Terminology You Need To Understand When Buying and Selling Business

Keiran James

Keiran James is a Registered Business Valuer (RBV) and the co-founder of BusinessSales.com.au.

Keiran has a Business and Commerce degree from the University of Newcastle and prior to BusinessSales Keiran worked as an Investment Advisor to High-Net clients investing in domestic and international shares and as a buyers agent helping business owners get into business and expand through acquisitions.

Table of Contents

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 the value of ownership that can be converted into cash.

Assets can be tangible assets e.g. a computer or intangible e.g. a brand name.

 

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 companies 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.

This is the most common type of sale for small businesses (under $5M). The other option is a “share sale”.

 

Balance Sheets

The term balance sheet refers to a financial statement that reports a business’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.

As a buyer, the balance sheet is very important in a share sale, but not as important in an asset sale as no liabilities are transferred to you.

 

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 you determine where a business fits in 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

**Over the past few years the Australian government has allowed businesses to use various forms of accelerated depreciation. This makes the book value essentially irrelevant for small businesses.

Here’s a guide on how to value your business properly.

Business

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

  1. Sole Trader – A type of business enterprise or proprietorship that is owned by one person who is fully liable for the business’s debts and fulfilment of contracts with their personal wealth.
  2. Partnership – A type of business enterprise or proprietorship that is owned by two or more people who are fully liable for the business’s debts and fulfilment of contracts with their personal wealth.
  3. Proprietary Limited Company (Pty. Ltd.) – private company limited by shares. Where the shareholders are not personally liable for the company’s debts.
  4. Trust – A trust is a structure where a trustee carries out the business on behalf of the trust’s members (or beneficiaries).

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.

Here’s a guide on how to use the capitalisation rate to value your business properly.

 

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).

At BusinessSales we use a confidentiality deed which is similar but doesn’t require “consideration” to be enforceable like an agreement does. You should ask your lawyer for more information if you have questions. 
 

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 that 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, a 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 choose not to pay themselves the market level of compensation that similar executives in the industry might earn for various reasons. 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 need to be adjusted in order for the business to be valued properly.

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.

Currently, the Australian government allows businesses various forms of accelerated depreciation so it’s important to check this with your accountant. 

 

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.

Currently, the Australian government allows businesses various forms of accelerated depreciation so it’s important to check this with your accountant. 

 

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.

Here’s a detailed guide on how to value your business properly.

 

Estoppel

Is a legal doctrine where a party is barred from claiming or denying an argument on an equitable ground. An example of this is, a seller might inform potential buyers 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.

 

Unconditional 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 unconditional status which then binds both parties legally.

Exit Strategy

A method a business owner intends to use to get out of a particular investment. E.g. selling your business. 

Fair Market Value

It depends on who you ask!

The High Court stated in Spencer v. Commonwealth that the value of land on a given day is determined by inquiring “What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?”

The International Valuation Standards (IVS) define Market Value as “The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.”

Today most professional business valuers use the IVS definition of market value.

Here’s a detailed guide on how to value your business properly.

 

Financial Adjustments

Are the normalisation of financial accounts to reflect the operational profit of a business. 

GAAP

Generally Accepted Accounting Principles. These are US based, in Australian we use the AASB (Australian Accounting Standards Board) standards 


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 covers all the intangible aspects of a business such as the brand and reputation.

When buying a business the difference between the purchase price and the net asset position is the goodwill component.

 

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 business advice relevant to your circumstances.

 

Heads of Agreement (HoA)

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. It’s typically not binding. 

 

Incorporated (Inc.)

Restricted to non-profit associations.

Information Memorandum

A document that describes a business and its financial performance. This document is prepared to help buyers, their accountant and their bank understand the business and sellers having to answer the same questions for every buyer. The Information Memorandum should not mislead and is distributed to potential financial and strategic buyers after the execution of a confidentiality deed.

An Information Memorandum is included in our silver listing package.

See a sample Information Memorandum here.

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 ability 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 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 / business owner or business broker and then by using any marketing channel or medium to share the opportunity.

BusinessSales.com.au is Australia’s Only Live Business Sales Platform

Our platform was purpose-built to allow professional business brokers and hardworking business owners to connect with active, verified potential buyers looking for their next move and pass the baton on to a new owner. 

When listing your business for sale on BusinessSales you can be sure that you have the tools you need to maintain confidentiality so you can protect your business value and enable your transition on the best possible terms.

 

Market price

The price at which a business can be bought and sold at an open market.

Here’s a detailed guide on how to value your business properly.

 

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 others. An NDA may also be referred to as a confidentiality agreement.

At BusinessSales we use a confidentiality deed which is similar but doesn’t require “consideration” to be enforceable like an agreement does. You should ask your lawyer for more information if you have questions. 

 

Negotiation

Is dialogue intended to resolve disputes, produce an agreement upon courses of action, bargain for individual or collective advantage, or craft outcomes to satisfy various interests. 

It’s normal for the buyer and seller of a business to have a negotiation over the price of the business.

Here’s a detailed guide on how to price your business for sale with this in mind.

 

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.

Here’s a detailed guide on how to value your business properly.

 

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 that contains terms sufficiently definite to create an enforceable contract if the other party accepts the invitation.

Offers are typically non-binding until a contract is signed. 

 

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 that 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 brokers, finance brokers, solicitors/lawyers and bookkeepers.

 

Profit and Loss Trading Statements

A profit and loss statement is a record of financial information such as 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 party selling a business or their advisors and is distributed to potential financial and strategic buyers after the execution of a confidentiality agreement.

An Information Memorandum is included in our silver listing package.

See a sample Information Memorandum here.

 

Share Sale

What is the difference between a share sale and a 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 both the company’s assets and liabilities.

This is the most common type of sale for medium-sized businesses (over $5M). The other option is an “asset sale” where 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 the same an approval because it does not include verification of the information provided by the buyer.

Risk

The probability of incurring loss.

Rule Of Thumb Method

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

Here’s a detailed guide on how to value your business properly.



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 manager).

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

From a proprietor’s point of view – when the owner is operationally involved in their own business.

This is based on one full-time working owner only. If a business is run by a husband and wife couple, then market based wages would need to be included for one member of the couple. 

  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.

Calculating these properly can be complicated – Here’s a detailed guide on how to value your business properly or ask your accountant to do it for you. 

 

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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