Deciphering M&A Jargon

Having a basic understanding of common terms used in a business transaction can help make the process easier. Read through these definitions to gain a better understanding of the meaning behind general M&A terminology.

“In order to be accretive and gain synergies from the economies of scale, the EBITDA must be $2MM and we must utilize a 338(h)(10) election in our Share deal which we memorialized in our LOI…” Would that be a yes or no to my question?

The world of business sales and acquisitions uses many acronyms, abbreviations and buzzwords. Below we help you unravel and interpret some of the most common M&A terms used with privately held companies:

Accretion

An improvement in per-share metrics post-transaction (after issuing additional shares).

Acquirer

The firm which is purchasing a company in the acquisition (the buyer).

Acquisition

The purchase of the controlling interest or ownership of another company.

Amalgamation/Consolidation

The joining of one or more companies into a new entity. None of the combining companies remains; a completely new legal entity is formed.

Angel investor

A wealthy individual (accredited investor) who provides seed or early-stage financing from his or her own funds in return for equity. Angel investors sometimes provide industry knowledge and contacts, and sometimes play a direct role on the board, but infrequently participates in management. Angels invest either as individuals or in groups.

Asset deal

The acquirer purchases only the assets of the target company (not its shares).

Backward integration

A company acquires a target that produces the raw material or the ancillaries which are used by the acquirer. It intends to ensure an uninterrupted supply of high-quality raw materials at the fair price.

Bootstrapping

Generally used with startup companies, meaning the financing of business efforts with personal, existing and often scarce resources.

Bottom line

The net income “line” of the income statement.

Business cycle

A recurring pattern of expansion and contraction in the economy. The average cycle is three to four years.

Capital expenditure—CAPEX

A large expenditure which acquires a new capital asset or improves the useful life of an existing capital asset. The cost is spread/expensed over the useful life of the asset. A company’s CAPEX needs is a consideration when valuing a business. Large CAPEX needs would reduce the amount of cash a buyer could expect from their investment.

Capital asset pricing model

An element of modern portfolio theory. A mathematical model showing an “appropriate” price, based on relative risk combined with the return on risk-free assets.

Capitalization

Term used to describe a company’s permanent capital, long-term debt and equity.

Capital structure

The composition of the invested capital of a business enterprise; the mix of debt and equity financing.

Cash consideration

The portion of the purchase price given to the target in the form of cash.

Cash flow

Cash that is generated over a period of time by an asset, group of assets or business enterprise. It may be used in a general sense to encompass various levels of specifically defined cash flows.

Confidential information memorandum (CIM)

A description of the business including its history, products, markets, management, facilities, competition, financial statements, product literature, and a review of its key investment considerations and growth potential. This document is used to market a business to potential buyers.

Covenants

Provisions in the legal agreements on loans, bonds, or lines of credit. Usually written by the lender to protect its position as a creditor of the borrowers.

Deal structure

Typical deal structure may include stock, seller debt, earn outs or other valuables besides cash. The complex nature of deal structure is an important reason why middle-market intermediaries are often hired.

Dilution

A worsening of per-share metrics post-transaction (after issuing additional shares).

Discontinued operations

Operations that have been or will be discontinued by the company. These items are reported separately on the income statement.

Discount for lack of control

An amount or percentage deducted from the pro rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control.

Discount for lack of marketability

An amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.

Discount for lack of voting rights

An amount or percentage deducted from the per-share value of a minority interest voting share to reflect the absence of voting rights.

Divestiture

The sale, for cash or for securities, of a segment of a company to a third party which is an outsider.

Drag-along rights

Rights that enable a shareholder or group of shareholders (usually those who own a controlling interest in the company) to compel other shareholders to sell their stock in the event a purchaser desires to purchase more than what the controlling shareholder(s) own(s).

Due diligence

In the process of an acquisition, the acquiring firm is often allowed to see the target firm’s internal books, operations and internal procedures. The acquiring firm reviews all areas of the target to satisfy their interests. Offers are made contingent upon the resolution of the due diligence process.

Earn out

An arrangement in which sellers of a business may receive additional future payments if certain performance metrics are met.

EBITDA

Earnings before interest, taxes, depreciation and amortization.

Exclusivity (no-shop) requirement

A contractual requirement that prevents a company from soliciting or negotiating other deals for a specified period of time, while it is exclusively negotiating with a potential investor, group of investors or acquirers.

Economies of scale

Fixed costs decrease because merged companies can eliminate departments with repetitive functions or gain operational efficiencies.

Economies of scope

A gain of more specialized skill or technology due to the merger.

Fully diluted shares outstanding

The number of shares a company has outstanding after options, convertible securities, etc. are exercised.

Golden parachute

An employment contract that guarantees extensive benefits to the executive if the executives are made to leave the company.

Goodwill

The excess purchase price over and above the target’s net identifiable assets (after fair value adjustments).

Horizontal integration

Merging of companies in the same lines of business, usually to achieve synergies.

Identifiable assets

An asset that can be assigned a fair value and can include both tangible and intangible assets.

Indication of interest (IOI)

Letter from buyer to seller indicating general value and terms a buyer is willing to pay for a company. The letter is non-binding on both parties.

Intangibles

All intangible assets like goodwill, patents, trademarks, unamortized debt discounts and deferred charges.

Intrinsic value

The estimated value of the business using discounted cash flow analysis (often on a per-share basis).

Letter of intent (LOI)

Letter signed by both buyer and seller which contains major provisions of a deal. The letter is non-binding upon both parties except for certain provisions.

Leveraged buyout

This is the acquisition of a company using significant amounts of debt to increase returns on investment.

Liquidation value

The amount which is available if the assets of the business are sold off and converted to cash.

Merger/Statutory

The purchasing company acquires all of the target company’s shares/assets when the target company ceases to exist (acquirer survives).

Multiple

The inverse of the capitalization rate; common measure of value to compare pricing trends on deals.

Net book value of assets

Book value of assets minus book value of liabilities.

Net cash/Net debt deal

Purchase price assumes that seller retains all balance sheet cash and pays all third-party/interest-bearing debt. When the term is used, it should be supplemented by a specific definition.

Net debt

Cash asset less company debt.

Normalized earnings

Economic benefits adjusted for nonrecurring, noneconomic, or other unusual items to eliminate anomalies and/or facilitate comparisons.

Offer price

The price offered per share by the acquirer.

Other closing costs

This may include due diligence fees, legal fees, accounting fees, etc. related to the deal.

Pari passu

A Latin term referring to the equal treatment of two or more parties in an agreement. For example, an investor may want to have a certain right that is pari passu with investors in a previous financing round.

Portfolio company

A company that has received an investment from a venture capital fund is said to be a portfolio company of that venture capital fund.

Post-money valuation

The value of a company after investors invest in a given round of financing.

Pre-money valuation

The value of a company before investors invest in a given round of financing, or value based on transaction value without consideration of capital structure.

Preferred stock

Stock that gives its holders certain rights, preferences and privileges over holders of common stock and other securities.

Pro forma shares outstanding

The number of shares outstanding after the transaction has closed and additional equity has been issued.

Purchase price allocation

The breakdown of the total purchase price between net identifiable assets and goodwill (used for tax purposes and must be agreed upon by buyer and seller).

Recapitalization

Restructuring a company’s debt and equity mixture, most often with the aim of making a company’s capital structure more stable; a partial sale of a company which allows a seller a liquidity event plus a retention of partial ownership of stock, generally by a private equity investor.

Restructuring charges

Any fees or charges related to early debt repayments that are part of a restructuring.

Sandbagging

Target company playing along with the less desirable bid and stalling for time while waiting for a better offer to appear.

Sensitivity analysis

A method of testing how sensitive certain outputs in the model are to changes in certain assumptions.

Share/Stock deal

The acquirer purchases all the shares for the target (and assumes all assets and liabilities).

Stock consideration

The portion of the purchase price given to the target in the form of shares of the acquirer’s stock.

Subsidiary

Acquirer completely takes over the target but preserves the target’s brand for the sake of brand reputation or customer base.

Synergies

Cost savings and revenue enhancements that are expected to be achieved in connection with a merger/acquisition.

Tag-along rights

These rights enable the holder to participate in a sale of stock from another shareholder to a third party, typically in proportion to the number of shares the holder holds in the company. Co-sale rights are usually designed and intended to protect the holder if a founder or a majority shareholder decides to sell his, her or its interest in the company. The co-sale rights holder can participate in the sale, usually with the same terms and conditions as the founder or majority shareholder.

Target (Acquiree)

The firm that is being acquired (the seller).

Term sheet

A document which outlines the key terms of a proposed transaction. The term sheet is typically nonbinding, except for certain provisions.

Timing of synergies

How long it is estimated to take to realize the synergies in the transaction.

Transaction close date

The date on which the transaction is expected to be officially completed.

Vertical integration

Merging with companies that are in its supply chain. It is composed of both forward and backward integration.

Warrants

A derivative security that gives the holder the right to purchase securities (usually common stock) from the issuer at a specific price within a certain timeframe.

338(h)(10) election

IRS election to treat a stock sale as an asset sale for tax purposes only.

For more information or to explore your options related to mergers and acquisitions, please contact Ann Hanna, managing director and owner, at ah@taureaugroup.com or any member of the Taureau Group team at 414-465-5555.