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Decoding M&A Terms: Part 2

8/31/18 – Ely Friedman

As mentioned in Part 1 of the series, this segment will analyze some of the less common terms associated with mergers and acquisitions and share how and why they are so important in negotiating the purchase or sale of a business. Although it may seem odd, we’ll start with post-sale terms like earn-out, seller’s note, and “second bite of the apple.” Earn-outs are payments the seller receives if certain financial performance goals are achieved.  Many buyers attempt to keep sellers from achieving these payments in an effort to avoid paying the earn-out. For example, if you agree to sell your business, and the earn-out is based on growing EBITDA 20%, a buyer may try and include additional expenses to reduce EBITDA and keep you from reaching that goal.

We fight hard to protect our clients from these “got-ya” type moments. Another form of deferred compensation paid after closing is a seller’s note. A seller’s note is simply a loan the seller is giving to a buyer in lieu of cash at close. This is most commonly used by buyers who can’t afford to pay cash or from buyers who believe the seller affects the future performance of the business and is necessary to stay involved.

Most Common Terms

  • Letter of Intent “LOI” – referred to as “under contract”
  • Earnings Before Interest Tax Depreciation & Amortization “EBITDA”
  • Stock Purchase Agreement “SPA” or Asset Purchase Agreement “APA”
  • Multiple (shown as “x”)
  • Rollover Equity – the seller’s money rolls into the new company with the buyer
  • Exclusivity – communication with other interested parties is disallowed

What Actually Happens During Diligence?

Every buyer has a process that involves fact checking certain information the seller has shared about the company. This process confirms or disputes information the seller has provided thus far and provides insight as to what they can expect in purchasing the business. Legal diligence is usually one of the last parts of the diligence process, and depending on how complicated the legal structure/industry is, it may take up to one month to get through the purchase agreement.

The purchase agreement is typically an Asset Purchase Agreement (“APA”) or a Stock Purchase Agreement (“SPA”). As the name implies, the asset agreement is like buying a car or any other asset, but a stock agreement has a much wider meaning. It is not always clear which one is best from a legal or accounting standpoint. Our team utilizes our experience, including over one hundred deals, and our trusted accounting/legal teams, who focus on M&A, to come to a consensus on which is right for each transaction.

Less Common Terms

  • Asset-Based EBITDA
  • Earn-out
  • Seller Note
  • Quality of Earnings “QofE”
  • Leverage Buy-out Model “LBO”
  • Discounted Cash Flow “DCF” model

Documentation is invaluable when it comes to legal diligence. A buyer needs definitive evidence that the sellers are the real owners of the business, and there isn’t a threat to someone else making a claim to your company name, website, brand, and/or assets. Additionally, it takes time to organize all of this information. Our team utilizes confidential and secure virtual data rooms for sensitive information.

Be careful not to let diligence documentation slow your business down, or it can throw a wrench into the process – it happens all the time. There are several ways a good investment bank will help mitigate this risk and work hard with you to have as little impact on your business as possible.

In the next segment, we’ll touch on other less-common terms including QofE, financial modeling, and the early stages of the transaction.

For additional information, contact your VonLehman M&A advisor.