Glossary
Browse the most commonly used
Terms and Terminologies
Acquisition
The process by which one company purchases most or all of another company’s shares to gain control of that company. Acquisitions are typically made to gain a company’s strengths and resources, such as its brand, customer base, intellectual property, or geographic presence. The acquiring company can absorb the acquired company into its operations, often leading to greater market share and competitive advantage.
Asset Sale
A transaction where a business sells its individual assets rather than its stock. This can include physical assets such as equipment, inventory, and property, as well as intangible assets like trademarks and patents. The buyer typically avoids inheriting the seller’s liabilities, making this a cleaner form of transaction, especially for small businesses or startups looking to sell part of their operations.
Exit Strategy
A plan for how an owner will sell or transfer ownership of their business, designed to maximize the value of the business. Exit strategies include selling the business to another company, merging with another company, going public with an IPO, or selling to a private equity firm. A well-thought-out exit strategy helps ensure the business continues to thrive and meet the owner’s financial goals.
Business Valuation
The process of determining the economic value of a business or company. Business valuation is used to determine the fair market value for various purposes, including sale value, establishing partner ownership, taxation, and even divorce proceedings. Common methods include the asset-based approach, earning value approach, and market value approach.
Capitalization Rate
Also known as cap rate, it is a rate that helps in evaluating the return on investment properties or businesses. It is calculated by dividing the annual net operating income (NOI) by the purchase price of the property. A lower cap rate implies lower risk, while a higher cap rate suggests higher risk but potentially higher returns.
Cash Flow
The total amount of money being transferred into and out of a business, especially in terms of liquidity. Cash flow is a key indicator of a company’s financial health, reflecting its ability to maintain operations, pay debts, and fund growth. Positive cash flow indicates that a company’s liquid assets are increasing, allowing it to settle debts, reinvest in its business, and return money to shareholders.
Due Diligence
A comprehensive appraisal of a business undertaken by a prospective buyer, particularly to establish its assets and liabilities and evaluate its commercial potential. This process involves reviewing financial statements, business operations, legal liabilities, and customer contracts to ensure the buyer is making an informed decision. It is a critical step in mergers and acquisitions to assess risks and benefits.
EBITDA
Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA is a measure of a company’s overall financial performance and is used as an alternative to net income in some circumstances. It helps to compare profitability between companies and industries by eliminating the effects of financing and accounting decisions.
Enterprise Value (EV)
A measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. EV includes the market capitalization of a company but also short-term and long-term debt as well as any cash on the company’s balance sheet. It is often used in valuation ratios like EV/EBITDA to compare companies with different capital structures.
Escrow
A financial arrangement where a third party holds and regulates the payment of funds required for two parties involved in a transaction. It helps ensure that the transaction is secure by keeping the payment in a secure escrow account, which is only released when all the terms of an agreement are met. This is commonly used in real estate and business transactions to protect both buyers and sellers.
Fair Market Value (FMV)
The estimated price at which an asset would trade in a competitive auction setting. It is the price that a willing buyer would pay to a willing seller, with both parties having reasonable knowledge of the relevant facts and neither being under compulsion to buy or sell. FMV is used in various financial contexts, including taxation and business valuation.
Franchise
A type of license that grants a franchisee access to a franchisor’s proprietary business knowledge, processes, and trademarks. The franchisee is allowed to sell a product or service under the franchisor’s business name. In return, the franchisee usually pays a one-time franchise fee plus a percentage of sales revenue as royalty. Franchising allows companies to expand without the high cost of new locations.
Goodwill
An intangible asset that arises when a buyer acquires an existing business. Goodwill represents the portion of the purchase price that is higher than the sum of the net fair value of all of the acquired assets and liabilities. This often includes elements such as brand reputation, customer relationships, employee relations, and intellectual property that give the business a competitive advantage.
Initial Public Offering (IPO)
The process through which a private company offers shares to the public for the first time. Going public allows a company to raise capital from public investors. It also increases the company’s exposure, prestige, and public image. However, it involves significant regulatory compliance and reporting obligations.
Intangible Assets
Non-physical assets such as intellectual property (patents, trademarks, copyrights), brand recognition, and business methodologies. These assets are valuable but do not have a physical presence. They play a crucial role in a company’s value and competitive advantage and are considered in business valuations and mergers and acquisitions.
Leverage Buyout (LBO)
The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans in addition to the assets of the acquiring company. LBOs allow companies to make large acquisitions without having to commit a lot of capital.
Liquidity Event
An occurrence that allows business owners to convert some or all of their ownership into cash. This can include events such as the sale of the business, an initial public offering (IPO), a merger, or acquisition. Liquidity events are significant milestones that provide financial returns to investors and founders.
Market Capitalization
The total market value of a company’s outstanding shares. It is calculated by multiplying the current share price by the total number of outstanding shares. Market capitalization is used to determine a company’s size and evaluate its performance relative to others in its industry.
Merger
The combination of two companies to form a new entity. Mergers are usually done to achieve synergies, expand market reach, increase efficiencies, or gain competitive advantages. They can take various forms, such as horizontal mergers (between companies in the same industry), vertical mergers (between companies in different stages of production), and conglomerate mergers (between companies in unrelated businesses).
Multiple
A factor applied to a financial metric to estimate the value of a business. Common multiples include the price-to-earnings ratio (P/E), EV/EBITDA, and price-to-sales ratio. These multiples help investors and analysts compare the value of different companies and make informed investment decisions.
