Financial Terms
Assets
• Description : These are the assets, tangible or intangible, that a company owns (buildings, patents, stocks, etc.) and which can be used to generate income.
• Example : A building or a patent owned by a company.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
• Description : Measures a company's financial performance without taking into account interest, taxes, and depreciation, often used to compare profitability.
• Calculation : EBITDA = Revenue – Cost of sales – General and administrative expenses.
Cash Flow
• Description : Indicates a company's ability to generate cash to pay its debts and finance its operations.
• Calculation : Free Cash Flow = Operating Cash – Capital Expenditures.
Net debt
• Description : Represents the company's total liabilities minus its available cash.
• Calculation : Net debt = Total debt – Cash.
Valuation
• Description : The process of determining the current value of a business or asset, often calculated by methods such as earnings multiples or valuation of future cash flows.
• Calculation : Enterprise Value = EBITDA × Industry Multiple.
Evaluation multiples
• Description : Financial ratio used to evaluate a company by comparing its performance to that of similar companies.
• Example : Multiple based on EBITDA or revenue.
Leveraged Buyout (LBO)
• Description : Acquisition of a company financed mainly by debt, often secured by the assets of the company purchased.
• Example : A company is purchased by borrowing 70% of the purchase price and using 30% equity.
Fair Market Value (FMV)
• Description : The price at which an asset or business would sell between a reasonably informed and unhurried buyer and seller.
Earnout
• Description : Deferred payment in an acquisition, where the seller receives a portion of the price based on the future performance of the business.
• Example : Seller gets 10% of future profits for 3 years after sale.
Goodwill
• Description : Additional intangible value paid upon acquisition, typically related to a company's reputation, customer base, or brand.
• Calculation : Goodwill = Purchase price – Net asset value.
Free Cash Flow (FCF)
• Description : The amount of cash a business generates after covering its operating and capital expenses.
• Calculation : FCF = Operating cash flow – Capital expenditures.
Return on Investment (ROI)
• Description : Measures the financial return obtained relative to the initial cost of the investment.
• Calculation : ROI = (Investment gain – Investment cost) / Investment cost.
Enterprise Value (EV)
• Description : The total value of a company, including its debt and cash.
• Calculation : EV = Market capitalization + Long-term debt – Cash.
Accretion/Dilution
• Description : A positive or negative impact on earnings per share after a merger or acquisition.
Private Equity
• Description : Private investment funds intended to acquire stakes in companies, often to restructure or increase value before resale.
Mezzanine debt
• Description : Hybrid debt, often subordinated to other debt, used to finance acquisitions.
Financial ratios
• Description : Indicators used to assess the financial health of a company (e.g. debt ratio, liquidity ratio).
Excess Purchase Price
• Description : Difference between the price paid for a business and the net value of its assets.
Leveraged Recapitalization
• Description : Strategy where a company issues debt to buy back its own shares or pay dividends.
Capital Expenditures (CapEx)
• Description : These are the expenses a business incurs to acquire or improve physical assets such as buildings or equipment. They are essential to understanding a business's investment needs.
• Calculation : CapEx = Asset Acquisition + Asset Improvement.
Net Operating Profit After Taxes (NOPAT)
• Description : Represents a company's profits after taxes but before deducting interest on debts. It is often used to assess a company's operating performance regardless of its financing structure.
• Calculation : NOPAT = EBIT × (1 – Tax rate).
Working Capital
• Description : A company's working capital, which represents the difference between its current assets and its current liabilities. It is a key indicator of a company's liquidity and its ability to cover its short-term needs.
• Calculation : Working capital = Current assets – Current liabilities.
Discounted Cash Flow (DCF)
• Description : A valuation method used to estimate the present value of a company's expected future cash flows. DCF is commonly used to determine the intrinsic value of a company in merger or acquisition decisions.
• Calculation : Net present value (NPV) of future cash flows.
Beta
• Description : A measure of a company's systematic risk relative to the market as a whole. A beta greater than 1 indicates that the company is more volatile than the market, while a beta less than 1 indicates lower volatility.
• Calculation : Beta = Covariance (firm return, market return) ÷ Variance of market return.
Cost of Capital
• Description : Cost of capital is the cost for a company to raise funds, whether through borrowing (cost of debt) or through equity (cost of equity). It is often used to evaluate investments or acquisition projects.
• Calculation : Cost of capital = (Cost of equity × Weight of equity) + (Cost of debt × Weight of debt).
Weighted Average Cost of Capital (WACC)
• Description : A measure of a company's cost of capital, weighted by the proportion of equity and debt in its financing structure.
• Calculation : WACC = (E / V × Re) + (D / V × Rd × (1 – Tc)), where E is the value of equity, D is the value of debt, V is the value of the firm, Re is the cost of equity, Rd is the cost of debt, and Tc is the tax rate.
Internal Rate of Return (IRR)
• Description : The internal rate of return is an indicator of the expected return on an investment project. It is often used to compare different investment projects or mergers.
• Calculation : IRR is the rate that cancels out the NPV (net present value) of a project.
Depreciation and Amortization (D&A)
• Description : These are non-cash expenses that reflect the wear and tear of tangible assets (depreciation) or the expiration of the value of intangible assets (amortization) of a business over time.
Capital Gains Deduction (CGD)
• Description : The capital gains deduction (CGD) is a Canadian tax mechanism that allows an individual to benefit from a tax reduction when selling certain types of eligible assets, such as shares in a small business or farm or fishing property. This means that a portion of the capital gain realized on the sale is exempt from tax, up to a limit defined by Canadian tax law.
• Example : If an entrepreneur sells eligible shares of his or her Canadian-controlled private corporation and realizes a capital gain, he or she may be eligible for the capital gains deduction, which would reduce the amount of the taxable gain. In 2024, the maximum CGC amount is $971,190 for eligible small business shares.
• Calculation : If you realize a capital gain of $1,000,000 on the sale of your eligible shares, the capital gains deduction would exempt up to $971,190 , and you would only be taxed on the difference, or $28,810.
• Background : This deduction is particularly useful for entrepreneurs and individual investors when they sell eligible businesses or assets, allowing them to significantly reduce the tax burden associated with the transaction.
Legal Terms
Letter of Intent (LOI)
• Description : Preliminary document describing the terms proposed in an acquisition.
Exclusivity Agreement
• Description : Grants a potential buyer an exclusive period to negotiate an acquisition.
Covenant not to Compete (non-compete)
• Description : Clause prohibiting the seller from competing with the buyer after the sale.
Compensation
• Description : Guarantee provided by the seller to the buyer to protect him against possible losses.
Asset Purchase Agreement (APA)
• Description : Contract specifying which assets are acquired in the transaction.
Non-Disclosure Agreement (NDA)
• Description : Confidentiality agreement to protect information exchanged during negotiations.
Representations and Warranties
• Description : Formal statements regarding the financial and legal situation of the company.
Non-compete clause
• Description : Clause prohibiting the seller from creating a competing business for a certain period of time.
Shareholders' agreement
• Description : Shareholders' agreement to govern corporate governance after a merger.
Preemption clause
• Description : Gives current shareholders the right to purchase new shares before they are offered to third parties.
Regulatory Compliance
• Description : Legal obligation to comply with laws and regulations, particularly in tax and environmental matters.
Hart-Scott-Rodino Act (HSR Act)
• Description : US law requiring companies to notify authorities before a major acquisition.
Due Diligence
• Description : Process of verifying the accuracy of financial, legal and operational information before the transaction is concluded.
Indication of Interest (IOI)
• Description : Preliminary indication from a potential buyer showing interest in acquiring the business.
Holdback
• Description : Portion of the purchase price held back to cover possible claims after closing.
Contingent Consideration
• Description : Conditional payment based on the future performance of the business after the sale.
FCPA (Foreign Corrupt Practices Act)
• Description : U.S. law prohibiting bribery and corruption in international acquisitions.
Data Room
• Description : Secure space where sensitive information about a company is shared during the due diligence process.
Escrow Account
• Description : Account in which part of the sale price is retained in case of claims.
Payment and Financing Structures
Earnout
• Description : Payment device based on future performance.
Equity Carve-Out
• Description : Partial sale of a subsidiary or division via an IPO.
Fairness Opinion
• Description : Report from an independent third party confirming that the terms of the transaction are fair.
Good Faith Deposit
• Description : Amount paid by the buyer to demonstrate his commitment to finalize the acquisition.
Purchase Price Allocation (PPA)
• Description : Allocation of the purchase price to specific assets acquired in a transaction.
Stock Swap
• Description : Exchange of shares of the acquiring company for shares of the target company.
Dilution
• Description : Reduction in the participation of existing shareholders following the issue of new shares.
Contingent Value Rights (CVR)
• Description : Additional rights granted to shareholders based on the future development of the acquired assets.
Debt Financing
• Description : Debt financing to finance an acquisition.
Bridge Loan
• Description : Temporary loan used to cover immediate needs before long-term financing is finalized.
Equity Financing
• Description : Raising capital by issuing shares.
Convertible Debt
• Description : Debt that can be converted into equity at a later date.
Extraordinary dividend
• Description : Special dividend paid after an acquisition to redistribute excess cash.
ESOP (Employee Stock Ownership Plan)
• Description : Employee participation plan in the company's shareholding.
Acquisition Strategies
Merger
• Description : Merger of two companies to create a new single entity. The two companies cease to exist separately and their assets and liabilities are combined.
Acquisition
• Description : Purchase of one company by another. The acquiring company obtains a majority stake, often more than 50%, of the shares of the target company.
Horizontal Merger
• Description : Merger of two companies that operate in the same industry and at the same level of the production chain. The goal is often to eliminate competition or increase market share.
Vertical Merger
• Description : Merger between a company and one of its suppliers or distributors. This allows the integration of additional stages in the production or distribution chain.
Conglomerate Merger
• Description : Merger between two companies that have no direct relationship in their sectors of activity. This allows for diversification of activities and reduction of risks related to a single market.
Synergies
• Description : Benefits obtained through the merger of two companies, often in the form of cost reductions (operational synergies) or increased revenues.
Hostile Takeover
• Description : An attempt to acquire a company against the wishes of its management. This is often done by going directly to shareholders to obtain a majority of the shares.
Friendly Takeover
• Description : Acquisition approved by the board of directors of the target company, which facilitates the transaction.
Forward Integration
• Description : Acquisition strategy where a company purchases a distributor or retailer in the production chain in order to control the distribution process.
Backward Integration
• Description : Strategy where a company purchases a supplier to secure the supply chain.
Tender Offer
• Description : A public offer made to shareholders of a target company to purchase their shares at a price higher than the market price, in order to obtain control of the company.
Greenmail
• Description : A tactic where an investor acquires a large stake in a company, threatening a hostile takeover, and forces the company to buy back its shares at a higher price to avoid the takeover.
Golden Parachute
• Description : Substantial financial compensation paid to a company's executives if they lose their jobs following a merger or acquisition.
Poison Pill
• Description : A defense strategy against a hostile takeover, where the target company makes its shares less attractive to the acquirer, often by allowing existing shareholders to purchase shares at a discount.
Gray Knight
• Description : A third party involved in a hostile acquisition attempt, often seen as a more favorable alternative to the “Black Knight” (the initial hostile acquirer).
Black Knight
• Description : A term for a company or individual seeking to acquire a company in a hostile manner.
Crown Jewels Defense
• Description : Defensive strategy in which the target company sells its most valuable assets to make the acquisition less attractive.
Dead Hand Provision
• Description : A protective clause in a “poison pill” that only allows the old management to disable the defensive strategy, even after it has been replaced.
Defensive Merger
• Description : Merger or acquisition aimed at avoiding a hostile takeover attempt.
Scorched Earth Policy
• Description : An extreme strategy where a company sells its core assets to discourage a hostile acquirer.
Godfather Offer
• Description : An acquisition offer so attractive that the board of directors of the target company cannot reasonably refuse it.
White Knight
• Description : A friendly acquirer who steps in to buy a company threatened by a hostile acquisition.
Golden Handcuffs
• Description : A set of financial incentives aimed at retaining key executives after an acquisition or merger.
Dawn Raid
• Description : Quickly purchasing a large amount of shares in a target company when the markets open to gain control.
Reverse Merger
• Description : Acquisition where a private company buys a public company to avoid the lengthy and costly process of an IPO.
Governance and Management
Succession plan
• Description : Planning for leadership transition, often to ensure continuity of operations after the sale or acquisition of a business.
Management Buyout (MBO)
• Description : Acquisition of a company by its existing management team, often financed by debt.
Board of Directors
• Description : Governing body that oversees the management of the company and makes key strategic decisions, including mergers and acquisitions.
Golden Handshake
• Description : Significant financial compensation offered to executives when they leave the company, often after a merger or acquisition.
Change of control
• Description : When the majority of shares of a company are sold, resulting in a transfer of management and decision-making power.
Right of First Offer
• Description : Right given to existing shareholders to make an offer before a company is sold to a third party.
Exit Strategy
• Description : A plan of action for an investor or owner to exit a business, often through sale or IPO.
External Growth
• Description : Growing a business through acquisitions or partnerships, rather than internally.
Corporate Governance
• Description : System of control and management of companies, guaranteeing responsible and transparent management.
Interim Financing
• Description : Temporary financing to cover short-term needs before the finalization of a larger transaction.
Integrator
• Description : Person or team responsible for overseeing the integration of businesses after a merger.
Integration Planning
• Description : Planning the integration process after a merger or acquisition, aiming to combine corporate operations and cultures.
Chief Restructuring Officer (CRO)
• Description : Responsible for restructuring a company during a period of crisis or after an acquisition.
Acquisition Committee
• Description : Internal committee responsible for evaluating and overseeing potential acquisitions.
Strategic and Operational Terms
Economies of Scale
• Description : Reduction in unit costs through increased production following a merger or acquisition.
Economies of Scope
• Description : Reducing costs by producing multiple products or services simultaneously in a merged company.
Integration
• Description : The process of combining systems, people, and cultures after a merger.
Knowledge Transfer
• Description : Sharing of expertise, skills and knowledge between the merged companies.
Joint Venture (JV)
• Description : Business partnership between two companies to carry out a joint project, with sharing of risks and profits.
Operational Synergies
• Description : Efficiency gains achieved by combining the operations of two companies after a merger or acquisition.
Breakup Fee
• Description : Amount that the target company agrees to pay to the potential acquirer if it decides to end negotiations in favor of another buyer.
Financial synergies
• Description : Expected financial benefits from a merger or acquisition, such as reduced costs or increased revenues from the combination of businesses.
Spin-off
• Description : A transaction in which a company creates a new, separate entity by distributing the shares of that entity to existing shareholders.
Business Valuation
Business valuation is a key element of mergers and acquisitions because it helps determine the fair value of a target business prior to a transaction. There are several methods for valuing a business, each with its advantages depending on the circumstances. This section explores the main valuation methods and the terms that come with them.
1. Market Multiples Method
• Description : This method involves comparing the target company with other similar companies that have recently been sold or are publicly traded. Commonly used ratios include EBITDA multiple, revenue multiple, or net income multiple.
• Example : If a company in the same industry sells for 6 times its EBITDA and the target company generates an EBITDA of $2 million, its value could be estimated at $12 million (6 x $2M).
• Related terms :
• EBITDA multiple
• Multiple of turnover
• Comparable Companies (Comps)
2. Discounted Cash Flow (DCF) method
• Description : The discounted cash flow (DCF) method assesses the value of a company by projecting its future cash flows and discounting them at a rate that corresponds to the company's risk and its cost of capital. It is a method often used when future cash flows are predictable.
• Calculation : Net present value (NPV) of future cash flows.
• Example : If a company forecasts annual cash flows of $1 million for the next 5 years, and its cost of capital is 10%, the DCF method will discount these flows to arrive at present value.
• Related terms :
• Discounted Cash Flow (DCF)
• Cost of capital
• Net Present Value (NPV)
• Discount rate
3. Book Value Method
• Description : This method values a company by taking the net value of its assets after deducting its liabilities. It is often used for companies in very capital-intensive sectors, such as real estate or industrial production.
• Example : If a company has assets worth $10 million and liabilities of $3 million, the net worth would be $7 million.
• Related terms :
• Net assets
• Book value
• Fixed assets
4. Comparable Transactions Valuation Method (Precedent Transaction Analysis)
• Description : This method compares the target company to similar companies that have recently been transacted in the same industry. It uses the same market multiples, but based on actual transactions and not on publicly traded companies.
• Example : If a similar company in the same industry was sold at a multiple of 8 times EBITDA, the target company might have a value based on that multiple.
• Related terms :
• Comparable transactions
• Transaction multiples
5. Liquidation Value Method
• Description : This method is used when the company is facing forced liquidation. It determines the value of the company's assets if they were sold quickly on the market, often at prices below their book value.
• Example : If a company needs to sell its assets, such as machinery or inventory, quickly, they may be valued at significantly lower values than their original value.
• Related terms :
• Liquidation value
• Tangible assets
• Forced liquidation
6. Adjusted Net Asset Method
• Description : This method values a company by revaluing its assets at their current market value and subtracting liabilities. It is often used for companies whose assets have increased in value over time, such as real estate or patents.
• Example : If land owned by the company has increased in value over the years, the adjusted asset method would revalue that asset to its fair market value prior to the transaction.
• Related terms :
• Revalued assets
• Adjusted liabilities
• Market value of assets
7. Return on Equity (ROE) method
• Description : This method is based on the return generated by the equity invested in the company. It measures the return on equity and is used to evaluate the performance of the company.
• Calculation : ROE = Net income / Equity.
• Example : If a company has a net profit of $500,000 and its equity is $2 million, its ROE would be 25%.
• Related terms :
• Return on equity
• Equity performance
Differences between a merger, an acquisition and a joint venture
In business expansion strategies, the terms merger , acquisition , and joint venture often come up, but they represent distinct transactions. Each of these methods has different implications for the structure and management of the companies involved. Here are the main differences between these concepts:
Merger
A merger occurs when two separate companies combine to form a new entity, merging their assets, operations, and legal identities. In a merger, the two companies cease to exist separately and now operate as a single, unified entity. This type of transaction is often used to leverage operational synergies, increase market share, or strengthen competitiveness.
• Types of merger :
• Horizontal merger : When two companies in the same industry merge, often to reduce competition. For example, the merger between pharmaceutical companies Glaxo Wellcome and SmithKline Beecham to create GlaxoSmithKline.
• Vertical merger : When companies in the same production chain merge, for example a component manufacturing company merging with its supplier.
• Conglomerate merger : Merger between companies from completely different sectors, with the aim of diversifying activities.
• Example : The merger between Exxon and Mobil in 1999, creating ExxonMobil, is one of the largest mergers in history, aimed at combining forces in the oil industry.
Acquisition
In an acquisition , one company buys another. Unlike a merger, the acquired company typically continues to exist as a separate entity, although under the ownership or control of the buyer. There are two types of acquisitions:
• Friendly : When the target company approves the purchase, often with the agreement of the board of directors. Both parties work together for a smooth transition.
• Hostile : When the target company does not approve of the acquisition, and the acquirer attempts to gain control by repurchasing enough shares to gain a majority without the consent of the board of directors.
The acquisition may include the purchase of all of the target company's shares or only a portion sufficient to obtain majority control.
• Example : Amazon's $13.7 billion acquisition of Whole Foods in 2017 was a friendly acquisition, with Amazon buying the supermarket chain to strengthen its presence in the food sector.
Joint Venture (JV)
A joint venture is a temporary cooperation between two (or more) companies to carry out a common project. Each company retains its independence, but together they create a separate entity dedicated to a specific objective. Unlike a merger or acquisition, a joint venture does not mean a complete merger of operations or assets. The partners share the risks, benefits and resources needed for the project.
• Characteristics of joint ventures :
• Usually created for specific projects with a limited duration (new market, new product, new technology).
• Allows companies to share development costs, reduce risks and benefit from the expertise of a partner.
• The companies remain independent outside the joint entity.
• Example : The joint venture between Sony and Ericsson gave birth to Sony Ericsson, a manufacturer of mobile phones. This cooperation aimed to combine Sony's expertise in consumer electronics with Ericsson's expertise in telecommunications.
These three concepts – merger, acquisition and joint venture – offer different solutions for companies looking to grow, diversify or improve their market position. The choice between these strategies depends on the specific objectives of each company, its size, and the possible synergies with its partners or targets.
