Mergers and Acquisitions Definitions

Here we list Mergers and Acquisitions definitions alphabetically and try to add a little color about their significance.

Merger Definition

CAGR: Cumulative Average Growth Rate.  For example, revenues growing 30% in the first year, then 10 % in the second year and 5% in the third year has a three year revenue CAGR of 14.5%; the average annual rate to grow from 100 to 150 over three years.  While 14.5% per annum growth is positive, the declining trend is not.

CIM: Confidential Information Memorandum.  A CIM is the main overview document provided in the private company divestiture or private placement financing process.  A CIM is made available subsequent to signing an NDA and presents detailed company information as a basis for an indicative value discussion.  

Deal Fatigue: Deal fatigue refers to a condition, typically during Purchase and Sale agreement (“PSA”) negotiations, where parties on either side of the negotiation begin to feel frustrated by the time and level of detail that needs to be addressed. Deal fatigue can be managed by starting with a thorough LOI and then planning for a limited number of page turns on the PSA, each one addressing items that can be agreed upon or deferred where, between sessions, teams can review importance of issues and options.

Due Diligence: Due diligence is a detailed investigation of a business prior to signing the PSA.  Due diligence is often outsourced to accounting, legal and technology audit firms, For a full post on due diligence, see: What is the Due Diligence Process and What Does it Entail?

Earn-in: An earn-in occurs as part of an MBO where management is provided with an opportunity to earn more shares in a business than they can afford to buy at the closing of a transaction. For example, management may only have enough cash to acquire 10% of the business but if they reach certain performance targets can earn additional ownership in the company.

Earn-out: An earn-out is part of a sale transaction where the price to be paid is conditional on future performance. For example, the purchase price may be $10 million consisting of $8 million in cash and $2 million payable if revenues grow 20% in each of the next two years.

EBITDA (multiple/sustainable): EBITDA stands for earnings before interest, taxes, depreciation and amortization. EBITDA is a measure of cash-flow that excludes the capital structure of a business, thereby improving comparability. A multiple of EBITDA is the most common used valuation metric for private companies.

Sustainability is a key concept in valuation.  An EBITDA multiple is not applied to the latest or forecast EBITDA but to sustainable EBITDA.  Sustainable EBITDA is that number that can be counted on for several years to come.  While this should be established on an ad hoc basis, a common proxy is a weighted average formula such as 3/15*LTM-2 + 4/15*LTM-1 + 5/15*LTM + 3/15*LTM+1.

Enterprise Value (EV): Enterprise value is the value of a business independent of how it is financed. This includes in its calculation the market capitalization of a company but also short-term and long-term debt as well as any cash on the company’s balance sheet.

Free Cash flow (FCF): Free cash flow is cash flow available for distribution to shareholders after supporting the business’ strategic cash needs.   For a growing private company that can be zero at times, as all available cash is needed in the business to support working capital or capital investment.  Free Cash flow is after-tax earnings plus non-cash charges minus working capital requirements and required capital expenditures.

Funded Debt; Funded debt is third party debt such as the used part of a bank line of credit or bank term debt.  Not trade debt such as accounts payable.

Hold-back: A hold-back is always part of a purchase and sale agreement and ensures the buyer can collect on rep and warranty breaches. The shortest amount and period would be in the 5% and 6 months range, whereas more typical is 10% and 1 year.

Hold Period: The time a venture capital company or private equity firm holds its investment in a private company. Typically 3 to 7 years.

Horizontal Merger: A horizontal merger occurs when a business acquires a competitor. Competition tends to be higher among companies operating in the same space, meaning synergies and potential gains in market share are much greater for merging firms.

Letter of Intent (LOI): A letter of intent is used to summarize an understanding of a deal. This, typically 3 to 10 page summary forms the basis a full legal agreement. In the context of a sale process, it marks the critical point where power shifts from the seller to the buyer because LOIs typically require exclusivity. For a full post on the letter of intent, see: Why is the Letter of Intent (LOI) so Important?

LTM: Latest rolling 12 months.  Valuators typically want to reflect the most recent annualized information.  If the first quarter statements are available the will combine this with the last three quarters of the previous year to assemble a 12 month statement income statement to the end of Q1.

M&A: Short for Mergers & Acquisitions describes the activity of buying and selling businesses. The rationale for doing so will be based on either accelerating growth, improving profitability or reducing risk. Specific drivers are outlined here: How to Select the Best Possible Buyer for your Business.

Mezzanine Loan: A mezzanine loan (also called sub-debt or mezz loan for short), is a tier of funding that sits behind a secured bank term loan and before equity (typically preferred shares). Because the loan has less security and requires more cash-flow to pay back, it is priced between the cost of secured debt and equity. As an example, if term debt is provided in an amount of 3 times EBITDA and the cost is prime plus 300 basis points, a mezzanine loan could be in an amount of another 1 to 2 times EBITDA and would cost prime plus 600-1000 basis points (6% to 10%) or more.

Multiple of Revenues: A multiple of revenues is used as a measure of value, typically for hosted solution software (i.e. SaaS or Software as a Service) companies that are growing quickly but are not yet profitable.

Non Disclosure Agreement (NDA): Non Disclosure Agreements (NDAs, also called CA for Confidentiality Agreement and MNDA for Mutual Non Disclosure Agreement) are contracts that stipulate that information received from a counter-party will only be used for the purpose as defined in the NDA . For a full post on NDAs, see: NDA Agreement: Meaning and Sample Clauses

Non Solicit Agreement: A Non Solicit Agreement prevents the buyer from hiring the targets employees. It is generally part of an NDA.

Notional Value: A notional value determination is one in absence of an open market transaction which is, in other words, the intrinsic or stand-alone value.

Purchase and Sale Agreement: PSA or SPA in the case of a Share Purchase Agreement, is one document in a set of final documents that completes a company sale transaction. For a full post on the purchase and sale agreement, see: The Purchase and Sale Agreement Explained.

Recap: Short for recapitalization. A recap is a type of corporate reorganization involving a substantial change in a company’s capital structure.  Recapitalizations may be motivated by a number of reasons. Usually, the large part of equity is replaced with debt or vice versa.

Rolled Equity:   Rolled equity is when a buyer requires that a seller take a percentage of the proceeds from the transaction and re-invests it back into the company. For example if the buyer buys 70% of the business for $10M then the seller contributes $3M in rolled equity. Buyers require this mostly for the reason that the buyer wants the seller to have an interest in the continued success of the company. Rolled equity usually occurs between private company sellers and buyers, and is most often utilized by individuals, smaller companies and private equity firms.

Roll-up: A Roll-up is a consolidation strategy used by investors where multiple small companies in the same market are acquired and merged. The principal aim of a rollup is to reduce costs through economies of scale. Rollups also have the effect of increasing the valuation multiples the business can command as it acquires greater scale. Rollups may also have the effect of rationalizing competition in crowded and fragmented markets, where there are often many small participants but room for only a few to succeed.

ROR: Required Rate of Return is the return on investment, investors expect to earn for a particular investment based on rates being generated for other asset classes.  For example, if investors can earn 3% on government bonds then they might require 10% on a large cap equity investment.

SaaS: Software as a Service.  Cloud hosted software solutions typically accessed through a browser.  SaaS solution benefits to the consumer include infinite incremental scalability (up and down) and the potential to reduce IT support costs by outsourcing hardware and software maintenance and support to the SaaS provider.

Search Fund: A search fund is an individual looking to acquire and operate a single business. The individual is funded for a period of 12 to 18 months to find and buy a business buy a number of individual investors and small institutional funds. The target business typically has to be profitable with EBITDA from $1M to $5M. The idea was conceived at Stanford University in 1984.

Secondary: That part of an equity investment in a company that does not go into the company but rather out to shareholders. Also, the secondary market (also often called private equity secondaries or secondaries) refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds.

Sponsor (Independent / Fundless): An independent or fundless sponsor is a buyer looking to acquire a company without the capital in the bank to complete the transaction. However, similar to search funds, they will have relationships with hedge funds, private equity firms, family, and friends, or family offices to partner on a transaction.

Stand Still Agreement: A stand still agreement is used by public companies to stop prospective acquirers from acquiring more share during the negotiation process.

Unlevered: An unlevered return on investment is cashflow divided into the invested amount.  For example, if a business is acquired for $10 million and it generates $2 million in cashflow per annum then the first year ROI is 2/10 or 20%.  Leverage concentrates return on investment.  If the same business had been bought with $6 million in debt at a 10% interest rate, then ROI would be $2 million in cashflow minus 10% interest on $6 million, which leaves $1.4 million on invested capital of $4 million which is 35%.

Value to the Buyer: This represents the value a buyer can create by leveraging its assets such as distribution and customer relationships.  An M&A transaction typically occurs somewhere between the notional value and the value to the buyer.

Vendor Take-back (VTB): A vendor take-back is a vendor note, typically unsecured, or secured behind institutional funding (i.e. bank term loan and mezzanine lenders) provided by the seller to close the gap in price for an acquirer. There are certain businesses that are difficult to finance (i.e. a small private consulting business) or, in some cases the buyer does not have access to capital to complete an all-cash purchase (i.e. in the case of an MBO); in these cases an agreement by the seller to be paid over time from the business’ cash-flow can bridge the purchase price to an acceptable amount.

Vertical Merger: A vertical merger is a merger between two companies where the combined company extends the value chain and results in cost savings as a result of vertical integration. For example, a car manufacturer buys an engine manufacturer. For more on vertical mergers see: “Vertical Merger – Learn How Companies Try to Dominate an Industry

If we are missing any Mergers and Acquisitions definitions of interest, please let us know.

Recommended Further Reading

For more on how long an acquisition takes, see: How Long Does it Take to Sell a Business?

For more on how to optimize net proceeds, see:  Share Sale or Asset Sale: It is Mostly About Minimizing Taxes

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