Terms used when buying or selling a business. The term is listed followed by its definition.
Accounts Receivable
A financial claim by a business against a customer arising from a sale of goods or services on credit. One measure of the health of a business is how fast customers pay off their accounts. Less that 30 days is good, 30 to 60 days may be okay, and over 60 days could be a problem.
Accrued Interest
Unpaid interest to date on a note or mortgage.
Accumulated Depreciation
The total depreciation of an asset that has been charged as an expense to date.
Agreement in Principle
A preliminary agreement reached between the buyer and seller of a business that outlines the general terms under which more detailed negotiations will be undertaken.
Allocation of Purchase Price
In an asset sale, the purchase price must be allocated to certain assets; the balance is goodwill.
Amortization
A spreading out of costs over a period of time similar to depreciation. For example, it can be a reduction in a debt or fund by periodic payments covering interest and part of the principal over a period of time. It is different from depreciation in that depreciation usually refers to physical things where amortization applies to things that expire (mortgages, patents, etc.).
Arms-Length Buyer
Any person, corporation, or other entity with whom you deal regarding the sale of your business and who has no prior financial or family involvement with you.
Asset Sale
Purchase of certain assets and/or liabilities, leaving the seller the remainder as well as the corporate entity.
Asset-Based Lenders
Commercial lenders who are willing to take on more risk than commercial banks, lending against accounts receivable and inventory and being subordinate to commercial banks.
Book Value
Also known as net worth, the figure derived by deducting all the liabilities from all the assets.
Book Value (of a Business)
The book value of a business is determined from the financial records, by adding the current value of all assets (generally excluding such intangibles as goodwill), then deducting all debts and other liabilities. Book value of the business may have little or no significant to relationship to actual market value due to depreciation and lack of consideration for goodwill (intangible assets).
Book Value (of an Asset)
The accounting value of an asset shown on the balance sheet that is the original cost of the asset less its accumulated depreciation. Keep in mind that this value may have little or no relationship to the real market value of the asset. Frequently, depreciation expenses are charged much faster that the actual decline in the asset's value.
Bulk Transfer
Article 6 of the Uniform Commercial Code regulates the bulk transfer through the sale or ownership change of a large portion ( usually greater than 50%) of a business's inventory, material, supplies, merchandise, and equipment. Requirements include the advance notification of creditors of the impending sale of a business and its assets listed above to prevent fraud. Provisions in each state are somewhat different so check your local statutes.
Capitalization Rate
The conversion of income into value as part of the valuation process by the application of a capitalization factor ( any multiplies or divisor used to convert income to value).
Cash Flow
The amount of money left over after the cost of goods sold and general, selling, and administrative expenses, but before interest depreciation, taxes, and amortization.
Closing
The process of legally completing the purchase and sale of a business by exchanging asset titles. stock certificates, cash, and promissory notes.
Collateral
Property pledged by a borrower to protect the interests of the lender. Bank loans are often collateralized or secured by the company's accounts receivables, inventory, and/or equipment.
Commission
The negotiated fee, usually a percentage of the purchase and sale price of the total business cost, earned by a business broker for facilitating the sale of a business. Usually the value of the inventory and other non capitalized assets are excluded from the calculation of the commission.
Confidentiality
The provision of proprietary information by one party to another for that party's exclusive use, with a prohibition against passing it on to others.
Contingent
Dependent on or conditioned by something else. For example, the price established for the business may vary depending on some future event.
Contingent Payments
Future financial obligations that are dependent on contractual events taking place.
Covenant Not To Compete
An agreement given by the seller of a business to the business buyer to not compete in that or a similar business for a specified period of time, and within a specified geographic area.
Covenants
Binding agreements between the buyer and the seller that restrict each party from taking certain actions, particularly during the letter of intent period and closing.
Debt Service
This is the payment of principal and interest required on a debt (usually a loan or mortgage) over a specified period of time and interest rate.
Depreciation
Charges against earnings to write off the cost, less salvage value, of an asset over its estimated useful life. It is a bookkeeping entry for accounting and tax purposes and does not represent cash outlay.
Due Diligence
The investigation of the other party's business practices in an attempt to uncover previously unknown information.
Earnout
A part of the purchase price that is dependent on a future performance variable, such as profits or sales.
Employment Agreement
This is an agreement whereby key employees agree to remain with the business for a specified period of time under certain conditions.
Escrow
Money that is delivered to a third party and held on deposit until the party to receive it fulfills certain conditions.
Fair Market Value
What the assets would most likely sell for in the open market; this is often determined by a professional appraiser.
Fiscal Year
The annual accounting period selected by a business to best correspond to its operations. A fiscal year can correspond to a normal calendar year or begin/end anywhere in between, e.g.; the federal government's fiscal year begins October 1 and ends September 30.
Franchise
A form of business organization in which the franchisor (the primary company) provides to a franchisse (the local business) a market tested business package involving a product or service. The franchisse operates under the franchiser's trade name and markets goods and/or services in accordance with a contractual agreement.
Gross Revenues
Any positive cash flow that enter a business. Gross revenues do not take expenses into account, and are therefore not the most highly recommended figure to extrapolate a business’s value from.
Holdback Provision
In the purchase and sale agreement, a provision stating that if a buyer winds up having to pay a debt that the seller did not disclose, it will be paid from an amount that was held back at closing and placed in an escrow account.
Income and Expense Statement
A summary of a business's revenues, expenses, and profits for a specific period of time, usually for a full fiscal year.
Indemnification
Exemption for the buyer from incurred penalties or liabilities after the closing as a result of incomplete representations and warranties of the seller.
Intermediary
An agent who is a mergers and acquisitions consultant to the buyer or seller and is expected to facilitate the transaction.
Investment Banker
An intermediary who often provides additional services such as bridge loans or underwritings.
Lehman Formula
The industry standard commission rate, which is a sliding scale, i.e., 5-4-3-2-1 percent on each successive million dollars of the purchase price.
Letter of Intent
A preliminary offer to purchase a business, usually non binding, which if accepted by the seller leads to the drafting of a purchase ans sale agreement.
M & A
An acronym for mergers and acquisitions.
Middle Market
Companies with sales between $2 million and $150 million.
Net Present Value
Money paid out in the future discounted at the opportunity cost of capital for a similar risk over the specified period of time.
Note, Promissory
A written promise to repay a loan. Usually a key part of a business sale. Normally written from the buyer to the seller for a period of 5-10 years.
Overhead
Method of allocation all non-labor costs to the various products manufactured or services performed.
Partnership
A legal business association of two or more persons co-owning a business and sharing in the profits and losses. Although there are several kinds of partnerships, the tow most common are, general and limited partnerships.
Perquisites (Perks)
Elements of compensation in addition to a regular salary, such as the use of a company automobile, country club membership, entertainment allowance, etc.
Pro Forma
A set of projected financial statements which usually includes: income and expense statements, cash flow projections, and balance sheets. Generally, in a purchase and sale of a business, a seller prepares an optimistic pro forma statement. The buyer should ensure that a realistic pro forma is used as part of the business plan for the newly acquired business.
Profit and Loss Statement
The same as the income and expense statement.
Promissory Note
A written promise to pay a sum of money at a specified future date in accordance with a predetermined interest rate and payment schedule.
Representations and Warranties
Indemnifications and covenants written into the purchase and sale agreement that provide factual information that is important to protect the buyer in the event of future problems.
ROI, ROE
Return on investment and return on equity; they must be greater that the cost of capital in order to create shareholder value.
Seller Financing
A situation in which the seller extends his or her own notes to the buyer in lieu of paying all cash at closing or obtaining other debt financing, such as bank loans.
Stock Sale
Purchase of the company's shares of stock; the buyer then assumes all the assets and all the debt, both tangible and intangible.
Valuation
The formal process of estimating the worth of a business.
Walk Away Price
The highest price that a buyer will offer.
Working Capital
The readily convertible capital required in a business to permit the regular carrying forward of operations
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