Embarking on the journey to buy a small to mid-sized business (SMB) can be both exciting and daunting. One of the first hurdles you’ll encounter is the specialized terminology used in the industry. Understanding these terms is crucial as it can significantly impact your decision-making process and overall experience.
To help you feel more confident and informed, especially if you’re a first-time buyer, we’ve compiled a comprehensive list of key terms you’ll likely encounter. Let’s dive in and demystify the jargon so you can navigate your SMB search with ease and assurance!
APA (Asset Purchase Agreement)
This stands for Asset Purchase Agreement. This is an agreement that is drafted after the due diligence stage is completed and outlines what will be included in the sale, as well as the purchase price and any other terms as part of the sale.
Unlike a Letter of Intent (LOI), an Asset Purchase Agreement is binding. It is important to note that APAs are only signed for asset sales, whereas a Stock Purchase Agreement (SPA) is signed for stock sales.
Deal Structure
This is how the deal is structured, generally proposed by the buyer and then negotiated. It may be an upfront full cash offer or some sort of partial cash and earn-out offer. The deal structure may also include seller financing. Ultimately, it simply comes down to what’s negotiated between the Seller and the Buyer, as well as market conditions and demand for the business.
Due Diligence Period
This is generally a 30+ day period — typically longer for larger deals and shorter for smaller deals — after an LOI is executed where a buyer may ask for any documents to vet the business. During this period, the buyer generally has exclusivity to conduct due diligence and ultimately buy the business, and the seller agrees to not entertain other offers.
While this period indicates a serious intention to purchase, it is not binding, and either party may still walk away at any time. This is also generally where third-party advisors or due diligence service providers — such as Rapid Diligence — come in.
Investment Thesis / Investment Criteria
This defines what type of business a searcher or buyer is looking for. This generally includes the type of business, the purchase price, multiple, and more.
LOI (Letter of Intent)
A Letter of Intent (LOI) is generally submitted by the buyer to the seller when a buyer is seriously considering buying a particular business. An LOI — as the name states — simply demonstrates interest or intent to purchase the business and does not create a legally binding requirement in which the buyer must buy the business.
However, it does allow the buyer and seller to come to an agreement on price and general terms — which are subject to change depending on due diligence outcomes — and allows the buyer an exclusive 30-90+ day period to conduct due diligence on the business with exclusivity. Once an LOI is “executed” (signed by both parties), the exclusive due diligence period begins.
- Post-LOI: This simply refers to the period after an LOI is executed.
- Pre-LOI: This refers to the period before an LOI is executed. In context, this is generally a bit different than the search phase, which is technically also pre-LOI.
Earn-Out
Earn Out
This is generally a fraction of the deal that is not paid upfront and instead is paid to the seller post-acquisition and tied to performance metrics. For example, 5% of the total purchase price may be paid back as an earn-out over the course of twelve months post-acquisition, as long as the business’ monthly income does not fall below $10K per month.
Earn-outs tend to be a larger component of the overall deal structure when there tends to be greater uncertainty with the business, such as lack of history, declining financials, and more.
EBITDA
This stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This is a bit different from net profit but is generally what’s used to determine how much a business is making to then ultimately place a value upon it for purchase.
List Price
The price that the business is listed at by a broker or the seller themselves. This does not necessarily equate to the price that the business is actually purchased at.
Earnings Multiple
This refers to how many times the EBITDA the business will be valued at. Strong businesses are valued at higher multiples, generally based on the type of business, how long it’s been around, the defendability of its offering, and growth.
Personal Guarantee
This is when a loan, such as an SBA loan, requires the loanee to tie some or all of their personal assets to the loan as collateral. In the event of a default, this allows the loaning institution to claim those assets.
In general, loans with a personal guarantee tend to have a lower interest rate, as they are viewed as less risky by the loaning institution.
Purchase Price
This is the price that the business is actually being sold at. It may differ from the list price and is generally lower than the list price (after negotiations) but can also be higher.
QoE (Quality of Earnings)
A Quality of Earnings is a complete review of the business’ financials, including income, expenses, and add-backs. It is generally also a reconstruction of the Profit and Loss statement.
PRO TIP: A Quality of Earnings can vary in both price and thoroughness, based on the firm that is providing it. We recommend always asking for a sample of the final deliverable, as well as gauging the credentials of the individual or team completing it. Ideally, your QoE should be completed by a CPA with SMB M&A experience, because that is ultimately what you’re purchasing.
SBA (Small Business Administration)
This stands for the Small Business Administration, a government entity in the United States that backs parts of the loans provided by banks.
A lot of SMB buyers use SBA loans to fund their deals. Currently, the SBA will cover loans up to $5M USD for business acquisitions.
Searcher / Search Fund
This is someone who is “searching” for a business to buy full-time, either individually through their own capital or through a search fund, generally backed by investors.
Search Phase
This is the period during which a client is still searching for a business that fits their criteria.
Seller Financing
This is where the seller provides financing for part of the deal. In essence, the buyer provides payment to the seller — generally with interest — until the loan is paid off. Unlike an earn-out, this is generally not tied to performance metrics.
SMB
Stands for small and medium-sized businesses, which is what most searchers are looking to acquire. This differs from large enterprises and corporations.
Target
This refers to the business the buyer is considering. You may see it used as “What’s the target’s list price?”
Valuation
A valuation is simply what the business is claimed to be worth. Different parties provide different valuations. When brokers provide a valuation, they use that number to come up with a list price.
At Rapid Diligence, we also provide valuations on our reports, which are based on the actual sale price of similar businesses we’ve seen. Generally, a valuation is simply EBITDA x multiple.
Conclusion
Buyers and sellers can use these phrases as a starting point for negotiations and a guide through the many legal and practical considerations involved in a purchase. However, it should be noted that each transaction’s specifics are different. Thus, other conditions may be applicable.
Thinking of Buying a Business?
Taking the leap into your first (or hundredth) acquisition? Our team at Rapid Diligence is here to offer a wide range of due diligence services for your small business acquisition. If you have questions or are still trying to figure out where to begin, set up a free call with our team to discuss how we can help you find your perfect business.
