By Neil Seiden, Managing Director, Asset Enhancement Solutions, LLC
This is the fourth in a series of articles regarding Mergers & Acquisitions in the Middle Market. Asset Enhancement Solutions, LLC is committed to educating business owners and their trusted advisors on this topic as well as other pertinent issues that affect Middle Market companies.
The world of Mergers and Acquisitions in the Lower Middle Market has many unique terms that may not be familiar to the typical business owner. To provide business owners with a better understanding of the M & A environment we have defined some of these terms below.
EBITDA - The acronym for "Earnings before Interest, Taxes, Depreciation and Amortization". EBITDA is a financial measurement of cash flow and profitability from operations that is widely used in mergers and acquisitions in the middle market.
Adjusted EBITDA - It is not unusual for adjustments to be made to EBITDA to normalize this metric which allows Buyers to compare the performance of one business to another. EBITDA is often adjusted for certain items such as nonrecurring items of revenue, expense, non-operating income/expense, discontinued operations, changes in LIFO Reserve, excessive T & E, excessive compensation etc.
Asset Approach - One approach to valuing a privately held business. Under this approach, value is estimated by subtracting the market value of liabilities from the market value of assets as of a particular valuation date.
Earn-Out - A clause in a Purchase & Sale Agreement which provides for the Seller of a business is to receive additional payments in the future based on the business achieving certain agreed upon financial metrics.
Discount for Lack of Marketability - A reduction in the value of a privately held company compared to that of a similar publicly traded company.
Multiples - A valuation methodology that compares the value of public and private companies as a ratio to a financial metric such as revenue, EBITDA or net income.
Income Approach - One approach to valuing a privately held business. Under this approach, the present value of future cash flows are calculated by using a rate of return that reflects the risk associated with achieving the projections.
Key Person Discount - An amount deducted from the value of a business that reflects the reduction in value due to the loss or potential loss of a "key person" integral to the business.
Market Approach - One approach to valuing a privately held business. Under this approach the value of a company is determined by comparing it to similar businesses that have been sold.
Data Room - A site where prospective Buyers can review confidential information about a company that is for sale. In the past, a Data Room was a physical location where prospective Buyers would review hard copy documents. Today, most Data Rooms are virtual, with potential Buyers accessing information online.
Drag-Along Rights - Typically in the context of the sale of a company, the right of an equity holder to force another equity holder to sell his or her equity, provided that the person being "dragged" receives the same terms as the person exercising the drag along rights. These rights allow for the sale of 100% of an entity and prevent minority owners from holding up a sale.
Hart-Scott- Rodino Act - A federal law established in 1976 that provides that parties must not complete certain mergers, acquisitions or transfers of securities or assets, including grants of executive compensation, until they have made a detailed filing with the U.S. Federal Trade Commission and Department of Justice and waited for those agencies to determine that the transaction will not adversely affect U.S. commerce under the antitrust laws.
Quality of Earnings - The degree to which a company's earnings are attributable to business operations, strong cash flow and the use of conservative accounting standards. If a company's profits are attributable to artificial items such as inflation or aggressive accounting methods it has a low "Quality of Earnings".
Contingent Value Rights - A type of right given to the Seller of a company that ensures they receive additional benefit if a specified event occurs. For example, if the event is a future sale of the company, the Seller would have an upside if the Buyer is able to sell the company in the future at a profit.
Holdbacks - A holdback is a portion of the purchase price that is not paid at the closing date by the Buyer. This amount is usually held in a third party escrow account to handle post-closing issues, secure a future obligation or until a certain condition is achieved. A Holdback is very common in agreements relating to the sale of a company.
Representation and Warranties - The representations that a Buyer and Seller make in a purchase and sale agreement which survive the closing. Both parties are relying on each other to provide a true account of all information and supporting documents to close the transaction. The Seller's representations usually relate to the information that the Buyer is relying on to value the company. Should the Seller breach these "Reps and Warranties", it can lead to a claim against the Seller.
There are many specialized issues and processes that must be addressed during the course of selling your business. While we are constantly increasing our vocabulary and knowledge, doing so while you are selling your business is probably not a good idea. When it comes to selling your business, it is best to have an experienced Deal Team who specializes in the sale of Middle Market companies. With the proper assistance from skilled professionals you will avoid costly mistakes and maximize the transaction value from a well-coordinated sales process.