A debenture is an unsecured bond; it requires no collateral in the form of a physical asset (such as a building). A debenture’s only security is the creditworthiness and reputation of the issuer (the borrower).
In business sale, these are instalment payments of the consideration agreed between the buyer and the seller to be made at future dates subsequent to completion of the sale. Deferred payments arrangement is a seller financing method and be helpful in achieving successful sale and completion.
Deferred payments, can be to the mutual benefit of both the buyer and the seller regarding the transaction. On the one hand it enables the buyer to finance the business (including using future profits of the newly acquired company) without resorting to expensive borrowing; and on the other hand the arrangement enables the seller to secure a timely sale, close and disposal of the business to the buyer – especially if urgently so required by business and personal circumstances. Also, just like earn out, deferred payments can help the seller secure a higher purchase price than would have been the case without it.
In accounting, depreciation is a scheduled expense allocated to the cost of a tangible asset over its lifespan of usefulness. The following example explains the understanding of depreciation: if a company spent £50,000 on a machine expected to have 10 years of usefulness, it depreciates this expense by deducting £5,000 each year from its taxable income over the course of the 10 years.
Being a non-cash expense, depreciation increases free cash flow while decreasing reported earnings.
Disclosure letter is a documentation consisting of warranties, indemnities and disclosures that a business seller gives the buyer about the business when selling it.
This documentation, having been prepared, signed and given by the seller, and accepted by the buyer at the time of the deal, inures to the benefit of either party especially as recourse in any post deal dispute.
Due Diligence is an investigative research and assessment of an enterprise before a business transaction, such as a company sale.
The process involves examining all financial and operational records and other materials pertaining to the sale. Due diligence includes assessing an enterprise’s earnings, assets, liabilities, other liabilities that may be hidden or undisclosed, potential risks, prospects, and the general suitability of the business as an investment.
The due diligence process and negotiations thereof will largely influence the ultimate valuation and purchase price.
Whilst the foregoing applies more to the buyer, it is important for the seller to also undertake due diligence on the buyer – so as to examine the potential buyer’s history, business experience, reliability and, above all, ability and capability to make the purchase.
A company’s net income in a specific period (say, a year) is what is commonly called earnings. Although the term usually refers to a business’ after-tax net income, it is also sometimes used to mean a company’s pre-tax profit or revenues.
A business’ earnings history is one of the key determinants of its valuation and sale price.
This is the actual or expected growth in a company’s profits over two comparable periods of time, such as year-on-year. As an example of actual earnings growth, if a company had a profit of £100,000 in 2013 and a £130,000 profit in 2014, then it has achieved 30% earnings growth.
A business with high earnings growth – especially at an increasing rate – is likely to enjoy high valuation and sale price.
A contractual agreement between the seller and the buyer of a business stipulating that part of the business purchase price will be paid contingent upon the business achieving specified and agreed future earnings subsequent to the sale.
As a negotiated contract term, earn out helps the seller secure a higher purchase price than would have been the case without it.
As standard practice, earn out usually ranges from 10% to 50% of the purchase price, and can be for one to three years depending on seller-buyer negotiations.
Earnings Before Interest and Tax (EBIT) is a company’s net income without subtracting tax liability and interest charges on any debt. It is commonly called operating profit. Related to EBIT is EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation), which is a company’s net income without subtracting tax liability, interest charges on any debt, depreciation and amortisation.
Enterprise Value (EV)
A company’s enterprise value is its entire worth as a going concern. EV is also assessed as the market value of a company if it were considered for a takeover at present.
An ownership interest or stake in a company. Equity, as presented and represented on a company’s balance sheet, is the vendor’s total funds plus retained earnings (or losses). This is also known as shareholders’ equity.
This is an agreement to ensure that a party to the contract does not enter parallel, similar arrangements with another party. Thus, an exclusivity agreement guards against ‘double-dealing’.
In business sale, an exclusivity agreement is a contract that prevents a business seller from pursuing an offer from another potential buyer for a specified period of time after signing the indicative offer/letter of intent (LOI) with the current potential buyer.
In the context of a business sale, an exit strategy is a business owner’s decisive and forward-thinking roadmap of plans and preparations to sell the business.
Exit strategies include selling the company to a buyer (a trade sale), selling it to the management team (management buy-out or MBO), or even taking the company public via an initial public offering (IPO) on the stock market. The choice entirely depends on the business owner’s goals and circumstances.
Fair Market Value
Fair market value is the price that could be obtained for a business in a transaction between a willing buyer and a willing seller with reasonable knowledge and relevant information about the deal, with neither of them being under no compulsion to buy or sell.
A report of a company’s assets and liabilities that paints a clear and comprehensive picture of its financial health – that is, its profits, losses, revenues, cash flow and other financial variables. Examples of financial statements are balance sheet, income statement and cash flow statement. Financial statements are usually produced quarterly and yearly.
A period of time following the completion of a business sale during which the seller continues with the business sold in order to ensure non-disruptive and successful handover of the company (practically) to the buyer. This could be from a few months to a few years depending on what has been agreed between the two parties.
The seller may negotiate a higher purchase price for the business and/or to be paid a good remuneration for the handover period and his/her services thereof.
During the handover period, the seller helps the buyer to hit the ground running with the new business acquisition.
It is worth noting that, this arrangement may be in the interest of the seller too for various reasons: for example if contractual terms like earn out and deferred payments have been agreed in the sale.
IBO (Institutional Buy Out)
IBO stands for Institutional Buy Out. It is the purchase of a controlling stake (51% or more stake) in a company by institutional investors such as private equity and venture capital firms.
Indemnities are contractual provisions aimed at protecting both the buyer and the seller against post-transaction risks. Indemnities cover damages, costs and losses for which the seller is liable. For example, any third party claims, environmental claims and liabilities (such as accounts payable, taxes and litigation) that arise and are associated with issues that existed before completion of the sale.
Both the buyer and the seller are somewhat protected and assured regarding any arising adverse occurrences and/or discoveries related to and pre-dating the sale.
Indemnities give the buyer greater confidence against any unpleasant surprises (emerging liabilities) pre-dating, but arising after completing the sale. Buyers seek well thought out indemnities written into the sale agreement as some level of protection against such liabilities.
With indemnities negotiated and agreed with the buyer, and written into the sale agreement, what the seller could be liable for is well documented and thus protecting against arising liabilities not covered in the indemnities.
Just like many other aspects of the business sale process, indemnities are subject to negotiation. For the seller, offering more, helpful seller indemnities would give the buyer greater assurance about the sale and could help increase the valuation and sale price. However, much caution needs to be exercised as to the quantum and extent of indemnities offered so as to limit liabilities one could bear in the event of breaches.
Indicative Offer [also known as a letter of intent (LOI)]
It is a non-binding offer by a potential buyer in a sale process for the purpose of securing contractual negotiations with the seller, and with the view to agreeing and completing a sale eventually. It is submitted by a potential buyer to the seller after obtaining the Information Memorandum (Sales Memorandum) from the seller
Typically, an indicative offer will state the purpose and structure of the transaction, tentative purchase price, payment terms, how and when the potential buyer will finance the purchase, timetable of negotiations, timings of due diligence, and a tentative date of completion.
An indicative offer also contains an exclusivity agreement to ensure that the seller does not enter parallel negotiations with another potential buyer.
Information Memorandum (Sale Memorandum)
Information Memorandum (also called Sale Memorandum) is a documentation designed and prepared to give potential buyers concise insight into a company put up for sale; it is to provide preliminary information to prospective buyers to initially assess the sale.
It contains salient information about the company, such as its:
- Industry and market
- Products and services
- Customer base
- Employee data
- Financial performance
- Reason(s) for the sale
- Why the sale makes a good investment
- Patents and trademarks (if any)
- Asking price and terms.
To demonstrate good faith and openness, a disclaimer could be footnoted telling prospective buyers to undertake the necessary research and due diligence (although any serious buyer is certain to do so anyway).
The Information Memorandum should impress and attract potential buyers, heighten their interest in the sale, make it competitive and, as a consequence, boost the valuation and sale price of the company. It must be entirely truthful; but it must also be compelling and present a strong case for the health and potential of the enterprise in question. Given its confidential nature, it should only be given to pre-qualified potential buyers upon signing a non-disclosure agreement (NDA). The Information Memorandum should be exceptional in order to generate much interest from potential buyers without releasing important company information at this stage. It is a balancing act that must be gotten right.
This is the true value of a business. In other words, a company’s intrinsic value is its actual worth – which may be different from its current market value. The latter is largely influenced by prevailing market conditions.
A company’s inventory is the stock of raw materials, finished products for sale, and products currently being produced for sale. Inventory categories can be individually valued in various ways: such as by cost or current market value; and collectively by stock valuation methods known as ‘First-in, First-Out (FIFO) and ‘Last-In, First-Out’ (LIFO).
IPO (Initial Public Offering)
IPO or Initial Public Offering is the first sale of a company’s shares to the public to raise capital to finance expansion, raise money for its current private shareholders and rebalance the balance sheet, among other reasons. It is done by listing the shares on a stock exchange. Thus, through an IPO the business moves from being privately-held to being publicly-owned and traded on the stock exchange.
Joint Venture (JV)
Joint venture is a business enterprise in which two entities (persons or companies) collaborate by joining forces for the mutual business interest and benefit of both parties.
Key Performance Indicators (KPIs)
KPIs are methods by which an organization measures and assesses its business outcomes in terms of pre-established goals and objectives. The particular goals are periodically assessed and reviewed to determine if they are being met and what actions to take further. Key performance indicators are used in areas of business such as management, production, marketing, sales, customer service and human resources.
Liabilities are an entity’s legal responsibilities to settle a debt, pay taxes, damages or fulfil other obligations. The fewer liabilities a company has the more it is likely to attract higher valuation and purchase price.
A loan note is a contract document issued by a lender to a borrower regarding money borrowed by the latter. It specifies details of the loan and the terms and conditions thereof: the principal, interest rate, the payment schedule, the rights and obligations of both the lender and the borrower.
MBO (including BIMBO, MBI)
MBO (Management Buy-Out) is the acquisition of a company by its managers thus gaining ownership and control of the business.
Related to MBO is BIMBO (Buy-In Management Buy-Out): an acquisition of a company by its current managers and outside investors. Thus, both groups collectively acquire the company completely or purchase a controlling interest in it and become its new owners.
Further related also is MBI (Management Buy-In). In this type of buy-out, an outside investor (or group of outside investors) buy a company and leave the current management in charge.
A company’s earnings multiplied a number of times to determine its value. This understanding of ‘multiples’ is used in the multiplier method for valuing a business for sale. What is the multiplier method? When using adjusted net profit, it is: Adjusted Net Profit x Multiple (of industry) = Valuation. The multiples of earnings approach is usually the preferred method of valuation of a lot of SMEs. When valuing such businesses, multiples are applied to adjusted net profit, earnings before interest and taxes (EBIT / EBITDA) to determine sale price. However, in lieu of adjusted net profit, a multiple can be applied to cash flow or even gross margin.
Net Asset Value (Book Value)
This is the value of all of a company’s assets less its liabilities. It is an account of the value of the company’s assets minus the value of its liabilities. Put differently, net asset value is the underlying value of a company, rather than a perceived value dictated by market forces and conditions, demand and supply (how much a potential buyer is willing and able to pay for it), or supply and demand (how much the seller is willing and able to sell it for). Net asset value is also called book value.
A company’s total revenue less its operating expenses, taxes, interest charges paid, depreciation, and amortisation. Alternatively called retained earnings, net earnings are a company’s profits after paying all its operating costs and other liabilities.
Non-Disclosure Agreement (Confidentiality Agreement)
Non-disclosure agreement (NDA), also known as confidentiality agreement, is a legally binding document purposed to prevent confidential information covered by the agreement from being disclosed. NDA is a crucial element in the business sale process – especially when seeking potential buyers. The highly important Information Memorandum should only be given to pre-qualified potential buyers upon signing a non-disclosure agreement (NDA).
This is any type of commercial investment by a private equity firm, a venture capital firm, or an angel investor in acquiring part or all of the equity ownership of a company. Broadly speaking, private equity is investments made directly in private-held companies by private capital funds and similar investors. In high finance, private equity also involves buyouts – usually leveraged buyouts (LBOs) – of public companies which are thence delisted from the stock exchange where they had, hitherto, been publicly traded. When this happens, such a company is said to have been taken private.
Profit and Loss (P&L)
This is a financial report of a company detailing its revenue, costs and other expense items to show its net profit or loss for a specified accounting period – usually a quarter or a year. The profit and loss statement is one of the major ways of empirically assessing a company’s financial performance over specific periods covered by it.
Net profit is colloquially referred to as the bottom line because of its base location on the income statement.
Return on Equity
A percentage measure of net profit on shareholders’ equity (book value, net assets, net worth) in a company within a specific period of time. Return on equity is a measure of profitability: that is, how much profit a certain amount of equity (a shareholding) is making for the owner.
The total amount of money a company earns or makes through its operations and other sources. It is different from profit (which is arrived after subtracting expenses) and cash flow (which is cash generated and used by the business).
As happens in business sale, the sales process is the path and progression of various steps, activities and endeavours between and by the seller and prospective buyers/potential buyer from first contact to completion of the sale. From start to finish, whether initiated by the seller or buyer, the sales process involves identification, presentation, due diligence, confidentiality, valuation, pricing, negotiations, copious time, other comings and goings till completion of the sale.
Sale Purchase Agreement (also called Purchase of Business Agreement / Business Sale Agreement / Business Purchase Contract / Business Transfer Agreement)
The Sale Purchase Agreement (also variously known as Purchase of Business Agreement; Business Sale Agreement; Business Purchase Contract; and Business Transfer Agreement) is a business sale and a business purchase contract specifying and detailing the purchase of a business by a willing buyer from a willing seller. The Sale Purchase Agreement (SPA) outlines all details of the sale, such as:
- The business assets to be transferred
- The valuation
- The amount (purchase price) to be paid for the business
- Payment terms, milestones, and deadlines
- The arrangements on completion of the business sale
- The transfer of business contracts
- The outgoings and other payments between the seller and the buyer
- Seller’s warranties
- Post-completion rights and obligations (for both parties)
- Dispute resolution and arbitration protocol
- The closing date, location, and signatures page
Financing of a business purchase by the buyer through certain contractual terms agreed with the seller – such as earn out and deferred payments. Seller financing helps the seller to secure higher valuation and purchase price as well as timely completion of the sale.
Specifically, the arrangement of deferred payments also helps the buyer to avoid taking on expensive borrowing to finance the purchase.
Seller’s warranties are legally binding and enforceable statements about a business offered for sale which the vendor confirms are true and correct. Warranties obligate the seller to bear any liabilities covered after the business purchase is completed. Warranties and what they cover are open to negotiation between the seller and the buyer. However, once included in the Sale and Purchase Agreement (SPA) and the sale completed, warranties, like all other provisions in the SPA, are irreversible. As such, great care needs to be taken by both the seller and the buyer in agreeing what is specified and guaranteed as warranties in SPA.
It is worth noting that the more favourable warranties the seller gives the more assured the buyer will be with the purchase as well as even generate a valuation premium for the business and how much he/she is willing to pay in the end to secure the purchase. The seller however needs to be circumspect and tread cautiously not to commit to unbearable potential liabilities – the stark realities of which will only dawn long after the completion, if they occur.
Standard Operating Procedures (SOP)
Standard operating procedures are well-documented and established operational measures and processes put in place in a business by its management so as to ensure that the company’s activities, products and services are effectively and efficiently undertaken according to expected standards.
A business operated by productive standard operating procedures is not only well run, it is also perceived by potential buyers to be well run. This combination of reality and perception can increase the valuation of the business when put up for sale. The standard operating procedures efficiently and sufficiently enable the business to be run without the vendor. This is re-assuring for a potential buyer – that the company is not dependent on the vendor to operate and gives the potential buyer great opportunity to grow and expand the business after acquiring it.
Valuation is a methodical assessment and determination of the true worth of a business. Ultimately, in a business sale, valuation is the price the potential buyer is willing to pay and the seller is willing to accept; or the price the seller is asking and the potential buyer is willing to pay.
Valuing an enterprise is an immersive process involving all manner of transaction steps, activities, and endeavours such as due diligence, valuation, assessments, negotiations, bargaining and trade-offs between the seller and the potential buyer.
A company’s profitability, revenue, cash flow, earnings growth, growth prospects, brand recognition, intellectual property, all assets and liabilities as well as prevailing market conditions, demand and supply can vastly affect its valuation. But a valuation arrived at is largely dependent on the method used; what is being valued is as important as how it is being valued.
A good valuation is best achieved with a combination of any number of methods. Various methods used in business valuation include:
- The multiplier method. In this valuation method, adjusted net profit, EBIT or EBITDA is multiplied by a multiple (a number, could be 2, 3, 4, 5, 6, 7, or even 8) – it is usually an industry multiple.
The valuation is calculated as a multiple of the adjusted net profit, EBIT or EBITDA. A specific multiple used in a valuation broadly depends on the type and size of the business, its industry and growth prospects.
As the term implies, adjusted net profit is net profit adjusted to account for certain costs and expenses not considered when calculating the net profit. For example, if the current owner-manager had not been receiving appropriate salary from the business.
When using adjusted net profit, the valuation is calculated as follows: Adjusted Net Profit x Multiple (of industry) = Valuation. The multiples of earnings approach is usually the preferred method of valuation of a lot of SMEs.
An enterprise’s EBIT or EBITDA is also used in this method of valuation. A multiple can also be applied to cash flow or even gross margin.
- Asset valuation. In standard practice, a company’s account will show the net book value (net asset value) of the business. It is assets less liabilities. To get a valuation, the net book value is re-assessed to determine the current net worth of the assets rather than what has been stated in the books.
- Discounted cash flow forecast. In this valuation method, estimated future cash flow is used to determine the value of the business. It is done by assessing how much cash the business generates yearly. The cash flow figure derived is then forecast (say, 5 years) and calculated as the value of the business.
- Cost of starting a similar business. This valuation method estimates the capital outlay of starting a similar business currently to show how much the established business is worth based on current entry costs.
- Rule of thumb. Depending on the industry, a business could also be valued based on the number of variables. In the retail industry for example, such variables could be the number of outlets, turnover and customers.
Working capital is a company’s available funds for its day-to-day operations. It is current assets minus current liabilities. A company’s working capital is affected and assessed by its cash position, inventory, sales, accounts receivable, accounts payable, short-term debt due, inventory management, debt management, revenue collection, and payments to suppliers.
How much working capital a business has is a measure of its financial health and performance, because it determines its ability to operate on a daily basis. The more working capital a company has, the more it can improve, grow and expand its operations. Vice versa, the less working capital a company has, the less it is able to improve, grow and expand its operations; such a development is a threat to its very existence in the medium to long-term.
Even a profitable company can fail if it does not manage its working capital effectively.
Working capital is also variously called net current assets and current capital.