The terminology listed in this paragraph is used extensively in the business sales process and Income Approach to Valuation.
Business Selling Terminology
- Owner’s Cash Flow: This constitutes every amount of money that an owner takes out of the business in a fiscal year.
- Owners Discretionary Cash Flow: Same thing as owner’s cash flow.
- EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. Easy to compute from the 1st page of the business tax return, whether a C or S corp. Start near the bottom of the first page of the return and add: net profit before taxes, depreciation, amortization, and interest expense. EBITDA is not a complete figure in a small, closely held corporation. This figure does not include owner’s salary which is a large part of owners cash flow.
- Adjusted EBITDA: This is broker terminology to read EBITDA and owner’s salary as one total. This does not include owner’s perks. Third party lenders (the bank) usually contest owner parks. This is because the borrower (the banks customer) will usually require the same perks to operate the business. i.e. owner’s cars, car expenses, meals, cell expenses etc.
- Owner Add Backs: This is the term for owner expenses in P&L statement that business brokers add to the owner’s cash flow. Unfortunately, lenders will often contest these expenses. This is because the buyer will often have to have the same expenses in running the business. Brokers will use these expenses or “perks” to show prospective buyers what the owner is really realizing out of the business.
- Recasting financials: Broker terms for adding back the “owner add backs” to owner’s cash flow.
- Multiple/s: This is the number that you multiply by adjusted EBITDA to arrive at the sale price. This number is from recently sold market transactions with the same amount of adjusted EBITDA. Further, its the industry type and industry configuration (such as a transportation broker with no fixed assets, as opposed to a transportation company with following stock which would be more valuable.)
- Offering Memorandum: The offering memorandum is the broker’s dossier on the business for sale. The memorandum will have the recast financials and a list of the operational aspects of the business. This document is the roadmap for the parties in starting the selling process.
- Letter of Intent: Usually referred to as the LOI. This document is largely non-binding except for the no shop period. A qualified, motivated buyer will use an LOI to start the purchase process.
- No Shop Clause: The binding period in an LOI. It states the seller cannot entertain other offers or talk to other interested parties for the specific period listed in the letter.
- Definitive Agreement: aka Final Contract, the Contract, the Asset Purchase Agreement, or the Stock Purchase Agreement. Basically, this is the final legal binding contract between the parties that is signed at or in the period just before closing.
- Valuation: Valuation is the method and final product of determining the value of a business. Although the parties in the transaction can arrive at this value, but usually an accredited Valuation Specialist and/or an experienced professional business broker will arrive at this value.
- Income Approach to Valuation. There are several methods of valuating a businesses. The universal method is the Income Approach to Valuation. This approach is the multiple of adjusted EBITDA. Therefore, prospective sellers should become familiar with elements of this valuation method.