Super Glossary – Income Mixology

The information contained in this glossary and this web site is NOT to be considered legal or financial advice. Please consult your CPA and / or attorney for financial and legal matters.

123 A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

123 1031 Exchange

Method of tax deferral, not tax reduction or relief, on the sale of real estate. Here are some key points:

Defer taxes on the sale of one or more properties when exchanging them for one or more properties
The exchange must be done with like-kind properties
Properties must be within the US, and possibly US Territories.
The exchange must be done within certain time parameters 45 days to identify a replacement and 180 days to complete the exchange.
Only applies to investment property, not personal property, primary residences, or businesses
- There may be exceptions such as personal property used in business exchanged for exactly the same type of property. Examples include business aircraft for business aircraft.
Investment property to be sold must have been held for a certain period of time. The amount of time may depend on various factors that the IRS considers, such as intent for both properties involved in the exchange. Most advisors feel a conservative holding period is two years, while some feel a year is sufficient. The way in which the property to be sold was treated in past tax returns is important.
May need to File for tax extension: Here is a case study on a disallowed exchange:
X filed their tax return on April 15 and acquired replacement property within 180 days, but the purchase closed after they had already filed their tax return. The Tax Court cited failure to comply with the deadlines, specifically the requirement to complete the exchange within 180 days OR the tax filing date, whichever is earlier.

Plan out your real estate strategy. Without a plan, you might sell an investment property, pay taxes on the gain and buy another investment property later. Barring other circumstances, you could have done a 1031 exchange to defer your taxes. In this sense, you’re not just deferring taxes, you’re saving taxes compared to selling and buying a gain outside a 1031 exchange.

Is it better to exchange, or just keep adding to the portfolio with new purchases? If you can keep buying, consider it. That means you don’t need the cash from the exchange. A 1031 exchange enables investors to leverage real estate into a better real estate situation without being penalized by taxes. Reasons for a 1031 exchange may include:

Diversification by exchanging parts of the portfolio into other locations, markets, property types
Switch property type to change cash flow / appreciation characteristics
Consolidation of multiple properties into fewer
Expansion of one property to multiple smaller properties
Reduce management responsibilities, e.g., exchange multiple rental units for one single-tenant commercial property.
Exchange for a more expensive property to increase depreciation
Switch to a property or properties better suited for heirs / estate planning
Reposition equity if new property can yield a better return after considering selling and purchasing costs and changes in financing and depreciation
Other preferences for different location, market, or property type

1031 exchanges can get complicated. They can be simultaneous or delayed, two-party or three-party, forward or reverse, possibly done with vacation properties, involve an improvement on the replacement property, or involve seller financing, Consult 1031 exchange experts and intermediaries and tax professionals.

2 Out of 5 Year Rule

see IRC 121

A

Accounts Payables

Amounts owed to suppliers on credit, shown as a liability on the balance sheet.

Accounts Receivables

Amounts due from customers who purchased on terms, shown as an asset on the balance sheet. Industries with accounts receivables can include product manufacturing or consulting services. Many small retail businesses such as restaurants, gas stations and salons, have no accounts receivables since all goods or services are paid in advance or at time of delivery. Accounts receivables are a key component of working capital, an important number to consider in the purchase or sale of a business. In smaller transactions, the seller of the business keeps the accounts receivables. In larger transactions, the seller of the business may provide the accounts receivables to the buyer. There is no clear transaction size where receivables are kept by the seller of the business, so this can be a source of confusion or tension in businesses at the intersection between small businesses handled by business brokers and larger businesses handled by M&A advisors.

Accrual Method of Accounting

An accounting method where revenue or expenses are recorded when a transaction occurs versus when payment is received or made (Cash Method of Accounting). Sometimes the difference between a business’s financials reported on Tax Returns versus Income Statements can be attributed to a difference in accounting method between the two documents. This difference will be noted on the tax return section M1 Reconciliation of Income (Loss) per Books With Income per Return.

Some P&Ls will state whether the accounting method is cash or accrual. One easy to way to find out is to look at the monthly COGS percentage over 12 months. If it’s consistent, it’s the accrual method and if it fluctuates it’s the cash method.

With the accrual method of accounting, cost of goods sold for each unit of inventory is tracked individually. This method of accounting only accounts for cost of goods when a unit is sold. Before the unit is sold, it is an asset on the balance sheet.

Add Backs

Expenses added back to profit to show the true cash benefit to the owner of a business. Add backs include non-cash items such as amortization and depreciation, non-recurring expenses such as office relocation or a financial settlement, non-operating costs such as expenses related to other businnesses or real estate, and items benefitting the owner such as a personal automobile or owner health benefits. Add backs are often not agreed upon between buyers, sellers and lenders. For a more in-depth discussion of add-backs with examples, see How To Find the True Profit in a Business.

Adjusted EBITDA (Adjusted Earnings Before Interest Taxes Depreciation and Amortization)

EBITDA adjusted with add backs (see Seller’s Discretionary Earnings (SDE) for a definition of EBITDA and comparison with SDE).

Adjusted Net Income

Net Operating Income adjusted with add backs.

Advertising Injury

Advertising injury coverage is a component of commercial general liability insurance that protects the policyholder against claims of stolen ideas, invasion of privacy, libel, slander and copyright infringement related to advertising.

Affiliate Business

A business arrangement where business partners, known as affiliates, promote and link to products or services of another business. These arrangements are common in digital businesses and some affiliates garner their entire revenue via this model. An example is a fitness influencer with a large YouTube following and fitness blog who frequently mentions her favorite health supplements, but the manufacturer of the supplements is not a sponsor. Rather than paying the influencer to promote the supplements, the manufacturer enables the influencer to earn revenue from sales generated. Affiliate commissions can range from 5% to 50%. Affiliate businesses create content that builds audiences, and then leverage their audience to earn commissions on products related to their content. These content creators may also derive revenue from their own products, courses, consulting, or speaking engagements. Affiliate networks are platforms that link affiliates to brands. There are various affiliate tracking software options that assist affiliates and the brands they promote. The affiliate marketing industry has several worldwide affiliate marketing conferences.

After Repair Value (ARV)

The price an investor can sell a property for after repairing it. See Is it better to buy a business or flip real estate?

Amazon DSP (Amazon Delivery Service Partner)

A program by which Amazon engages entrepreneurs to build small businesses that hire drivers to deliver packages for Amazon. Entry fees are relatively low but acceptance into the program can take months or years for qualified candidates depending on available locations.

Amazon FBA (Fulfillment by Amazon)

Fulfillment By Amazon (FBA) is Amazon’s alternative to FBM – Fulfillment by Merchant. With Amazon’s FBA program, you invest in products that you store in Amazon’s warehouse and Amazon takes care of shipping and returns. In exchange, Amazon takes a fee as a percentage of revenue which can amount to half your profit. That doesn’t necessarily mean you can double your profit with FBM, since the money you save on Amazon fees will now have to go toward space, personnel, and logistics costs and software. Both FBA and FBM are different from dropshipping.

Amortization

see definitions and comparisons between Amortization and Depreciation

Appreciation

Appreciation is an increase in the value of an asset over time. Assets that have a chance to appreciate also have a chance to depreciate. Real estate, land, stocks, art, wine, precious metals, vintage cars, NFTs and other alternative investments and collectibles can all appreciate and depreciate. Capital appreciation refers to an increase in the value of financial assets such as stocks.

This is unlike depreciation, which lowers an asset’s value over its useful life. Assets that typically only depreciate include automobiles, boats, furniture, electronic devices and most physical assets utilized in business operations other than real estate such as computers, equipment, machinery, and work vehicles.

Asset Allocation

The IRS requires both buyer and seller to allocate assets by class on form 8594 in the event of a sale of a business. The form is required since different asset classes are taxed differently. While the IRS instructions provide desccriptions of the asset classes and details on how the form is to be completed, buyers and sellers should consult their tax advisors because of the tax ramifications of the form.

While there is no legal requirement that the buyer’s and seller’s allocations match, most tax advisors agree that a match will decrease the chances of an audit. This is another point of negotiation in the sale of a business since buyer and seller motivations are at odds for most asset classes. For very simple businesses, reaching an agreement may be very straightforward.

Tax treatments vary depending on business entity types (C-corp, S-Corp etc) and whether the sale is an asset sale or stock sale so it is important to consult a tax professional. Most small businesses are sold as asset sales.

Asset Class	Description	Seller’s Preferred Allocation	Buyer’s Preferred Allocation
I	Cash and Equivalents	No preference	No preference
II	Securities	No preference	No preference
III	Accounts Receivable	No preference	No preference
IV	Inventory	Low (to minimize ordinary income)	High (immediate deduction against ordinary income)
V	Other Tangible Assets
	Real Estate	High (long term capital gain)	Low (provides long depreciation term)
	Non Real Estate such as FFE and Vehicles	Low (to minimize ordinary income)	High (provides a deduction against ordinary income, but sales tax may have to be paid on these purchases)
VI	Covenants Not to Compete & Other Intangible Property:
	Covenant Not to Compete	Normally low (taxed as ordinary income over term of covenant), unless the non-compete is sold as part of goodwill	Normally low (deducted over 15 years) unless buyer’s attorney prefers a higher amount for enforceability reasons
	Other Intangible Property	High (long term capital gain)	Normally low (deducted over 15 years)
VII	Goodwill & Going Concern Value	High (long term capital gain)	Low (deducted over 15 years)

Notice that Class VI and VII items have the same tax treatement for the buyer. If the buyer is indifferent, the buyer and seller may agree to allocate none of the purchase price to the covenant and allocate more of the purchase price to goodwill. The seller prefers goodwill because it is a capital asset. The buyer is indifferent because both covenants and goodwill are amortized over 15 years. However, the buyer’s attorney may advise the buyer to increase the amount reasoning it will be easier to enforce the covenant not to compete due to the reasonably significant value paid for it.

Asset Liquidation Sale

An asset liquidation sale is a sale of assets, usually of an unprofitable or very minimally profitable business. The seller may feel the business does not have enough value to undergo an asset sale of an ongoing business, or may not be aware of a business broker’s ability to sell the business for more than the assets.

The assets are typically the physical assets of a company. Intangible assets may be listed and sold, but their value is likely to be very low since they did not contribute to a profitable venture.

Asset List

Itemized list of physical assets which may include furniture, fixtures and equipment (FF&E), including machines, vehicles, tools, tooling, molds, and appliances. The list usually contains columns for make, model, description, value and notes. Value is the current market value or replacement value of an asset of the same age and condition.

The asset list may include items such as domain names, trademarks and other intellectual property that may be difficult to value. The asset list does not contain inventory. An inventory list is treated separately since it is more fluid than an asset list.

Asset Sale

Not to be confused with an asset liquidation sale, an asset sale or asset purchase is one of two methods of transferring a business. The other method is a stock sale or stock purchase. Asset sales and stock sales have different pros and cons for the seller and the buyer which are generalized below.

Most main street business transactions facilitated by business brokers are asset sales because the individual small business buyer is unlikely to buy a business in which they have to assume any existing liabilities, known or unknown, of the existing business. Stock sales are less common in the sale of small businesses, more complicated, and require more advisors and thus come with higher legal and professional (tax) fees. Any tax savings for a Seller are going to be offset in some way by these higher fees. There are certain exceptions when both may agree to a stock sale, such as when a business is grandfathered with a zoning variance that is critical to the business. In this case, the Buyer may be willing to assume the risks of buying the business via a stock sale in order to receive the full benefits of the business.

Typical Ways to Structure the Sale of a Business

	Asset Sale	Stock Sale
Size of Business (typically)	Smaller	Larger
Tax Ramifications Favor the…	Buyer (if physical assets)	Seller (always)
Corporate Entity	Buyer creates new	Buyer assumes existing
Purchase Agreement	Asset Purchase Agreement	Stock Purchase Agreement
Typical Intermediary	Business Broker	M&A Advisor
Securities License of Intermediary	Not Required	Required
Buyer Assumes Liabilities	N	Y
Buyer Assumes EIN	N	Y
Buyer Assumes Banking and Financial Accounts	N	Y
Items in jeopardy of transferring (zoning variances, grandfathering, customer or vendor contracts, etc)	Good for Buyer if items in jeopardy are of low value	Good for Seller taxes, good for Buyer & Seller to transfer full value of business, but Buyer inherits liabilities
Many assets / high depreciation	Good for Buyer Step up basis for depreciation and not inheriting (most) liabilities	Good for Seller Sale taxed at capital gains
Mostly goodwill (sale taxed at capital gains)	Good for Buyer not inheriting (most) liabilities	Good for Seller Sale taxed at capital gains
Legal Fees	Low	High

This table summarizes the two types of transfer in general. Consult tax and legal advisors for finer details and possible hybrid approach.

There is a hybrid business acquisition option known as a “deemed asset sale” allowable under internal revenue code IRC 338(h)(10). Generally speaking, this is a sophisticated method that requires considerable investment in legal services. Therefore it is only applicable in larger deals with significant physical assets.

B

Balance Sheet

This financial statement covers a moment in time, usually at the end of a month which may fall at the end of a quarter, half, fiscal year, or rolling 12 month period. It shows the detailed assets, liabilities and equity of a business and can be a stand alone report, or part of a tax return. The balance sheet adheres to the equation asset = liabilities + shareholder equity. Since it adheres to this equation, it is always in balance. the significance of the equation is that the company must pay for all of it assets with either liabilities or shareholder equity. Thus you may hear the terms debt financing and equity financing in strategic or analysis discussions.

A balance sheet is one of three three primary financial statements used to evaluate or understand a business and its performance. See financial statements for a comparison table.

Bill of Sale

A bill of sale is a legal document that transfers property ownership in exchange for payment. People are most familiar with a bill of sale in the transfer of automobiles, but a bill of sale can apply to other vehicles, equipment, firearms, animals, electronics and personal property. It can even apply to mobile homes, but it does not apply to real estate which requires a purchase agreement and warranty deed. With the sale of a business, the transfer also requires a purchase agreement. Components of a bill of sale may include:

Name, addresses, and contact information of the parties
Description and condition of the item/s being transferred
Price
Method of payment
Date of the purchase
Signatures of parties
Warranty or guarantee details if any, or “as-is”

BizBuySell

The Internet’s largest business for sale exchange platform. See places to find business for sale online.

Blog Business

Online business whereby content creator writes blog posts to grow and retain traffic that can then be monetized with ads on the blog website, affiliate marketing, or the sale of digital or other products, courses, consulting, training, etc. Blog entrepreneurs may also use other media such as YouTube or social media channels to generate income in the same ways.

Bolt-On

see Platform

Boot

Boot is cash or other consideration added to an exchange of goods to make the trade acceptable to both parties. In a real estate 1031 exchange, boot is the non-like-kind portion of the exchange. For example, if you sell a property for $300,000 but only re-invest $250,000, the $50K difference is known as boot which will be taxed at your capital gains rate. It is the part that is not tax-deferred when you exchange into a property of lesser value. Investors should be aware that boot can come as a surprise. Factors that can create boot include cash proceeds, mortgage reduction, non-like-kind property, and non-transactions costs such as tenant deposits.

Breakup Fee

Termination fee incurred by a party to a contract for breaking an agreement. In M&A, this is typically a 1% to 3% (of contract price) fee imposed on a seller for backing out after signing an agreement. It compensates the Buyer for lost time and expenses. It can also be applied to a buyer who backs out, compensating the Seller for their time, expenses, and time with the business listing off the market. When the fee applies to the buyer, it may be referred to as a reverse breakup fee or reverse termination fee.

Business Appraisal

A business appraisal is a process to determine how much a business is worth. Certified valuation specialists and appraisers typically utilize several valuation methods, just as real estate appraisers do. Valuation methods can be based on assets, profitability, comparable sales, and projected cash flows. Many lenders, especially for SBA loans, require a valuation performed by a third-party appraiser. SBA loans cannot exceed the appraised value of the business. Divorces and changing ownership scenarios may also require an appraisal.

Business appraisal and business valuation are often used interchangeably in the industry. However, one source suggests a difference – “An appraisal serves as a pricing guide but has no legal standing; a valuation provides a definitive value that can be used for legal matters.” This definition has not yet been confirmed through any other source.

Business Broker

A business broker is an intermediary who helps people buy and sell businesses. See these posts: What are the Pros and Cons of Being a Business Broker and How Do You Get Started as a Business Broker?

Bulge Bracket

A range of businesses typically over $1 billion in revenue where mergers and acquisitions are served by Investment Bankers. Some sources define the market tiers with slightly different lower and upper limits and other sources define the tiers by EBITDA. See Lower Middle Market for a breakdown of the tiers.

Buy-Sell Agreement

Despite the name, buy-sell agreements have little to do with buying and selling companies. They are contracts between co-owners that dictate the sale on an owner’s interest, who can buy, and at what price. Buy-Sell agreements typically guide buyouts between the owners themselves and may be referred to as buyout agreements. An owner may depart for several reasons including:

retirement
disability
divorce
death

Without a buy-sell agreement, a departing owner could transfer their share to anyone which has potential to be disruptive to the remaining owners. If the reason is divorce, a good buy-sell agreement requires the former spouse of a divorced owner to sell any interest received in a divorce settlement back to the company or the other co-owners at a price determined by a valuation method specified in the agreement.

Buyer Types [for a business acquisition]

Here is a comparison table of the types of buyers that acquire businesses. While this table helps understand the types of buyers, their backgrounds and motivations, it is important to note that there are hybrid buyer types, or a buyer type that acts like another buyer type in certain situations.

	Financial Buyer	Strategic Buyer	Sophisticated Individual	Common Individual
Types of Buyers	private equity, fundless sponsor, search fund, family fund	competitor, supplier, customer, partner, private equity platform	business owner, ex-CEO, private equity or M&A background	entrepreneur to executive
Volume of Acquisitions	high for PEGs, low for all others	low to medium	low	low
Size of Acquisitions/s	$1M – $2M minimum EBITDA, possibly less for bolt-ons	any size, however small deals still take time so there will be a minimum size set by each strategic	typically $500K – $1M+ EBITDA	up to $1M+ EBITDA but likely < $500K EBITDA or SDE
Time Horizon and Exit Goals	typically 5-10 yrs, longer for family funds	long term	until retirement	until retirement
Source of Funds	internal for family office, leverage external funds for all others	internal funds or combination with lenders, possibly PE-backed	internal with or without SBA, friends and family	internal with or without SBA, friends and family
Industry and Technical Expertise – executives, personnel and layoffs	Find and insert executives plus long transition or new role for current owner	Utilize existing executives plus possible new role for current owner	moderate to strong alignment with background and interests	moderate to strong alignment with background and interests
Financial and Strategic Synergies	Align with portfolio, reduce administrative costs	Grow with same or new customers, reduce friction and redundant costs	possibly align with another business	possibly align with another business
Typical Intermediary	M&A Advisor, possibly high end business broker	Investment bankers, M&A advisors, business brokers	M&A advisor or business broker	Business Broker

C

Cap Rate

A cap rate is a metric used in real estate investing to compare investments on their merits regardless of financing. Cap rate = net operating income divided by property value. Since costs may vary by season or by occupancy and since income may vary based on occupancy, cap rates typically look at a one year period of net operating income. While the cap rate is used to compare investments prior to acquisition, it is also useful during the holding period of the property to understand its efficiency relative to other properties in a portfolio or new opportunities. Remember that the denominator is not the acquisition price, but the current property value.

Example
Jojo purchased a property 2 years ago for $225K. The current value is $250k. Over the last 12 months, the income was $30k and operating costs were $10k. She also paid $12,000 in loan payments over the past 12 months netting her $8,000 after expenses and debt service. The cap rate = 100 * ($30k – $10k)/$250k = 12.5%.

Net operating expenses do not include interest, taxes, depreciation, amortization, principal payments, improvements, or capital expenditures.

Carve Out

In M&A, carve out means separating a business unit, subsidiary, or line of business from its parent company. For smaller business transactions, it can simply mean designating some portion of the business that is not for sale. See What is Included in the Sale of a Business for real life examples of things business owners wanted to carve out from the sale, including websites, products, and even employees.

Cash Conversion Cycle

The cash conversion cycle (CCC) is the number of days it takes a company to convert cash outflows into cash inflows. The lower the cash conversion cycle, the better for business operations. The cash conversion cycle measures how long cash is tied up in working capital. It quantifies the time to complete the process while working capital is the amount needed to keep the business solvent.

Cash Flow

Cash flow is the cash and cash equivalents entering and leaving a business which measure the amount of gas a business has to keep running. In reference to businesses for sale, cash flow is synonymous with the owner’s benefit from the business, which includes owner’s salary, benefits, perks and profit from the business. BizBuySell, the largest online platform for business for sale, uses the term cash flow to indicate the owner’s total benefit from the business – see Seller’s Discretionary Earnings.

In real estate investing, cash flow is the amount of money left after deducting all the expenses from income each month.

Cash Flow Statement

This financial statement covers a period of time, and tracks the cash and cash equivalents entering and leaving the business. Cash flows are analyzed in three main areas: operations, investing and financing.

While profit and loss statements are important for measuring the efficiency of a business, it does not show the timing of income and expenses. Cash and cash equivalents are the fuel needed to sustain the business engine, so timing is everything and that’s why some people will say “cash is king.” The cash flow statement shows how much cash is available to fund operations, pay debts and invest in growth.

A company may have negative cash flow which could mean it is on the brink of bankruptcy or less alarmingly, it is being managed for intentionally for expansion or growth.

Cash flow can be calculated b the direct method or indirect method. The direct method is simple and can be used when a business uses the cash basis accounting method. When a company uses an accrual method of accounting, revenue is recognized when earned, not received. This causes a disconnect with cash on hand. The indirect cash flow method accounts for this by adjusting for non-cash transactions on the income statement by analyzing balance sheets at the beginning and end of the income statement period.

A cash flow statement is one of three three primary financial statements used to evaluate or understand a business and its performance. See financial statements for a comparison table.

Cash Method of Accounting

Revenue and expenses are recognized only when money changes hands, whereas the accrual method of accounting recognizes revenue when it’s earned, and expenses when they’re billed (but not paid). The cash method of accounting may be suboptimal if it underestates earnings in the profit and loss statements, and therefore understates the value of the business. Cash acounting is more suitable for small businesses that do not carry inventory, or significant accounts receivables an acconts payables.

CAC

see Customer Acquisition Cost

CBI

see Certified Business Intermediary

CEPA (Certified Exit Planning Advisor)

see Exit Planning Institute

Certified Business Intermediary (CBI)

Advanced certification for business brokers provided by the IBBA.

Certified Exit Planning Advisor (CEPA)

see Exit Planning Institute

CIM

see Confidential Information Memorandum

Closing Statement

A closing statement is one of the closing documents that records the details in a financial transaction such as real estate or transfer of a business. The words closing and settlement are interchangeable, so a closing statement is sometimes referred to as a settlement statement. The statement documents the price and all the fees that are to be settled at closing which may include:

escrow fees
title fees
lender fees
transfer taxes and prorated taxes
utility payments
commissions
legal or other professional fees
inspection or contractor fees
lien payoffs
loan disbursements
fees or payments associated with a lease
insurance payments
franchise fees

Closing statements are often prepared by escrow agents or attorneys. Closings that do not involve real estate or loans can be quite simple.

Commercial REALTOR®

Licensed professional intermediary who is a member of the National Association of REALTORS® and works typically on commission to hep buyers and sellers buy and sell property that often has potential to generate income, including office or retail space, restaurants, malls, factories and warehouses. Here’s where they operate within the four real estate classes:

Land (typically land zoned for non-residential purposes or mixed use)
Residential (over four units)
Commercial
Industrial

Refer to this article for further discussion on which professionals you may encounter when buying a business with real estate or a lease.

NOTE: A commercial real estate professional may operate legally without being a member of the NAR see REALTOR®.

Confidential Information Memorandum

Detailed business profile provided to potential acquirers of a business, typically after they have signed an NDA. Components a CIM may include

Broker Introduction
Company Overview
Financial Overview
Products /and or Services
Owners, Founders and Key Executives
Employees and Org Structure
Marketing and Sales
Manufacturing and Logistics
Customers, Industries, Markets
Industry and Competition
Key Differentiators
Legal Issues and Risks
Financial Statements / Trends and Projections
Growth Opportunities
Summary of Offer
Next Steps

Consumerism

see this article: Is Minimalism Good or Bad?

Co-op

A cooperative business, also known as a co-op, is a type of organization that is both owned and controlled by its members. In co-ops, owners pool resources to bring about economic results that are unobtainable by one person alone.

In some cooperatives, only those who are currently using the products or services or have used them in the past own it and have access to their products and services. In these co-ops, percent ownership might be based on equity contribution or how much of the products or services the member purchases.

However, in other co-ops, employee owners do not have to use the co-ops products or services. The co-op is simply a business structure where employees own the business. This type of co-op is comparable with an ESOP, although there are significant differences. Both co-ops and ESOPS are business types centered on employee ownership. See Employee Stock Ownership Plan for a comparison table.

Here is the mission statement from a non-profit organization in Detroit dedicated to helping create and supporting co-ops.

The Center for Community-Based Enterprise’s mission is to build a more sustainable, equitable and inclusive living-wage local economy, by developing a network of worker-owned cooperatives in Detroit and throughout our great state of Michigan. This is because worker ownership, or employee ownership, has the worker and the business’ sustainability at its center, not just profit. For the community, worker ownership increases local spending and civic engagement. For the business, it increases productivity and growth. It helps job creators to lower worker turnover and leave a lasting legacy in their community.
C2BE Mission Statement

Current Assets

see Working Capital

Current Liabilities

see Working Capital

Customer-Acquisition-Cost (CAC)

A measure of sales, marketing and operational efficiency that considers the total costs of obtaining new customers. CAC may be measured and compared across different sales or marketing channels within a company or the overall CAC may be compared with similar businesses. CAC is one of the contributing factors to measuring the profitability of different customer types or potential new customers. It is also important to consider how valuable certain customers are after they are acquired, so companies also look at returns, support, churn, recurring revenue, referrals, repeat business and life time value attributed to certain customers or customer groups.

Customer Concentration

A business is at a disadvantage when a significant portion of its revenue comes from a small number of customer. Retail businesses such as restaurants, shops, stores serve many customers and do not have customer concentration. Some professional service firms, such as specialized engineering or consulting, may have customer concentration while others, such as tax preparation or insurance, may not have customer concentration.

Example
The worst scenario is a customer concentration of one. While this may simplify operations, there is significant risk due to over-dependence. The Amazon Delivery Service Partner (DSP) program is a perfect example of a business with built-in customer concentration. While these independent businesses performing last-mile delivery for Amazon are not barred from serving other customers, most do not. Amazon’s contract states that Amazon can cancel the agreement at any time without providing a reason. People can speculate as to how valuable such an opportunity is and how likely or unlikely Amazon would change strategies, but most people have no insights as to where Amazon’s high level strategy sessions may lead.

D

Deal Structure

Deal structures define the terms of the business sale transaction including cash, debt, equity / ownership, corporate structure, and transition.

Business acquisitions are seldom done as simple all cash transactions at closing. They are more commonly structured as a percentage down payment at closing with future payments in the form of regular periodic loan payments or earnouts triggered by milestones.

Ownership can also be a variable on larger transactions. Smaller deals are typically purchased outright, but in larger deals, the seller may be offered equity in the acquiring business as part of their compensation for relinquishing ownership if their current business.

Debt Burden

Also know as debt service, debt burden is the amount of debt payments a company must make over a period of time. A company is considered overleveraged when its debt burden is higher than its operating cash flow and equity. A real estate investment is considered underwater if all expenses and debt service exceed its income.

Deemed Asset Sale

see Hybrid Asset-Stock Sale

Deferred Sales Trust

A deferred sales trust can be an ideal 1031 exchange alternative if you cannot complete your 1031 exchange within the time parameters required by a 1031 exchange. A qualified intermediary may be able to transfer the funds from your property sale to the deferred sales trust.

Depreciation

The purpose of accounting depreciation and amortization is to spread the cost of an asset over the life of the asset to match the cost of an asset with the benefit of it use over time. Depreciation and amortization are non-cash expenses on a profit and loss statement. Since expenses reduce taxable income, the tax benefit is spread out over the life of the asset versus, for example, at one time when a cash outlay occurs for the purchase. Business take depreciation and amortization regularly to move the asset’s costs from the balance sheet to the income statement. Read How To Find the True Profit in a Business.

	Amortization	Depreciation
Non-Cash Expense	Y	Y
Treatment on an Income Statement	expense	expense
Treatment on a Balance Sheet	value equals historical cost minus accumulated amortization, a contra item on the balance sheet	value equals historical cost minus accumulated depreciation, a contra item on the balance sheet
Type of Asset	Intangible	Tangible
Examples	patents, licenses, copyrights, trademarks, lease rental agreements	plant, building, machines, equipment, vehicles
Method of Spreading the Cost	Straight Line	Straight Line, Accelerated, Per Unit
Salvage Value	N	Y
Possible Impair-ment Write Down	Y	Y

Depreciation Recapture

Depreciation recapture means when you sell, you will be taxed on the appreciation and the depreciation. This means that all the depreciation that helped you while you owned the property re-enters the picture to bite you when you sell, unless you defer the gain with a 1031 exchange.

When you buy, you hop on the depreciation bus. When you sell, you hop off and the bus runs you over.

Digital Minimalism

see this article: Is Minimalism Good or Bad?

Discounted Cash Flows (DCF)

This is one of many ways to value a business. It is typically used for larger transactions in the mergers and acquisitions space more than in business brokerage of main street businesses. It uses historic cash flows to project future cash flows and then discounts the future cash flows to produce a present value. The discount rate is also projected along with future cash flows. These projections make the DCF method inherently risky. The DCF method works well in industries or situations when future cash flows can be reasonably estimated.

Dropshipping

Dropshipping is a form of retail fulfillment for online stores who do not wish to handle inventory and shipping. It comes in two scenarios. 1) The dropshipper purchases products from third-party suppliers as customers make orders. The products are then shipped directly to the consumer. In this scenario, you don’t own any merchandise and act as a middleman between suppliers and customers. This is a popular scenario for online entrepreneurs. 2) The dropshipper produces their own branded products and has a reliable manufacturing partner that ships directly to the consumer. This requires more business savvy, capital, and effort in exchange for greater control and potential.

Due Diligence

Due diligence is the detailed investigation process in a business acquisition that starts after a signed purchase agreement. The buyer may request and be given access to more extensive financial and operational documents and data than what was provided during the steps leading up to the signed purchase agreement. Due diligence can take days or weeks for small businesses, or it can take many months to the better part of a year for larger businesses. For larger M&A deals, due diligence typically consists of three phases that last a month or more each. The phases typically occur in this order due to the cost of professional fees in each phase. If a lender is involved, they will conduct a simultaneous due diligence and business valuation on the acquisition target.

Commercial due diligence by Buyer
Financial due diligence by Buyer and their CPA or accounting team
Legal due diligence by Buyer’s attorney or legal team

A seller can also do due diligence on a buyer, typically before entering an agreement unless the agreement specifies certain conditions that the Buyer must meet or allows the Seller to cancel upon some discovery of the Buyer’s background. A seller’s due diligence on the Buyer is critical when the deal structure requires the Seller to accept some portion of payments in the future, such as seller financing or earnouts.

Savvy buyers and sellers will use a due diligence checklist. In many states, either party can back out during due diligence without a reason, and recover their deposit if one exists.

Due Diligence Release

A step in the acquisition of a business when the buyer signs a release indicating due diligence is complete and the buyer will not back out due to any due diligence items without losing their deposit. The buyer still has other options to back out which may include conditions that must be met before closing, items covered up by the seller, actions of the seller after due diligence.

E

E&O Insurance (Errors and Omissions Insurance)

see Professional Liability Insurance

Earnest Money Deposit

A sum of money placed in escrow in good faith by a buyer before starting due diligence. The higher the deposit as a percentage of the price, the more the seller has faith in the seriousness of the buyer. The earnest money may be returned to the buyer if the buyer is not satisfied with due diligence or by mutual consent to cancel. The earnest money is applied to the price if the transaction proceeds to closing. The earnest money is earned by the seller if the buyer backs in a way that violates the purchase agreement.

It is important to note that the escrow company cannot move earnest money to the buyer or the seller without agreement by both parties. If there is no agreement, the parties must fight a legal battle. The escrow company will typically release the funds to a court and thus conclude their involvement. Some attorneys advise buyers to never agree to earnest money deposits due to the difficulty and expense of retrieving the deposit in the event of a dispute. Such advise is less likely to be given in residential real estate transactions or small business brokerage deals, and is more likely to be given in larger M&A deals.

Earnest Money Goes Hard

This is when the earnest money is no longer refundable, typically after due diligence release is signed by the buyer. The term is often used when the earnest money is handled in stages such that a portion of the earnest money is no longer refundable after a certain milestone is reached during the due diligence period. This stepped approach may be a negotiations concession or an enticement to a seller.

Earnings Before Interest Taxes Depreciation and Amortization (EBITDA)

see Seller’s Discretionary Earnings

Earnout

To mitigate risk, a buyer may structure their offer with earnouts, or payments after closing that are contingent on the business reaching certain milestones. Unlike seller financing which requires monthly payments to the owner regardless of the financial performance of the business, earnouts offer flexibility in the timing of payments and are only paid under certain conditions.

Earnouts are often paid annually for two to three years. However, they could be paid quarterly, semi-annually, and they could last less than two years. Earnouts are not likely to be accepted if proposed payments are greater than a year and extend past three years in total, since they are meant to be a fairly short term transition of ownership and risk.

Example
A business suffers from customer concentration, but is otherwise attractive to a buyer. To mitigate risk, the buyer offers 25% of the purchase price at closing and at the 1st, 2nd, and 3rd anniversaries of the closing. The earnouts are paid as long as the largest customer orders at least 80% of the average orders over the three years prior to the sale of the business.

A very similar deal structure was arranged between a buyer and seller on a business I sold that had only one customer. The buyer was comforted by the fact that the customer had been loyal for decades, but still needed some assurances to limit their investment risk. While the sellers pointed to the long standing relationship with the customer and an open purchase order, they did not have a long term contract and realized the business would not sell without agreeing to earnouts.

The contract details had to clearly define all the what-if scenarios, such as “what if the buyer caused the customer to reduce orders” or “what if the economy caused the customer to reduce orders” or “what if they customer orders 60% in year one and then 150% in year two.” Business brokers can provide tremendous value in these situations by making sure both sides think of all the what-if scenarios that could effect their outcome, bringing the parties together and facilitating the give-and-take required to reach an agreement, and then bringing in the attorneys to tighten the language in a clear and thorough manner. See this article on buying a business with little or no money.

EBITDA

see Earnings Before Interest Taxes Depreciation and Amortization
The term EBITDAC was coined shortly after the 2020 pandemic due to the wide toll that COVID shutdowns and ensuing supply and logisitics issues had on businesses. (Earnings Before Interest Depreciation Amortization and Coronavirus).

Employee Stock Ownership Plan (ESOP)

An Employee Stock Ownership Plan is a business structure based on employee ownership. An ESOP is a federally-regulated employee benefit plan that gives ownership interest by allocating shares from the ESOP trust.

ESOPS exist in various industries including marketing, manufacturing, distribution, construction, engineering, research, consulting, food, retail, supermarkets, health care and more. Some notable ESOPS include Black and Veatch, CH2M Hill, Davey Tree, Graybar, Herman Miller, Publix, Rosendin Electric, W.L. Gore & Associates, WinCo Foods. Clif Bar was a 20% ESOP owned company that was purchased by food giant Mondelez (Oreos, Wheat Thins, Cadbury etc) for $2.9B resulting in $580M for its 1300 ESOP participants.

Another employee ownership model is a co-op. Most ESOPs have at least 15 to 20 employees to have enough tax benefit to offset administrative costs. Cooperatives may be a more feasible option for the smallest of businesses.

When selling to an ESOP or a worker co-op (selling is the method for transitioning a company to an ESOP or co-op structure), the seller can exercise considerable control over his or her business exit and choose to stay on as an employee-owner.

Comparison Table ESOP v. Co-op

	ESOP	Co-op
Ownership	ESOP trust owns shares (up to 100%) for the benefit of employees who receive shares and cash out at retirement or upon leaving.	Employees directly own over 50% of the combined voting power of all classes of stock.
Voting	Democratic governance is optional. Employee owners may or may not have voting rights.	Each employee-owner has one vote. Not all employees must be owners.
Eligibility	Eligibility is subject to IRS non-discrimination guidelines, but ESOPS must cover a significant percentage of employees who are 21, have worked there at least a year, and are not highly paid.	Ownership is optional for employees who meet certain criteria which may include tenure, hours worked per year, buy-in contribution, vote by current members.
Dividends	ESOP dividends are optional. Dividends for an ESOP-owned C-Corp may be tax deductible.	Allocated based on “patronage” which may mean hours worked, wages, jobs created or other measures.
Taxes	The ESOP portion of an ESOP S-Corp business is not subject to federal income taxes which frees cash flow for a competitive advantage. Employee participants who receive dividends are taxed, so their benefit is tax deferral not tax avoidance. ESOP S- and C-corps are treated differently.	The co-op pays income taxes and worker-owners must be paid reasonable salaries and payroll taxes. Allocation of profits to dividends enables employee-owners to share tax responsibility, but owners may qualify for the 20% pass through deduction.
Financing	Employees do not “buy in” to participate. In rare non-leveraged ESOP sales, the company contributes cash to the ESOP and the ESOP purchases shares. Leveraged sales often involve lender AND seller financing.	In most cases, workers each contribute a buy-in and the co-op secures a loan for the rest of the sale price. Member equity is rarely enough to cover the sale price. Seller notes are commonly part of the sale structure.

Employee Retention Bonus

An incentive provided to key employees to entice them to stay with a company. This is often used in the sale of a business to ensure a smooth transfer for the buyer when key employees are critical, at least for some time until the buyer is more familiar with the day-to-day operations of the business or has had time to find substitutes for key employees. An example is a bonus to be paid to a key employee six months after new ownership.

EPI

see Exit Planning Institute

Equity

In real estate and finance, equity is ownership in a property or business. Equity in a home is the amount of your home you actually own. Home Equity = Current Home Value – Outstanding Mortgage Balance/s. Similarly, equity in a business is the amount remaining if all assets were liquidated and all debts were paid off. Owner’s Equity or Shareholder’s Equity = Total Assets – Total Liabilities (see Balance Sheet). An equity stake is a percent ownership.

Errors and Omissions Insurance (E&O Insurance)

see Professional Liability Insurance

Escrow

A legal arrangement in which an asset (such as cash or securities) is deposited into an account under the trust of a third party (the escrow agent) until satisfaction of a contractual contingency or condition. Escrow is a legal concept whereby an asset or money is deposited into an account and held by a third party known as the escrow agent, escrow holder, or escrowee, until satisfaction of a contractual contingency or condition. Learn more about an escrow holder’s roles, responsibilities and limitations in a business or real estate transaction.

Escrow Holdback

Funds are held back at the closing until a condition is met after closing. The funds could be a portion of the funds already in escrow or additional funds collected prior to closing. Situations that may warrant an escrow holdback include required or agreed upon repairs to be done after closing, or tax clearance that will be done and proven after closing. Learn more about an escrow holder’s roles, responsibilities and limitations in a business or real estate transaction.

Escrowee

An escrowee is the third party escrow holder. Depending on the state, escrow holders may need to be licensed and not a party to the transaction. In a real estate or business for sale transaction, the escrowee may be part of or affiliated with a title insurance company, real estate attorney, or lender. Learn more about an escrow holder’s roles, responsibilities and limitations in a business or real estate transaction.

ESOP

see Employee Stock Ownership Plan

Estoppel Certificate

A prospective buyer of real estate can prepare such a binding document, also know as a tenant estoppel letter, that clarifies the current status, terms and details of a lease that they will inherit.

Exclusion from Capital Gains Upon Sale of a C-Corp

see Qualified Small Business Stock

Exit Planning

As the name indicates, this is the discipline or process for planning a business transition allowing the owners to exit the business. An exit may be a merger, sale, non-sale transfer (perhaps to a family member), liquidation or termination. The planning process creates a comprehensive roadmap that may account for business, personal and financial goals.

Since a significant part of exit planning focuses on value growth well before an exit, exit planning is an ideal framework for running and growing a business at any stage, even for startups.

An exit plan can be initiated early in the life of the business. In fact, owners can achieve the best results building a company with an exit in mind. The consideration of an exit forces the owner to keep a clean house and instill discipline in processes, financial reporting, risk management, the executive team, and so on. Exit planning frameworks look at all aspects of the business, attacking risks first and then low hanging fruit. Exit planning sets a cadence for business owners and conditions them to ask the question “grow or exit” every 3 months, which can be a powerful tool even for running a business years into the future. Read Exit Planning and Business Timing.

Exit Planning Institute (EPI)

An authoritative organization helping exit planning professionals with events, education, training and certification through its Certified Exit Planning Advisor (CEPA) credential. CEPA certified professionals are often CPAs, wealth advisors, estate planners, business consultants or M&A professionals. Read Exit Planning and Business Timing.

F

FF&E

see Furniture, Fixtures and Equipment

Family Fund

Also know as a family office, this type of business buyer comes is a highly successful family-owned business. The business has set up a strategic fund to seek acquisitions to further its success and build for future generations. It may deploy key owners or executives, or hire professionals or business school graduates with strong financial and M&A backgrounds to find, acquire, and possibly run the acquired business or businesses. They typically have lower deal volume and longer time horizons than private equity buyers. They may look for strategic opportunities or diversification opportunities. See Buyer Types for a comparison table.

Financial Buyer

This is a type of business acquirer that evaluates opportunities largely from a financial perspective. Their focus is on return on investment, the ability to roll up several businesses within an industry or niche, administrative synergies within their portfolio, preservation of capital and leverage, significant growth potential, and a readily available market for an exit in the future. These buyers include private equity groups, large family funds. They often look for a significant sized “platform” company for the foundation of their portfolio within an industry or niche, and subsequently add “bolt-on” companies that may be smaller but are aligned with the platform. They typically lack industry or technical expertise within their organization, but have a network of potential executives with relevant experience that they will place within the acquired company. See Buyer Types for a comparison table.

Financial Statements

The three financial statements used to analyze and evaluate a business are the Cash Flow Statement and Income Statement, both covering a period in time, and the Balance Sheet depicting a moment in time. Net operating income from the Income Statement is used in the Cash Flow Statement to determine cash flow from operations, but the Cash Flow Statements adjusts for non-cash items on the Income Statement such as depreciation and interest. Therefore the Cash Flow Statement gives an accurate portrayal of cash inflows and outflows and the liquidity of the business. The Cash Flow Statement also measures cash from investing and financing activities and relies on a beginning and ending balance sheet for this information.

	Profit & Loss Statement (P&L) or Income Statement	Balance Sheet	Cash Flow Statement
Span	Period of Time monthly, quarterly, annual, rolling 12 months	Point in Time typically last day of a month	Period of Time monthly, quarterly, annual, rolling 12 months
Focus	Profitability	Current financial health or net worth	Liquidity, timing of cash flows, “gas in the tank”
Measures	Efficiency of a business	What a business owns, what it owes, and amount invested by shareholders	Cash management from operations, investments and financing
Equation	Profit = Revenue – Expenses	asset = liabilities + shareholder equity	Ending cash = beginning cash + cash in – cash out (cash or cash equivalents)
Analyze Debt and Equity Financing	No	Yes	Yes
Cash Method	simple	no AR or AP	Direct
Accrual Method	compare with cash flow statement	AR and AP	Indirect Adjust for non-cash items
Limitations	does not reveal liquidity includes non-recurring gains and losses	point in time differences in depreciation judgement of uncollectibles	good cash flows could be positive or negative w.r.t efficiency
How They Tie In (Net Income)	shows/calculates Net Income	last period Retained Earnings + Net Income from P&L -Dividends = Retained Earnings	Net Income from P&L + cash in – cash out +-non-cash adjustments = cash flow from operations
How They Tie In (Cash)		closing cash balance from cash flow statement is cash on the balance sheet	sum of cash from operations, investments and financing is the closing cash balance
How They Tie In (Depreciation)	$10,000 depreciation expense	retained earnings decrease by $10,000	Net Income on top of CF Statement decreases by $10,000, but a depreciation add back zeros out CF impact
How They Relate (Financing)	Interest Expense	principal amount of debt owed	change in principal amount owed shows in the cash from financing section
How They Relate (Investing)	investments such as capital expenditures do not appear on a P&L cash from investments may appear as other or extraordinary income	capital expenditures are in the Property, Plant and Equipment account on the balance sheet	capital expenditures flow through cash from investing on the CF statement

In the sale of a business, most buyers ask for the income statement first, then the balance sheet. Many buyers never ask for the cash flow statement. Tax returns are almost always required during due diligence. Tax returns are not considered a financial statement. However, tax returns may incorporate a balance sheet. Unlike corporations and partnerships (including LLCs treated as corporations or partnerships), a single-member LLC, which is a disregarded entity for tax purposes, is not required to include a balance sheet in its tax returns.

For Sale By Owner (FSBO)

For Sale By Owner means selling your real estate without a real estate agent or selling your business without a business broker. See this article Can I sell My Business Without a Business Broker? and How Do I Buy a Business For Sale By Owner?

Franchise Area Developer

A franchisee who signs an Area Development Agreement (ADA) with the franchisor to open and run a number of franchise units within a geographic area on an agreed upon time schedule. This multi-unit owner is looking for a way to carve out a territory with no competition from other franchisees. Also see Master Franchisee.

Franchise Recruiter

Salesperson who sells franchises. This can be a salaried employee of a franchisor, or more commonly an independent contractors who has agreements with several non-competing franchisors and earns commissions by helping people find the right franchise.

Franchise

The term franchise has a general meaning and a more specific meaning in reference to sports teams or a type of business. The general meaning is an authorization granted by an entity, which could be a company or even a government, to an individual or entity enabling them to carry out specified commercial activities such as providing products or services.

Government franchise examples include taxi permit, bus route, an airline’s use of a public airport, or a cable company’s use of local government cable lines.

North American sports leagues (MLB, NHL, NFL, NBA) run a franchise system where franchises (teams) have territorial rights, usually exclusive to remove rivals within a major metropolitan areas. Major League Soccer (MLS) has a unique structure where teams and player contracts are centrally owned by the league, although each team has an investor-operator that is a shareholder in the league.

In business, a franchise is a business that licenses business methodology which may include, but is not limited to, products and services, processes and procedures, and brand and marketing. The business owner is a franchisee and the franchise provider is the franchisor. The franchisee must follow certain guidelines established in its contract with the franchisor, and typically paid an initial franchise fee and ongoing fees and royalties in exchange for the brand, concept, training and operations support.

Franchising is a method of growth for a business or concept owner who becomes a franchisor and builds a system for other entrepreneurs to deliver the business concept, products and services.

Franchisee

Entrepreneur who invests in a “proven” franchise business and agrees to abide by certain rules and procedures set by the franchisor in exchange for knowledge, processes and support from the franchisor. Franchisees are entrepreneurs who favor proven systems over a more autonomous route as an independent entrepreneur.

Franchisor

Company that recruits entrepreneurs to invest in their “proven” business concept with an up front payment and ongoing fees and royalties in exchange for training, support, systems, branding and marketing. Franchisors are often successful independent entrepreneurs who elect to grow by franchising their business concept.

FSBO

see For Sale By Owner

Full Standby

– see Seller Standby

Fully Executed

A fully executed document is one that has been signed by all parties forming a legal contract.

Furniture, Fixtures and Equipment (FF&E)

Furniture, fixtures, and equipment are tangible, moveable assets that have no permanent connection to the structure of a building such as:

vehicles
office furniture
partitions
computers
electronic equipment
machinery

FF&E does not include food, water, paper products, consumables or office supplies. FF&E is sometimes referred to as furniture, fixtures, and accessories (FF&A). FF&E is a subset of PP&E, or Property, Plant and Equipment (not to be confused with PPE or Personal Protective Equipment). PP&E also includes:

buildings
permanently attached fixtures
undeveloped land

Notice that with the addition of real estate, a business is more likely to refer to tangible assets as PP&E than FF&E. This applies to businesses that own the real estate where the business operates. This does not apply to an owner who owns the real estate under a separate company or business entity. In that case, the business is most likely to refer to tangible assets as FF&E since it does not own the real estate, which is owned by a separate entity with its own set of accounting records.

Industries that are capital intensive and have a significant amount of tangible assets include manufacturing, automotive, airline, mining, oil and gas, and real estate.

FF&E and PP&E characteristics include:

physical or tangible assets
typically have a life of more than one year
found on the balance sheet
each FF&E or PP&E item has a different useful life per IRS guidelines
businesses account for wear and tear by depreciating their values over their useful lives
depreciation helps avoid a significant cash outlay in the year the asset is purchased
depreciation spreads the cost out over years allowing the company to earn revenue from the asset
some investors prefer asset light businesses for a better return on investment
other investors value ownership of tangible assets
investors analyze PP&E to determine the business’s capital expenditure requirements and sources, and opportunities to raise cash if needed
lenders like asset heavy businesses since there is significant collateral for the loan

Strategic management of capital expenditures is vital to the health of asset intensive companies. Capital expenditures may propel a company but may drain cash, increase debt, or dilute shares if new equity is the source of funds (see Return on Equity).

NOTE: Tangible assets are depreciated for accounting purposes whereas intangible assets are amortized.

G

GAAP (Generally Accepted Accounting Principles)

These are ten major principles designed by the Financial Accounting Standards Board (FASB), a private non-profit standard-setting body, to support clear, concise and comparable financial reporting. While GAAP is not required for all businesses, publicly traded US companies are required by the Securities and Exchange Commission (SEC) to follow GAAP. Only the accrual accounting method is allowed by generally accepted accounting principles (GAAP). The ten principles are:

Principle of Regularity: compliant accountants strictly adhere to GAAP established rules and regulations.
Principle of Consistency: consistent standards are applied throughout the financial reporting process and from one period to the next with clear disclosure of any changes or updates.
Principle of Sincerity: compliant accountants are committed to accuracy and impartiality.
Principle of Permanence of Methods: consistent procedures are used in the preparation of all financial reports.
Principle of Non-Compensation: both positive and negative performance are fully reported and should not seek to compensate a debt with an asset, a revenue with an expense, etc.
Principle of Prudence: speculation does not influence the reporting of financial data. This accounting principle aims to show reality, revenue should be recorded only when it is certain and a provision should be entered for an expense which is probable.
Principle Of Continuity: assume that the business will not be interrupted, so assets do not have to be accounted at their disposable value, but it is accepted that they are at their historical value.
Principle Of Periodicity: reporting of revenues is divided by standard accounting periods, such as fiscal quarters or fiscal years. If a client pre-pays a subscription (or lease, etc.), the given revenue should be split to the entire timespan and not counted for entirely on the date of the transaction.
Principle Of Full Disclosure/Materiality: complete financial accounting information and values fully disclose the financial position of a business.
Principle of Utmost Good Faith: all parties are assumed to be acting honestly.

General Liability Insurance

General liability insurance, sometimes called a business owner’s policy, protects small businesses against claims involving bodily injuries and property damage resulting from your products, services or operations, as well as advertising injury. It may also cover you if you are held liable for damages to your landlord’s property.

Professional Liability (also known as E&O Insurance) and general liability insurance are optional for business owners (unlike worker’s compensation insurance which has different requirements by state). However, an employer or client may require a business to carry professional liability, general liability or both as a condition of a contract.

A common over simplification is that general liability covers physical risks while professional liability covers financial risks. General liability requires a physical address whereas professional liability does not. This can mislead some business owners, especially those who operate virtually or do not meet clients, suppliers or other people at their place of work, to feel they do not need general liability. But owners need to understand that besides physical risks, general liability will protect against advertising injury liability, including cases of slander or libel. Consult your insurance professional.

Goodwill

A type of intangible asset that that differs from other intangible assets in that it is more difficult to quantify, cannot exist separate from a company and cannot be sold separately. Customer loyalty, brand reputation, executive team experience, record of R&D innovation can all be part of goodwill. In the sale or merger of a company, goodwill is the difference between the price paid and the vale of assets minus liabilities. Goodwill only shows up on a balance sheet during a merger or acquisition. – See Intangible Assets for a comparison table.

Gross Rent Multiplier (GRM)

GRM is a metric to evaluate an a real estate investment against others. It is the purchase price divided by annual rental income. On a $200k purchase with $2500 rent, the GRM = $200K/$30K = 6.7. GRM is not the payback period since it does not factor in expenses. A GRM target is supposed to be between 4-7, with the lowest GRM being the best. Certain markets are better for appreciation while other markets are better for rental income. Our example is within the target range discussed by the investing community. It would be difficult to get on the low end of the range without sacrificing the quality of the neighborhood.

H

Hedge Fund

A hedge fund invests money from high-net-worth and institutional investors using a wide range of strategies including leveraging or trading of non-traditional assets. To protect against market uncertainty, the fund might make two investments that respond in opposite ways. Mutual funds are for the general public while hedge funds are for accredited investors.

Hedge funds tend to buy and sell public securities such as stocks and bonds whereas private equity firms buy whole companies and investment banks help bigger businesses buy one another or issue stock. See the comparison table of financial investment companies.

Horizontal Integration

see Vertical Integration for a comparison table.

Hybrid Asset-Stock Sale

A Hybrid Asset-Stock Sale is also known as a Deemed Asset Sale (see Typical Ways to Structure the Sale of a Business). IRC 338(h)(10) allows certain transactions to be structured as stock deals, but taxed as asset deals, enabling buyer and seller to each have their cake and it it too. This hybrid tax treatment can
accommodate the seller’s desire to sell stock and the buyer’s desire to purchase assets (and/or obtain contracts of target that are non-assignable in an asset sale). While there are many variations of the structure, the basic concept is as follows:

seller sells shares to the buyer in order to claim the capital gains exemption and reduce taxes on the sale
seller then sells assets to the buyer so the buyer can start the clock and depreciate the assets over time
buyer then redeems the shares

While this hybrid structure may appear to be a silver bullet in certain situations, some experts warn that any mixture of stock sales and asset sales must be very carefully thought out and clearly documented to avoid disappointing results or unintended consequences. This is a sophisticated method that requires considerable investment in tax and legal advice and therefore is only practical in larger deals. Furthermore, it is only practical in deals with significant physical assets.

I

iBuyer

iBuyers are corporate real estate investors that use technology to value and purchases homes by making cash offers. iBuyers may be local, regional, or national. Home owners often do not maximize their sale, but they do fast closings on their homes “as-is” without preparing or repairing.

The business model has had its detractors from mom-and-pop investors fearing competition from well-funded corporations to real estate professionals to home owners and renters in places where a high concentration of homes are corporate-owned.

While iBuying still exists with Opendoor, Offerpad, Homelight and others, the most recognized names in real estate tech, Zillow and Redfin, closed their iBuying operations in 2021 and 2022, respectively. In both cases, the companies never figured out how to handle a real estate downturn, a fatal flaw in an obviously cyclical industry.

IBBA

see International Business Brokers Association

Impound

With respect to mortgages, a lender will group other expenses with your monthly mortgage payment such as home owner’s insurance, property taxes and private mortgage insurance. While these other payments are not technically part of your mortgage, they are bundled with your mortgage into one payment. The lender controls the impound account to ensure these payments are made so that the property is in good standing. Impounds may be optional (you pay the other expenses yourself) or required under certain situations, such as loans guaranteed by state or federal agencies such as FHA or VA. Some lenders may offer an incentive such as a slightly lower interest rate to encourage impounds.

Income Statement

see Profit and Loss Statement

Indemnity

Indemnity is security or protection against a loss, financial burden, or legal liability. Indemnity is an insurance term that says your insurance company pays for a loss so you don’t have to. In M&A and business brokerage, an indemnity clause addresses how one company will be compensated by another for certain losses suffered during a merger or acquisition.

see Fundless Sponsor

Indication of Interest (IOI)

Interested buyers of businesses may provide this to a seller to see if both parties are close in their expectations of price and terms. An IOI is typically the first of three documents expressing interest, the others being a Letter of Intent and then the purchase agreement.

An IOI is non-binding, but the purpose is to save time when there is no advertised price. It typically includes a price range, deal structure, proposed seller transition, and plans for due diligence. On the other hand, it has little value on a smaller deal with a listed price where the buyer would typically go straight to a purchase agreement.

Intangible Assets

Assets that are not physical but identifiable such as intellectual property, goodwill, and other intangibles. The table below compares three types of intangible assets with each other and tangible assets.

	Tangible	Intellectual Property (Intangible)	Goodwill (Intangible)	Other Intangibles
Can be sold	Yes	Yes	No	Yes
Life	Finite	Finite	Indefinite	Finite
Value Method	Depreciation	Amortization	Amortization	Amortization
Examples	furniture, vehicles, buildings, land, equipment, tools, computers, machines, cash and securities	patents, trademarks, copyrights, trade secrets, designs, symbols, art, images, names, custom software	customer loyalty, brand reputation, executive team experience, record of R&D innovation	customer lists, broadcast rights, licensing, contracts
As listed on the balance sheet	Short Term: cash, accounts receivables* securities, inventory Long Term: property, plant and equipment	Long Term: part of Intangible assets	Long Term: appears as goodwill only during a merger or acquisition	Long Term: part of Intangible assets

*Note that while accounts receivables do not have a physical presence, most consider it a tangible asset since it can be converted to cash in the short term (less than a year.)

Intellectual Property (IP)

A category of intangible assets that represent creations of the mind such as patents, trademarks, copyrights, trade secrets, designs, symbols, art, images, names.

Intentionalism

see this article: Is Minimalism Good or Bad?

Intermediary

An intermediary is a middleman who helps people and companies buy and sell other companies. There are various intermediaries for different size businesses and transaction types. Read about the differences between a business brokers, M&A advisors, and investment bankers.

International Business Brokers Association (IBBA)

The IBBA is the world’s largest trade organization for business intermediaries, specifically business brokers and M&A advisors.

The IBBA concentrates on supporting and educating business brokers. It awards the Certified Business Intermediary® (CBI) certification as well as the courses and seminars required to obtain this certification.

The IBBA and the M&A Source are Specialty Sections of the International Association of Business Intermediaries, Inc. (IABI), a Texas non profit organization. Both have their annual conferences back to back in the same location for professionals who want to attend both.

M&A Source concentrates on supporting and educating M&A advisors. It awards the Merger and Acquisition Master Intermediary certifications (CM&AP, M&AMI and M&AMIFin [acquisition financing professionals]) as well as the courses and seminars required to obtain this certification.

Inventory List

Inventory can include raw materials, work-in-process and finished inventory. While inventory is almost always included in a sale, it may or may not be included in the offer price used to advertise a business for sale. This may be because the inventory list is not readily available at the time of listing or because it may change significantly at closing. Nevertheless, a buyer needs to know the value of inventory since this is a critical metric for running the business.

An inventory list is an itemized list of all inventory including a description and value. The value is typically represented as the cost to the seller. The seller’s cost accounting system will indicate the cost of raw materials plus value added labor for in-process and finished inventory.

A purchase agreement will indicate the value of the inventory, whether or not it is included in the contract price, and whether or not the price will adjust at closing by the amount of change in inventory value.

A seller is better off lsiting the business with a price that does not include inventory, and include an estimate of the value of the inventory that a buyer would need to purchase on top of the business. This way the buyer will see a more competitive or lower multiple since the price is lower. Furthermore, the seller should value the inventory as a “landed cost” which would include the shipping and customers fees paid to get the inventory on site.

Investment Banker

A financial professional or business intermediary who works on the largest deals relative to business brokers and M&A advisors. Here is an excerpt from the article Pros & Cons of Being a Business Broker.

Middle Market – $50 – $500 million of revenue: M&A Advisors and Boutique Investment Bankers
Upper Middle Market – $500 million – $1 billion of revenue: Investment Bankers
Greater than $1 billion of revenue – Bulge Bracket Investment Bankers

Investment Banks

Investment banks primarily help larger businesses, public or private, buy one another or issue stock. They are primarily involved as middleman raising capital or assisting large firms with the movement of capital via debt or equity. This includes facilitating Initial Public Offerings (IPOs), raising funds through credit facilities with the bank, selling shares to investors through private placements, or issuing and selling bonds on behalf of the client. Investment banks work with larger companies in the Middle Market and higher.

Over time, private equity firms, which tupically invest for themselves rather than serve as middlemen, have increasingly taken on investment banking activities. See the comparison table of financial investment companies.

IOI

see Indication of Interest

IRC 1202

see Qualified Small Business Stock

IRC 121 (Internal Revenue Code 121)

IRC 121 allows taxpayers up to $250,000 ($500,000 for certain taxpayers who file a joint return) of exclusion from taxes on the gain from the sale (or exchange) of real property used as a principal residence for at least 2 of the 5 years prior to the sale. This is a pure tax savings, not a tax deferral. If you live in a house for 2 or more years, then move out and keep it as a rental, you have three years to sell it and take advantage of IRC 121. This requires planning since you would have to list, sell and close before 3 years is up. Once 3 years have passed as a rental, the only way to take advantage of IRC 121 is to move back in for at least 2 years before selling.

You might wonder, what if I move back in after year three plus a day? Then wouldn’t I only need to live there 1 year before selling since I have another year that I lived there on the front end of the 5 year window? The answer is no. If you moved in on year 3 plus a day, you would only have banked 1 year minus a day. Then with each passing day, you bank a new day and lose a previously banked day so you have to bank two years.

What defines a primary residence that qualifies for IRC 121?

place of employment
amount of time used
where other family members live
address used for tax returns
driver’s license, car and voter registration
bills and correspondence and location of taxpayer’s banks and clubs

Edge Cases & Possible Exceptions

employment: exception permitted if the new job site is at least 50 miles farther from the old home than the old workplace was from that home
health: exception permitted if the primary reason is related to a disease, illness or injury or if a physician recommends a change in residence for health reasons, which may include health of close relatives requiring a sale and move to care for sick family members
Unforeseen Circumstances:
- death
- divorce or legal separation
- becoming eligible for unemployment compensation
- change in employment that leaves the tax payer unable to pay the mortgage or reasonable basic living expenses
- multiple births resulting from the same pregnancy
- damage to the residence resulting from a natural or man-made disaster, or an act of war or terrorism
- condemnation, seizure or other involuntary conversion

IRC 338(h)(10)

see Hybrid Asset-Stock Sale

J

K

L

Leverage

Leverage is a physics concept of amplifying an input force to provide a greater output force. In finance, it is the concept of borrowing, or using other people’s money (OPM), to magnify one’s return on investment. For example, an investment of $100,000 in an asset that increases in value to $200,000 provides a 100% ROI. [($200,000 – $100,000) / $100,000] *100 = 100%.

However, if the investor only invested with a 10% down payment of $10,000 and borrowed $90,000 and the total cost of the loan including interest payments made is $40,000, the investor’s return is [($200,000 – $40,000 – $10,000) / $10,000] *100 = 1500%.

Leverage is a powerful financial concept. However, it assumes the risks of borrowing money which include regular payments which are mostly interest in the early life of most loans. If these payments are not made, the borrower risks defaulting on the loan, damaging their credit, and losing the investment. Many real estate gurus hype OPM while other finance celebrities like David Ramsey characterize debt as horrible and evil.

Letter of Intent (LOI)

Interested buyers of businesses may provide this to a seller to move along in the process. An LOI is typically the second of three documents expressing interest, the others being an Indication of Interest which comes first and the purchase agreement which comes last.

An LOI happens after discussion of the IOI. It usually narrows down the value range from the IOI to a specific offer price and lands on terms agreed during discussions between the parties. In essence, it is signaling to the Seller that the Buyer will close the transaction on the price and terms in the LOI, barring any adjustments the buyer needs to make as a result of due diligence.

The buyer expects the Seller to take the listing off the market once he signs the LOI. The Buyer can then proceed with due diligence which can take months. On smaller transactions, Sellers will prefer to skip this step and go straight to a purchase agreement with an earnest money deposit from the buyer before the seller is comfortable taking the listing off the market.

Listing Agreement

Agreement between an agent or intermediary with an owner to list and sell property, assets or entities most commonly used in residential and commercial real estate, business brokerage and M&A. The most common types of listing agreements are exclusive, giving the intermediary or agent exclusive rights to sell and earn commission for a period of time. When the listing is 100% commission based, the rationale is to provide enough incentive for the agent or intermediary to work diligently to complete a sale.

Types of Listing Agreements

	Exclusive Right To Sell	Exclusive Agency	Open Listing
Number of Agents?	One	One	Any Number
How is a Commission Earned?	Agent earns commission no matter who procures Buyer	Agent earns commission unless Seller procures Buyer	Only the agent who procures the buyer earns a commission
*Is a Net Commission an Option?**	Yes	Yes	Yes

*A net commission is when an owner sets a minimum amount of net proceeds from a sale and the agent receives payment on any amount above the minimum net proceeds.

The key components of listing agreements include:

Type of listing agreement
Names and contact information for agents and owners
Time period
Item/s for sale and exclusions
Price
Payment terms
Tail (period of time when commission may earned after expiration)
Cancellation policy
Obligations of the parties
Guidelines in case of disputes

LOI

see Letter of Intent

Lower Middle Market (LMM)

Lower Middle Market describes a tier of businesses by size. Various sources will have different lower and upper limits that define this tier. Furthermore, some sources will define the tier by EBITDA while other sources will define the tier by revenue. Here is an example breakdown by revenue from a section of the article Pros and Cons of Being a Business Broker called The difference between Business Brokers, M&A Advisors, and Investment Bankers.

Main Street– <$5 million of revenues: Business Brokers
Lower Middle Market – $5 – $50 million of revenue: M&A Advisors
Middle Market – $50 – $500 million of revenue: M&A Advisors and Boutique Investment Bankers
Upper Middle Market – $500 million – $1 billion of revenue: Investment Bankers
Greater than $1 billion of revenue – Bulge Bracket Investment Bankers

Different business intermediaries facilitate the purchase and sale of businesses within the different tiers using different processes, methods, and terminologies. There are no clear cut dividing lines. For example, high end business brokers may serve businesses with over $10 million in revenue and some M&A advisors are coming downstream to serve businesses that may have less than $5 million in revenue, although they typically work with businesses well over $1M in EBITDA.

M

M&A

see Mergers and Acquisitions

M&A Advisor

An M&A Advisor is an intermediary who helps companies buy, sell or merge with other companies. See intermediary, Mergers & Acquisitions, and also read this article that compares M&A Advisors with other intermediaries: What are the Pros and Cons of Being a Business Broker?

M&A Attorney

Attorney that specializes in mergers and acquisitions. It is critical to find the appropriate attorney for the appropriate size deal when selling, buying or combining businesses. M&A attorneys hired to handle main street business sales or acquisitions are not a good fit. Likewise, most small business transaction attorneys are not equipped to handle larger M&A deals. A mismatch in the expertise between attorneys for the buyer and seller can create problems and often lead to failed deals. M&A attorneys are likely to need experience in the following areas

corporate structures
deal structures
financing
stock sales versus asset sales
private equity
intellectual property
joint venture, licensing and other agreements
reps and warranties
due diligence
closings

M&A Source

Trade organization so named because it represents “the source” of opportunity and professional growth for merger and acquisition M&A advisors and strategic professionals who are dedicated to the lower middle market (LMM). See International Business Brokers Association for more on M&A source and its relationship with the IBBA.

Main Street

A range of businesses typically under $5 million in revenue where purchase and sales of businesses are served by business brokers. Some sources define the market tiers with slightly different lower and upper limits and other sources define the tiers by EBITDA. See Lower Middle Market for a breakdown of the tiers.

Malpractice Insurance

see Professional Liability Insurance

Master Franchisee

A franchisee who signs a Master Franchisee Agreement (MFA) with the franchisor to develop a geographic region in the same way the franchisor develops other regions. A common scenario is a U.S. Franchisor who enlists a master franchisor in Canada or vice versa. This helps a franchisor grow into new territories that may be far way, have different laws, or is otherwise difficult to manage without a local partner. The master franchisee steps into the shoes of the franchisor and sells and services franchises and franchisees, collects franchise fees and royalties, and provides support to franchisees including financing, site selection, store buildout, training, marketing reporting and other processes. Also see Franchise Area Developer.

Mergers and Acquisitions (M&A)

The process of purchasing or combining companies through various financial transaction methods which may be complete or partial, assets or stock, friendly or hostile, and between companies of similar or different sizes.

Middle Market

A range of businesses typically in the $50 – $500 million revenue where mergers and acquisitions are served by M&A Advisors and Investment bankers. Some sources define the market tiers with slightly different lower and upper limits and other sources define the tiers by EBITDA. See Lower Middle Market for a breakdown of the tiers.

Minimalism

see this article: Is Minimalism Good or Bad?

MLS

see Multiple Listing Service

Multiple

In business brokering and M&A, this is a term used to describe the value of a business relative to its earnings, or less commonly to its revenue. A multiple of earnings is most important to a buyer. Some industries use multiple of revenue by convention and this may be fine when businesses within an industry tend to be similar and easy to compare (such as accounting practices) relative to other industries.

The multiple of earnings tends to be low for main street businesses, often in the 1-3 range. For example, a business with an adjusted net profit of $150,000 may sell for a multiple of 2 or $300,000. Larger businesses with $millions in adjusted profit may sell for multiples of 3-7 and beyond. Businesses with tens of millions in profit ccan sel for multiples close to or greater than 10. The multiple will vary depending on many factors which may include:

market position
size of earnings and revenue
quality of earnings
recent annual financial performance trends
owner involvement
strength of executive team
systems and processes
tangible assets
intellectual property and intangible assets
external market conditions
type of buyer (for example, financial versus strategic)
deal structure, offer terms and financing

When a business has inventory, more often than not it will be listed at a certain price not including the inventory. This is important when a buyer calculates the multiple to see how it compares with other opportunites.

Example

Adjusted earnings or SDE: $300,000
Inventory: $150,000

Asking price: $900,000 not including inventory	Asking price: $1,050,000 including inventory
Multiple of Earnings = ($900k/$300k)	Multiple of Earnings = ($1,050k/$250k)
Multiple of Earnings = 3	Multiple of Earnings = 3.5
Look better to buyer	Looks better to seller

The accounting method is another important consideration that can effect how the value of a company is presented. For example, the same company might show a mutlipe of 3.7 via the accrual method of accounting and a 4.3 vis the cash method of accounting. The 4.3 would be less attractive to buyers than the 3.7, despite the fact that both describe the same company.

Multiple Listing Service

MLSs are private databases created, maintained and paid for by real estate professionals to share information on properties they have listed with cooperating brokers to sell homes more efficiently.

The MLS is private for confidentiality and security reasons. Listings may have information on how to access the home including key codes, lock combinations, or listing agent notes about the seller or tenant meant to help other real estate professionals with showings and offers. The MLS provides members with access to all the information while excluding confidential information from the public.

There is no national MLS. In fact, there are over 500 regional multiple listing services. Some that are close together may have reciprocal arrangements that allow real estate professionals who belong to an MLS to access neighboring MLS’s.

Through IDX or Internet Data Exchange, listing agents can share a property listing with certain data feeds like Zillow, Redfin and Realtor.com While Zillow has 50-100 fields of information and pictures, most MLSs have hundreds of fields and photos per listing as well as a history of listings that can go back decades for real estate professionals to conduct research. Nonetheless, data feeds to national sites like Zillow, a process called syndication, provide added exposure for listings and listing agents. Syndication is typically an option for the listing agent to check. The majority of listing warrant syndication for maximum exposure, although there may be rare cases when a seller may not authorize syndication. If a homeowner does not see their home listed on Zillow and other sites within a few days of it being listed on Zillow, the listing agent may have failed to check the box.

In most cases, access to non-confidential information from the MLS is free to the buying public. On the other hand, sellers who wish to list the properties For Sale By Owner (FSBO) on the local MLS need to be licensed in real estate and paid members of the MLS, or they can enlist the services of a flat fee broker to list the property on their behalf.

See REALTOR® to learn more about the relationship between MLSs and REALTORS®, real estate professionals, and the National Association of REALTORS®.

With respect to businesses for sale, there is no structure equivalent to the real estate industry’s network of regional MLSs. There is an equivalent to national for-profit real estate platforms like, Zillow and Redfin. These business for sale platforms include BizBuySell and its competitors. See Best Places to Find Businesses for Sale.

N

NDA

see Non-Disclosure Agreement

Net listing

see Listing Agreement

Net Operating Income (NOI)

NOI is income minus operating expenses. It excludes long term capital gains and expenses such as interest, depreciation, amortization, capital expenditures and one-time or unusual expenses. In real estate, NOI excludes loan payments. It may be referred to as Net Ordinary Income.

NOI

see Net Operating Income or Net Ordinary Income

Non-Compete Agreement

This is a common clause in employment contracts that prevent workers from working for competitors during or after their current employment typically bounded by time, industry, and/or geography.

Enforceability of non-compete agreements varies by state. Employer-employee non-competes are either entirely or largely unenforceable in a few states, while other states have bans for low-wage workers. While there is no national ban as of this writing, the federal government, specifically the Federal Trade Commission, may look into a ban or limit on non-competes.

While non-compete agreements are legal in all 50 states with respect to the sale of a business, enforceability of the length of the non-compete varies by state. In the sale of a business, non-competes typically require the seller from competing within 3-5 years after the sale and within a geography that depend on the market served by the business for sale.

In one case, I had a buyer of a business request that the number of years in the non-compete clause be lowered. The buyer explained that their attorney preferred a number that was enforceable.

Non-Disclosure Agreement (NDA)

Legal contract that binds parties receiving confidential information, materials and knowledge to maintain confidentiality. As most legal contracts do, the NDA define the parties and the length of the agreement. The NDA also defines the scope of the obligation and any exclusions. NDAs can protect one or more parties.

unilateral – only one party is obligated to keep the other part’s confidential information private
bilateral – both parties shall keep each other’s confidential information private
multilateral – all parties shall keep all other party’s confidential information private

In business brokerage and M&A, a seller often requires an NDA from prospective buyers prior to releasing information, often including the seller’s identity.

O

Owner’s Benefit

see Seller’s Discretionary Earnings

Owner’s Discretionary Earnings (ODE) or Income (ODI)

see Seller’s Discretionary Earnings

Owner’s Employment Taxes

see Owner’s Salary

Owner’s Health Insurance

see Owner’s Salary

Owner’s Salary

This is an add back to net operating income showing the total cash flow or owner benefit from a main street business. Buyer’s can then compare business opportunities based on owner’s benefit which can include one owner salary, payroll taxes on that salary, health insurance for one owner, perks such as cell phone and auto expenses run through the business, and profit. On larger businesses, the profit number used to compare opportunities is adjusted EBITDA, and may not include an add back for any owner’s salary, the rationale being a new owner will likely need to continue to the pay the owner as an employee or hire a replacement at the owner’s salary.

P

P&L

see Profit and Loss Statement

Partial Standby

– see Seller Standby

Personal Guarantee

This is an agreement that allows a lender to go after one’s personal assets in the event of a default. SBA Loans require personal guarantees. Seller financing may or may not include personal guarantees depending on what is negotiated between buyer and seller. While a seller may argue that since a personal guarantee is required by an SBA lender, the Seller also requires a personal guarantee, the buyer may refuse and either party can accept or walk away.

Pettifogger

A pettifogger is an inferior legal practitioner. They may deal with petty cases or employ dubious practices. A parallel term for a doctor is “quack.”

Platform

A larger foundational business acquired by a private equity firm that plans to acquire additional related firms called “bolt-ons” to create a larger firm with market dominance in a niche.

PP&E

see Property, Plant and Equipment

Private Equity (PE)

Private Equity refers to the financial arena where private equity groups (PEGs) are investment partnerships that buy, manage and sell companies. Private equity partners are general partners and their investors are limited partners. Investors are wealthy individuals, large family funds and institutional investors including pension funds, investment companies, endowments, foundations, insurance companies and sovereign wealth funds.

Target companies are not publicly traded typically, thus the “private” in private equity. PE firms may gain control of public companies to make them private, may acquire divisions of public firms, and may even acquire public firms outright although this is not common since public companies are typically run more efficiently and with greater oversight than private ones. Money is invested in target companies for an ownership or equity stake in the company, thus the “equity” in private equity. That said, PE firms primarly use debt in their acquisitions. PE firms are none other than the leveraged buyout (LBO) firms of the 1980s under a new name. These LBO firms primarily used debt (thus the “leverage” in teir name) and were also know as corporate raiders.

Venture capital is a form of private equity as both invest in private companies in exchange for equity or ownership stakes in the company. Both raise capital from outside hands-off investors called limited partners. Limited partners are charged 1.5 – 2.0% of assets under management (or less with more time under management) and roughly 20% (carried interest) on profits from investments over a minimum return (hurdle rate). See the comparison table of financial investment companies.

Private Equity Group (PEG or PE firms)

A type of financial buyer that is very active in mergers and acquisitions by leveraging capital from investors such as wealthy individuals, pensions, and state-owned funds. Per the name, private equity firms acquire private companies, ones that are not publicly traded. PEGS acquire companies within a niche or industry, find synergies or ways to cut costs, and exit for large future returns to the investors and themselves, collecting fees along the way. They can achieve growth by buying a larger initial platform business and later acquiring synergistic bolt-ons. See a comparison table of buyer types.

On a darker note, a PEG may be characterized as a financial firm that buys small profitable companies, combines them and sells the larger entity can make money from the higher value (multiple of earnings) placed on larger companies. In many of these cases, private equity firms do not create value. In fact, they often destroy value by reducing competition, leveraging debt, putting that debt burden on the acquired company, eliminating jobs and cutting costs to the long term detriment of the company, the industry, employees and consumers. Brendan Ballou explains how widespread these firms are in the U.S., how detrimental the industry is, and how in bed they are with politicians and the legal framework of American capitalism. Nonetheless, he does offer hope in his book Plunder. When I heard about the book, I sought answers to three questions given the terrible repuation of the industry and these are my conclusions.

Why do investors invest with private equity firms? TBD
Why do owners sell to private equity firms? They are bribed by PE firms, so they sell out and are sometimes fattened.
Are there any good (value add) private equity firms or business models? TBD

Comparison Table	Private Equity	Venture Capital	Investment Bank	Hedge Fund
Role	Participate in M&A(Buy Side)	Type of Private Equity that Invest in Startups	Facilitate M&A (Sell Side), help firms raise or move capital	A fund know for risky strategies, it hedges with short positions.
Type of Funds Used To Invest	Debt and Equity	Equity	NA	Debt and Equity
Sources of Funds or Revenue	high fees from pension funds, insurance firms, endowments, wealthy individuals	high fees from pension funds, insurance firms, endowments, wealthy individuals	transaction fees from publicly traded or large privately held companies	high fees from pension funds, insurance firms, endowments, wealthy individuals
Investment Targets	Whole companies in many Industries, privately held	Startup companies in tech Industries	NA	securities, commodities, currencies, derivatives, and real estate
Stage	Relatively Mature	Startup or Early	NA	Mostly mature
Percentage	Majority stake up to 100%	Minority stake	NA	Minority stake
Risk Associated with Targets	Lower / Solid and Stable	High / Unicorns	NA	High
Management Involvement	Higher	Lower (Board Roles)	Low (service provider, not operator)	Low (investor, not operator)
Staff Backgrounds	Investment banking professionals seeking more balanced work life	Startup founds, executives, consultants and bankers	Top-tier MBAs who don’t mind ruthless hours	Degrees in Finance and Economics, great analysts
Notable Firms	Carlyle Group, Blackstone Group, KKR, Bain Capital, Clearlake Capital, Insight Partners, Thoma Bravo, CVC Capital Partners, EQT Partners, Hellman and Friedman, BlackRock, Warburg Pincus,	Intel Capital, Google Ventures, Accel Partners, Kleiner Perkins, Sequoia, Tiger Global Management, Bessemer Venture Partners, New Enterprise Associates, Khosla Ventures, Andreessen Horowitz	Bulge: JP Morgan Chase, Goldman Sachs, UBS, Morgan Stanley, CitiGroup, Credit Suisse, Barclays, Middle Market and Boutique: Houlihan Lokey, KPMG, Baird, Rothchild, Raymond James, Blair, Lazard, Jefferies, Stifel, Perella Weinberg, Baird	Elliot, Bridgewater (Ray Dalio), Man Group, Haidar Capital, Garda Capital, ExodusPoint, Lighthouse Investment Partners, Element Capital, Balyasny Asset Management, Viking Global Investors, Adage Capital

Profit & Loss Statement (P&L)

Also known as an income statement, this financial statement covers a time range such as a month, quarter, half, fiscal year, calendar year, rolling 12 months or multi-year period. It shows the detailed revenue, expenses, and profit or loss over that time period. It is one of the primary documents used to value a business along with tax returns and balance sheets.

A P&L is one of three three primary financial statements used to evaluate or understand a business and its performance. See financial statements for a comparison table.

Professional Liability Insurance

Professional Liability insurance, also known as Errors and Omissions (E&O) coverage and, in some industries malpractice insurance, protects businesses that provide advice or professional services. It protects against claims that professional advice or services you provided caused a customer financial harm due to actual or alleged mistakes or a failure to perform a service.

Professional and general liability insurance are optional for business owners (unlike worker’s compensation insurance which has different requirements by state). However, an employer or client may require a business to carry professional liability, general liability or both as a condition of a contract. General liability insurance requires a physical address whereas professional liability does not.

Promissory Note

A promissory note is simply a legal document that contains a promise to repay a debt such as a car loan, student loan, mortgage, business or personal loan. Promissory notes may may or may not be secure by collateral, have interest charges, have payments or be paid in one lump sum (simple promissory note).

Property, Plant and Equipment (PP&E)

PP&E includes FF&E – see Furniture, Fixtures and Equipment.

Purchase Agreement

A purchase agreement is binding between the buyer and seller. For larger transactions, it is often preceded by an LOI, which may be preceded by an IOI. Due diligence is done after a signed LOI for these larger deals, so the purchase agreement is the last step that captures any modifications agreed upon as a result of due diligence. The time between a fully executed purchase agreement and closing can be short in these deals since the due diligence has been done. The remaining items may be to meet certain conditions for closing and allow enough time for attorneys and closing services to prepare for closing.

For smaller deals, the purchase agreement encompasses the due diligence process since there is no IOI or LOI. Closings can take place in weeks or months after a fully executed purchase agreement depending on the complexity of the business, the number of advisors reviewing the business and the presence of third-party financing.

An earnest money deposit is typically required by a seller for these smaller deals, and is typically refused by buyers of larger deals. These definition of small and large are not exact. Financial buyers typically pursue businesses with approximately $1 million or more in adjusted EBITDA (profit) and typically use the IOI, LOI, purchase agreement process with no earnest money deposit.

There are two ways to purchase a business. An asset purchase utilizes an asset purchase agreement and a stock purchase utilizes a stock purchase agreement. Business Brokers have asset purchase agreements while stock purchase agreements will typically be provided by M&A attorneys.

Q

Qualified Intermediary

Also know as a 1031 exchange intermediary or accommodator, the qualified intermediary is an independent person or company that facilitates the transfer of proceeds in a 1031 exchange. These intermediaries can be an independent CPA or attorney (not your CPA or attorney) or a bank. Fees may be roughly $1000 for one property with discounted fees for additional properties in the exchange beyond two.

Qualified Small Business Stock (QSBS)

Under IRC Sec. 1202, a qualified C Corporation can exclude taxable gains from the sale of Qualified Small Business Stock (QSBS).

The maximum amount of the exclusion is the greater of $10 million ($5 million if married filing separately [lifetime limit for each investment]) or 10 times your original investment annually.

Requirements

Stock must have been issued by a domestic C Corporation after August 10, 1993 and acquired as follows:
- A 100% capital gains exclusion for QSBS acquired after Sept. 27, 2010.
- A 75% capital gains exclusion for QSBS acquired between Feb. 18, 2009, and Sept. 27, 2010.1 However, 7% of the excluded gain is subject to AMT.
- A 50% capital gains exclusion for QSBS acquired between Aug. 11, 1993, and Feb. 17, 2009.1 However, 7% of the excluded gain is subject to AMT

Aggregate tax basis of the corporation’s assets cannot exceed $50 million before and immediately after the issuance.
The stock must have been issued by a corporation that uses at least 80% of its assets in an active trade or business. Certain trades or businesses are specifically excluded from IRC Sec. 1202, including most professional service firms, finance and investment management businesses, and hospitality businesses.
The taxpayer must have received the stock at original issue (i.e., not in a secondary sale) in exchange for money, other property or services.
The stock must be held for at least five years.

Sec. 1202 cannot be used to exclude corporate-level gains from the sale. However, as long as the corporation subsequently distributes the proceeds of the sale to its shareholders in a complete corporate liquidation, the shareholders should be able to use the exclusion.

QSBS acquired between August 10, 1993 and Sept. 28, 2010, does not qualify for a 100% exclusion and is subject to a partial alternative minimum tax (AMT) adjustment on any gain excluded under Sec. 1202.

Quality of Earnings (QoE)

Not all profit is created equal. Thus the term ‘quality of earnings” which is a concept whereby an analyst seeks to delve deeper into the impacts and sustainability of the profit. Profit that cannot be repeated, is short term, or unsustainable is of lower quality than recurring long term profitability. Profit from the sale of assets or from selling goods purchased at a one-time bargain are of low quality. Profit from recurring revenue, subscriptions or long-term commitments are of high quality.

Quitclaim Deed

Unlike a warranty deed, a quitclaim deed transfers the title of property with little or no protection for the receiving party. Quitclaim deeds are faster and are often used among relatives or known parties.

Example:
Five heirs inherited a property that does not generate income and will not generate income without considerable investment, yet has expenses associated with maintenance and taxes. Two of the heirs express an interest in giving up their ownership rather than contribute to the expenses and future investment and the other three heirs agree to accept full responsibility. Quitclaim deeds can be used in this case.

Note that such a transfer may only be valid if 1) the grantor delivers the quitclaim deed to the grantee and 2) the grantee accepts. Yet quitclaim deeds do not need the signature of the receiving party or witnesses depending on the state or county. As such, trouble can arise if the grantor has the conveyance recorded with the county without the grantee’s knowledge. The grantee will then be obliged to file a court petition to void the conveyance.

Quitclaim deeds do not relinquish responsibility on a mortgage. Here are some common uses for quitclaim deeds:

Marriage: easily add spouse to title.
Divorce: convey to you or ex-spouse.
Gifts: easy, less costly title transfer.
Fixing Errors on Title: Examples include names of parties or witnesses are missing or incorrect

R

Rainmaker Advantage Plan

see Roth Advantage Plan

RAP

see Roth Advantage Plan

REALTOR®

REALTOR® is a trademark of the National Association of REALTORS® which specifically identifies someone as a member of the National Association of REALTORS® who pledges to abide by a strict Code of Ethics and Standards of Practice.. The proper use is all caps with the registered trademark symbol, although it is common to find the trademark without one or both.

Any real estate agent who is a member of the National Association of REALTORS® is also a member of their state and local board of REALTORS®. To become a REALTOR®, a real estate licensee must join all three associations: local, state, and national. NAR refers to this as the three-way agreement.

Not all licensed real estate professionals are REALTORS®

Since the 1960s, there have been legal challenges to REALTOR® associations that restrict Multiple Listing Service (MLS) access to members of the REALTOR® association that owned and operated the local MLS. In 1994 the NAR decided to eliminate the requirement that participants in REALTOR®-association MLSs must be REALTOR® association members. As a result each MLS may determine for itself whether non-members will or will not be permitted to participate in the MLS. In either circumstance the MLS will be in compliance with NAR policy and thus covered by the NAR Professional Liability insurance policy coverage.

While most real estate professionals, whether agents or brokers, are REALTORs®, they may not be. However, all licensed professionals must abide by the rules of the MLS and their state board that governs real estate professionals.

Reps and Warranties

Representations and warranties are statements and disclosures made by one party to another. Reps and warranty clauses in purchase contracts can provide the parties with a path to cancellation or termination prior to closing, and serve as a foundation for indemnification claims.

Here is the difference between representations, warranties and covenants.

Representations refer to the past and present
Warranties refer to past, present, but mainly the future
Covenants mainly refer to the future

In business acquisitions, it primarily relates to the seller regarding assertions and assurances about the current and expected future state of the business. Some contract clauses ask purchaser to accept and agree that no representations or warranties are made by the seller.

Representation and Warranty Insurance are most commonly purchased by a buyer for protection in the form of monetary compensation for losses relating to a seller’s breach of representations or warranties. Representation and Warranty Insurance for a seller can provide liability coverage and may reduce or eliminate the need for an escrow.

Retrade

Retrade refers to a change in the offer or terms of an LOI during due diligence. When a buyer discovers something negative with the business, they are perfectly within their right to change the offer, most commonly by lowering the offer price. Many deals are lost when this happens, so it is important for Sellers to be as up-front and thorough with information from the outset. Experienced buyers understand this is a bad experience for sellers, and may avoid retrading on minor issues.

Return of Capital (ROC)

Return of capital is the return of the principal only. It is what someone means when they say “I need to at least make my money back.” The capital invested is the cost basis for tax purposes, so a return of any portion of the capital invested is not a loss or gain and not considered income for capital gains. In this context, capital invested = principal = cost basis.

Return on Assets (ROA)

Financial metric that indicates the efficiency of total assets held be the company in generating profits. This metric is important for asset-heavy businesses. ROA = Net Income / Total Assets. A higher ROA indicates the company is investing capital wisely and efficiently to generate optimal returns.

Since the Balance Sheet equation is Assets – Liabilities = Shareholder’s Equity, ROA accounts for a company’s debt and ROE does not. The more leverage and debt a company takes on, the higher ROE will be relative to ROA.

Return on Equity (ROE)

ROE is net operating income divided by shareholder equity. By comparing the net income to the equity of the firm, it measures the efficiency of generating income.

ROE can be negative if profits are negative or if equity is negative. Equity is assets minus liabilities. If a company has to borrow to stay in business and liabilities are greater than assets, then equity is negative. If ROE is negative due to negative equity, than a higher negative ROE is preferable as it indicates a higher profit and a more favorable outlook than a lower negative ROE. As with all ratios, comparisons with similar companies, within industries, or within a company at different times are more useful than comparisons with different types of companies or industries.

For a company with shareholders, ROE can measure how efficiently a company generates income from equity financing, or capital raised through selling shares of stock.

The concept of ROE is important in real estate, where equity is the difference between a property’s worth and it’s outstanding mortgage or debt. Here are some key points about return on real estate equity:

Every year you keep a property, you are “re-buying” it. Your equity is your “cash re-invested.”
As your equity grows, the return on equity usually falls, unless appreciation is sufficiently strong.
Calculate equity each year and the return on equity if you decide to keep the property another year.
Compare that ROE to what you could earn if the equity was reinvested in a different property.
If you can do significantly better in a different investment, it’s time to move your equity.
There are three ways to move your equity: sell, refinance or 1031 exchange (highly preferable if your new investment is still real estate).

Return on Investment (ROI)

ROI is a measure of the gain or loss over a period of time expressed as a percentage of the initial investment.

It is a simple measure of profitability or efficiency of an investment and is useful for comparison against other investment opportunities. The simple equation is [(Current Value of Investment – Investment)/Investment] x100. The numerator is the gain or loss and the x100 expresses the result as a percentage.

EXAMPLE: If you double your money, your ROI is 100%

[(2,000-1,000)/1,000] x100 = 100

Confusion, Misuse and Limitations of ROI

ROI is is often provided without reference to a time period which is fairly meaningless. In the previous example it is important to know whether it took 1 year or 5 years to double your investment.
I often hear salespeople, or their customers, make statements such as “The ROI is 3.5 years.” They are probably referring to the payback period, i.e. the amount of time it takes to make back their initial investment.
ROI does not factor inflation or the time value of money. Formulas that account for the time value of money are Net Present Value (NPV) expressed as a dollar amount and Internal Rate of Return (IRR) expressed as a percentage.

NOTE: Return of Investment is a much less common term – see Return of Capital.

ROA

see Return on Assets

ROBS

see Rollover for Business Startups

ROC

see Return of Capital.

ROE

see Return on Equity

ROI

see Return on Investment

Rollover for Business Startups (ROBS)

ROBS are a source of funds for business acquisition that may or may not be used in conjunction with other funds such as the buyer’s cash, and SBA loan, or seller financing. Roll over pertains to rolling the buyer’s 401K retirement account into a business tax-free. The retirement account becomes an investor or shareholder in the business at whatever percentage it contributes to the acquisition of the business. A ROBS business must be a C-Corp. Because ROBS accounts can cost close to $5000 to set up and hundreds of dollars for monthly maintenance, most ROBS providers advise potential candidates to consider ROBS if they have $50,000 or more in their retirement account.

Because this is not a loan, there are no monthly loan payments. However, the percentage of profit attributed to the retirement fund cannot be distributed to the owner tax-free. However, the owner can take a salary prior to calculating the profit allocation to the retirement fund. Here is an example:

Business Acquisition = $500,000
Source of Funds = $250,000 from buyer’s savings and $250,000 from Buyer’s 401K ROBS account
Owner’s Salary = $50,000
Profit after operating expenses including owner’s salary expense = $200,000
Profit attributed to ROBS account is $100,000
Profit attributed to to owner is $100,000

NOTE: The IRS also allows you to borrow 50 percent of your 401k up to $50,000 for any reason without paying taxes. The loan must be repaid with interest within five years or upon employment termination. This type of loan can also be used to fund a business. However, this type of loan is better used as a bridge loan when there is a clear path to repayment. Due to the short term of five years, the payments, although they are payments of principal and interest back to your retirement, can be high and the business may not be able to support the payments. See this article on buying a business with little or no money.

Roth Advantage Plan (RAP)

Also know as the Rainmaker Advantage Plan, this is a similar concept to ROBS except it invests cash or retirement funds and it invests post-tax money in the business. See this presentation for details.

S

SBA Lender

A bank or financial institution that provides SBA Loans. These banks may be national banks or local banks. They may provide SBA-backed loans and non-SBA backed loans. Since the SBA has certain criteria for the loans they will guarantee, the lending process can be much longer than it is for a real estate loan since there are two parties, the bank and the SBA, that each have their own criteria. SBA loans can take 60-90 days from the time of the application.

SBA Certified and Preferred Lenders have more authority on credit decisions than a regular SBA lender. Certified Lenders have partial delegation of authority on approving loan applications and account for about 10% of SBA loans. Preferred Lender have full delegation of authority on approving loan applications and account for about 18% of SBA loans. While Certified and Preferred Lenders can shave days and weeks off the approval process, this amount of time savings is watered down across a 60-90 day funding time frame and often un-noticeable.

SBA Loan

A loan backed by the Small Business Administration (SBA) used for acquiring a business. The SBA doesn’t provide the funds. They back the loans, thus reducing the risk for banks to make loans for business acquisitions. SBA loans have terms are up to 7 years for working capital, up to 10 years for business acquisitions, and up to 25 years for real estate acquisition or construction.

The most common SBA-guaranteed loan is an SBA 7a loan which can go all the way up to a maximum $5 million dollar loan and take 60-90 days to fund. Up to 85% of the SBA 7a Loan is guaranteed by the SBA. An SBA Express is backed by the SBA up to 50% of the loan, goes up to $500,000 maximum loan amount, and has higher interest rates. SBA Express loan approvals can happen within 36 hours versus 5-10 business days for a 7a loan. Despite a faster approval process, lenders may still take a long time to process and fund the loans. So the “Express” in SBA Express Loans refers to the approval time frame, not the overall time to receive funds.

Lenders must qualify both the buyer and the business. The buyer is qualified based on their credit and financial data. They are also assessed for their ability to run the business they are acquiring. The business is qualified based on profitability and collateral.

For sellers, the benefit of SBA loans is they open up the buyer pool to a greater number of buyers. Another benefit is the seller may not have to finance any of the purchase, or finance a smaller amount. The largest drawback is that the SBA loan process will add months to the selling process, and the seller need to be prepared to provide tax returns, financials, and a significant amount of documentation.

For buyers, the benefits of an SBA loan include longer terms and larger loan amounts that what a typical seller would grant with seller financing. A personal guarantee is required on an SBA loan. For seller financing, the seller may or may not require a personal guarantee. An alternative or supplement to SBA loans and seller financing is ROBS.

Even for the most organized buyers and sellers, the frustrations can mount when asked to provide information continuously and seemingly out of order. A common example is a request for a tax clearance certificate as one of the final requests, despite the turnaround being months depending on the state. See this article on buying a business with little or no money.

SDE

see Seller’s Discretionary Earnings

Search Fund

This is a type of business acquisition model involving an individual, typically an experienced recent MBA graduate who seeks to acquire and run a business and who is backed by investors who have already committed to the search, pay a modest salary to the entrepreneur for a search of up to a couple of years, and will invest in the target. Because the investment in the target is not actually committed, this is a fundless model. However, it differs from the fundless sponsor model in that the search entrepreneur will actively run the business. The entrepreneur’s industry and technical alignment with the target may or may not be strong, but will be a consideration for the entrepreneur, the investors, and the seller. The origins of the search fund model are traced to a Stanford Business School professor H. Irving Grousbeck, who originated the concept while lecturing at Harvard Business School in 1984. Both business schools have active support and research for the model and other top business schools have jumped on board. Investors are often business school alumni.

The searcher can earn 8 1/3% ownership upon close of acquisition, another 8 1/3 over their tenure, and another 8 1/3 based on performance. This gives the searcher 25% ownership versus a PE operator who may own a percentage in the single digits. See Buyer Types for a comparison table.

Second Bite of the Apple

A feature of a deal structure in which the seller is granted equity in the acquiring company so that the seller may benefit a second time when the acquiring company has an exit in the future.

Section 1202

see Qualified Small Business Stock

Self-Directed IRA

A self-directed IRA is a type of individual retirement account that allows you to invest in assets that are off-limits for conventional IRAs, including precious metals, art or real estate. The self-directed IRA simply allows more flexibility with the types of assets you can own in your retirement account.

If you are open to investing your retirement funds in ways other than the stock market or mutual funds, you can do so with a self-directed IRA. There are many firms that can help you establish accounts and direct funds towards investments like real estate, art, etc. The catch is that any proceeds or dividends resulting from these investments, like rent or interest, must go back into the retirement versus into your bank account.

Personally, I think this is a great way to be a landlord. Many people have more wealth in retirement accounts than savings and checking accounts. Buying real estate this way with no mortgage reduces the financial stress of being a landlord.

Seller Financing

A seller may finance a portion of the sale of their business. The buyer and new owner is the borrower and the seller is the lender. Seller financing can be done in conjunction with other financing such as an SBA loan or ROBS. Most sellers do not like the idea of seller financing as they would prefer to cash out and move on. When they agree to seller financing, it is typically for a shorter time frame (one to five years) and a smaller percentage of the sales price (less than 50%). Interest rates are often negotiated to be similar to SBA loan rates.

Buyers like seller financing because it avoids the tedious SBA loan application process which they may not qualify for. Seller financing also causes the seller to have a vested interest in the buyer’s success. And if the seller is amenable, the buyer may be able to avoid a personal guarantee. Earnouts are similar to seller financing in that they defer payments from buyer to seller until after closing and they cause the seller to have a vested interest in the buyer’s success.

The major advantage for a seller is the ability to reach more potential buyers. This is critical given the difficulty in selling a business. The seller may be able to get a higher sale price. Seller financing may also reduce or spread out the taxes due on the sale of their business. In the event of default, the business is the collateral and the seller may be able to take back ownership. While this is typically not an appealing scenario to a seller who wants to exit, it does provide some insurance.

While the terms of seller financing can be worked out between buyer and seller with the help of a business broker, an attorney should draft or review and approve a seller financing agreement. Also, see this article on buying a business with little or no money.

Seller Standby

Seller financing can be done with a full standby or partial standby. Full standby means that payments on the seller note are not made until the borrower pays the SBA loan back in full. Partial standby means that payments on the seller note are not made until after a specified period of time. While these options may not sound attractive to a seller, there are considerable advantages to the seller.

Taxes on the sale are deferred over time for the portion that is financed by the seller.
The bank may not need to include buyer payments to the seller when calculating debt service coverage, even if the seller standby is as short as 2 years. This means the buyer can qualify for a little larger loan, which may mean they are able to offer a little higher price to the seller.

Seller’s Discretionary Earnings (SDE)

SDE is the primary measure of cash flow or profit used to value small businesses and includes the owner’s compensation as an adjustment. EBITDA is the primary measure of cash flow or profit used to value mid to large-sized businesses and does not include the owner’s salary as an adjustment. SDE and adjusted EBITDA both adjust for depreciation and amortization, interest, and perks such as personal auto, phone, or travel expenses. Adjusted EBITDA typically has fewer add backs or adjustments than SDE, since larger businesses typically have fewer personal benefits expensed through the business. Read How Do You Find the True Profit in a Business?

Seller’s Discretionary Income

see Seller’s Discretionary Earnings

Settlement Statement

see Closing Statement

Silver Tsunami

This is an expression that describes the increase in the number of older people in the world. In the U.S., baby boomers (born 1946 to 1964) make up one third of the population and are a large contributor to the silver tsunami in the U.S. Economists raised concerns about this demographic phenomenon.

the health care system would be overburdened
housing prices would drop with a large number of older owners selling
significant workforce exodus, along with institutional knowledge and certain skillsets
shortage of senior housing

Many business publications also predict a large transfer of wealth through the sale of small businesses, as Baby Boomers own half to two-thirds of all small businesses in the U.S. and arguably more established higher value businesses.

Since these early predictions, we have experienced the Great Recession in 2008 and the pandemic of the early 2020s. These and other factors have affected these predictions. The healthcare system has been strained by greater longevity and the pandemic. Housing has not crashed and there hasn’t been a shortage of senior housing because older people are keeping their homes longer. Many older people are working longer and hanging on to their businesses longer, pouring cold water on the predictions of sudden workforce declines and stretching out small business transfers. For now, it appears the tsunami is a series of fairly manageable waves.

Standby

– see Seller Standby

Stock Sale

– see definitions and comparisons of Stock Sales and Asset Sales.

Stopped Business

A business for sale that has ceased operations permanently or temporarily may be referred to as a stopped business. The sale becomes closer to an asset liquidation sale than the sale of an ongoing enterprise.

Strategic Buyer

This is a type of business acquirer that evaluates opportunities largely from a strategic perspective. Their focus is on growing their existing business through acquisition, increasing market share, gaining a competitive advantage, increasing their product or service offerings, increasing vertical integration, increasing operational efficiencies, and reducing friction. These buyers may range from large industrial firms or professional services providers. While they often seek to deploy cash from the business, they may use financing or even be backed by a private equity firm. See Buyer Types for a comparison table.

Success Fee

A success fee is earned upon the successful conclusion of an activity, such as the closing of a real estate transaction or sale of a business and is associated with the term 100% commission.

Successor Liability

When a buyer acquires a business, even under a seemingly safe asset purchase agreement (versus a stock purchase), buyer may still be held responsible under successor liability which is governed by the state. For example, the state may require the current business owner to be liable for defective products sold by the previous owner. The risks increase when buying a distressed or insolvent business. Buyers may wish to purchase successor liability insurance.

SWOT Analysis

SWOT analysis is a business planning process that identifies a company’s strengths, weaknesses, opportunities and strengths. It considers internal and external factors and is a great foundation for business strategy development. Findings are often outlined in a 2×2 matrix and revisited frequently as the company and its strategies evolve.

T

Tangible Assets

Physical assets such as furniture, fixtures, equipment, vehicles, inventory, land, cash and securities that can be written down by depreciating them. See Intangible Assets for a complete picture of asset types.

Tax Clearance Certificate

When selling or closing a business, the owner should request a Tax Clearance Certificate from the state to verify that all state taxes have been paid. A Buyer may require a Tax Clearance Certificate before closing and a Buyer’s lender will almost certainly require it. This is good practice or a Buyer because some states have successor liability, which means the Buyer may be liable for the pervious owner’s unpaid taxes, which could include sales and use, gross receipts, withholding, unemployment, excise, franchise, corporation, gaming, liquor, and fuel.

The challenge is that tax clearance certificates can take a long time, sometimes months, depending on the state. Timing this request with a closing date can be difficult. It is not uncommon for a portion of the Seller’s proceeds to be held back on the date of closing, kept with escrow, and released once the Tax Clearance Certificate is delivered. The Seller may be able to minimize the amount of the hold back by providing records of past tax payments or a letter from a CPA stating that state taxes have been paid.

See Closing Checklist (future product)

Third Party Financing

A loan from a party other than the seller, most commonly an SBA lender.

Trailing Twelve Months (TTM)

Period of time, usually in reference to financial data, spanning the prior full twelve months. For example, on November 15th, the TTM income statement covers November last year through the October that just ended (i.e. November 1 prior year through October 31 this year).

TTM

see Trailing Twelve Months

U

Upper Middle Market

A range of businesses typically in the $500 million to $1 billion in revenue where mergers and acquisitions are served by Investment bankers. Some sources define the market tiers with slightly different lower and upper limits and other sources define the tiers by EBITDA. See Lower Middle Market for a breakdown of the tiers.

V

Valuation

see Business Appraisal

Venture Capital

Venture capital is technically a form of private equity as both invest in private companies in exchange for equity or ownership stakes in the company. Both raise capital from outside hands-off investors called Limited Partners who may be pension funds, endowments, insurance firms, or high net-worth individuals. In both cases, limited partners are charged 1.5 – 2.0% of assets under management (or less with more time under management) and roughly 20% (carried interest) on profits from investments over a minimum return (hurdle rate). See the comparison table.

Vertical Integration

Vertical integration is a company growth strategy in which a company expands into another stage of production or distribution beyond the stage where it currently operates. Horizontal integration is a growth strategy where the company expands within the same stage in the production or distribution process.

	Vertical Integration	Horizontal Integration
Revenue Growth	add customers or increase revenue with current customers who value more than one stage	add customers or capture more revenue from current customers with wider offerings
Cost Reduction	via economies of scope	via economies of scale
Acquire Another Company	A local parts manufacturer buys a related assembly business. A software development company buys a software consulting firm serving the same vertical.	In 2010, LoopNet, an online exchange for commercial real estate, buys BizBuySell, an online exchange for buying and selling businesses. A year later, LoopNet is acquired by rival CoStar.
Do it In-House	Possible: A local manufacturer buys delivery trucks to bring local deliveries in-house. Integration is required of the new delivery operation.	No. Adding products/services organically or simply capturing more market share does not require integration.
Strategy for a Strategic Buyer	Yes	Yes
Strategy for a Financial Buyer	Yes	Yes

W

Warranty Deed

A warranty deed is a document used in real estate to certify that a property is owned free and clear of any liens, mortgages, or any other types of claims. The seller uses the warranty deed to prove to the buyer that they own and have the right to sell the property. Warranty deeds provide the buyer a high level of protection and assurance that they’ll need for a mortgage and title insurance. Because of the warranty, the buyer can legally sue the seller if any title issues come up and the Seller would be liable, even for things the Seller may not have been aware of. Other deeds, such as quitclaim deeds, may not offer any assurances.

Worker’s Compensation Insurance

Workers’ compensation insurance covers medical costs and lost wages for work-related injuries and illnesses. This policy is required at the state level, although different states have different rules on when it is required of an employer. Different states require it when there is a certain number of employees. Some count part-time employees.

Sole proprietors, independent contractors, and partners who do not have employees don’t have to carry workers’ compensation insurance, but can purchase policies to protect themselves.

Real estate agents are typically 1099 independent contractors. Yet some states like CA require brokers to have worker’s compensation insurance to cover agents. Other classes of workers may be exempt may be treated differently by state, such as Agricultural workers, domestic workers employed in private homes, federal employees and railroad workers.

Working Capital

Working capital is a measure of a company’s ability to cover its short term expenses. It is simply short term assets minus short term liabilities, otherwise known as net working capital. Positive working capital means a business can cover its current activities. However, a high working capital might mean the business is not efficiently managing cash – not investing, not utilizing low cost debt, having too much inventory.

Current assets are short term assets that can be converted to cash within a year and current liabilities are short term liabilities that debt or payables due within a year.

Current Assets	Current Liabilities
cash and equivalents inventory or stock accounts receivables supplies prepaid expenses	accounts payables wages payable current portion of debt or notes payable accrued tax payable dividend payable advance payments, customer deposits or unearned revenue

In business acquisition, M&A buyers request working capital as part of the deal which may include accounts receivables minus payables. They may request the previous 18 months of balance sheets to calculate average working capital so that they do not underestimate the needs of the business based on seasonal or other fluctuations in working capital needs. This request may be a surprise to owners who have little experience selling businesses and who feel they are giving up income they earned when accounts receivables exceeds payables.

In smaller main street deals handled by business brokers, buyers do not ask for working capital. SBA lenders may include working capital as part of their loan to borrowers.