M&A Monitors
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Articles By Jack Woodcock
Articles By Mike Thompson
Glossary of Terms
AUCTION:
Process for divesting a business, in which
the primary interest of the seller is to sell the business
to the highest bidder. Typically, the process is run with
strict guidelines and bid deadlines. The auction was in
its heyday in the mid to late eighties, but its use has
declined because many potential buyers now shy away,
in principle, from bidding wars.
BACKLOG:
An accumulation of work or orders
which have either not been started or completed and in
both cases refers to orders or portions of orders which
have not been billed.
BOOK VALUE:
Value of investments, shares or
operating assets, as they have been recorded according
to GAAP, and as they appear on the books and records
of the owner. Typically book value represents original
cost less any reserves or depreciation/amortization/
depletion recorded.
BOTTOM-FEEDER:
A slang term for a buyer with a
history of, or reputation for, seeking opportunities to
make bids for and hopefully buy businesses from
desperate sellers at amounts significantly below what
would reasonably be considered to be their true worth
or market value.
BREAK-UP FEES:
Corporate Finance fees charged
to clients if, once retained, the client cancels or
discontinues the mandate, generally for any reason
other than fraud or negligence on the part of retained
firm.
CALL:
To have a Call is to have the right to buy a predetermined
quantity of an equity or debt security at a
pre-determined price, for a pre-determined time.
CAPITALIZATION:
Refers to the total amount of
capital employed by a business, including debt and
equity, in financing its net operating assets.
CAPX:
Acronym for "Capital Expenditures", referring
to the annual amount of historic or projected additions
to fixed assets.
CAPITAL COST ALLOWANCE (CCA):
Defined
term under the Canadian Income Tax Act referring to
the amount of annual fixed asset write-off allowed, by
class of asset, to be deducted against income in the
determination of taxable income.
CLOSING:
The time at which a transaction is
completed, funds are paid, and/or ownership of assets
is conveyed.
CLOSING COSTS:
All costs associated with the
Closing of a transaction, including, but not necessarily
limited to legal, accounting, M & A and banking fees.
CONTINGENCY FEE:
A fee that only becomes payable
upon the occurrence of a pre-determined and defined event.
COVENANT:
A condition, action, promise, or financial
ratio which an investee or borrower agrees to fulfil, uphold
or maintain in return for the infusion of equity or debt by an
investor or lender.
COVERAGE RATIOS:
Various ratios which measure a
business' ability to service debt principal and/or interest
from pre-tax operating cash flow, on an annual basis. Most
commonly used ratio is:
(Earnings Before Interest, Taxes and Depreciation, minus normal CAPX)
(Principal plus interest due within 1 year)
DCF:
Abbreviation for Discounted Cash Flow.
DEBENTURES:
A debt obligation not secured by a
specific claim to property; usually an unsecured note or
bond of a corporation or club.
DEBT/EQUITY RATIO:
Measures the ratio of the
amount of debt versus equity employed in the capital
structure of a business. Generally, the higher this ratio is,
the weaker the subject Balance Sheet is considered to be.
DEBT SERVICE:
The amount of money required on a
monthly or annual basis to make payments on account of
principal and interest in accordance with the terms of a debt
obligation.
DISCOUNT RATE:
Rate used to calculate the present
value of a future stream of operating (pre-interest) cash
flows. The most common calculation is the Weighted
Average Cost of Capital (WACC).
DISCOUNTED CASH FLOW VALUE:
The present
value of a projected future stream of after-tax operating cash
flows and terminal value, discounted to present using an
investor's Weighted Average Cost of Capital (WACC).
DUE DILIGENCE:
A final set of procedures carried out
by a buyer / investor before Closing, to ensure that they are
aware of all material facts relating to the investment, and
that all information supplied to them has been accurate.
Although historically this process has been focussed on
financial records, the examination of customer and supplier
relationships, union contracts, trademarks, real estate
matters, and more recently, environmental issues are now
key components of a comprehensive due diligence process.
EARN-OUT:
A portion of a business' purchase price,
negotiated to be paid to the vendor over a pre-determined
period of time, contingent on the business reaching some
agreed to performance target (sales, margin, EBIT etc.) over
that time period.
EBIT:
Earnings before interest and taxes. This is a
frequently used measure of operating earnings, before
taking into account capital structure or income taxes.
EBITDA:
Earnings before interest, taxes, depreciation
and amortisation. This is the most frequently used
measure of operating cash flow, before taking into
account capital structure, income taxes working capital
requirements, or the cost of capital purchases and
replacements (CAPX).
ESCROW:
A written agreement between at least three
parties, under which documents or property/funds is
deposited with one of the parties as designated
custodian to be delivered to the intended recipient upon
the fulfilment of certain specified conditions.
FAIR MARKET VALUE:
The actual or anticipated
price of an asset, sold between willing arms-length
parties, in an unrestricted market, at a specified time
and place.
FINANCIAL BUYER:
A buyer interested in bottom
line returns and/or gains from future asset sales,
without specific reference to the type of business.
Typically such a buyer will not have similar existing
operations, and will run the business as a stand-alone
entity.
FIRST STAGE FINANCING:
Generally the third
level of Venture Capital (after Seed and Start Up)
required by a new business where sales have started
but additional capital is required for full commercial
production and selling activities.
FLOAT:
Refers to the number of shares of a public
company that are widely held by "non-insider"
shareholders.
GAAP:
Generally Accepted Accounting Principles as
established by the accounting body with jurisdiction. In
Canada this is the Canadian Institute of Chartered
Accountants (CICA), and in the US, it is the American
Institute of Certified Public Accountants (AICPA).
While there are differences between the two, the
standards are harmonized between the two countries,
and to a great extent, amongst members of the
industrialized world.
GOING CONCERN:
A business that is financially
viable as opposed to one that cannot meet its debts.
Also used to describe a business that has good
prospects for success as opposed to one that has run its
course.
GOODWILL:
In the abstract, means the inherent
value of a business, or a name, attributable to
widespread positive recognition (for high quality
product and or level of service) of the business/name
by customers and/or the public, generally by virtue of
having been in existence for a long period of time. In
technical financial terms, Goodwill is the excess of the
Purchase Price over the Book Value of a business or assets
sold.
HOCKEY STICK:
A metaphor for an aggressive Income
Statement forecast. Specifically, sales and/or earnings are
projected to "take off" in future years well beyond the trend
based on actual levels attained currently and in the recent
past.
INTERMEDIARY:
A financial advisor, retained by a
company and/or its Principal(s) to conceive, initiate,
facilitate, negotiate, or perform all of the above with regards
to a merger, acquisition, divestiture, or one of many types of
fund raising or restructuring. An intermediary does not act
as principal to the transaction, but is working for a fee.
IPO:
Initial Public Offering. Refers to the first time a
company sells securities (generally equity) through the
public markets, ending its status as a private company.
IRR:
Internal Rate of Return. It is the rate of return
required such that the present value of annual cash flows
(usually an initial outflow or investment, and subsequent
annual inflows) over the life of a project equals zero.
JUNK BONDS:
Slang term making reference to the very
poor quality of this type of debt as an investment.
Popularized through their use as financing in large
leveraged buy outs in the mid to late eighties, these
securities have little or no security backing, are not of
investment grade, and generally bear an extremely high
coupon rate. Also becoming known as “High Yield Debt”.
LBO:
Leveraged Buy Out. This is an acquisition in which
the purchaser finances a very large portion of the purchase
price with debt, counting on strong future operating cash
flow and perhaps asset sales to cover interest costs and pay
down the debt as quickly as possible.
LEHMAN FORMULA:
An M&A industry standard
advisory fee structure for calculating an intermediary's
Transaction Fee payable on Closing. A "Single Lehman" fee
calls for 5% on the 1st million of purchase price, 4% on the
2nd, 3% on the 3rd, 2% on the 4th, and 1% on the balance
of the purchase price. A"Double Lehman" fee calls for the
same percentages, but they are applied to successive $2
million increments rather than $1 million increments. The
purchase price upon which the fee is based includes the
total consideration paid or assumed by the purchaser, and in
turn is the total benefit received by the seller. Therefore the
Purchase Price includes any interest bearing debt assumed
by the purchaser, in addition to cash paid.
LETTER OF INTENT:
The stage of an offer preceding a
formal Purchase and Sale Agreement. The terms of the deal
as agreed between buyer and seller are spelled out in
significant detail, but most often are subject to Due
Diligence. In certain circumstances, the Letter of Intent can
be binding, and may be accompanied by a nonrefundable
deposit as a show of the seriousness of the
acquirer to go forward to Closing under the terms
outlined in the letter.
LEVERAGE:
This is a financing technique, whereby
the proportion of debt to total capital employed is
maximized, thereby minimizing the equity component.
The effect of this is to increase the percentage of
bottom line return over equity invested. The technique
only works successfully where the EBIT of a business,
as a percentage of total capital employed, exceeds the
average before tax cost of debt (raw interest rate).
LIQUIDATION VALUE:
Also known as “Breakup
Value”, this is the likely value that could be received if
the assets of a business were sold off in a piecemeal
fashion. This value is usually much lower than if the
assets are sold as part and parcel of a healthy,
profitable, going concern business. Typically in a
liquidation under strained financial conditions, the
proceeds are not sufficient to pay creditors one hundred
cents per dollar owed to them.
LOSS CARRYFORWARDS:
These are losses for
tax purposes, incurred in prior years, which are
available to a corporation to carry forward, for a
prescribed number of years, and are available within
that time period to reduce taxable income and the tax
that would be otherwise payable. Both Capital and
Non-Capital losses may be carried forward for
specified periods.
MBO:
Management Buy Out. This occurs when
members of the management team of a business put
together the funds, with the help of financial backers
(typically management doesn't have sufficient funds to
Close the transaction). Management is key to the
success of the business going forward and therefore the
transaction, and it is often outside financiers who
approach management and initiate the transaction. One
of the sensitive decisions (apart from reaching
agreement with the current owners) surrounds how
much equity management should receive for the
minimal funds they have put into the deal.
MINORITY DISCOUNT:
A reduction in value,
ascribed by an investor, to an equity (or equivalent)
security, by virtue of the fact that the percentage of the
total securities outstanding held by the investor,
represents less than a controlling interest. The buyer of
a minority block is willing to pay less per security than
the buyer of a majority block, because he has less
influence on the decision making process and is
subordinate in influence to the controlling block(s).
MULTIPLE:
Used in referencing quick or "rule of
thumb" valuations of businesses or companies. Most
commonly used are multiples of Earnings, EBIT, Book
Value, and Revenue. Each can be very misleading if used in
isolation.
NET OPERATING ASSETS:
Generally refers to the sum
of the book values of receivables, inventory, prepaids, and
net fixed assets, less trade payables and any accrued
operating expense liabilities.
NON CASH WORKING CAPITAL:
The net sum of the
book values of all working capital items excluding cash and
any current debt.
NON COMPETE AGREEMENT:
An agreement,
typically signed by the seller of a company or business,
whereby seller agrees with buyer that seller will not
compete in the same business for a specified time period,
and generally with reference to particular geographic areas.
Frequently this agreement will be assigned a portion of the
overall value of the transaction.
NON-RECOURSE DEBT:
Generally debt that is
unsecured and for which the lender has no recourse to the
borrower in the event of late or non payment, or default.
NORMALIZED EARNINGS:
Earnings that have been
adjusted to exclude the effects of unusual, one time, or
discretionary types of expenses or revenues. Typical
adjustments might include the add back of "above market"
compensation or bonuses to owner-managers in their
management role, one time relocation expenses, an
unusually large foreign exchange gain or loss etc..
OPERATING CASH FLOW:
It is the annual amount of
cash flow generated by a business, before taking into
account interest charges (which are a function of the capital
structure, not the dynamics of the business), depreciation
charges (not a cash expense), and income taxes (exigible on
any profitable business). This is essentially the same as
EBITDA, described above.
OPTION:
A security granting the holder the right to
purchase an asset (security, commodity, business etc.) at a
pre-determined price for a similarly specified time period.
Options themselves may or may not have value or be
publicly traded.
PREMIUM:
The amount by which an amount paid for an
asset or security exceeds a referenced benchmark such as
Book Value or quoted Market Value.
PRESENT VALUE:
The value today of a series of
payments or a single payment of nominal dollars to be paid
at some point in the future, after discounting the amounts to
reflect the interest that would have been earned up until the
future payment date, had the monies actually been paid
today.
PRO FORMA:
Projections based on historical
performance and financial relationships, along with
certain stated assumptions about future growth,
profitability and financing.
PUT:
The right to sell a pre-determined quantity of a
specific equity or debt security at a pre-determined
price, for a pre-determined time period.
REDUNDANT ASSETS:
Those assets owned by a
business which are not required in the day to day
operation of the business. Examples would include
excess cash balances, vacant parcels of land, or an art
collection.
REPLACEMENT COST:
The lowest cost to replace
a specified existing asset of a business with a like asset,
such that there is no impairment to the operation of the
business.
REPS & WARRANTS:
Short for the Representations
and Warranties that are given by parties to a
transaction, to each other which, if later prove to be
false or misleading may, under specified circumstances
lead to damages or possibly the annulment of part or all
of the transaction.
RIGHT OF FIRST OFFER:
A right generally held
by a current co-owner or want-to-be owner of a
business, granting the holder the right to make the first
offer for the business, or that portion which he does not
already own, once the current owner has decided to sell
his stake. Once the offer is received, the current owner
is free to solicit higher bids from third parties with the
proviso that if none are received, the owner will be
compelled to sell to the submitter of the "first offer".
RIGHT OF FIRST REFUSAL:
A right generally
held by a current co-owner or want-to-be owner of a
business, granting the holder the right to match any
offer received by the current owner of the business, or
that portion not already owned by the right holder, and
to be the successful buyer at that price. If the holder
decides not to match the outside offer, he generally
gives up all future rights to buy the business, and the
current owner may sell to the party of his choice at a
price not less than that refused by the right holder.
SECOND STAGE FINANCING:
Generally the
fourth level of Venture Capital (after Seed, Start Up,
and First Stage) these funds are used to support the
initial expansion of companies that are making
progress, but are not yet profitable.
SEED FINANCING:
The first level of Venture
Capital; the expenditure of these funds is generally a
high risk proposition, with the money being used to
prove a concept and/or for product development.
SENIOR DEBT:
This is the first ranked level of debt on a
company's Balance Sheet. Generally it has first claim to any
and all assets of the business in the event of a default or
bankruptcy and is therefore the least risky to the lender, and
will normally bear a lower interest rate than lesser secured
debt of the same company or borrower.
SHAREHOLDERS AGREEMENT:
As agreement
usually negotiated and existing between two or more
shareholders of a company. It is highly advisable to have
such an agreement, so as to provide, in advance, for preagreed
solutions, and/or courses of action, in the event of
possible future occurrences including, but not limited to the
death of a shareholder, a shareholder’s desire to dispose of
his or her shares, the divorce of a shareholder, legal or
practical insolvency of the Company.
SHOTGUN:
A provision in a Buy/Sell or Shareholders
Agreement, which generally provides that if one shareholder
offers to buy another's shares at a specific price and the offer
is refused, then the offeree is then forced to buy the offerer's
shares at that same price.
SINKING FUND BOND:
A bond the features of which
include a requirement on the part of the borrower to provide
and maintain a sinking fund to provide for its ultimate
repayment and retirement.
START-UP FINANCING:
The second level of Venture
Capital (after Seed), these funds are normally required for
use in product development and initial marketing. Key
management and a business plan are generally in place.
STRATEGIC BUYER:
As opposed to a financial buyer, a
strategic buyer is interested in a target business based on the
fact that it is in the same or a complementary industry, and
that there are synergies which stand to be realized.
SUBORDINATED DEBT:
Also known as "Sub" Debt,
this type of financing is generally advanced based on the
expectation of sufficient cash flow being generated to
service the debt, but without the benefit of tangible security
in place. It ranks behind most other levels of debt in a
liquidation, and accordingly carries a high coupon rate and,
in many cases, substantial fees and/or equity "give-aways"
to the lender.
SUCCESS FEE:
A fee payable to a Merchant Banker or
other advisor/intermediary, which is contingent on the
successful completion of the transaction for which the payee
was engaged to arrange and close. In the absence of
completion, no Success Fee is payable.
SYNERGY:
This generally refers to the benefits/savings
realised on a merger or acquisition, the nature of which
usually relate to eliminating overheads, achieving
economies of scale and/or increased market/pricing power.
Best conceptually described as "one plus one equals three",
the synergies are created by eliminating duplicate
functions of the previously separate businesses, and/or
increasing margins through greater market share
leverage. Synergy is often what allows a buyer to pay
more for a business, than would otherwise be practical
if the business was to continue as a stand alone entity
within its industry.
TAG ALONG:
A provision contained in a
Shareholder or Buy/Sell agreement, which generally
allows minority shareholders to force a buyer of shares
from the majority shareholder(s), to purchase their
shares under the same terms and conditions, or be
precluded from buying any at all.
TOMBSTONE:
A notice published by a broker,
intermediary or other agent announcing the completion
of a transaction between named parties, and the
involvement of the publisher in facilitating the
transaction. This is a common marketing method
employed by financial services advisors.
TRANSACTION FEE:
Same as Success Fee.
TURNAROUND:
Describes a situation wherein a
business is generally not in a profitable position, and
requires a number of specific actions to "turn it around"
such that it may attain profitability. Required changes
may include management, strategy, capital structure,
plant, or a combination of these and many other
attributes of the business.
UNDEPRECIATED CAPITAL COST (UCC):
The
Canadian tax system equivalent of Net Book Value for
accounting purposes, the UCC of a particular class of
fixed assets is the amount remaining to be written off
against otherwise taxable income.
VENTURE CAPITAL:
The type of equity financing
generally required to take a new business venture from
concept to profitable commercialization. The various
levels of Venture Capital are typically referred to as
Seed, Start-Up, First Stage, and Second Stage
financing.
WEIGHTED AVERAGE COST OF CAPITAL
(WACC):
The WACC reflects the anticipated longterm
capital structure to be employed by the subject
business. It is expressed as a per cent and is calculated
as follows:
(Cost of Debt * (1-Tax Rate) * % Debt Funded)+(Cost
of Equity * % Equity Funded)
This rate may be used to calculate the present value of
a future stream of operating (pre-interest) cash flows.
WORKING CAPITAL:
The net amount of Current
Assets less Current Liabilities required for a business to
operate at a particular revenue level. Typically it consists of
the dollars tied up in operating Cash, Accounts Receivable,
Inventory, Prepaid and Sundry Assets; all net of Accounts
Payable, Accrued Liabilities, demand loans/lines, and the
current portion of any Long Term Debt. Most businesses
cannot operate without a permanent investment in Working
Capital, with the actual level required increasing or
decreasing with the level of Revenue.
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