Your Definitive Glossary to M+A Jargon
The Anatomy of a Deal Newsletter December 28, 2021
Every specialized field has its own terminology. While it’s handy to have short-hand phraseology for those of us who do this on a day-to-day basis, it can be confusing to those who are new to the process. So this month, we’re bringing you a reference guide to some of the commonly used lingo in the M+A world. We’ve introduced many of these concepts in prior installments, but here they are all in one place. Links have been inserted where we’ve published a more comprehensive overview of certain terms or concepts.
To help illustrate, let’s examine each of these concepts through the lens of the pending sale of Madison Hotels by its new owner, Billy Madison, to an investment group led by the evil Eric Gordon.
- Basket – A limitation on
the seller’s liability for certain breaches of the seller’s
representations and warranties. Losses for which the seller is responsible
to the buyer get aggregated into the basket, and once the basket is
exceeded, the seller then has to pay the buyer.
Comes in two basic forms: “deductible” basket or “tipping” basket (also sometimes referred to as a “threshold”).
Example: Billy negotiates for a $200,000 deductible basket, meaning that Eric can’t make claims against Billy for breaches of the general representations and warranties unless and until Eric has suffered the first $200,000 in losses from such breaches (excluding de minimis losses, as described below).
- Break-up fee – A fee paid by a seller to a buyer if the seller walks away from the deal for certain reasons.
Example: Billy walks away from the deal after signing the agreement because he couldn’t get all of the necessary approvals to close, so Madison Hotels may have to pay a break-up fee to Eric to compensate Eric’s group for its efforts in pursuing the deal.
- Bring-down – General term
to refer to the process by which contractual obligations made at the time
of signing a purchase agreement are renewed as of (or “brought down” to)
Example: The representations and warranties state that there is no litigation at the time the agreement is signed. Eric wants to be sure that this representation and warranty (and others) are “brought down” to the date of closing to ensure no litigation was filed between the date on which the agreement was signed and the date the deal closes.
- Cap – A maximum limitation on the total amount that the seller is obligated to repay to the buyer for losses sustained by the buyer based on certain breaches of the seller’s representations and warranties.
Example: If the deal contains a $5,000,000 cap and all kinds of existing problems get uncovered after the closing, Billy can take some solace in knowing that his total out-of-pocket exposure to Eric for most claims will be limited to $5,000,000.
- CIM – Confidential
information memorandum (or sometimes CIP, confidential information
presentation), which is the
primary marketing document prepared by the investment banker to highlight the investment
opportunity and possible benefits of acquiring the target company.
Example: Billy engages an investment banker to take Madison Hotels “to market” and the investment banker prepares a detailed CIM to share with a universe of potentially interested buyers to drum up interest in a possible transaction.
- Collar – A band or cushion
around various economic terms in the deal whereby the parties effectively
agree not to make certain adjustments/payments to each other, so long as
the actual numbers are “close enough.”
Example: The working capital adjustment is subject to a $50,000 collar. So, if Madison’s closing working capital is $10,000 less than the peg (see definition below), the collar means that there will be no adjustment to the purchase price even though Madison’s working capital was actually a little short of the peg.
- De Minimis (or Mini
– A smaller basket that ignores relatively small individual losses
for purposes of the indemnification entirely; the seller doesn’t have to
indemnify the buyer for these losses at all, and they don’t even count
toward the regular basket or cap—they’re ignored entirely. As the name
implies, the dollar threshold here is quite low.
Example: Billy pushed hard to get a $10,000 de minimis in place so that Eric won’t be coming back on small, nuisance claims after the closing. Billy hates getting “nickeled and dimed.”
- Earnout – Purchase price that is not guaranteed and is instead contingent upon the satisfaction of some condition after the closing.
Example: Billy receives $50,000,000 in cash purchase price at closing, but has the chance to earn up to an additional $5,000,000 in an earnout if Eric’s group achieves certain agreed revenue thresholds during the two years following the closing.
- EBITDA – Earnings Before
Interest, Taxes, Depreciation and Amortization. Most deals are priced as a
multiple of EBITDA.
Example: Eric’s group offers to buy Madison Hotels for a purchase price equal to 6x of Madison’s TTM (see definition below) EBITDA.
- Enterprise value – The
“top line” value of the company without regard for its specific
capitalization, such as debt.
Example: Madison Hotels has a total enterprise value of $50,000,000, but that number isn’t what Billy would get in a sale because of the debt.
- Equity value – The “bottom
line” value of the company that the shareholders actually would receive
Example: Madison Hotels still has a total enterprise value of $50,000,000, but there’s $20,000,000 of debt on the company. So the equity value is only $30,000,000.
- Fundamentals – Short-hand
for “fundamental representations and warranties,” which are certain
representations and warranties that are so fundamental to the transaction
that they generally aren’t subject to many of the limitations of
liability, such as
caps and baskets.
Example: Billy remains responsible for 100% of the losses Eric’s group may suffer from breaches of Madison’s fundamentals, such as the legal organization and existence of Madison as a company, and that Billy actually owns and can transfer to Eric’s group 100% of Madison’s ownership, free from liens.
- IOI – Indication of
In auction processes, the IOI is the first indication from the universe of potential buyers as to how much those buyers may be willing to pay for the company. The IOI is much less detailed
than the LOI (see below) and usually provides a range of possible values,
rather than a single proposed purchase price. The primary purpose of the
IOI is to narrow down the list of potential suitors who are invited to
move to the next stage of the process, which is usually management
Example: After distributing the CIM, Billy and his investment banker received 10 IOIs and selected 4 bidders (including Eric’s group) to continue to management presentations.
- Joint & several –
Theory of liability whereby each seller is liable for 100% of the buyer’s
losses, even if the seller only owned a portion of the business. While the
gut reaction is that this may seem unfair, this is actually pretty typical
because the buyer just wants to be made whole and doesn’t want to have to
chase every seller for every dollar it is owed. Sellers in this situation
oftentimes will agree to reallocate responsibility among themselves in
accordance with their respective portion of the purchase price through a
contribution agreement or similar arrangement.
Example: Billy owns only 90% of Madison Hotels, with the other 10% being owned (somehow) by Frank. After selling the company, Frank blows all of his proceeds partying and chasing penguins. When Eric has a claim against the sellers for breach of the agreement, Eric recovers all of it from Billy under the theory of “joint and several” liability. Poor Billy is now left to try to chase Frank for his 10% share of the amounts Billy paid back to Eric’s group.
- LOI – Letter of intent. Present in virtually every deal,
whether or not an investment banker is involved, the letter of intent sets
forth the key terms of the business deal and provides a framework for
moving forward with a potential transaction. While most of the LOI is
non-binding, certain provisions are usually binding.
Example: Billy enters into an LOI to sell Madison Hotels to Eric’s group for $50,000,000 (plus earnout), and then they really start working in earnest on getting the deal closed.
- MAC or MAE – Material Adverse Change or Material Adverse Effect. Something
really big and really bad—and that’s expected to have a meaningful
duration—that happens to the seller’s business prior to closing. While
this concept appears in almost every deal, a MAC or MAE almost never
Example: Eric’s group enters into a contract to buy Madison Hotels. One of the conditions to closing is that no MAC or MAE shall have occurred prior to closing. On the night before closing, Madison’s biggest and most profitable hotel burns down—something about a bag of flaming poop outside one of the rooms spreading throughout the whole hotel. Is it a MAC?
- No-Shop – Sometimes called an “exclusivity provision,” the no-shop is simply a prohibition on the seller trying to find another buyer/deal while engaged with a potential buyer. Usually found in the LOI and,
for delayed closings, in the purchase agreement.
Example: In the LOI, Billy agrees to a 90-day no-shop while attempting to finalize a deal with Eric’s group.
- Peg – Shorthand for the working capital target value, meaning the minimum amount of
working capital the seller must have in the business at closing. If the seller
delivers working capital at closing that is less than the peg, there’s
usually a downward adjustment to the purchase price. On the other hand, if
seller delivers working capital at closing that is greater than the peg,
there’s usually an upward adjustment to the purchase price.
Example: At closing, Madison Hotels has $2,000,000 of working capital, but the working capital peg is $2,500,000. The purchase price is reduced by the $500,000 difference between the actual closing working capital and the peg.
- Q of E – Quality of
Earnings analysis or report, which is a key financial due diligence
performed by an accounting firm that assesses numerous items that
speak to the target company’s ability to produce income and cash flow in
Example: Prior to engaging in an auction process, Billy engages an accounting firm to prepare a sell-side Q of E to identify any weaknesses that can be addressed prior to closing, thereby increasing the likelihood of a successful transaction.
- Reverse break-up fee – A fee paid by a buyer to a seller if the buyer walks away from the deal for certain reasons.
Example: Eric said he could get financing to close on the purchase of Madison Hotels but ultimately fails. Eric may owe Billy a reverse break-up fee to get out of the purchase contract.
- Sandbagging – Refers to
contractual provisions that allow the buyer to sue for a breach of the
representations and warranties after the closing, even if the buyer knew
that the representations and warranties weren’t true at the time of
closing, but closed anyway. Conversely, anti-sandbagging provisions
prohibit a buyer from suing the seller for breaches of representations and
warranties of which the buyer was aware at the time of closing. While it
seems unfair, sandbagging is actually generally permitted.
Example: On the eve of closing, Eric finds that Madison Hotels hasn’t been properly paying sales and use taxes in a few states. While the number is significant, the deal still makes sense for Eric’s group to do, but Eric doesn’t want to limit his ability to recover these unpaid taxes from Billy after the closing. Eric closes anyway and then sues Billy to recover the unpaid taxes. Eric sandbagged Billy, but it’s probably actually something Eric can do, absent a clear anti-sandbagging provision in the agreement.
- Scrape – Refers to the
concept of removing materiality (and Material Adverse Effect) qualifiers in applying the
indemnification provisions. So, even though the seller will have
negotiated for various materiality qualifiers to soften some of the
representations and warranties, those qualifiers get ignored (either in
whole or in part) for purposes of the buyer’s indemnification due to the
scrape. The scrape comes in two main flavors. The first is where we remove
(or “scrape”) the materiality qualifiers only for purposes of determining
the amount of the buyer’s losses after a breach has been proven, but the
qualifiers remain for purposes of determining whether the representation
and warranty was breached in the first place (a “single scrape”). The
second is where we remove (or “scrape”) the materiality qualifiers both
for purposes of calculating the amount of losses, but also for purposes of
determining whether a breach has occurred (a “double scrape”). The double
scrape all but renders the materiality qualifiers meaningless.
Example: Eric is pushing hard for a double scrape because he feels that the deductible and de minimis limitations give Billy enough protection against immaterial breaches of the representations and warranties.
- True-up – Refers to the post-closing adjustment made to compare the closing
estimates of working capital, cash, debt, etc. against the actual closing
Example: Billy and Eric agree to close the deal based on Madison’s estimates of closing net working capital, cash, and debt, but they’ll need a true-up 90 days post-closing once the actual closing numbers are known.
- TTM – Trailing twelve
months. Used commonly in calculating purchase price and the working
capital peg because the TTM period is the most recent period, and
therefore often viewed as the most relevant period.
Example: The working capital peg is equal to Madison’s average monthly net working capital over the most recent TTM period.
- Turn – This one actually has two meanings in the M+A world:
- First, a “turn” is 1x
EBITDA. Commonly used in talking about purchase price or in terms of how
much of the purchase price a lender is willing to lend on.
Example: Eric’s group is paying six turns of EBITDA, meaning that the purchase price is 6x Madison’s historical EBITDA. If Eric’s senior lender is allowing Eric’s group to borrow on 4.5 turns of Madison’s EBITDA, then Eric still has to find a way to cover the remaining 1.5 turns of EBITDA.
- Second, a “turn” also
refers to each draft of the definitive deal documents.
Example: After receiving an initial draft of the purchase agreement from Eric’s lawyers, Billy’s lawyers turned their revised draft of the purchase agreement to Eric’s lawyers for review.
Next Month: M+A Forecast for 2022
Read last month’s piece: The People in Your (Dealmakers) Neighborhood: Part 4 – Meet Your Lawyer