Important Terms and Phrases in Mergers and Acquisitions
Like any topic, M&A has a language that you have to get a handle on to understand the field. The following words are part of the basic building blocks of M&A.
The lingua franca of M&A is an amalgam of accounting and banking terms sprinkled with initialisms, acronyms, and words and phrases adjusted and twisted to suit certain needs at certain times.
The transaction is when Buyer sells a company to Seller. Transaction is a more formal version of deal; most documents, agreements, and contracts use the word transaction (often capitalized as a defined term), but conversations and e-mails may use deal and transaction interchangeably. Think of deal as transaction’s popular cousin from the wrong side of the tracks.
Consideration is what Seller receives from Buyer as a result of selling the business. In its most obvious form, the consideration is cash, but cash is not the only way to pay for a business.
Buyer may issue stock to Seller in exchange for the business. Seller may accept a note from Buyer (Buyer promises to pay later). Or perhaps the price of the business is contingent, and Buyer pays Seller an earn-out based on the performance of the business after the transaction’s completion.
Consideration is not an either-or situation. The consideration may consist of some cash at closing, stock in the acquiring company, and an earn-out. Or perhaps the consideration is a note plus an earn-out.
No single right or wrong way to structure a deal exists.
EBITDA (earnings before interest, tax, depreciation, and amortization) is one of those horrible business jargon terms, but it’s unavoidable in M&A. EBITDA (and its variations) forms the basis for most deals.
EBITDA is the cash flow of a company without accounting for interest payments or interest income, tax bills, and certain noncash expenses (depreciation and amortization). In other words, EBITDA measures the cash generated from doing what the company is supposed to do: sell its goods or services.
Why is this number so gosh-darn important? EBITDA is often (but not always) the basis a company uses to determine its valuation and is often a defined term in the agreements and contracts. Banks quite often include EBITDA as one of the covenants for making a loan.
EBITDA is commonly pronounced ee-bah-dah. And in case you’re wondering, EBITDA is not a generally accepted accounting principles (GAAP) term. (Neither is adjusted EBITDA.) However, both EBITDA and adjusted EBITDA are perfectly acceptable terms for the purposes of M&A activities.
Adjusted EBITDA, which is EBITDA’s wild and crazy cousin, is simply EBITDA with adjustments! For example, a business owner often takes a salary larger than industry standards, so a Buyer may want to add back part of that salary to arrive at a more reasonable level of earnings.
Say the owner of a company with $20 million in revenue receives total compensation of $500,000 when the industry standard for the president of a like-sized company is $250,000. In this case, adding $250,000 (plus the pro-rated amount of income tax) back to the EBITDA figure makes sense.
Other adjustments to EBITDA may include add backs for other owner-related expenses (cars, gas, cellphone, country club, health club, and so on). If certain employees won’t be part of the business after the deal is complete, adding back their salaries (and corresponding payroll tax and benefits expenses) is appropriate.
No set standard exists for adjusted EBITDA; adjusted EBITDA is whatever Buyer and Seller agree it is.
Although running certain personal expenses through a business may be common, the practice may run afoul of the IRS. Consult with your tax advisor for the proper treatment of personal expenses.