Understanding Common Terminology in M&A Transactions
- Mac
- 7 hours ago
- 5 min read
When buying or selling a business, understanding the language used in mergers and acquisitions (M&A) is crucial. The process involves many technical terms that can be confusing for those new to the field. Knowing these terms helps buyers and sellers communicate clearly, make informed decisions, and avoid costly mistakes. This guide covers the most important terminology you need to navigate business transactions confidently.
Sales Purchase Agreement (SPA)
The sales purchase agreement is the central legal document in any business sale. It outlines the terms and conditions agreed upon by the buyer and seller. This contract specifies the purchase price, payment method, closing date, and any warranties or representations made by either party.
For example, a sales purchase agreement might state that the buyer will pay $2 million in cash and assume certain liabilities. It also includes clauses about what happens if either party fails to meet their obligations.
Due Diligence
Due diligence refers to the detailed investigation a buyer conducts before finalizing a purchase. This process involves reviewing financial records, contracts, customer data, employee agreements, and legal compliance. The goal is to verify the business’s value and uncover any risks.
A buyer might hire accountants and lawyers to examine tax returns, outstanding debts, or pending lawsuits. Sellers should prepare by organizing documents and being transparent to build trust. Due diligence process typically last between 2 - 4 months, potentially longer in more complex cases.
Business Valuation
Business Valuation is the process of determining how much a business is worth. Several methods exist, including:
Asset-based valuation: Adding up the value of all assets minus liabilities.
Income-based valuation: Estimating future earnings and discounting them to present value. Better known as discounted cashflow earnings (DCF)
Market-based valuation: Comparing the business to similar companies recently sold.
For instance, a company generating $500,000 in annual profit might be valued at three times earnings, or $1.5 million. For most SME sale in the lower market segment, market-based valuation tend to be commonly adopted.
Read Next Article: Business Valuation: Your Guide to Selling a Small Business in Singapore
Earnout
An earnout is a payment structure where part of the purchase price depends on the business’s future performance. This arrangement helps bridge valuation gaps between buyer and seller.
For example, a seller might receive $1 million upfront and an additional $500,000 if the business hits certain revenue targets within two years. Some investors prefer this approach as a means of aligning seller's and buyer's long term interest together.
Seller Financing
Seller financing aka owner financing is an arrangement where the seller extends financing to a buyer, allowing them to purchase a business without paying everything upfront. Buyer typically pay for the acquisition over time through instalments, with interest.
Letter of Intent (LOI)
The letter of intent is a non-binding document that outlines the preliminary terms of a deal. It shows serious interest and sets the framework for negotiations and due diligence.
An LOI typically includes the proposed price, timeline, and any conditions that must be met before signing the purchase agreement.
Confidentiality Agreement
Also called a non-disclosure agreement (NDA), this contract protects sensitive information shared during negotiations. Both parties agree not to disclose business secrets or financial data to outsiders.
This agreement is essential to maintain trust and prevent competitors from gaining an advantage.
Closing
The closing is the final step where ownership transfers from seller to buyer. At closing, all documents are signed, payments are made, and assets are handed over.
For example, the buyer might wire funds to the seller’s account, and the seller delivers company records and keys.
Representations and Warranties
These are statements made by the seller about the business’s condition. They cover areas like financial accuracy, ownership of assets, and compliance with laws.
If a representation proves false, the buyer may have legal recourse or the right to adjust the purchase price.
Indemnification
Indemnification protects one party from losses caused by the other. In M&A, sellers often agree to cover damages arising from breaches of representations or undisclosed liabilities.
For example, if a tax issue appears after the sale, the seller might have to reimburse the buyer.
Asset Purchase vs. Stock Purchase
In an asset purchase, the buyer acquires specific assets and liabilities, not the entire company. This allows buyers to avoid unwanted obligations.
A stock purchase involves buying the company’s shares, transferring ownership of all assets and liabilities.
Each method has tax and legal implications, so understanding the difference is vital.
Working Capital Adjustment
This term refers to changes in the company’s short-term assets and liabilities at closing. The purchase price may be adjusted to reflect the actual working capital to ensure the business operates smoothly after the sale.
For example, if working capital is lower than expected, the buyer might pay less.
Escrow
An escrow account holds part of the purchase price for a set period after closing. This protects the buyer against undisclosed problems or breaches of contract.
If no issues arise, the funds are released to the seller.
Breakup Fee
A breakup fee is a penalty paid if one party backs out of the deal without valid reason. It compensates the other party for time and expenses.
For example, if a buyer withdraws after due diligence, they might owe a breakup fee.
Synergies
Though often used in corporate speak, synergies refer to the benefits gained when two companies combine, such as cost savings or increased revenue.
Buyers look for synergies to justify paying a premium.
Letter of Credit
A letter of credit is a bank guarantee ensuring the buyer’s payment to the seller. It reduces risk, especially in international deals.
Material Adverse Change (MAC)
A MAC clause allows a party to withdraw if significant negative changes occur before closing, like a sudden loss of customers or legal issues.
Leveraged Buyout (LBO)
The acquisition of a company using a significant amount of borrowed money (debt), with the target’s assets often serving as collateral.
Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA)
A common metric used to evaluate operating performance and set valuation multiples. There are buyers from different parts of the world that uses profit after tax (PAT) as a valuation metrics.
Seller Discretionary Earning (SDE)
Seller Discretionary Earnings is a cash-flow-based valuation metric used primarily for small, owner-operated businesses (typically under $5M revenue) to determine the total financial benefit a single owner derives. It calculates the business's true earning potential by adding back the owner's salary, benefits, and non-essential/personal expenses to the net income.
Strategic Buyer
A company in the same or related industry seeking to gain synergies (e.g., market share, technology).
Horizontal Integration
Merging with a direct competitor to increase market share.
Vertical Integration
Merging with a supplier or customer to control the supply chain.