Some Basic Terms of M&A

EBITDA – This is the cash flow generated by a business in a defined period, formally defined as Earnings Before Interest, Taxes, Depreciation, and Amortization. Drawn from the income statement, you take net income (revenues less expenses), and add back interest, taxes, and the non-cash expenses of depreciation and amortization. It is a definition of cash flow used almost universally in M&A transactions.

Purchase Agreements – Sales of companies are ultimately memorialized in a written contract. If the transaction is an Asset Sale (below), the agreement is usually called an “asset purchase agreement” or “APA.” If the transaction is a Stock Sale (below), the agreement is usually called a “stock purchase agreement” or “SPA.” And oftentimes, the document is just called a “purchase and sale agreement” or “PSA.”

Comparables – In the M&A world, these are usually businesses or companies that are similar to the business being sold. There is never an identical company, so the relevance of the comparable company is increased the more it is similar to the business being sold in terms of type of business, business model, size, location, profitability, and any other material features of the business.

Asset Sale - Sales of businesses are structured as either an asset sale or a stock sale. In an asset sale, the seller remains the owner of the legal entity and retains long-term debt obligations (unless specifically assumed by the buyer). The cash in a business is normally not included in an asset sale.

Stock Sale - In a stock sale, the buyer buys the entity and receives all the assets and assumes all the liabilities (subject to any negotiated exceptions). Again, the cash in a business is normally not included in a stock sale.

Working Capital – This is generally a company’s current assets (liquid assets or assets that are expected to be liquid in less than a year) less its current liabilities (liabilities that are payable now or will be payable in the next year). Current assets usually include cash, cash equivalents, accounts receivable, and inventory. Current liabilities usually include accounts payable and any amounts of debt payable that are due in the next year. For the third time, but well worth it, cash is usually not included in the sale of a business.

“Normalized” Working Capital – The normal level of working capital necessary in the ordinary course of business. This is part and parcel of a stock sale, and is usually included in an asset sale, even though it includes the accounts payable liability.

GROW and SELL Advisors, wholly-owned by Traversi & Co., LLC, is a premier sell-side M&A advisory firm – a boutique investment bank – serving the lower middle market.  Visit us here.

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This Is What Sets the Value of Your Company

Selling a business is purely Economics 101…the interplay of supply and demand. The more in demand your business is, the higher the valuation and the price you’ll receive. The lower in demand your business is, the lower the valuation and the price you’ll receive.

In over 30 years of activity in the M&A markets, we have seen many brokers and investment bankers (i.e., basically, brokers working on bigger, often more complicated deals than ordinary business brokers) proclaim a valuation to their client, or prospective client, prior to taking the business to market. It is often an optimistic valuation, given the broker or banker wants to be selected to represent the client in the sale and no client wants a pessimistic intermediary representing them.

But the problem with this dynamic is that the client remembers the optimistic valuation and then is disappointed when the offers, and ultimately the selling price, come in lower than that optimistic valuation. The whole thing leaves a bad taste in the client’s mouth, with them feeling like they were the subject of a bait-and-switch.

What a broker or banker should provide you is an analysis of all the possible valuation methods that might be used by buyers and the wide ranges of valuation that each of those methods suggest. And they should run a process that optimizes the price and all other terms. In other words, the process described in How To SELL Your Business!

So, what methods might be used, and which are most appropriate? Check back soon for upcoming posts.

GROW and SELL Advisors, wholly-owned by Traversi & Co., LLC, is a premier sell-side M&A advisory firm – a boutique investment bank – serving the lower middle market.  Visit us here.

For a short video clip on this topic, click here.