Transaction Terminology
As with any discipline, selling a business has its own language. Here’s a reference guide:
01 Abbreviations
CA: Confidentiality agreement
EBIT: Earnings before interest and taxes
EBITDA: Earnings before interest, taxes, depreciation, and amortization
GAAP: Generally accepted accounting principles
GP: General partner
IOI: Indication of interest
IP: Intellectual property
IRR: Internal rate of return
KPI: Key performance indicator
LOI: Letter of intent
LP: Limited partner
M&A: Mergers & acquisitions
NDA: Non-disclosure agreement
Q of E: Quality of earnings
ROA: Return on assets
ROE: Return on equity
TTM: Trailing twelve months
EBIT: Earnings before interest and taxes
EBITDA: Earnings before interest, taxes, depreciation, and amortization
GAAP: Generally accepted accounting principles
GP: General partner
IOI: Indication of interest
IP: Intellectual property
IRR: Internal rate of return
KPI: Key performance indicator
LOI: Letter of intent
LP: Limited partner
M&A: Mergers & acquisitions
NDA: Non-disclosure agreement
Q of E: Quality of earnings
ROA: Return on assets
ROE: Return on equity
TTM: Trailing twelve months
02 Terminology
Amortize: Spreading a repayment, cost, or deduction over a period of time.
Assign: Transferring property and/or ownership rights from one party to another. Generally refers to transferring your customer contracts to a buyer.
Call/Put Options: Options are an obligation for the purchase or sale of an asset. A call option generally refers to the buyer’s right to “call” or buy the seller’s shares. A put option refers to the seller’s right to “put” the shares.
Cap Table: A schedule of who owns the shares in the company.
Caps & Baskets: A “cap” is the total amount of money the buyer may recover from the seller for damages. A “basket” is the minimum amount that must be met before a buyer can demand reimbursement for damages. Sellers want a large basket and a small cap. Buyers want a small basket and a large cap.
Due Diligence: The “homework” a buyer does to determine if it wants to make the acquisition. Surprises during this phase can be lethal to a deal.
Earnout: Money that is paid in the future based on meeting previously agreed upon performance numbers. Used to close a valuation gap between buyer and seller but should be avoided when possible.
EBIT: Earnings before interest and taxes. EBIT is a rough estimate of the company’s profitability before taxes.
EBITDA: Earnings before interest, taxes, depreciation, and amortization. EBITDA is commonly used as an approximation for cash flow, though it is often only an approximate measure.
Enterprise Value: The value of the company, usually based on a multiple of current earnings or discounted cash flow of future earnings.
Escrow: A third-party account that holds a portion of transaction proceeds for a period of time to cover pre-specified liabilities as agreed upon by the buyer and seller.
Indication of Interest (IOI): A non-binding offer generally used to ensure buyer and seller agree on valuation and high-level terms.
Letter of Intent (LOI): A legal agreement documenting high-level deal terms. An LOI generally includes an exclusivity clause, which means you will break off communication with other potential buyers and work exclusively with the chosen buyer for a period of time.
Multiple: A multiplier that is applied to either cash flow, EBITDA or revenue to determine the value of a company. E.g., A company with EBITDA of $2 million and a multiple of 5X has a valuation of $10 million.
Net Working Capital (NWC): A company’s current assets minus current liabilities (represents the amount of capital needed to run the business). A buyer will expect net working capital to be left to operate the business post-close.
Non-Disclosure Agreement (NDA)/Confidentiality Agreement (CA): A legal contract that outlines information and materials that are considered confidential, and restricts the parties from sharing confidential data.
Owner Earnings: Cash flow to the owners of the business. Defined as Net Income + D&A - maintenance capital expenditures - additional working capital - normalized owner compensation. Good buyers generally base valuations on a multiple of owner earnings.
Purchase Agreement: A legal document that outlines the terms and conditions of the sale of assets or equity from a seller to a buyer.
Quality of Earnings (Q of E): A proctology exam for your financials performed by an accounting firm. Financial statements will be compared with bank account cash flows to ensure accuracy.
Representations & Warranties: n. A representation is an assertion of a fact. A warranty is a promise of indemnity if the assertion proves to be false. Reps and warranties are outlined in the purchase agreement and exist to share risk between the seller and the buyer.
Right of First Refusal: The legal right to purchase something from another party before the asset may be sold to a third party. Majority owners typically have a right of first refusal on all minority owner’s shares.
Rollover: The amount of value from a sale that a seller will use to acquire or “roll” ownership in the new ownership structure of the company.
Seller Note: Seller-funded debt.
Assign: Transferring property and/or ownership rights from one party to another. Generally refers to transferring your customer contracts to a buyer.
Call/Put Options: Options are an obligation for the purchase or sale of an asset. A call option generally refers to the buyer’s right to “call” or buy the seller’s shares. A put option refers to the seller’s right to “put” the shares.
Cap Table: A schedule of who owns the shares in the company.
Caps & Baskets: A “cap” is the total amount of money the buyer may recover from the seller for damages. A “basket” is the minimum amount that must be met before a buyer can demand reimbursement for damages. Sellers want a large basket and a small cap. Buyers want a small basket and a large cap.
Due Diligence: The “homework” a buyer does to determine if it wants to make the acquisition. Surprises during this phase can be lethal to a deal.
Earnout: Money that is paid in the future based on meeting previously agreed upon performance numbers. Used to close a valuation gap between buyer and seller but should be avoided when possible.
EBIT: Earnings before interest and taxes. EBIT is a rough estimate of the company’s profitability before taxes.
EBITDA: Earnings before interest, taxes, depreciation, and amortization. EBITDA is commonly used as an approximation for cash flow, though it is often only an approximate measure.
Enterprise Value: The value of the company, usually based on a multiple of current earnings or discounted cash flow of future earnings.
Escrow: A third-party account that holds a portion of transaction proceeds for a period of time to cover pre-specified liabilities as agreed upon by the buyer and seller.
Indication of Interest (IOI): A non-binding offer generally used to ensure buyer and seller agree on valuation and high-level terms.
Letter of Intent (LOI): A legal agreement documenting high-level deal terms. An LOI generally includes an exclusivity clause, which means you will break off communication with other potential buyers and work exclusively with the chosen buyer for a period of time.
Multiple: A multiplier that is applied to either cash flow, EBITDA or revenue to determine the value of a company. E.g., A company with EBITDA of $2 million and a multiple of 5X has a valuation of $10 million.
Net Working Capital (NWC): A company’s current assets minus current liabilities (represents the amount of capital needed to run the business). A buyer will expect net working capital to be left to operate the business post-close.
Non-Disclosure Agreement (NDA)/Confidentiality Agreement (CA): A legal contract that outlines information and materials that are considered confidential, and restricts the parties from sharing confidential data.
Owner Earnings: Cash flow to the owners of the business. Defined as Net Income + D&A - maintenance capital expenditures - additional working capital - normalized owner compensation. Good buyers generally base valuations on a multiple of owner earnings.
Purchase Agreement: A legal document that outlines the terms and conditions of the sale of assets or equity from a seller to a buyer.
Quality of Earnings (Q of E): A proctology exam for your financials performed by an accounting firm. Financial statements will be compared with bank account cash flows to ensure accuracy.
Representations & Warranties: n. A representation is an assertion of a fact. A warranty is a promise of indemnity if the assertion proves to be false. Reps and warranties are outlined in the purchase agreement and exist to share risk between the seller and the buyer.
Right of First Refusal: The legal right to purchase something from another party before the asset may be sold to a third party. Majority owners typically have a right of first refusal on all minority owner’s shares.
Rollover: The amount of value from a sale that a seller will use to acquire or “roll” ownership in the new ownership structure of the company.
Seller Note: Seller-funded debt.