M&A terms you should know
By Victor Harding
There are several terms that sellers and buyers of businesses should know. Here are some of the most important ones.
EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization is the key variable that most M&A professionals use to value a company. Essentially, EBITDA takes annual earnings of a company and adjusts for non-cash items like depreciation and amortization and financing issues giving rise to interest. Despite many finance purists warning us that EBITDA is a dangerous variable to use to assess a company, it is still very much used. Anytime you use the multiple of earnings method to value a business the odds are that you will be using EBITDA as a key metric.
“Adjusted” EBITDA: To get at the proper EBITDA number to value a business, EBITDA often has to be “adjusted” for any non-recurring revenue expense items and for non-business expenses put through the company’s income statement. An example of these adjustments might be a one-time large legal bill for a once in a lifetime lawsuit. The other common adjustment to EBITDA is for the owner’s salary, depending on how it compares to what a buyer would have to pay a new manager to do what the owner has been doing. Some owners over-pay themselves while others under-pay, taking money out of the company through dividends.
Seller’s Discretionary Earnings (SDE): This term is sometimes used to value very small companies and differs from EBITDA because the owner’s salary and expenses are added back into earnings with no deduction for what the owner’s replacement might cost. SDE generally produces a higher earnings number but a lower multiple used to value the company.
Expression of Interest (EOI) and Letter of Intent (LOI): Normally an EOI is given by a seller to express their interest in buying a company but the offer will not go into much detail. EOIs normally come earlier in the sales process – say, within the first month— with LOIs coming later on, in the second month. I would never recommend a seller “go to bat” with a buyer based simply on an EOI. They don’t contain enough important information about the offer.
Asset Purchase Agreement (APA) and Share Purchase Agreement (SPA): An Asset Purchase Agreement is the final, binding document used to close a deal where just the assets are being sold. Today, many alarm account deals are done using an APA. A Share Purchase Agreement is used when the shares of the company are being sold. SPAs are usually considerably longer and more complex than APAs.
Trailing Twelve Months (TTM): You see this term used in regards to the financial statements shown to buyers in a deal. Most buyers will want to see the trailing 12 months of financials before arriving at an offer.
Running an Auction: When selling a business, most M&A types will effectively run an auction amongst the various buyers to try to maximize the price and terms for their client. Running an auction means just what it says — putting the selling package out to several if not many potential buyers and soliciting bids back in from as many as possible. It is critical here that the buyers know that an auction is being held and that they will be bidding against several others.
Non-compete versus a Non-solicit: M&A deals will normally have one or the other of these two clauses in them and sometimes both.
In simple terms, a non-compete is the more all-encompassing clause which a seller should be careful with unless they are truly about to retire for good. A non-compete generally prevents the seller from operating at all in the industry that their business is in for a certain geographical area and for a period of anywhere from two to five years.
For those not ready to retire, they should try to restrict the non-compete in regards to what they can’t do, where and for how long. I always suggest sellers be careful when they sign a non-compete because they may change their minds about what they want to do and where. The courts have stepped in the case of some non-competes where the buyer tries to restrict an owner or employee from working after a sale in the only industry that they are trained in.
A non-solicit is usually narrower in scope and directed at preventing the seller from approaching the customers or employees he is currently selling for a period of two to five years. As a broker, I fully support most non-solicits as it seems only fair that a seller cannot go back to customers they have just sold.
Non-circumvention period or a “Broker’s Tail”: Most brokers or M&A professionals will insert a non-circumvention clause into their brokerage agreements with their clients, preventing the client from cancelling the agreement, then selling the company to a buyer that the broker found without paying the broker.
Typically non-circumvention periods are set at two years. This means that the broker will still get paid if a business is sold to someone that the broker negotiated with while the agreement was active and within two years of the brokerage agreement being terminated. I personally set my “tail” at 12 to 18 months in most of my agreements.
Vendor Take Back (VTB): A VTB is a finance term describing the fact that a seller has been willing to forgo getting paid all of the purchase price up front and will take a “note” for part of the purchase price. VTBs generally range in size from 15 to 30 per cent of the total purchase price and often attract some interest and are paid out over two to four years. VTBs are used by the seller to help close the gap between what a buyer and seller think the company is worth or to help close a deal where the seller knows the buyer cannot come up with 100 per cent of the purchase price and the buyer’s bank will not cover all the difference. Agreeing to a VTB usually indicates the seller has confidence in and trusts the buyer.
It helps to know these standard M&A terms if you are a seller. These are just some. More to come!
Victor Harding is the principal of Harding Security Services (email@example.com).