Accrual Basis Accounting: A method of accounting wherein income and expenses are recognized, within the statements, when the business first acquires the right to receive the income, or the obligation to pay the expense. Companies with inventories are required to use the accrual method for tax purposes. (Also see Cash Basis Accounting.)
Add-backs: All or a portion of expenses that are added back to net income in an effort to place the figures as close as possible to the economic earnings that were actually derived from the business. Used in the calculation of Seller Discretionary Earnings (“SDE”)
Asset Sale: A form of acquisition where the individual selling a business agrees to sell all or certain assets and, in some cases, liabilities to a purchaser. The corporate entity itself is not transferred. An asset sale is a method by which a business owner transfers ownership of tangible and intangible assets, and possibly some liabilities, to another owner without transferring the ownership entity. It is the most common type of transaction in the sale of a small business.
Business Broker: A professional intermediary dedicated to serving clients and customers who desire to sell or acquire businesses. A business broker is committed to providing professional services in a knowledgeable, ethical and timely fashion. Typically, a business broker provides information and business advice to sellers and buyers, maintains communications between the parties, and coordinates the negotiations and closing processes to complete desired transactions.
Business Valuation: The act or process of arriving at an opinion or determination of the economic value of a business or enterprise, or an interest therein. A business valuation can be conducted for a variety of purposes, including, but not limited to, a merger or acquisition; gift, estate, or inheritance tax planning; ESOPs and other employee benefit plans; going public; buy-sell agreements; marital, partnership, and corporate dissolutions; and bankruptcy reorganizations.
Closing: The final steps in the sale of the business. The closing entails execution of all necessary legal documents and funding to consummate the transaction. The parties involved in the closing are usually the buyer and seller, attorney for the buyer and seller, the bank attorney, and possibly the business broker.
Confidential Business Review (CBR) – sometimes referred to as the Confidential Information Memorandum (CIM):
A book containing a detailed description of a business and its growth opportunities. The CBR includes information on products and services, markets, competitors, promotional activities, organization, facilities, and historical and projected financial information. The CBR is sent to potential buyers who have signed a confidentiality agreement. Also referred to as an Offering Memorandum.
Discretionary Earnings (DE) – Sometimes Seller Discretionary Earnings (SDE):
The earnings of a business enterprise prior to the following items: income taxes, non-operating income and expenses, nonrecurring income and expenses, depreciation and amortization, interest expense or income, one owner’s entire compensation, including benefits and any non-business or personal expenses paid by the business. Seller’s Discretionary Cash Flow (SDCF) and Adjusted Net are other terms used.
Due Diligence: The assessment of the benefits and the liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present and predictable future of the business to be purchased. Due diligence occurs after the Letter of Intent is agreed. During the due diligence process a buyer conducts a detailed review of accounting history and practices, operating practices, customer and supplier references, management references and market reviews.
Earnout: The portion of a purchase price in an M&A transaction that is contingent on future performance. It is payable to the sellers only when certain predefined levels of sales or income are achieved.
EBITDA: Earnings of a business prior to interest (expense or income), income taxes, depreciation and amortization expenses.
Exit Plan: A strategy to depart an existing situation. The creation of an overall strategy that prepares a business owner and his/her company for the time when that business owner is no longer involved in the operation of the company. Examples of unplanned exits include death, divorce, management disputes, influx of competition, technological obsolescence, loss of a major customer, or other unforeseen economic events.
Fair Market Value: The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.
Goodwill: A) Those elements of a business that cause customers to return in sufficient volume to generate profit in excess of a reasonable return on tangible assets. B) That intangible asset that arises as a result of name, reputation, customer patronage, location, products and similar factors that have not been separately identified and/or valued but which generate economic benefits.
Intangible (Hidden) Assets: The assets of a business that have value but are nonphysical and not shown on the balance sheet, such as patents, software, heavily depreciated fixed assets, strong contractual relationships and an experienced workforce. Also referred to as Off Balance Sheet items.
Management Buy-out: A process whereby management of a company acquires all or some of the ownership of the company they manage either independently or in partnership with a private equity fund/group (PEG). Management buy-outs (MBO) are generally pursued by management teams that have little or no ownership in a business and want to obtain more ownership but lack the financial resources to buy the company from the current owners. In these circumstances, a PEG can provide the financing necessary to facilitate the purchase of the business. The PEG also gives the management team a large equity stake to cement their commitment to continue running the business.
Multiple: Also known as Enterprise Value (EV) Multiple, is the inverse of the capitalization rate. It is usually the ratio of the price to earnings, particularly for public companies. It can also be the ratio of selling price to discretionary earnings (DE) for a small business. A multiple can be used to estimate the value of a company. Most often, however, a multiple is a generated value as an outgrowth of the valuation of a business.
Nondisclosure Agreement (NDA): Document that requires all information about a business to be kept confidential; also referred to as a confidentiality agreement.
Private Equity Firm: Entities that raise capital with the goal of acquiring businesses and maximizing the value of the initial investment. Also referred to as PE firms. PE firms typically buy part or all of a company, provide the missing resources currently preventing the company from growing at an accelerated rate, help the company grow extensively for a few years, and then sell it for a solid return on their investment.
Recasting: Recasting, or financial statement adjusting, eliminates from the historical financial presentation, items that are unrelated to the ongoing business, such as superfluous, excessive, or discretionary expenses, and nonrecurring revenues and expenses. Recasting provides an economic view of the company as though it were run by management dedicated to maximizing profitability and allows meaningful comparisons with other investment opportunities.
Stock Sale: A form of acquisition whereby all or a portion of the stock in a corporation is sold to the purchaser.
Succession Planning: Process of identifying and training certain employees and/or family members to fill key management positions within a business as these become available. This needs to be done prior to selling a company, since businesses that can operate smoothly in the absence of the current owner are more attractive to professional buyers. a strategy for passing on leadership roles – often the ownership of a company – to an employee or group of employees. Also known as “replacement planning,” it ensures that businesses continue to run smoothly after a company’s most important people move on to new opportunities, retire, or pass away.