A guide to transaction jargon
Selling a business is a new experience for many of our clients and the language and terms used can often feel like confusing jargon. We have therefore put together a beginner’s guide to help you through. The definitions below are listed in the order you are likely to encounter them.
Corporate Finance Adviser
It is the job of a corporate finance adviser to make the transaction happen! Broadly their role will include introducing you, the seller, to potential buyers of your company, presenting the business in the best possible light to them and then negotiating the best deal for you.
Stands for Mergers & Acquisitions – perhaps more familiarly known as the buying and selling of companies.
Sell-side / Buy-side
These terms are used to designate the sellers or buyers of the company and the people or firms associated with each of them (e.g. advisers).
Stands for Earnings Before Interest, Taxes, Depreciation and Amortisation, and is used extensively in the corporate finance world. The reason for EBITDA’s popularity in M&A is that it is a useful proxy for the cash generated by a business and it will be one of the focal points during sale negotiations.
The way private business owners operate a business might be different to how it would be run under different ownership. For example, owners may pay themselves through dividends (which do not impact EBITDA) rather than salary (which does impact EBITDA). When presenting financial information on the business to buyers, it is therefore important to adjust (or “normalise”) the EBITDA figure for these differences. Adjustments might also be needed for one-off or non-recurring items (for example legal costs relating to a closed dispute) which are not relevant to the future profits of the business.
One of the most common ways to value a business is to apply a multiple to its adjusted EBITDA. There are two types of EBITDA multiples commonly used for valuations. The first is EBITDA multiples of listed companies, which are publicly available so can show you, the seller, the latest multiples in your sector. Different sectors tend to drive different values of EBITDA multiples. The second EBITDA multiple we use is generated from an analysis of completed transactions in your sector to show what sort of multiples buyers have been paying for comparable companies – although sometimes extremely helpful, the reality is most valuations of private companies are not publicly disclosed, so it can be challenging to find accurate data using this methodology.
Enterprise Value (“EV”)
The headline price for the business without giving consideration to the equity structure of the business. Broadly speaking, any cash or cash-like items are added to the EV, and debt or debt-like items are deducted, in order to reach the Equity Value.
This is often the closest figure to the price actually paid by the buyer and the amount of cash received by those selling. Any debt owed by the company will naturally be deducted to reach the Equity Value.
Information Memorandum (“IM”)
Prepared by the corporate finance adviser, using information provided by the sellers, the aim of this document is to give a buyer all the information they need in order to understand the business in sufficient detail to put forward an offer to acquire it. It is important the corporate finance adviser clearly explains (and emphasises!) the valuable aspects of your business to ensure the maximum price is achieved on a sale.
A one or two page condensed version of the IM, shared with potential buyers, encapsulating the key messages contained within the longer document.
Non-Disclosure Agreement (“NDA”)
This is an important and legally binding document preventing potential buyers from sharing the confidential information provided to them during the sale process.
A trade or strategic buyer is another company usually, though not always, operating in the same or a similar industry. They will often buy a business to integrate it in some way with their existing operations. This integration can be “vertical”, meaning earlier or later in the supply chain, or “horizontal”, expanding their offering at the same stage of the supply chain. Using an example of an ice-cream manufacturer: buying a milk farm would be vertical integration, while buying a sprinkles manufacturer would be horizontal. This integration might allow a trade buyer to benefit from cost-lowering or revenue-generating synergies.
Financial buyers do not operate in your industry and would not know how to run the business without the company’s management team. Typically, their investment is purely to generate a financial return.
Private Equity (“PE”)
A type of financial buyer which typically raise a fund, consisting of committed capital from a pool of institutional investors, which will then be deployed into businesses that align with their particular investment strategy. These “buy-side” organisations invest via minority or majority stakes (but not 100%) and back promising management teams seeking to undertake Management Buy-Outs. Once an investment has been made, the PE firm are likely to take a seat on the company's board of directors to oversee the implementation of a pre-agreed, ambitious growth plan. The length of a private equity investment is typically 4-5 years, at which time they will seek to exit the business.
Management Buy-Out (“MBO”)
When the senior management of a business purchases shares in the company from the existing shareholders, it is called an MBO. This can be financed using equity from a Financial Buyer, debt from a bank or debt fund, or by the sellers of the shares themselves (called a Vendor Loan Note).
Vendor Loan Note
In MBO deals, payment to the seller is typically split between cash on day one and a remaining amount which is deferred, i.e. paid to the seller over an agreed period of time, for example, 4-5 years. This is, in effect, a loan offered to the buyer (Management), from the seller. These “loans” are called Vendor Loan Notes and are a type of deferred consideration.
High Street Bank
High street lenders are well-known banks operating in the corporate debt market. Typically, these lenders will offer the most competitive interest rates, though do not be surprised if the quantum of debt (i.e. the amount that can be borrowed) is lower than other options.
Challenger banks are lenders looking to compete with and “challenge” the high street lenders. They typically offer more flexibility on both the quantum of debt and the structure than would be available on the high street.
These debt providers sit at the other end of the spectrum to high street banks, usually offering the largest quantum of debt, but commanding the highest cost of borrowing.
Sits at the very top of the capital structure and is secured against the assets of the business. This means that in the event of bankruptcy and liquidation, the issuer of the senior debt receives payment before other types of debt, such as junior or mezzanine debt.
A hybrid debt issue which is subordinated to another debt issue from the same issuer. Mezzanine debt has embedded equity instruments attached, often known as warrants, which increase the value of the subordinated debt and allow greater flexibility when dealing with creditors. It is higher risk than senior and junior debt and is lower in the capital structure. This means that in the event of business insolvency, mezzanine debt is paid back to the issuer only after senior and junior debt.
If you, the seller, and your corporate finance adviser decide to run a sale process involving multiple potential buyers, your adviser should draft a Process Letter. This is sent out to interested parties, along with the IM. The document provides further guidance on the process and typically includes a timeline, instructions for participants, relevant contact information and the items to be addressed within offers.
As with many commercial transactions, having multiple options when negotiating with buyers increases the chances of securing the best deal for you as the seller. Having an adviser who is experienced at creating competitive tension between bidders helps vendors secure the optimal mix of Cash, Certainty and Chemistry.
Heads of Terms
An incredibly important document which sets out the commercial terms for the transaction, in a manner understandable to “non-lawyers”. Our experience suggests the more detailed the Heads of Terms, the clearer understanding both vendors and buyers have on the prospective transaction, and the more likely a transaction is to complete once exclusivity to a single buyer is given.
Once the Heads of Terms has been agreed, buyers typically require Exclusivity. This prevents vendors from speaking with any other buyers for an agreed timeframe, while the “exclusive” buyer spends money on “buy-side” advisers. These advisers will undertake due diligence on the company and draft detailed legal documentation reflecting the Heads of Terms agreement.
Until this point, the buyer has relied on information provided by the vendors as being factually correct. Once Exclusivity has been granted, the buyer typically appoints a series of advisers to corroborate information provided and to ensure no undisclosed liabilities are present. This is often one of the most testing times of the process for vendors – huge numbers of questions are asked by multiple due diligence teams, with responses being uploaded to a Virtual Dataroom. Your adviser should co-ordinate and lead this process, taking as much of the strain from you as possible.
An online, secure platform where highly confidential information is shared with selected members of the buyer’s team during the due diligence process. The dataroom supplier allows the vendors and their advisers to track the progress of the buyer (number of logins, which files have been accessed etc) and to disclose important information in an organised manner.
Sale and Purchase Agreement (“SPA”)
Often drafted by the buyer’s legal advisers (though sometimes by the seller’s), this legally binding document governs the main terms of the transaction, which typically have already been agreed at the Heads of Terms stage. This document is significantly longer than the Heads of Terms document, partly because it contains warranties and potentially indemnities provided by the vendors, but also because it is written by lawyers!
Warranties and Indemnities
Found within the SPA, Warranties and Indemnities are forms of assurances provided by the seller to the buyer. Warranties are statements about the company the sellers believe to be true (subject to anything noted in the disclosure letter). After the transaction, should it transpire that any of the warranties provided are not true and that the buyer has suffered a demonstrable loss (and the seller has not disclosed against the warranty in the disclosure letter), the buyer may raise legal proceedings against the seller for compensation. Indemnities are undertakings provided by the seller to compensate the buyer should a specified issue transpire after the transaction.
Drafted by the seller’s legal adviser, this is used by the seller to make the buyer formally aware of any important matters regarding the business being sold and to disclose information in relation to the warranty statements in the SPA. To the extent information has been disclosed against a warranty claim, the buyer should not be able to claim a loss in relation to that warranty.
Although a Trade Buyer often acquires 100% of the shares, it is not uncommon for them to pay less than 100% of the Equity Value on the day of the transaction, with a portion of the consideration deferred. Sometimes this is a straight deferral and does not have conditions attached to it. It can also be contingent on the future performance of the business under the ownership of the buyer – in which case it is called an Earnout. Financial buyers normally include an earnout in their transaction structure.
Any portion of a selling shareholder’s equity not sold as part of the sale is “rolled over” into the new structure, meaning they would continue to have an equity stake going forwards. Depending on the structure of the transaction and activities of other shareholders in the transaction, the shareholding in the new company could be diluted or concentrated (i.e. go down or go up relative to the original percentage).
It is sometimes agreed that the buyer may withhold a portion of the proceeds payable to the seller for a set time period in the form of an Escrow. This is kept in a third party account and is used in instances where a price adjustment is needed after completion or where warranty claims have been made.
Buyers typically require sufficient liquidity (or Working Capital) to be left in a company upon acquisition so that the business can operate normally during the period after the transaction. Should there be an excess of Working Capital in the company at the time of the acquisition, the buyer pays £ for £ for that excess. Similarly, if there is a shortfall, this amount is deducted from the Enterprise Value £ for £. Given the direct impact Working Capital has on net proceeds to vendors, it is often a heavily negotiated area requiring specialist M&A knowledge.
This is one of two widely accepted methods of finalising the amount payable by the buyer to the seller (the other being the Locked Box method). Under the Completion Accounts method, the amount payable by the buyer to the seller (broadly the Equity Value) is determined using the actual balance sheet of the company as at the date of completion. This involves drawing up the accounts in the days and weeks following the transaction, and therefore although an estimated final value is payable by the buyer on the date of completion, the actual/final amount is not known or paid until a set period of time afterwards.
Under this completion mechanism, the Equity Value is determined using the balance sheet at an agreed date sufficiently in advance of completion. This enables the buyer and its advisers to validate the balance sheet during the due diligence process. The Equity Value is then fixed (hence the Locked Box) with only agreed adjustments (such as an additional payment by the buyer to the seller based on the number of days between the Locked Box date and completion, or a deduction from Equity Value for any cash taken out of the company by the sellers outside of the normal course of business).
Champagne time! This is when the legal documents are signed and the transaction concludes, with the shares being transferred to the buyer and proceeds being received by the sellers.