Glossary of Merger & Acquisitions Terms

The glossary features a comprehensive list of some of the most common terms used in a merger or acquisition transaction. Familiarize yourself with these words to gain knowledge and insight on your transaction whether you are buying or selling a business.

 

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Acquisition: The process by which the stock or assets of a corporation are transferred to a buyer, either through a purchase of stock or a purchase of assets.

Accretion: Refers to the growth of a company or other asset, either by internal expansion or acquisition.

Adjusted Book Value: The book value (equity) of a company after adjusting the values of assets and liabilities to reflect estimated market values rather than depreciated tax values and removing non-operating assets and liabilities from the balance sheet.

Adjusted Earnings: The earnings of a business after adjustment for one-time or extraordinary expenses, excess owner compensation, and discretionary expenses or other expenses that are not essential for the successful ongoing operation of the business.

Adjusted Working Capital: Normal Working Capital (see definition below) excluding any debt in current liabilities. Synonymous with debt free working capital.

Allocations of Purchase: The assignment of value to tangible and intangible assets of an acquired company for which a premium over historical cost has been paid.

Asset Based Approach: A way of estimating the value of a business ownership interest using one or more methods based on the value of the Adjusted Book Value of the company.

Asset Based Lending: A type of financing, commonly found in leveraged buyouts, based on a percentage of some value (book, liquidation, market, and auction) of an asset. Asset based lenders typically analyze a target company's viability as a going concern and its ability to service debt from cash flow.

Asset Sale: A form of acquisition whereby a selling entity agrees to sell all or certain assets and liabilities of a company to a purchaser. The corporate entity is not transferred.

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Base Year: The Company’s current fiscal year. Since complete financial statements are not available for the current year, sales and income are projected based on the expectations of management.

Basket: A dollar amount set forth as the loss that must be experienced by the buyer before it can recover damages under the indemnity provisions.

Blue Sky: Any intangible portion of a price above the maximum goodwill that can be reasonably supported through the application of established valuation methodology.

Book Value: The value, net of depreciation, at which an asset appears on a company’s balance sheet.

Business Enterprise: A commercial, industrial or service organization pursuing an economicmactivity. The business enterprise can be seen as the sum of all operating assets of the business including normal working capital, operating fixed assets, and all intangible assets related to the production of the income and cash flow stream being valued.

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.

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Capital Structure: The mix of invested equity and debt financing of a business enterprise.

Capitalization Factor or Rate: Any multiple or divisor used to convert anticipated economic benefits over time into a present economic value.

Capitalizing Net Income: Determining the value of a Company by dividing annual adjusted income by the capitalization rate (required ROI).

Cash Flow: The amount by which the total cash coming into a business from all sources exceeds the total cash going out.

Cash Flow Lending: A type of unsecured financing based on the timing and certainty of the borrower's cash flow.

Cash Flow Statement: An analysis of all the changes that affect the cash account during an accounting period. These changes may be shown as either sources or uses of cash.

Collar: A strategy using options that is designed to protect the seller who receives publicly traded stock in a transaction from price fluctuations in the stock.

Confidential Business Review (CBR): 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.

Confidential Business Profile (CBP): A brief profile of a business used to solicit buyer interest. The CBP does not reveal the name of the business profiled.

Confidentiality Agreement: Signed by potential buyers, it requires them to keep the information contained in the CBR and ensuing discussions confidential.

Consulting Agreement: A form of deal structure whereby the seller provides business advice and direction for a specified period of time in return for a specific amount.

Contingent Liabilities: Improbable but possible obligations. Probable obligations are real liabilities and require adjustment in accounting records. Contingent liabilities require footnote disclosure only. Some examples are pending lawsuits, purchase commitments carrying default penalties, and warranties and guaranties for which no historical basis is available for assessing the possible obligation.

Covenants: Provisions in purchase documents that define the obligations of the parties in respect to their conduct, the most significant of which is operating the business in the normal course.

Covenant Not to Compete: A condition often found in acquisition agreements by which the seller agrees to abstain from business that would compete with the entity being sold. The restriction is usually for a specific time period and may be for a specific region.

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Deal Structure: The combination of types of payment by which the purchase of a business is accomplished. It can include cash, notes, stock, consulting agreements, earnout provisions, and covenants not to compete. The sale can take the form of an asset sale or a stock sale. See those definitions.

Debt Free Cash Flow: Debt free net income plus depreciation less provisions for working capital and capital expenditures.

Debt Free Net Income: The income of a company presented as if the company had no debt.

Depreciation and Amortization: A reduction in a capital account of the value of an asset over time.

Discount Rate: A rate of return used to calculate the present value of a stream of payments.

Discounted Cash Flow Value:

Discretionary Earnings: Earnings of a business enterprise prior to these expenses:

  • Income taxes
  • Non-operating income & expenses
  • Non-recurring income & expenses
  • Depreciation and amortization
  • Interest expense or income
  • A single owner’s total compensation and benefits.

Doctrine of Fraudulent Conveyance: A conveyance of property (i.e., a business) without any consideration of value, for the purpose of deferring, hindering or defrauding creditors. Such a transfer will, when proven to the satisfaction of judge or jury, be declared void.

Due Diligence: The assessment of the benefits and the liabilities of a proposed acquisition by inquiring into ail relevant aspects of the past, present, and predictable future of the business to be purchased. Due Diligence occurs subsequent to the Letter of Intent.

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EBIT: Earnings before interest and taxes.

EBITDA: Earnings before interest, taxes, depreciation, and amortization.

Earnout: The portion of the purchase price that is contingent on future performance of the business. It is payable to the sellers after certain predefined levels of sales or income are achieved in the year(s) after acquisition.

Economic Life: The period over which tangible (real estate, equipment, etc.) and intangible (goodwill, R&D, etc.) property may be profitably used.

Employee Stock Ownership Plan (ESOP): The period over which tangible (real estate, equipment, etc.) and intangible (goodwill, R&D, etc.) property may be profitably used.

Enterprise Value: The total value of the stock of the business, plus the face value of all interest-bearing debt owed by the business.

Evaluation Report: Document detailing and supporting the fair market value of a business entity.

Excess Cash: The amount of cash in excess of what a business enterprise needs to operate through a business cycle. In an M&A transaction, excess cash is normally retained by the seller at the close.

Exit Plan: A definitive action plan on the part of the owner(s) of the target company to strategically exit the business through the M&A process. The exit plan should take into consideration the owner's personal and financial objectives.

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FASB: Financial Accounting Standards Board. This Board issues rulings that govern how accounting reports are prepared.

Fair Market Value: The estimated price at which an asset or service would pass from a willing seller to a willing buyer, assuming that both buyer and seller are acting rationally, at arms 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. It is also presumed that the price is not affected by special or creative financing or sales concessions granted by anyone associated with the sale.

Financial Buyer: A buyer interested in a target based on the financial return of the investment rather than a strategic or synergistic reason.

Fixed Interest Rate: An interest rate which does not fluctuate over the term of the loan.

Free Cash Flow: Cash available for distribution to owners after taxes but before the effects of financing. Calculated as net income, plus depreciation and amortization, plus interest expense, less required capital expenditures and changes in working capital.

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Going Concern Value: The gross value of a company as an operating business. This value may exceed or be at a discount from the liquidation value. The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.

Goodwill or Intangible Value: The amount by which the price paid for a company exceeds the company’s estimated net worth at market value of the underlying tangible assets and liabilities. Goodwill is a result of name, reputation, customer loyalty, location, products, etc.

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Horizontal Integration: Purchasing similar businesses, including competitors.

Hurdle Rate: A discount rate usually set by the board of directors in a corporation that must be applied to a projected earnings stream that must be met or exceeded before an acquisition or investment will be approved.

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Impairment: In the context of FA SB (Financial Accounting Standards Board) Statements 141 and 142, impairment is an overstatement of the goodwill values shown on a company's balance sheet, compared with their fair value. FASB 142 requires that a business test for impairment on an annual basis, as well as between annual tests if an event or circumstances change that more likely than not reduce the fair value of assets, below their carrying value.

Income (Income Based) Approach: General way of determining the value of a business, business ownership interest, security, or intangible asset using one or more methods that calculate the present value of anticipated future income.

Indemnification: The section of the purchase document that sets forth the circumstances under which either party can claim damages or take other remedial action in the event the other party has breached a representation or warranty or failed to abide by the covenants.

Initial Public Offering (IPO): The first sale of stock by a private company to the public. IPOs are often smaller, younger companies seeking capital to expand their business.

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.

Internal Rate of Return: The rate of return where the net present value of cash inflows and outflows equals zero, thereby indicating that the future cash flows on the investment equal the cost of the investment.

Intrinsic Value: An analytical judgment of value based on the perceived characteristics inherent in the investment as distinguished from the current market price.

Investment Value: The value to a particular investor based on individual investment requirements and expectations.

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Letter of Intent: A written agreement that defines the respective preliminary understandings of the parties about to engage in contractual negotiations on a transaction. Items covered typically include price, terms, and conditions.

Letter Stock: Unregistered shares in a small firm that are issued without underwriting.

Leveraged Buyout (LBO): A transaction in which a company's capital stock or its assets are purchased with borrowed money, resulting in the company's new capital structure being primarily debt.

Leveraged Valuation Approach: The leveraged valuation approach simulates the leveraged buyout of a business. It illustrates a typical buyout transaction with the corresponding deal structure and valuation driven by: 1) the leveragability of the target company's balance sheet and cash flows, 2) the coverage ratios required by senior lenders, and 3) the internal rate ofretum sought by the equity investor(s).

Liquidation or Liquidating Value: The estimated value, net of liabilities, of a company based on the market value of its assets.

Liquidity: The cash position of a business and its ability to meet maturing obligations.

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Management Buyout (MBO): A leveraged buyout where the existing management team is brought in as shareholders.

Market (Market-Based) Approach: General way of determining a value indication of a business, business ownership interest, security, intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold.

Market Capitalization: The market price of an entire company, calculated by multiplying the number of shares outstanding by the price per share.

Market Multiple: A factor that can be applied to the subject company's financial, operating or physical data to generate an indication of value. The market multiple is derived from observed transactions in the marketplace where the value can be divided by the comparable companies' financial, operating or physical data to generate the market multiple.

Multiple Buyer Process: The process of involving multiple buyers in the purchase of a business. The process typically increases the price paid for the target and/or improves the deal structure.

Merger: The combination of one corporation with another.

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Net: Total assets less total liabilities.

Net Book Value: With respect to a business enterprise, the difference between total assets (net of depreciation, depletion and amortization) and total liabilities as they appear on the balance sheet (synonymous with Shareholder’s Equity). With respect to a specific asset, the capitalized cost less accumulated amortization or depreciation as it appears on the books of account of the business enterprise.

Net Cash Flow: Cash available for distribution after taxes and after the effects of financing. Calculated as net income plus depreciation less expenditures required for working capital and capital items.

Net Income: Revenue less expenses, including taxes.

Net Present Value: The value today of a future payment, or stream of payments, discounted at some appropriate compound interest (discount) rate.

Net Operating Loss (NOL): For tax purposed, an excess of expenses over revenue results in a net operating loss. Under certain, limited, circumstances a NOL may provide a tax benefit to a buyer.

Net to Owner: The amount realized by the owners of a business from a sale. Usually "equal to the Business Enterprise Value of the business less debt - retained in the business, plus the net of assets and liabilities not included in the sale and retained by the owners.

Nine-Year Ramp: The financial presentation of the target company that a buyer requires an intermediary to provide as part of the M&A process. Specifically, the nine-year ramp includes the latest three historical years, a base year and five pro forma years.

Non-Compete Agreement: A form of deal structure whereby a portion of the purchase price is based on an agreement prohibiting a seller from operating a competing business for a specified time following sale.

Non-Operating Assets: Assets shown on the company's balance sheet that are not used in the operation of the business. That is, "extra" assets that are not necessary to generate the revenue and cash flow stream being valued. These would be recast when valuing the business.

Normal Working Capital: The amount of working capital needed by the company to sustain operations throughout the year. Calculated as the average of current assets (which include a normal amount of necessary cash) minus current liabilities on a monthly basis over the most recent twelve months.

No-Shop Agreement: A provision in the letter of intent or purchase document that inhibits the target from soliciting or encouraging other bids.

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Pooling of Interests: One method of accounting for a company merger, in which the balance sheets of the two companies are combined line by line without a tax impact. Only allowed under certain circumstances.

Post Acquisition Planning: Strategic steps taken prior to the acquisition to plan for the successful integration of target and acquirer, including how to exploit synergies, merge management, and support corporate culture.

Pre Tax Income: The income earned by a business prior to the provision for federal or state income taxes.

Product / Service Extension: Adding a product or service that can be sold in the acquirer's current geographic areas and/or to current customers.

Pro Forma Financial Statements: Hypothetical financial statements. Financial statements as they would appear if some event, such as increased sales or production had occurred or were to occur. Also used to make projections for future years.

Projection: Prospective financial statements which present an entity’s expected financial position, results of operation and changes in financial position, based upon one or more hypothetical assumptions.

Purchase Document / Acquisition Agreement: The legal document transferring ownership from seller to buyer. Drafted by buyer, it sets forth structure and terms; discloses legal, financial, and other pertinent information about buyer and seller; obligates both parties to complete the transaction; and governs what happens if problems arise.

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Quick Ratio: A measure of a company's liquidity, used to evaluate credit worthiness. Equals quick assets divided by current liabilities.

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Rate of Return: An amount of income (loss) and/or change in value realized or anticipated on an investment, expressed as a percentage of that investment.

Recapitalization: The reconfiguration of a company's capital structure. Typically recapitalization occurs to reduce immediate interest payments, reduce debt, reduce taxes, or leverage the operation.

Recasting: Financial recasting eliminates from the historical financial presentation, items such as excessive and discretionary expenses and nonrecurring revenues and expenses, since they reflect the financing decision of the current owner and may not represent financing preferences of a new owner. Recasting provides an economic view of the company, and allows meaningful comparisons with other investment opportunities.

Recast Book Value: See also Adjusted Book Value. The value of a balance sheet item(s) (asset, liability, or equity) after recasting adjustments have been made.

Regulatory Barriers: Federal, state, or local statutes or regulations in a variety of areas, including antitrust, securities, employee benefits, bulk sales, foreign ownership, and the transfer of title to stock or assets.

Replacement Cost New: The current cost of a similar new item having the nearest equivalent utility as the item being valued.

Representation and Warranties: Intended to disclose all material legal, and any material financial aspects of the business to the buyer. Buyer makes similar reps about its legal and financial ability to complete the transaction.

Residual Value: The estimated market value of an asset at the end of the period being considered.

Retained Assets: Assets personally kept by the owner(s) of a company upon the sale of the business.

Return on Equity (ROE): A measure of how well a company used reinvested earnings to generate additional earnings, equal to a fiscal year's after-tax income divided by book value, expressed as a percentage.

Return on Investment (ROI): The rate of return at which the sum of the discounted future cash flows plus the discounted future residual value equals the initial cash outlay.

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S.W.O.T. Analysis: Refers to an analysis of a company's strengths, weaknesses, opportunities and threats. A S.W.O.T. analysis is necessarily key to understanding a target company's competitive positioning and long-term growth potential.

Secured and Unsecured Note: A form of deal structure whereby the buyer owes money for the purchase and this debt is secured by real property, equipment or other assets. In contrast, an unsecured note is not backed by the pledge of collateral.

Shareholder Value: Business Enterprise Value less the debt retained in the business and assumed by the new owners.

Situation Analysis: A general assessment of a company's past, present and future. A situation analysis often limes provides a benchmark to the business’ future growth potential.

Stock Sale: A form of acquisition whereby all or a portion of the stock in a corporation is sold to the purchaser.

Synergistic Buyer: A buyer willing to pay a premium above economic value based on projected additional growth and profit to be achieved through the benefits of consolidation.

Synergistic Value: A premium value offered by a Synergistic buyer above economic value, the difference being attributed to potential additional growth and profit beyond that which the target can achieve on its own and benefits the buyer brings.

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Tangible Assets: Assets clearly having physical existence, such as cash, real estate, and machinery.

Target: Company being acquired.

Tax Free Reorganization: A stock swap. The seller accepts stock of the buyer's company in lieu of cash, which is a nontaxable event. Only when the seller divests of the stock are taxes paid.

Tender Offer: A general publicized bid by an individual or group to buy shares of a publicly owned company at a price significantly above the current market price.

Term Sheet: A preliminary, non-binding agreement setting forth the basic terms and conditions under which an investment will be made. Generally speaking, a term sheet usually precedes the Letter of Intent.

Terminal Value: The value of the company at the end of the five-year pro forma period. Terminal value is determined by dividing the fifth year pro forma cash flow (normalized for depreciation and capital expenditures) by the required Return on Investment. Terminal value is sometimes referred to as residual value.

Terms: Details of an agreement such as price, payment schedule, interest rate, and due date.

Tombstone: An advertisement, usually in financial publications such as The Wall Street Journal, announcing an acquisition, securities offering, or underwriting. Also, a commemorative plaque announcing the transaction.

Transaction Value: Total of all consideration passed at any time between the Buyer and Seller for an ownership interest in a business enterprise and may include but is not limited to all remuneration for tangible and intangible assets such as: furniture, equipment, supplies, inventory, working capital, non-competition agreements, customer lists, employment and/or consultation agreements, franchise fees, assumed liabilities, stock options or redemptions, real estate, leases, royalties, earn-outs, and future considerations.

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Valuation Approach: A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more valuation methods. There are three Approaches generally used to value a business: Asset Approach, Income Approach, and Market Approach.

Valuation Method: Within a Valuation Approach, a specific way to determine value.

Valuation Procedure: The act, manner and technique of performing the steps of an appraisal method.

Value: The consideration at which a business enterprise passes from a willing seller to a willing buyer. It is assumed that both buyer and seller are rational and have a reasonable knowledge of relevant facts.

Variable Interest Rate: An interest rate that adjusts periodically to a predefined margin above or below an index rate. A commonly used index is the bank prime rate.

Vertical Integration: A strategy to achieve economies of scale in purchasing, sales, and distribution. Vertical backward integration is buying a supplier. Vertical forward integration is buying a customer

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Working Capital: The excess of current assets over current liabilities.

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