Jargon Buster

The Alternative Investment Market, a listed company market, mainly for smaller companies.

Where an acquisition is for the assets and good will of the company, usually leaving a cash pile in the company to settle creditors, the excess being distributed to shareholders.

An individual that may act like a private equity institution, usually investing comparatively small amounts – most investments are less than £50k.

The Seller will prepare a list of documents and a “Disclosure letter”, to disclose certain facts, where the warranties are not entirely true. For example, the Seller may warrant that there are no claims by any employees against the company, but disclose that one ex-employee is taking action against the company on the grounds of unfair dismissal. This disclosure nullifies the ability of the Seller to reclaim against the Seller, in the event that the stated employee successfully wins their case.

This is the review, risk assessment or verification process undertaken by a Buyer, when buying a business. It is exacting and very time consuming in that they are seeking to examine every aspect of the business, to understand the risks and sustainability of trading. It is usually divided into three parts:-

Commercial DD usually the acquirer reviewing contracts, understanding production or processes, costings, revenue and margins;

Financial DD often undertaken by a third party firm of accountants, to verify past, current and future trading and have a real understanding of the balance sheet and any off balance sheet liabilities. Where the acquirer is raising funds (such as for an MBO), the bank may insist that this due diligence is undertaken on the bank’s behalf; in this case, will also appraise the business plan and financial projections of the acquirer;

Legal DD a very lengthy shopping list is given to the Seller to collate all information in respect of legal DD, which will span from the property lease agreement to every employment contract. This legal DD will form the basis of the warranties.

Don’t underestimate the importance of the DD process, nor the time it will take the Seller to collate all information and respond to queries. It is a lengthy and time consuming process, but one that is necessary.

Earnings Before Interest, Tax, Depreciation and Amortisation.  Depreciation and amortisation are added back to profit, as they are non-cash items that are charged to the P&L, so in effect can reflect additional cash generation.

Usually EBITDA x a multiple. This gives the total value of a company, excluding cash , debt and any freehold property or similar assets.

The financial assistance rules are no longer in place, although the principles and risk remain the same. If a company uses its own cash to purchase its shares (whether that be by security on bank debt, for an MBO, or other reason), then the directors should have taken a detailed review of the prospective cashflow of the business for the next twelve months, to ensure that the purchase of shares does not prejudice the repayment of creditors.

The sales document prepared by advisers in the event of a trade sale.

The compound growth rate sought on investment from a private equity/venture capital investor. This is usually estimated at 30%, ie the full value of the investment is expected to grow at 30% per annum, on a compound basis.

When banks lend to fund an MBO or acquisition, they will usually take the main security against the assets of the target company. The Seller may have been paid partly cash and partly loan notes; the inter creditor agreement dictates the relationship between the two lenders (the bank and the Seller) and limits the actions available between the two parties, in the event that the company defaults on repayment to either party. Be aware that these are usually prescriptive, the bank will not leave much room for negotiation on the part of the Seller.

Finance advanced, usually as a percentage of the debtor ledger. Banks are increasingly keen to use invoice finance as an alternative to overdraft, as it (a) provides them better security and (b) reduces the exposure to the bank, in the event of a fall in turnover.

Management buyout, where the owner sells the company to existing senior staff.

This differs from a management buy in (MBI) whereby an individual, external to the company, acquires the company, bringing their own skills to the company. Usually, they need to leverage the business (raise debt and possibly secured against the company).

Banks are increasingly shying away from the MBI as the portfolios of loans over the last fifteen years have proven them to be very high risk. Banks now prefer to lend to Buy in management buyouts (BIMBOs) where the MBI candidate joins forces with the existing management team of a company to buy out the owners as there is likely to be a greater understanding of the business, and its weaknesses or risks.

When the enterprise value of a company has been determined, a multiple is applied to arrive at the amount to pay for a business. This can depend on the sector and nature of the business, the scale and financial robustness of the business.  Some saas businesses for example, trade a high multiples (in excess of ten), whilst a small company with few barriers to entry acting as a sub-contractor in manufacturing, might sell on a much lower multiple..

During a sale and purchase of a company, it might be agreed that the balance sheet net assets need to be an agreed amount at completion – if they exceed that, the Sellers benefit from the uplift and if they are less, it is reduced from the amount paid to the Seller. This will necessitate completion accounts, prepared after completion of the sale and purchase, to define the net asset value at completion date.

A company newly formed (off the shelf) for the purposes of an acquisition

The most junior listed company market.

Equity provided by funding institutions (usually managing the funds on behalf of pensions, or wealthy individuals), invested into mainly private companies that are seen to have exceptional growth potential. Suitable for only a small minority of companies, where there is likely medium term exit, plausible growth plan and real competitive advantage within a niche marketplace. Simply, can the business double in value in two to three years, or treble in five?

Where the company purchases its own shares from individual shareholders, then cancelling them; the number of shares therefore decreases and the remaining shareholders proportionate ownership increases. However, under company law the company must have sufficient distributable reserves to do this.

The agreement which binds conduct between shareholders which includes any venture capital funders who will impose certain rights of veto in their agreements to prevent management undertaking certain actions without consent from the funder.

The shares, rather than assets are acquired, which means that everything within the company (intellectual property, cash, land and buildings) are included in the price.

Sale and purchase agreement – the legal agreement between buyer and seller.

Increasingly, this term is used for equity applied to smaller investments, although historically, it has been used as an alternative term to private equity.

During the sale and purchase of a transaction, the Seller will warrant to the Buyer that certain facts are true; if these prove not be the case, the Buyer has legal recourse to recover the monies quantified as the amount by which the warranty overstated the value of the company. This is similar to an indemnity, except that where the Buyer is indemnified, it has only to prove the breach, rather than the quantum, which is usually defined.