Terminology You Need To Understand When Buying or Selling A Business

The following definitions are regularly used in business sales transactions in Australia.

Acceptance

The act of taking something that is offered with approval.

Asking Price

Is a price a seller of a good is willing to accept for that particular property. It is also the price a seller is hoping to achieve for a particular property.

Amortisation

Amortization can refer to the process of paying off debt over time in regular instalments of interest and principal sufficient to repay the loan in full by its maturity date.

Asset

In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything that can be used to produce positive economic value. Assets represent value of ownership that can be converted into cash

ASIC

The Australian Securities and Investments Commission is an independent commission of the Australian Government tasked as the national corporate regulator. ASIC’s role is to regulate company and financial services and enforce laws to protect Australian consumers, investors and creditors.

Asset Sale

In an asset sale, a firm sells some or all of its actual assets, either tangible or intangible. The seller retains legal ownership of the company that has sold the assets but has no further recourse to the sold assets. The buyer assumes no liabilities in an asset sale.

Balance Sheets

The term balance sheet refers to a financial statement that reports a company’s assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company’s capital structure.

BAS Statements

A Business Activity Statement (BAS) is a statement that businesses must submit to the Australian Taxation Office (ATO) in order to report and pay their tax liabilities. A large part of BAS is related to GST collected and PAYG liability.

Benchmarks

Industry Comparison benchmarking for business valuation is important because the results help the analyst determine where a business fits on the value range.  The value range can be thought of as the price spectrum that businesses have actually sold for in specific industries.

It is important to note various definitions can apply in different scenarios.

Book Value Method

It is the equity of a company which is arrived at after the values of assets and liabilities are adjusted. It represents the estimated market value.

Business

Is a legally recognised organisation designed to provide goods and/or services to consumers. There are many types of businesses entities including:

  1. Sole Trader – A type of business enterprise or proprietorship which is owned by one person who is fully liable for the company’s debts and fulfilment of contracts with their personal wealth.
  2. Partnership – A type of business enterprise or proprietorship which is owned by two or more people who are fully liable for the company’s debts and fulfilment of contracts with their personal wealth.
  3. Proprietary Limited Company (Pty. Ltd.)– private company limited by shares.
  4. Proprietary Limited Company As Trustee For A Trust (Pty. Ltd. ATF) – In Australia companies can act as a trustee for a trust.

Business Profile

A format for presenting, illustrating and describing a business and its financial performance. This document is prepared at varying levels depending on the business which in all cases should not mislead and is distributed to potential financial and strategic buyers after the execution of a confidentiality agreement.

Buyer

A person who contracts to acquire an asset in return for some form of consideration.

Information Brief

A format that describes a business and its financial performance. This document is prepared at varying levels (usually a short form version of an information memorandum) which should not mislead and is distributed to potential financial and strategic buyers after the execution of a confidentiality agreement.

Capitalisation Rate Multiple

Is a measure of the ratio between the net profit income produced by an asset and its current market value. There are different capitalisation rates used for different net profit types.

Comparability Adjustments

An adjustment made to a financial statement to facilitate a comparison between the subject company and other businesses in the same industry or geographic location. These adjustments are intended to eliminate differences between the way that published industry data is presented and the way that the subject company’s data is presented in its financial statements.

Competitors

A business relationship in which two or more parties compete for customers.

Confidentiality Agreement (CA)

Is a legal contract between at least two parties that outlines confidential materials or knowledge the parties wish to share with one another for certain purposes, but wish to restrict access to. It is a contract through which the parties agree not to disclose information covered by the agreement. (It is also known as a non-disclosure agreement (NDA), confidential disclosure agreement (CDA), proprietary information agreement (PIA), or secrecy agreement).

Consideration

Is a concept of legal value in contract law. It is a promised action, or omission of action, that the promisee did not already have a pre-existing duty to abide by. It can take the form of money, physical objects, services, or a forbearance of action. Both parties to a contract must pass consideration to the other party for there to be a valid contract.

Contract

Is an exchange of promises between two or more parties to do, or refrain from doing, an act which is enforceable in a court of law. It is a binding legal agreement. For a contract to exist it must satisfy the following concepts: Offer, acceptance, consideration, estoppel and intention to be legally bound.

Contractual Terms

Is any provision forming part of a contract. Each term gives rise to a contractual obligation, breach of which can give rise to litigation. Not all terms are stated expressly and some terms carry less legal gravity as they are peripheral to the objectives of the contract. For a list of common terms please read the standard terms and conditions of a contract.

Discretionary Adjustments

The owners of private companies may be paid at variance from the market level of compensation that similar executives in the industry might command. In order to determine fair market value, the owner’s compensation, benefits, perquisites and distributions must be adjusted to industry standards. Similarly, the rent paid by the subject business for the use of property owned by the company’s owners individually may be scrutinised.

Depreciation

The term depreciation refers to an accounting method used to allocate the cost of a tangible or physical asset over its useful life. Depreciation represents how much of an asset’s value has been used. It allows companies to earn revenue from the assets they own by paying for them over a certain period of time.

Depreciation Schedule

A depreciation schedule charts the loss in value of an asset over the period you’ve designated as its useful life, using the accounting method you’ve chosen. The point of having a depreciation schedule is to give you the ability to track what you’ve already deducted and stay on top of the process.

Due Diligence

Due diligence is an investigation, audit, or review performed to confirm facts or details of a matter under consideration. In the financial world, due diligence requires an examination of financial records before entering into a proposed transaction with another party.

Earnings Capitalisation Method

A common income-based valuation method that establishes the business value by multiplying the expected business economic benefit, such as the EBITDA, by the capitalisation rate multiple.

Estoppel

Is a legal doctrine where a party is barred from claiming or denying an argument on an equitable ground. An example of which is, a seller might inform a buyer that a vehicle is included in the purchase of a business. If the buyer relies on this notice, the seller could be estopped from not including the vehicle in the transaction.

Un-conditional Exchange of Contracts

Exchanging contracts legally completes the business sale process. It means the seller has accepted the buyer’s offer on the business and both have signed the contract of sale. A conditional exchange of contracts is the above definition that still has some component to be satisfied before reaching un-conditional status which then binds both parties legally.

Exit Strategy

A method a business owner intends to use to get out of a particular investment.

Fair Market Value

A reasonable price for securities based on supply and demand.

Financial Adjustments

Are the normalisation of financial accounts to reflect the operational profit of a business. The most common normalisation adjustments fall into the following four categories:

GAPP

Are generally accepted accounting principles.

Going Concern

A going concern is a business that is assumed will meet its financial obligations when they fall due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period.

 

Goodwill

Goodwill is an intangible asset that is associated with the purchase of one company by another. Specifically, goodwill is the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process.

 

GST

Goods and services tax (GST) is a tax of 10% on most goods, services and other items sold or consumed in Australia. If your business is registered for GST, you have to collect this extra money (one-eleventh of the sale price) from your customers. You pay this to the Australian Taxation Office (ATO) when it’s due.

GST is not typically payable on the sale of a business (but it is in some circumstances) – you should get professional advice relevant to your circumstances. 

Heads of Agreement

Heads of agreement will typically include a statement on the purpose of the document, an overview of the proposed transaction, clauses on confidentiality and publicity, clauses on exclusivity, a clause about the enforceability of the document, a timeline, and any other terms that have been agreed at that stage.

Incorporated (Inc.)

Restricted to non-profit associations.

Information Memorandum

A booklet that describes a business and its financial performance. This document is prepared as sell-side advisory engagement, which should not mislead and is distributed to potential financial and strategic buyers after the execution of a confidentiality agreement.

Intention To Be Legally Bound

There is a presumption for commercial agreements that parties intend to be legally bound. There are some parties that can not be legally bound they include people under the age of 18 (except under very specific circumstances) and mentally ill individuals.

Intrinsic Value

The inherent value of a business independent of its operational worth.

Legal Entity

Any individual, partnership, proprietorship, corporation, association or other organisation that has, in the eyes of the law, the capacity to make a contract or an agreement and the abilities to assume an obligation and to pay off its debts. A legal entity, under the law, is responsible for its actions and can be sued for damages.

Limited (Ltd.)

Private companies limited by guarantee, such as a charity or university.

Limited Partnership

Similar to a partnership except the partners are liable only to the extent of their original investment.

Business Listing

This is when a business has been offered for sale. The way it is “listed” can vary from a private seller or business broker and then by using any marketing channel or medium to share the opportunity.

Market Analysis

A systematic investigation of the growth and the composition of a market.

Market price

The price at which a product, financial instrument, service or other tradable item can be bought and sold at an open market.

Memorandum of Understanding

Similar to a contract, a memorandum of understanding is an agreement between two or more parties. Unlike a contract, however, an MOU need not contain legally enforceable promises. While the parties to a contract must intend to create a legally binding agreement, the parties to an MOU may intend otherwise.

 

Mislead

To lead someone to wrong information or to give someone wrong information through action or inaction.

NDA

A non-disclosure agreement is a legally binding contract that establishes a confidential relationship. The party or parties signing the agreement agree that sensitive information they may obtain will not be made available to any others. An NDA may also be referred to as a confidentiality agreement.

Negotiation

Is dialogue intended to resolve disputes, to produce an agreement upon courses of action, to bargain for individual or collective advantage, or to craft outcomes to satisfy various interests. It is the primary method of alternative dispute resolution.

Non-Operating Adjustments

If a business were sold in a hypothetical sales transaction, the seller would retain any assets, which were not related to the production of earnings or price those non-operating assets separately. For this reason, non-operating assets (such as excess cash) are usually eliminated from the balance sheet.

Non-Recurring Adjustments

The company’s financial statements may be affected by events that are not expected to recur, such as the purchase or sale of assets, a lawsuit, or an unusually large revenue or expense. These non-recurring items are adjusted so that the financial statements will better reflect the expectations of future performance.

Offer

An invitation to enter into a binding contract communicated to another party which contains terms sufficiently definite to create an enforceable contract if the other party accepts the invitation.

Owner

The individual or legal entity in legal possession (ownership) of a property.

Ownership

Is the state or fact of exclusive rights and control over property, which may be an object, land/real estate, business, intellectual property or some other kind of property. It is embodied in an ownership right also referred to as title.

Professional

A professional is a person in a profession which requires certain types of skilled work requiring formal training or education. They include but are not limited to bankers, financial and business advisors, accountants, business and finance brokers, solicitors/lawyers and bookkeepers.

Profit and Loss Trading Statements

A profit and loss statement is a record of revenue and expenses incurred by a business in a given period of time. A profit and loss statement is also called a P&L, an income statement, a statement of profit and loss, an income and expense statement, or a statement of financial results.

Selling Memorandum (also called an Information Memorandum or IM)

A booklet that describes a business and its financial performance. This document is prepared by the seller or their advisors and is distributed to potential financial and strategic buyers after the execution of a confidentiality agreement.

Share Sale

What is the difference between a share sale and business sale?

If you sell all the shares in your company, the buyer is taking ownership of the company. Therefore, they are taking control of the company’s assets and liabilities. Typically, when you sell a business, the buyer will not take on the company’s liabilities which were in existence before the sale.

 

Strategy

Are a plan of action designed to achieve a particular goal.

Qualification

Is the initial process to verify that a potential buyer has fulfilled enough requirements to purchase a business. Qualification is not an approval because it does not include verification.

Risk

The probability of incurring loss or misfortune.

Rule Of Thumb Method

Is a principle with broad application that is not intended to be strictly accurate or reliable for every situation.

Trust

A type of company that acts in the interest of its trusties to disperse income for tax benefit.

Types Of Net Profit

There are many types and ways to show net profit including:

From a management point of view – (including when an owner is a manger).

  1. EBITDA– Earnings before interest, tax, depreciations and amortisation.
  2. EBITD– Earnings before interest, tax and depreciation.
  3. EBIT– Earnings before interest and tax.

From a proprietors point of view – when the owner is operationally involved in the business.

  1. PEBITDA– Proprietors earnings before interest, tax, depreciation and amortisation.
  2. PEBITD– Earnings before interest, tax and depreciation.
  3. PEBIT– Earnings before interest and tax.

Valuation

A business valuation is a general process of determining the economic value of a whole business or company unit. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation, and even divorce proceedings.

 

Vendor

With the sale of a business the vendor is the person or entity that offers the  business for sale. 

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