Key Terms for Selling or Buying a Business
Updated: Nov 14, 2022
Are you looking to sell your business? Or are you in the market to buy a business?
This blog post will define some of the most important terms related to selling and buying businesses. Understanding these concepts enables you to make more informed decisions when negotiating a sale or purchase. Let's get started!
Common Terms Used in the Process of Buying or Selling a Business:
Add backs: Expenses added back to the business's profitability. Add backs can be used to adjust the EBITA for a more accurate measure of profitability.
Adjusted Book Value: A company’s valuation after liabilities, including off-balance sheet liabilities and assets adjusted to reflect actual fair market value.
Amortization: This spreads the cost of an intangible asset over its useful life. Amortization is used for items such as patents, copyrights, and goodwill.
Asking price: This is the price that the seller is asking for the business. It is important to note that the asking price is not always the same as the final sale price.
Asset Sale: This is a business sale where the buyer only purchases the business's assets, not the company itself.
Broker’s Opinion of Value: Estimates a value for a business based on market variables, comparable sales data, and industry expertise that a buyer would willingly pay for the company on the open market.
Business Broker: This is an individual or company that helps facilitate the sale of a business. Business brokers can provide valuable assistance throughout the process. If you're looking for help in California, contact Sacramento Business Brokers.
Business Valuation: This determines how much a business is worth. It is an essential step when determining the asking price of your business and is more comprehensive than a broker’s opinion of value.
Cash Flow: The amount of money coming in and out of the business every month.
Cash flow statement: A financial document showing how much cash is generated and used during a given period.
Client - An entity with whom a Business Broker has a fiduciary relationship.
Closing: This is the final step in the business sale process. Once the closing is complete, ownership of the business will be transferred to the new owner.
Confidential Business Review (CBR): A document provided to potential buyers that outlines the business's financial details. The CBR is necessary for due diligence purposes and should be reviewed carefully.
Contingency: A contractual requirement that must be met or removed before a closing can take place. There may be multiple contingencies in a transaction.
Cost of Goods Sold (COGS): The total amount your business paid as a cost directly related to the sale of goods or services. Depending on your business, that may include products purchased for resale, raw materials, packaging, shipping, and direct labor related to producing or selling the goods or services.
Depreciation: This is the process of allocating the cost of a physical asset over its useful life. Depreciation is often used for buildings, machinery, and vehicles.
Discretionary Earnings: This measure of the business's profitability considers the owner's salaries, benefits, and personal expenses.
Due diligence: This is the process of investigating a potential purchase, usually through financial and legal means. Due diligence is critical to ensure you get what you expect from the deal.
Earn-out: A provision in the contract stating that the seller of a business is to obtain additional compensation in the future if the company achieves specific financial goals, usually expressed as a percentage of gross sales or earnings. It’s often used when a significant portion of the revenue comes from one client.
EBITA: This stands for Earnings Before Interest, Taxes, and Depreciation. EBITA is a measure of profitability that can be used to compare businesses.
Escrow: An account where funds are held during the business sale process. Escrow is used to ensure that both buyers and sellers are protected in the event of a dispute.
Fair Market Value: This is the price that a willing buyer and seller agree to for the sale of the business. Fair market value is often used in asset sales.
Fiscal year: Annual period a business follows for financial reporting.
Franchise: A franchise allows you to use the business model of a larger corporation. Essentially, a franchise is the purchase of a licensing agreement. This licensing agreement can give you the rights to use the existing company’s logo, name, and model. While this method offers more structure and guidance, it comes with less control for you, the business owner.
Furniture, fixtures, and equipment (FF&E): This is the physical property of the business being sold. FF&E can include items such as machinery, inventory, and office furniture.
Goodwill: This is the value of the business that is not attributable to its physical or intangible assets. Goodwill can be based on factors such as reputation and customer relationships.
Gross Profit: That portion of net sales that remains after the subtraction of the cost of goods sold
Income Statement: A financial document that summarizes all income and expenses over a given period, including the cumulative impact of revenue, gain, expense, and loss transactions. They are also referred to as the profit and loss (P&L) statement.
Intangible assets: These are non-physical assets being sold with the business. Intangible assets can include things like patents, copyrights, and customer lists.
Investment Banker: This is an individual or company that helps raise business capital. Investment bankers can also help to facilitate the sale of a business.
Lease and Sale Comparables: These are businesses that have been recently sold, similar to the business being sold. Lease and sale comparables can be used to value a business.
Letter of intent (LOI): This document outlines the terms of a potential sale. It is not binding but can help solidify the deal's details.
Liabilities: These are the debts and obligations of the business. Liabilities can include things like loans, accounts payable, and leases.
Net Profit (Net Income; Net Earnings): This is the measure of profitability that includes all income and expenses, including taxes.
Non-compete clause: This clause in a contract prohibits the seller from competing with the buyer after the sale. Non-compete clauses are used to protect the buyer's investment in the business.
Non-disclosure agreement (NDA): This document protects confidential information. Both parties should sign an NDA before any sensitive data is exchanged.
Operating Cash Flow: This is the measure of the cash the business generates from its operations. Operating cash flow can be used to assess the health of a business.
Owner Benefit: Same as discretionary earnings.
Owner's Draw: This is the portion of the business's profits paid to the owner. The owner's draw can cover personal expenses or reinvest in the business.
Private Equity Group (PEG): An investment vehicle that raises funds to invest in private companies.
Pro Forma: This is a financial statement that projects the future income and expenses of the business. Pro forma statements can assess the feasibility of a proposed business sale. It typically includes a balance sheet, income statement, and cash flow statement.
Sale agreement: This is the final document that outlines the terms of the sale. This document is binding and will be used to transfer business ownership.
Seller Financing: When the owner(s) of the business offers financing to a buyer. It could be the total amount needed to finance the purchase or, in addition to the buyer finding third-party funding.
Seller's Discretionary Earnings (SDE): This measure of profitability includes additional factors such as the owner's salary and benefits. A seller's discretionary earnings can be used to value a business.
SBA Loan: This loan is guaranteed by the Small Business Administration. SBA loans can be used to finance the purchase of a business.
Term Sheet: This is a document that outlines the terms of a deal. A term sheet is often used as the basis for a sale agreement.
Third-Party Financing: This is when a lender provides financing for the purchase of a business. Third-party financing can be an attractive option for buyers who may not qualify for traditional loans.
Working Capital: calculated by subtracting current liabilities from current assets, as listed on the company's balance sheet, buyers will often raise additional working capital when seeking financing for purchasing a business.
While this isn't exhaustive, it's some standard terms you'll come across when buying or selling a business. Learning these terms helps understand the business sale process. If you have questions, contact us for a free consultation.