdback is typically used to alleviate concerns about the seller’s financial ability to cover post-closing indemnity claims if they should arise.
Negotiated language of the definitive purchase agreement that allocates risk between parties. Standard indemnification provisions focus on undisclosed liabilities, the timing of escrow holdback, and threshold limits on indemnification claims.
The threshold amount an individual loss must exceed for a specific claim before it counts toward the general basket.
Non-Fundamental Reps and Warranties
Any representation made within the purchase agreement that is not clearly defined as fundamental is by default non-fundamental. These representations are subject to the cap and basket limits.
Non-Tipping Basket (aka True Deductible)
An alternative to a tipping basket that entitles the buyer to recover only losses that exceed the deductible. This basket structure is more favorable to the seller.
The transaction payment method can comprise cash and non-cash considerations. Non-cash considerations include stock, seller notes, earnouts, holdback escrow, etc.
Reps & Warranties Insurance (RWI)
An insurance policy used in M&A transactions to protect against losses arising from a breach of specific representation in the definitive purchase agreement.
Equity that is rolled over by original shareholders into the new equity capital structure post-transaction. Private equity buyers typically require owner-managers to roll over equity to align incentives.
An alternative to bank financing wherein the buyer issues a debt security to the seller as partial payment for the company. The seller note has a claim on the company’s assets subordinate to senior debt.
The seller transfers the company common stock to the acquirer. The acquirer assumes both assets and liabilities of the company. A stock sale is typically a more straightforward process compared with an asset sale, and does not provide the acquirer with the same tax benefits. The seller still retains the cash and debt will be repaid using the proceeds of the sale.
A type of basket that entitles the buyer to full recovery of all losses, from the first dollar of losses, once the incurred losses have reached the basket threshold. This basket structure is more favorable to the buyer.
Investment banking, legal, and accounting advisor fees due at closing based on agreed-upon terms.
An M&A transaction may be structured as a sale of either the company assets or the company common stock.