The Founder’s Guide to M&A and Fund-Raising Terms

338(h)(10) Election

A term only a bureaucrat could love. It’s the IRS code that allows buyers of S Corps to treat the transaction both as a purchase of assets and of equity. From the buyer’s perspective, that’s the best of both worlds. Specifically, they can depreciate/amortize the target’s assets to reduce profit and therefore taxes.

Then, like when buying control equity, they also avoid the hassle of having to renegotiate any of the seller’s non-transferable contracts, e.g., agreements that become invalid should one of the parties change ownership. Probably the most sensitive of such contracts would be with employees, suppliers and, especially, clients.

But the downside for sellers is that, in a 338(h)(10) Election, they are taxed as if they had sold the assets. That is, their gain on the sale’s value over the depreciated or amortized value of their assets would be taxed at regular income rates. They’d much rather sell equity for a much lower capital gains tax rate.

Whether the seller signs off on a 338(h)(10) Election may depend on whether the buyer can figure out how to share the benefits for mutual benefit. Or, less charitably, when the buyer concludes that the seller has no better offer. See Bloomberg for more details.

Accretive Transaction

When a public company acquires a target for a lower price/earnings (P/E) multiple than its own, the deal is considered “accretive.” It’s called that because when the target’s earnings are added to the acquirer’s, they increase the acquirer’s stock price more than it costs the acquirer to buy the target. That’s the theory, anyway.

Adjusted EBITDA

Adjusting EBITDA means adding back non-recurring expenses and excess owner-operator compensation. It also means excluding non-recurring gains, such as gains on isolated foreign exchange trades. The idea is to normalize EBITDA fluctuations caused by factors unrelated to the business’s operations.

M&A advisors, especially those representing buyers, scrutinize such adjustments with care. Any change in EBITDA can drive value up or down by the EBITDA multiple at which the company is selling, typically 5x or more. Buyers also know that while specific expenses may not recur, unexpected or one-time expenses recur as a group. See this Corporate Finance Institute article for more info on the sometimes contentious art of adjusting EBITDA.

And learn more about not only adjusted EBITDA, but other indicators of sustainable financial performance like cash flow as revealed in a “Quality of Earnings” (QofE) analysis. Most mid-market buyers today require a QofE during due diligence.

Angel Investor

Angels are high-net-worth individuals (HNWs) who invest their own money in start-ups via “seed” rounds. Seed rounds follow initial investments from founders and their friends and family (F&F rounds).

Assets Under Management (AUM)

The definition of AUM for PEG (private equity group) and VC firms varies depending on whether you count only the market value of investments made or include the value of the limited partners’ remaining fund commitments as well. Ask the source if you’re unsure. Meanwhile, see this Accounting Insights article for more details.

PEGs call the limited partners’ funds that remain available for investment in portfolio companies “dry powder.” To avoid excessive risk exposure, many VCs and PEGs limit the dry powder they invest in any single opportunity to 5% of the fund they raised from limited partners.

If they are uncomfortable with committing more than a certain amount, and the target wishes to raise more, the PEG or VC may “lead” the round by inviting other investors to join them.

Backlog

The value of orders that clients have placed but the company has not yet fulfilled. Buyers regard backlog as an important indicator of the seller’s revenue reliability. The larger its size as a percentage of annual revenue, the more confident the buyer becomes in the target’s future.

Bolt-ons

Bolt-on acquisitions (aka add-ons) provide advantages to a PEG’s “platform” company, like access to new markets, technology, geography, production facilities, etc. They usually retain their own market identity as compared to “fold-ins” or “roll-ups,” which the acquirer’s platform absorbs Borg-like. For a grab bag of miscellaneous M&A jargon like the above, see M&A Science’s searchable list.

Bootstrapped

A company that has sold equity only to its original owners or key employees. The term “bootstrapped” alludes to the fact that such companies financed their growth solely through their cash flow and founders’ investment — as in “pulled themselves up by their bootstraps.”

Broker

A broker is an intermediary that represents the owners of smaller companies, usually to find them buyers. Want to know more about business broker and M&A advisor job descriptions? See my Which to Use — M&A Advisor or Business Broker? and How Do M&A Advisors Sell a Company?

Burn Rate

Burn rate is the amount of money that a company spends, net of whatever cash flow it generates. Dividing cash on hand by the monthly burn rate shows how many months the company has before it must at least reach cash-flow break-even. Or before it must raise more cash!

Buy-side

For M&A advisors and brokers, a buy-side (or buyside) engagement is one where they seek acquisition targets for their client’s company. They’re working for the “buy-side,” an acquirer. If they’re working for a seller, they’re representing the “sell-side.”

Buyout

A type of acquisition where the buyer purchases control of the seller’s company. Alternatively, the term can also describe the act of buying out an employee’s contract and accrued benefits to terminate their employment.

CAPEX

Capital Expenditure is the amount of money spent on depreciable assets, such as production machinery, or on intangible, amortizable assets, such as patents. CAPEX is not recognized as an expense on the income statement; it is recorded on the balance sheet. But once on the balance sheet, it slowly wastes away, draining through the income statement as a non-cash expense.

Cap (Capital) Table

A chart that lists a company’s equity, including convertible debt and options; the number and types of shares; who owns them; when they were acquired; and how much they cost. It also tracks the dilution (reduction in equity ownership percentage) that would result if option or convertible debt holders exercised their rights to acquire additional shares. As such, cap tables can get complicated.

To avoid complexity and bureaucratic entanglements, professional investors are averse to cap tables stuffed with small shareholders.

Cash-Free/Debt-Free Transaction

A common purchase structure used by private equity groups (PEGs) in which they buy all the seller’s equity or key assets but none of its excess cash or debt.

While a simple concept, the devil’s in the details of the cash-free/debt-free structure. What constitutes “excess” cash can provoke buyer-seller debate. It depends on whether the target’s current assets (cash, accounts receivable), will support the business going forward without additional contributions by the buyer. For a more complete description of the cash-free/debt-free deal, why it’s used, and how to apply it, see this WallStreet Prep article.

CIM

The Confidential Information Memorandum is a detailed description of a company available for sale. It’s sent to buyers who have signed an NDA (confidentiality agreement) and expressed interest in learning more about the target’s history, cap table, market, clients, operations, organization, historical and projected financial performance, and sometimes the reason for sale and preferred deal structure. To learn what’s in the perfect CIM, see my popular article on the subject.

M&A advisors originally printed CIMs in bulky leather-bound, individually numbered books (which explains why some people still call them books). But today, an increasing number of CIMs are electronic slide decks, with supporting details available in a virtual data room (VDR).

Data Room

Before the Internet, data rooms were typically windowless and oppressive, like closets. They were where companies seeking acquirers stored sensitive information, such as employee and client files. Over the past 20 years, sellers have converted this data into electronic formats available online.

Today’s virtual data room (VDR) operates 24/7, provides access to authorized users worldwide, tracks usage patterns, and refreshes content in real time.

You’d think such improvements in economy and speed would accelerate the due diligence process. You’d be wrong. In fact, VDRs have increased the amount of due diligence material gathered and delivered. It seems the more data sellers can make available, the more buyers want. Ironically, that increases the time needed to close. For more about this phenomenon, see my M&A Factoid #12: How Long Does Closing Take?

Dilution

Reductions in a shareholder’s percentage of company ownership caused by the issuance of additional shares.

Drag-along Rights

Rights held by controlling shareholders that compel other shareholders to sell their stock if a purchaser wants more than what the controlling shareholders own.

Due Diligence

Acquirers invariably conduct thorough due diligence (DD) on potential acquisition targets, a process that follows the signing of a Letter of Intent (LOI) and that takes months. While every target undergoes this inquisition, not all are found innocent. That is, DD rarely increases seller valuation.

DD covers every aspect of the company’s operations, market, legal and tax standing, customer relations, intellectual property, “quality of earnings,” competition, organization chart, etc. It also reviews performance during at least the prior three years and forecasts for the next three. For examples of when DD can become so tedious as to threaten the deal, see my article “How Buyers Kill M&A Deals.”

A competent sell-side M&A advisor will identify potential DD issues before going to market and help the seller address them or otherwise mitigate their impact on value. For lists of common DD problems and their antidotes, see 22 Quick Ways to Boost Company and Renovate Your Company’s Foundations.

And for both DD and other reasons why sellers can run into trouble while trying to close the sale of their company, see my How Sellers Kill M&A Deals.

EBITDA

The initials are for Earnings Before Interest, Taxes, Depreciation, and Amortization. Analysts commonly multiply EBITDA by some number when estimating a company’s worth. As in “Acorn Private Equity values Aero Corp at 6x trailing twelve-month EBITDA.”

Despite its ubiquity, multiplying EBITDA does a poor job of valuing a business. Buffett even considers it “meaningless.” That’s because it strips out non-operating expenses such as taxes, interest, and depreciation to get at “core” earnings. But these non-operating expenses are as real and as core as operating ones.

Omitting them artificially inflates a measure that resembles cash flow but isn’t. Acquirers must still pay non-operating costs, even if the amounts they pay differ from what the seller previously paid as an independent company.

For a truer picture of a company’s value, use present value. It examines actual cash flow, adjusted for differences between the buyer’s and the seller’s environments. Unlike EBIDTA, cash flow includes CAPEX, interest, taxes, and any other non-operating expenses or even gains that the acquirer could realize going forward. Of course, the analyst may “normalize” or smooth cash flows over several periods to avoid treating an extraordinary period as typical.

Despite its drawbacks, EBITDA remains a useful standard gauge of relative value. It’s a convenient, commonly used “back-of-the-envelope” method for comparing a company to its peers.

Enterprise Value (EV)

EV is roughly what you’d pay if you bought all a public company’s equity and debt. That is, if you purchased all its shares (valued as its “market cap” or market capitalization), agreed to pay all ts creditors, and took all its cash.

When you buy more than 50% of the company’s voting shares, you’d have to pay a “premium” over what non-control stock purchasers would pay. See this NetSuite article for more about what EV is and how to use it.

Meanwhile, what’s all this got to do with selling your private, mid-market company?

One way buyers can value your company is to calculate the average and median EV/EBITDA and EV/Sales multiples of public companies in your industry. Then they discount the multiples by 25%-35%. They do that to account for the private company’s limited share liquidity, typically smaller size, lower brand visibility, and looser accounting standards. Finally, they apply those discounted multiples to your company.

In a word, choosing the right private company discount rate can be a bit like raising a wet finger in the wind.

Expression of Interest (EOI) or Indication of Interest (IOI)

A buyer’s letter of intent (for a description of the LOI, see below) is specific regarding valuation, closing date, and other terms. In contrast, EOIs and IOIs either provide ranges or otherwise fail to address all relevant terms. Example: “The consideration to be paid is $50 to $65 million.”

Sell-side M&A advisors use EOIs/IOIs to weed out uncompetitive bidders and tire-kickers. Buyers use them to determine if they’re at least in the running to acquire the target.  See Divestopedia’s article on the subject.

Financial Buyer

VCs and PEGs are referred to as financial buyers because their primary contribution to the deal is cash. “Strategic” buyers theoretically bring not only that but also the promise of shared benefits from the M&A transaction’s operating synergies. The acquisition styles of these two buyer types differ, as do their plans for the target’s future. Competent sell-side M&A advisors understand these differences and manage them accordingly. For more details on the differences between buyer types, see Your Best Acquirer.

Forward/Backward/Horizontal Integration

Forward integration is a strategy used to acquire a company that brings the buyer closer to end users or to the final stages of the value-added production chain. Example: a manufacturer buying a distributor of its products.

Backward integration is a rationale used to acquire a company that brings the buyer closer to the origins or raw materials of the value-added chain. Example: a steel factory buying an iron ore mine.

Horizontal integration is a rationale for acquiring a company that provides greater scale or additional intellectual property for the buyer’s current operations. Example: a company serving the North American market acquires a company in the same industry serving European clients.

Golden Parachute

Employment contracts that guarantee extensive benefits to key executives at the selling company if the new owner fires or “constructively terminates” them within a specified period after closing. Parachutes motivate these executives to stay and assist in the company’s sale without undue concern for their financial future. Sellers may also grant bonuses to them for contributing to a sale that meets certain value, timing, or other criteria.

Goodwill

The amount an acquirer pays for an asset that exceeds its fair market value. They may do so because the asset is associated with the target’s brand, involves proprietary processes, or embodies intellectual value. New owners must depreciate or amortize goodwill over 10 years from the date of acquisition. If the value of estimated goodwill declines faster than anticipated, they must recognize this “impairment” as an expense on the income statement. See this Investopedia article for more.

Intermediary

An intermediary, or middleman, brings together—intermediates—between a buyer and a seller, or between parties joining together for a shared commercial purpose. Both M&A advisors and business brokers are intermediaries, though the former specializes in initiating complex financial transactions, while the latter focuses on selling smaller companies. For a more complete description of the differences, see Which to Use — M&A Advisor or Business Broker?

Letter of Intent (LOI)

Sellers want to see an outline of the buyer’s purchase terms before agreeing to take their company off the market and commit to the arduous due diligence process ahead (see DD defined above). LOIs, two to five pages long, typically:

1. Describe the buyer’s source of funds
2. Deal structure (asset versus equity purchase)
3. What’s being purchased (how much and which equity, assets or liabilities);
4. Amount of consideration paid and in what form (cash versus Newco equity versus earn-out versus debt, etc.)
5. Anticipated close date and
6. If relevant, where the target and its executives fit in the buyer’s corporate structure.

LOIs don’t bind the buyer beyond a good-faith obligation to pursue a timely closing in accordance with the outlined terms. In fact, unless stated otherwise, buyers can walk if they believe that DD reveals material weaknesses in the target or misrepresentations made by its owner.

On the other hand, as noted above, LOIs typically prohibit sellers from having contact with other buyers for the duration of a specified “lock-up,” “exclusivity,” or “no-shop” period that lasts at least several months. It’s during that time that DD and negotiations over terms proceed. For a complete description of an LOI’s contents, see The Perfect Letter of Intent.

Leveraged buyout (LBO)

LBOs are a type of company acquisition in which third-party lenders fund part of the purchase price, typically 20% or more, depending on target size and margins. Such lenders usually place liens on the acquired company’s assets as collateral.

From the seller’s perspective, an LBO is riskier than non-leveraged deals for two reasons: 1) closing the sale is contingent on the lender coming through; 2) heavy debt post-close can threaten the financial integrity of the company, bad news for a seller who holds equity or debt in it, or who expects earnout payments from it.

On the other hand, an LBO structure may fund a higher purchase price than any all-cash offer the seller would see from other potential acquirers.

Long-Term Capital Gain

If you sell an asset you’ve owned for at least a year at a price greater than your basis (cost minus depreciation), you’ve got a long-term capital gain. It’s taxed at a lower rate (currently 20%) than short-term capital gains, which the IRS treats as regular income.

Founders selling their company generally prefer to sell its equity rather than its individual assets because stock sales can qualify for long-term capital gains treatment. Yet buyers may prefer the opposite – the chance to write up the seller’s assets then depreciate them as a tax shield down the road. So goes the art of the deal.

Material Adverse Change (MAC)

MACs give buyers a legitimate reason to walk after signing an LOI, should the seller’s condition be materially worse than initially thought.

Conversely, if the seller had previously negotiated a break-up fee in the LOI and the buyer backs out for reasons unrelated to the seller’s condition, the buyer may owe the seller that fee. They range from 3% to as high as 15% of the deal’s value.

Mergers and Acquisitions (M&A)

An acquisition transaction is defined as one in which a buyer purchases shares that control more than 50% of the target’s voting rights, or acquires the bulk of the target’s key assets. Mergers occur when two companies contribute roughly equal value to a new company into which they “merge.” Mergers are more complex than acquisitions because they require agreement on the value of both companies.

Newco

Newco is the temporary name of a company that a PEG buyer will create to protect itself from the acquired target’s liabilities. It does that either by merging the target into Newco (“reverse triangular merger”) or by merging Newco into the target (“forward triangular merger”).

These transactions are called “triangular” because they involve three business entities — seller, buyer, and Newco.

Using these complex structures offers PEGs reduced taxes and protection from target liabilities. They also allow PEGs to avoid renegotiating non-transferable contracts with clients, suppliers, and others. See this Investopedia article for additional information.

Pipeline Data

Sales pipelines are more than a list of prospects salespeople work to convert into customers. Effective sales pipelines categorize prospects by stage, from initial identification through a scheduled delivery date. Each stage is associated with a probability of close multiplied by the order value.

Example: Stage 4 carries an 80% probability of close, and the order is worth $100,000. Therefore, the expected value of that order is $80,000. Adding all prospective orders yields an estimated future revenue. The larger the number relative to historical performance, the greater the likelihood that the target is growing.

Platform Company

Platforms are portfolio companies that a PEG considers leaders in their industry. It has available infrastructure capacity and strong management, which means the PEG is motivated to invest further by acquiring add-ons and roll-ups (see the terms above) and integrating them into the platform.

Portfolio Company

A company in which a PEG or VC has invested. In the case of PEGs, this usually means they own a controlling interest in the company. For individual VCs, they rarely do. Both VCs and PEGs advertise their current and former portfolio companies on their websites.

Present Value (PV) and Net Present Value (NPV)

The holy grail of valuation, present value, first looks at a company’s future cash flows. Then it discounts it back to the present based on the risk and time involved before you pocket the money. Net present value accounts for the cost of acquiring the cash flow. For fuller descriptions of both, see How to Value a Company.

Proprietary Advantage

Any competitive advantage that’s gained by using intellectual property (IP) — technology, data, know-how, or other processes and assets unique to the firm. It’s the sell-side M&A advisor’s job to uncover and promote these advantages. For a description of the four types of IP, and how to value and protect them, see this authoritative article.

Return on Equity

ROE is one measure of a company’s financial performance. It’s calculated by dividing net income by shareholders’ equity. Example: an ROE of 25% means that, over four years, the company will generate profit equivalent to the current value of its equity.

Some other useful measures of financial performance are:

• COGS (Cost of Goods)
• ROA (Return on Assets)
• ROS (Return on Sales)
• GM (Gross Margin, i.e., sales minus COGS)
• B/E (Operating Breakeven)
• SGA/Sales (Administrative Overhead)
• Inventory Turnover (COGS/Inventory)
• Sales Growth (Yr 2 – Yr 1)/Yr 1)

Sell-side

For M&A advisors and business brokers, a sell-side engagement is one where they seek a buyer for their client’s company.

Series A, B, and C Fund Raises

These are types of funding rounds financed by VCs.

Series A typically follows friend-and-family, angel, or seed rounds and involves the sale of preferred stock. Proceeds from these sales finance the conversion of an interesting idea into a working business. In 2023, the average Series A round raised about $22 million.

Series B funds the rollout of a business that has demonstrated commercial viability and that may benefit from economies of scale.

Series C—typically the final private round—fuels the expansion of an already successful business. The funds go toward new product development, entry into new markets, and related initiatives. Series C-round companies are typically mature enough to attract not only VCs but also PEGs and small hedge funds. For more details on funding series, see this Investopedia piece.

Target Criteria

The term is typically used by buyers to describe the characteristics of their ideal target. The criteria reflect the buyer’s “investment thesis.” Example: Positive EBITDA SaaS business serving the air transport industry with revenue of $50M – $100M.

In turn, sell-side M&A advisors work with their clients to define the ideal buyer. As a random example: Seller X prefers buyers who will:

• Pay 75% or more of the total consideration in cash;
• Allow the founder to exit within nine months of close, and
• Retain the current CFO for three years.

(FYI: these are pretty heady demands.) To facilitate comparisons among offers, M&A advisors and their clients may assign different weights to each criterion and then sum the weighted scores to rank a buyer.

Teaser

A brief (no more than two pages) description of an anonymous company for sale that sell-side M&A advisors circulate to potential buyers. They’re designed to pique buyers’ interest so they’ll sign an NDA to review a CIM (see above).

Pari Passu

A term referring to the equal treatment of two or more parties in an agreement. It’s Latin for “with even step.” For example, an investor may want rights that are pari passu (on a par) with those granted to earlier investors.

Pre-money/Post-money Valuations

The value of a company before investors put money into it versus its value after they do so. Example: a company valued at $10 million (pre-money) raises $3 million, making it now worth $13 million (post-money).

Preferred Stock

Stock that gives its holders certain rights, preferences, and privileges over holders of common stock and other securities.

Proforma Shares Outstanding

The total number of shares anticipated to be outstanding after the company issues new shares.

Purchase Price Allocation

The division of an asset purchase price into two buckets: net assets versus goodwill. Buyer and seller must agree on this allocation because how much goes into each bucket affects:

1. How much of the seller’s compensation is taxed as regular income tax versus
2. How much the buyer can depreciate the seller’s assets and therefore create a “tax shield” by reducing profit.

Recapitalization (or Recap)

Sandbagging

Bidders may claim that a sell-side M&A advisor is sandbagging them while waiting for a better offer—stalling for time.

Synergies

Cost savings and revenue enhancements that a buyer expects to realize from a merger or acquisition. Such expectations are often unmet. See Mistakes Buyers Make.

Tag-along Rights

Rights that enable a stockholder to participate in the sale of stock by another shareholder to a third party.

Valuation

The act of estimating what a company is worth. For established companies, analysts use three methods to do this and hope the values converge:

1. Present value of future cash flows;
2. Comparable company acquisitions and
3. Comparable public company values.

For early-stage companies with little or no revenue, analysts must use proxies for cash, such as “eyeballs” or milestone achievements. To learn more about both approaches, see How to Value a Company.

Warrants

A security that includes the right to buy shares (usually common stock) from the issuer at a certain price and within a certain time period. M&A advisors may earn warrants as part of their success fee.

Have questions about how to manage your company’s sale? Email us.

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