M&A jargon demystified LOI? kpmg.com/be/mandajargon. Alpha? Grace? The AMandA dictionary. CoCo? MBI?
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1 M&A jargon demystified kpmg.com/be/mandajargon Alpha? LOI? Grace? The AMandA dictionary MBI? CoCo?
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3 M&A jargon demystified Glossary of more than 150 commonly used terms in company mergers and acquisitions
4 Dépôt légal: D/2014/2664/551 ISBN: BP/KPMGMAL-BI14001 Editeur responsable: Hans Suijkerbuijk, Waterloo Office Park, Drève Richelle, 161 L, B-1410 Waterloo 2014 Wolters Kluwer Belgium NV Disclaimer Nothing in this publication, even in part, may be published, reproduced, translated or adapted in any form whatsoever, including photocopying, microfilming, recording or disk, or included in a computerized data bank without the previous express permission of the editor. The information provided in this document is general in nature and does not cover a particular person or entity. While we strive to provide you accurate and punctual information, it is impossible to guarantee the accuracy at the time of receipt or in the future. It is also not recommended for you to follow this information without the advice of a professional who specializes in this area and has taken care of thoroughly analyze your particular case. We would like to draw your attention to the fact that the views and opinions expressed herein are those of the author and do not reflect those of the KPMG network in Belgium. The information provided in this document is general in nature and does not refer to the specific situation of a person or entity. The author or publisher cannot be held responsible for any damage suffered by the reader as a result of imperfections in this book.
5 Foreword Among professionals who are active in the world of M&A (Mergers & Acquisitions, a term that is used for a transaction in which a company is acquired or is merged with another company), the use of jargon is well established, so well in fact that at times no one else can understand what they are saying. This book aims to create clarity in the tangle of technical terms. It is aimed at everyone who is interested in mergers and acquisitions or who would like to master M&A jargon. It puts simplicity first, so do not expect any «scientific» or legal explanations of the terms, but rather a didactic interpretation, based on our own experience and that of our colleagues from the KPMG network who work in M&A. After reading this book, you will perhaps possess a more thorough knowledge of mergers and acquisitions, but we do not recommend using these practical explanations in negotiations and contracts, or otherwise allowing them to have any effect on the transaction. This is to avoid misunderstandings. The book is structured by grouping content-related terms into chapters and, where possible, has also been presented in a logical sequence. Where we use new technical terms in an explanation, we explain them in a subsequent section. You therefore do not need to browse through the entire book to gain an understanding. If you wish to look up a term quickly, please refer to the alphabetical index at the back of the book. In this second, fully revised edition of this book, we have added a number of new terms, most of which are related to capital markets («the stock exchange») and updated a number of terms. This book was made possible through the efforts of many people. In particular: Yann Dekeyser, Stijn Potargent,Wouter Caers, Jorn De Neve, Koen Fierens, Luc Heynderickx, Peter Lauwers, Wouter Lauwers and Rosy Rymen. M&A jargon demystified 1
6 Finally, I would like to thank the marketing department of the KPMG network in Belgium and publisher Wolters Kluwer for their suggestions on writing style and language usage and their support with the layout. Additional comments and suggestions are always welcome, and can be sent to info@kpmg.be. KPMG Advisory About KPMG M&A Services KPMG M&A services are provided by independent member firms affiliated with the KPMG network. In Belgium these are KPMG Advisory burg. cvba and KPMG Tax & Legal Advisers burg. cvba. Each day, more than 5,000 professionals within the KPMG network, in 48 countries around the world, provide advice on mergers, acquisitions, divestments, joint ventures and strategic alliances. They assist clients throughout the entire transaction, from the strategic evaluation to the completion of the transaction and the final integration or divestment. 2 M&A jargon demystified
7 Table of contents Forward 1 1. Agreements Agreements in General Guarantee provisions in the agreemen 8 2. Deal structuring Price Transaction process viewed from the perspective of the buyer Transaction process viewed from the perspective of the seller Advisors Valuation Buy-out Perspective of the fund Debt financing Growth capital Operational elements of the deal Capital markets 65 Index 71 M&A jargon demystified 3
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9 Agreements 1
10 1.1 AGREEMENTS IN GENERAL An agreement on the sale of a company involves exchanging a large number of documents. We have listed the most commonly used below, in an order that attempts to reflect chronology to some degree. > NDA / Non Disclosure Agreement: an undertaking to ensure secrecy. In this agreement, the parties confirm that they will not misuse the information exchanged in the context of merger talks. An NDA also often includes other provisions, such as an agreement not to poach staff during the negotiations. > Offer Letter: a letter indicating the intention to purchase, which is often of a nonbinding character ( see also «Non-binding/binding»). > Exclusivity: a clause in a letter or an agreement in which the seller states that it is not negotiating with any other parties and will not begin or enter into any such negotiations. Exclusivity is for a limited time period. > LOI / Letter Of Intent: a declaration of intent. This term is used for the first written document setting out the intentions of the parties. Generally, it is nothing more than an intention to continue negotiating subject to only two binding clauses (i.e. exclusivity and secrecy). An LOI often contains both binding and non-binding clauses. > MOU / Memorandum Of Understanding: a statement in principle ( see also «LOI»). In practice, these terms are often used interchangeably. In addition to clauses concerning secrecy, an NDA often also contains other clauses. 6 M&A jargon demystified
11 > (Non) Binding: the binding character of clauses or the entire agreement is a matter that requires particular attention when preparing documentation to be exchanged by the parties. Non-binding statements are often chosen at an early stage and changed into more binding statements/documents as the sale process progresses. > MAC / Material Adverse Change: the lack of any fundamental change of circumstances (MAC) affecting the company is a very common condition for converting an LOI into a binding SPA. In practice, the proper definition of the MAC is often part of the discussions. Often, reference is made to maintaining profitability, not losing important customers, maintaining licenses, and similar matters. > SPA / Share Purchase Agreement: an SPA is the final agreement between the buyer and the seller on the sale of the company, subject to a number of CPs (condition precedents). > Heads of Agreement: an agreement in principle ( see also «LOI» and «MOU»). In practice, these terms are often used interchangeably. This term also refers to a binding list of basic elements that will be covered in more detail in a Share Purchase Agreement («SPA»). > CP / Condition Precedent: a CP is a condition for concluding the agreement. Legally speaking, this can have the character of both a condition subsequent and a condition precedent. A typical example of a CP is obtaining approval for the acquisition from the competition authorities. > Anti-Trust Filing: the notification of the acquisition to the competition authorities. > Closing agreement: the document setting out the final settlement of the agreement after the CPs have been met. This document results in the transfer of ownership and the payment taking place. Approval from competition authorities is a common CP M&A jargon demystified 7
12 1.2 GUARANTEE PROVISIONS IN THE AGREEMENT The guarantee provisions in the agreement are an important part of the negotiations. As the buyer receives only very limited statutory guarantees when buying shares, the agreement will often provide explicit extensive guarantees. A number of very commonly used terms are presented below. > Representations: statements. In the event that statements made by the seller about the company prove to be incorrect, these statements, either together with the warranties or otherwise, form the basis for subsequent indemnities. > Warranties: guarantees or general safeguards. The seller not only provides statements, but also guarantees that these statements are correct. The warranties may be time-limited and limited up to a certain amount of money. > Indemnities: compensation for damages. These are stipulated on top of the general safeguards ( see warranties) for a number of additional elements. Indemnities are used if it is known that a particular problem exists or could occur, for example if the cost of decontaminating the plot of land located at x is borne by y. General warranties and specific indemnities supplement each other > Guarantees: in order to assure the buyer that the seller will fulfill its obligations, the seller may provide certain financial guarantees. This is the case if a claim is submitted on the basis of the representations and warranties or the indemnities. These guarantee stipulations are also valid for a specific period of time and may be limited to a specific amount of money. The most commonly used types of guarantee are the bank guarantee (upon first request or otherwise) and escrow. 8 M&A jargon demystified
13 > Escrow: an amount deposited in a frozen bank account to guarantee that any losses will be compensated. > Bank guarantee: a guarantee issued by a bank to ensure that any losses will be compensated. If the seller does not pay the claim, it will be paid by the bank, instead of the seller, once certain conditions have been met, after which the bank demands repayment of the claim. Banks charge a fee for issuing this guarantee. An escrow may be replaced by a bank guarantee > Disclosures: notifications. This is a list of elements that the seller discloses to the buyer with the aim of avoiding subsequent disagreement as to whether certain information has or has not been divulged during the negotiations. It is important in this context to properly record whether these disclosures have an effect on the warranties or indemnities. If, for example, the seller discloses that soil has been polluted, this might prevent the buyer from making a claim for the pollution. > Threshold: frequently, parties agree only to submit claims if the total amount of the claims exceeds a specific minimum amount. Two systems can then be linked to this, specifically the basket and the threshold sum. Of course, hybrid systems may also be agreed on. > Basket: basket. Once the threshold has been reached, the loss will be compensated in full. Classical point of contention during negotiations: does the entire data room ( see page 28) constitute a disclosure? M&A jargon demystified 9
14 > Franchise: once the threshold has been reached, the amount of the loss in excess of the threshold will be compensated. This means that the threshold is similar to the franchise In an insurance policy. > De minimis: a minimum amount for individual claims is often specified as a claim or a combination of claims. It only counts towards the threshold if it is equal to or greater than a specific amount. 10 M&A jargon demystified
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17 Deal structuring 2 Tax Overeenkomsten 1. Overeenkomsten Finance Legal
18 In the case of the acquisition of a group of businesses and companies, it is important to properly assess the order in which companies or assets are acquired by existing companies or newly created companies. This analysis, which is called deal structuring, seeks to combine tax optimization with a healthy financial structure and legal simplicity and clarity. > Asset deal: an agreement in which the assets, not the shares of a company are sold. This has three special consequences. First, most of the debts, including the majority of hidden debts, remain behind in the selling company. Second, this agreement undergoes a different tax treatment ( see also tax treatment). Third, there are consequences for the legal continuity of the activities of the company. There are major differences between an asset deal and a share deal when it comes to taxation. > Share deal: an agreement under which the shares of the company are sold ( see also asset deal). > Tax treatment: usually, gains on shares are not taxable and the sale of shares (a share deal) may be preferred by the seller. On the other hand, the buyer may prefer an asset deal for tax purposes because the goodwill paid ( see chapter on Valuation - Goodwill) may be tax-deductible, which, in principle, is not the case with a share deal. > Legal continuity: this term refers to the question whether the company s existing contracts with customers, suppliers, staff, and authorities (including licenses), etc., are to be retained after the acquisition. In a share deal, the shares of the company are sold, which only rarely has an effect on the agreements An asset deal can include restrictions, such as not being able to transfer licenses 14 M&A jargon demystified
19 that the company has entered into ( see also Change of Control Clauses). In an asset deal, there is basically no legal continuity and all of the company s agreements with customers, suppliers, etc., must be entered into again, or at least be formally continued by the acquiring entity. With regard to legal continuity, we will look at two matters: the branch, and TUPE. > Branch of business: line of business. Under certain conditions of company law (acquisition of a line of business), an asset deal can be made with legal continuity. > TUPE / Transfer of Undertakings (Protection of Employment): according to European and Belgian social law, in many cases there is a mandatory transfer of employment contracts, even if there is no legal continuity for the company itself. Reference to this situation is made in a European context in TUPE, and in Belgium in CAO 32bis (section 32b of a collective bargaining agreement). > Change of Control Clauses: clauses in agreements concluded by the company (e.g. for a loan from a bank), that stipulate that the contract will no longer be valid or will be dissolved if there is a change in control of the company. Identification of the Change of Control Clauses is an important part of the analysis of the legal continuity of the acquisition. European TUPE regulations protect staff in an acquisition under an asset deal. > Debt pushdown: an exercise in which the acquisition debt is pushed «own» to the operating companies. Banks and other lenders prefer to provide funding to companies that generate the operating cash flow, particularly if the acquisition of shares is done through a holding company that has no operating activities itself. This is often the case in private equity deals. M&A jargon demystified 15
20 > Leakage: when setting up an acquisition financing structure involving several national and/or international companies, it is important to ensure that the intragroup distribution of the profits, or the repayment of loans, results in a minimum of taxes (thus value) «leaking» by means of unrecoverable withholding taxes (taxation at source) or dividend taxes, for example. > Financial assistance: this term refers to Section 629 of the Belgian Company Code, which states: A public limited company cannot advance any funds, nor permit loans or provide security with a view to the acquiring of its shares or profit-sharing certificates by third parties. This ban was lifted as of 1 January 2009, and «financial aid» or «financial assistance» is now possible under certain conditions. 16 M&A jargon demystified
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23 Price 3 10 million 1. Overeenkomsten
24 In view of the fact that a company is not only a complex body of activities, but also of assets and debts, various types of arrangements are agreed on to fix the price. This chapter contains a number of common terms that are used in discussions about pricing. A locked box is not recommended in situations where there is limited opportunity for due diligence and in complex carve-out situations A classic price formulation in a contract consists of a price for the activities of the company assuming normal working capital, minus the debts of the company, plus the cash present in the company. Schematically, we can present this as follows: Debt free/cash free price Minus debt Plus cash Minus/plus difference between existing working capital and normalized working capital The analytical methods used during the due diligence ( see chapter 4) examine in detail each parameter that can have an effect on the valuation at the time of the contractual conclusion of the operation (the closing date). The movements in working capital before the acquisition will receive the buyer s full attention. This is because the buyer wants to ascertain whether the receivables, the inventory and suppliers will be in line with those of a normal business operation at the time of the acquisition. The buyer will therefore want assurance that the receivables will not be abnormally quickly converted into cash due to pressure being placed on customers. In addition, the buyer will want to 20 M&A jargon demystified
25 deter the seller from liquidating the inventory of the company to generate cash, thus leaving behind a company that cannot meet customer demand. Finally, the buyer will want to deter the seller from building up delays in the payment of suppliers in order to accumulate cash on the closing date. A simple example We will take as our example a taxi company with five taxis. On the basis of a debt-free situation and half-full fuel tanks, you determine how much you want to pay for the taxis and the customer base. At the time of acquisition (the date of the closing accounts) you take an inventory. You notice that there are some car loans that need to be repaid, the fuel tanks are empty and there are still envelopes in the taxis containing cash for buying fuel. The final price will ultimately amount to the price payable for the business activity, minus the loan and the fuel shortage in the tanks, plus the cash found in the taxis.. > Debt & cash free: the price assuming a situation without financial debts and without cash free. > Working capital: the sum of the customers, suppliers, inventories and other current assets and liabilities necessary for the day-to-day operation of the company. > Normalized working capital: an analysis of how the working capital would look in normal circumstances. This involves adjusting for all exceptional and non-recurring items, such as the collapse of a major customer, a major supplier position due to the purchase of a machine, or a large inventory position due to a machine breakdown. M&A jargon demystified 21
26 > Target working capital: the state of the working capital to be used as a basis for settlement at the time of the closing. The target working capital is recorded in a contract during the negotiations and is often based on a historical analysis of the working capital requirements of the business. The settlement is based on the closing accounts, with the price being increased or reduced if the company has more or less working capital than the target capital on the date of the closing accounts. > Closing accounts: when the agreement is recorded in an SPA, a future date on which a balance sheet is to be drawn up (the closing accounts) is agreed. These closing accounts will then form the basis for determining the net debt and the working capital that will be used for determining the final price according to the agreed price formula. > Net debt: there is no official definition of net debt, which means it is important to define it properly in the LOI and SPA. The net debt generally comprises financial liabilities (in a broad sense) minus cash. Financial liabilities include the following: loans and associated liabilities (including interest that is current but not yet payable), bills of exchange, repayable subsidies, pensions and other longterm commitments to staff, commissions giving rise to cash outflows within the foreseeable future, off-balance sheet commitments that can be considered equivalent to debt, and certain leasing debts. > Belgian GAAP / Belgian Generally Accepted Accounting Principles: the generally accepted accounting principles in Belgium. This term refers to Belgian accounting law and accounting principles applicable in Belgium. If the SPA includes a pricing mechanism based on the closing accounts, it is important to specify under which GAAP these closing accounts must be drawn up. This could be under Belgian GAAP, or under Dutch GAAP, US GAAP, Swedish GAAP, etc., or alternatively under IFRS. > IFRS / International Financial Reporting Standards: this is an international GAAP used for reporting purposes by listed companies in Belgium and the EU. > Earn-out: if there is a major price discussion between the buyer and seller due to differing views on the future results of the company, an earn-out may 22 M&A jargon demystified
27 provide a solution. It makes the final price partly An earn-out can dependent on the future achievement of certain make integration objectives. However, it is essential to be vigilant. difficult. In addition to subsequent discussions on the measurement of the results on which the earn-out is based, an earn-out can also obstruct the efficient integration of the company. This is because the earn-out clause requires that the results after the acquisition are compared with the performance objectives recorded before the acquisition. The full integration of the company with the acquirer, and thus achieving synergies, can make the interpretation of any differences more complex. > Spread payment / vendor note / vendor loan: if the seller allows spread payments, it implicitly grants a loan (vendor note or vendor loan) to the buyer. > Locked box: a locked box mechanism is a price mechanism in which the price of the shares is determined on the basis of a historical accounting situation, rather than a future situation (closing accounts). The price is determined as a Example In the example of the taxi company (see page 20) the fuel payments made using the cash in the envelopes will reduce the cash but will also increase the contents of the fuel tanks, and thus have a neutral effect on the value of the company. debt and cash free price, minus historical debt, plus cash, and adjusted for the working capital surplus or shortfall at that same historical time. In addition, it is contractually agreed that there cannot be any cash flowing out of the company (the locked box) in the form of the payment of dividends or management fees. All other cash movements remain within the company and are thus assumed to have no effect on value. This method can only be applied if the buyer can obtain a very good picture of the balance sheet of the company during the acquisition process. M&A jargon demystified 23
28 Classic mechanism Closing accounts to crystallize the situation near the time of closing and to adjust the price Period covered by the historical financial statements Period covered by the closing accounts Ownership and control Dec 2013 Jan 2014 Feb Mar Apr May Jun Jul The locked box mechanism Period covered by the historical financial statements No closing accounts Ownership and control Dec 2013 Jan 2014 Feb Mar Apr May Jun Jul In a locked box system, the period between the last available balance sheet and the closing date is not covered by closing accounts but a contractual agreement that no capital can flow out of the company. 24 M&A jargon demystified
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31 Transaction process viewed from the perspective of the buyer 4 1. Overeenkomsten
32 Viewed from the perspective of the buyer, the sales process involves, among other things, the buyer wanting to form a good picture of the company it is buying, in the area of both risks and opportunities. This investigation, which is often called auditing the books, or due diligence, includes many elements that each form a separate element of the due diligence process. We summarize the most common elements below. > Financial due diligence: the review of the historical and future figures of the company. The focus in this context is often on the quality of earnings (how robust are the historical results?), the quality of net debt (which items could all be taken into consideration in determining the net financial debt? see also debt and cash free, the forecast (analysis of the budgets and future projections) and the normalized working capital. > Tax due diligence: the investigation of the historical and future tax situation and exposure of the company or companies in the areas of both direct and indirect taxes. > Legal due diligence: the review of the legal situation of the company in the areas of company law, review of contracts, labor laws, intellectual property (IP), permits, etc. > Commercial due diligence: the review of the markets in which the company operates and the commercial position in which the company finds itself. > Pensions due diligence: the review of the existing and future obligations related to pensions. The future commitments can vary based on the type of pension plan set up by the company. > Defined contribution plan: a pension plan in which the final amount is not fixed, but will be the sum of the contributions and the return achieved. In this context, the company does not give the employee a guarantee of what the How far do you go in your due diligence? 28 M&A jargon demystified
33 Is the past a good mirror for the future? final amount will be. However, for the members, the law protects the return on accrued reserves by imposing a minimum return. > Defined benefit pension plan: a pension plan in which the final amount to be obtained is contractually fixed. In an acquisition with this type of pension plan there is often discussion about the size of the existing pension debt. Specialized pension actuaries are therefore consulted to analyze these types of plans and to work out how the pension provision and the accrued specific investments relate to the pension debt. > Insurance due diligence: the investigation into the existing insurance coverage and variance analysis with the required coverage, as well as the investigation into the continuity of insurance coverage during the transaction process. > Operations and synergy due diligence: the investigation into the efficiency of the operations and how specific synergies can be achieved. > Environmental due diligence: the investigation into the environmental situation in relation to soil pollution, water pollution, air pollution and noise pollution. > Health and safety: the investigation into working conditions with a focus on health and safety. > Release/reliance (for financiers): due diligence reports prepared by advisors are used by the acquiror and also by parties The existence of defined benefit pension plans often makes a transaction more complex, depending on the type of pension plan (defined contribution or defined benefit). M&A jargon demystified 29
34 involved in financing the acquisition. It is usual, for example, for financing banks to have access to the reports following the exchange of a letter in which the responsibilities are defined. Broadly speaking, there are two types of access: simple release, in which the advisors do not have any specific accountability to the banks, and reliance, in which the advisors have a similar duty of care (accountability) to the banks as they do to the buyer. > Hold harmless letter / approved reader letter: letter of indemnity. A letter in which an adviser provides a party with access to a report or a file, in which this party agrees to indemnify the advisor from any liability that could arise from the access provided to files or reports. > Clean team: a clean team exists when an advisor is asked by both the selling and the buying parties to review a very specific topic that contains sensitive information, such as the customer portfolio. The clean team receives all the information, but only provides a summarized analysis to its clients (the buyer and the seller together). The parties could agree that, for example, the sale will not proceed if one of the top five customers disappears. If the seller would rather not disclose the identity of the customer, a clean team scenario could offer a way out, since the clean team can analyze the customers and report on them on an anonymous basis. > Data room: the room or space (may also be an electronic space, see also E-data room) in which specific data concerning the company are collected. By providing the buyer (and its advisors) with access to this space, the buyer will have the opportunity to read these documents and to form a picture of the company. Visits to a data room are governed by data room rules. > Data room rules: a set of rules that the visitor must first accept, laying down whether the visitor is to be given access to the data room, at what time, for how long, and what may happen to the information contained in it (e.g. whether or not copies can be made). > E-data room: electronic data room. Web-based applications make it possible to organize data rooms in a way that allows them to be consulted online (in a protected form) once all the documents have been scanned. 30 M&A jargon demystified
35 E-data rooms have the advantage of being easy to use and of being accessible 24 hours a day by an international team of specialists without any need for travel. M&A jargon demystified 31
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37 Transaction process viewed from the perspective of 5 the seller
38 If we look at the sales process from the perspective of the seller, we find a sequence of process steps involving a long list of candidates from which a short list is selected. These are sent a teaser and (after signing an NDA) also an information memorandum and a process letter. On the basis of the offer letters received, the decision is made as to who is to be given access to the data room and, potentially, to the VDD (Vendor Due Diligence) report. The terms below are therefore shown in chronological order insofar as possible. > Long list: the initial long list of potential buyers for the company. > Short list: the short list of companies that will be contacted in an initial phase to gauge their interest. The short list is often created after making a selection from the long list. > Teaser / blind profile: the anonymous profile of the company that is sent to potential buyers. The aim is to determine whether such a purchase could interest them without the identity of the company being disclosed. > Info Memo / Information Memorandum: information memorandum. After signing an NDA, the potential buyer may be sent an information memorandum and a process letter. The information memorandum is a document that describes the company and, in addition to a good summary, includes the following information: history of the company, description of products and services, market position, management, financial information, etc. > Process letter: the process letter contains information on how the seller wants to organize the sales process, by which date a bid is expected and what requirements it must meet and how the next phase will look after that bid. Making a teaser is often a difficult balancing act between preserving anonymity and providing sufficient information 34 M&A jargon demystified
39 > VDD / Vendor (initiated) Due Diligence: a due diligence investigation conducted by an independent party, often an audit firm or law firm, with which the initial client is the seller. After the closing of the transaction, the provider of the due diligence is accountable to the buyer. The seller is the initial client of a vendor due diligence, the buyer will be the final client M&A jargon demystified 35
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41 Advisors 6 1. Overeenkomsten
42 In a transaction, various advisors provide guidance to their clients and provide a number of services. We can identify the following classic roles and fees. > Deal advisor: the advisor (often an investment bank or corporate finance house), actingas a broker, which means that it looks for the parties and brings them together, conducts and organizes negotiations and draws up the various non-judicial sales documents (see also teaser, info memo and process letter). > Due diligence provider: specialized suppliers of due diligence assistance, often specialized departments of law firms or audit firms ( see also due diligence). > Lawyer / M&A lawyer: the specialized lawyers or corporate lawyers who write the contracts and negotiate ( see also Chapter 1: Agreements). > Specialist advisors: subject specialists are called upon during transactions to provide specific advice on the environment, pensions, taxes, etc. > Auditor: an auditor is often asked to issue a report on the closing accounts ( see page 21). > List of parties: a list of parties is drawn up in order to obtain a clear overview of the advisors and members of the management of the buying and selling parties. The list records the contact details of the various people involved in the transaction. An M&A team usually consists of a combination of people from within the company and external advisors 38 M&A jargon demystified
43 > Fees: the fee of the deal advisor generally consists of two parts, specifically the retainer and the success fee. The fees of other advisors are usually time and expense based. > Success fee: the portion of the fee that depends on the closing of the transaction. > Retainer fee: the fixed or monthly payment that is awarded regardless of whether the transaction is completed. > Time and expense based fee: fee based on hours worked and reimbursement of expenses incurred. Is the fee structure of the advisor in line with the interests of the client? M&A jargon demystified 39
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45 Valuation 7 1. Overeenkomsten
46 Many specific techniques and methodologies are used to determine the value of a company. These are described very extensively in the professional literature. It is not our aim here to give a description of the methodology as well, although some frequently used terms are described. REBITDAR REBITDA EBITDA EBIT EBT...? > Goodwill: the difference between the price paid for the shares and the book value of the equity of the company. > EBITDA / Earnings Before Interest, Tax, Depreciation and Amortization: the profit before interest, taxes, depreciation and amortization. This is a gauge of the operating cash flow of a company. > REBITDA / Recurring Earnings Before Interest, Tax, Depreciation and Amortization: the recurring profit before interest, taxes, depreciation and amortization. This is a gauge of the recurring operating cash flow of a company, and is the EBITDA adjusted for non-recurring items. Typical adjustments relate to the effect of a restructuring or a large one-off order or contract. > EBITDAR / Earnings Before Interest, Tax, Depreciation, Amortization and Rent: the profit before interest, taxes, depreciation, amortization, and rent. This is a gauge of the operating cash flow of a company before the payment of rent. Assets can be financed in different ways (renting, operating leases, finance leases, sale with loan, etc.) Since rent affects EBITDA whereas a sale with a loan The interpretation of results and the evaluation of the parameters used, not the calculation, appears to be the most difficult aspect of valuation 42 M&A jargon demystified
47 does not, EBITDAR is a concept that is used so that the results can be analyzed and compared independently of how the assets are financed. > Free Cash Flow: deducting the tax on the operating profit, investments and growth in working capital from the EBITDA provides an indication of the free cash flow. > PBT / Profit Before Tax: the profit before taxes, sometimes also described as EBT/earnings before tax. > PAT / Profit After Tax: the profit after taxes. > EBIT / Earnings Before Interest and Tax: the profit before interest and taxes. This is also called operating profit or operating profit before tax. > NOPAT / Normalized Operating Profit After Tax: the normalized operating profit after taxes. This is the operating profit after taxes, which is normalized by eliminating all extraordinary and non-recurring items. > DCF(F) / Discounted Cash Flow (to the Firm): a commonly used valuation method based on an actualization of future free cash flows. The future free cash flows are estimated on the basis of a forecast and then actualized to the current date by using an actualization rate or discount factor known as the WACC. > WACC / Weighted Average Cost of Capital: the weighted average cost of capital. The WACC is calculated by taking the weighted average of the cost of the capital and the cost of the debt (cost of equity and cost of debt). The weighting factor is the ratio of financing from the company s own funds (capital) to financing from borrowed funds (loans - debt). > Cost of debt: the cost of financing debt after deduction of the tax benefit owing to the tax deductibility of interest amounts. > CoE / Cost of Equity: the cost of capital, determined by equating it to the required return that average investors want to achieve on their investments, on the basis of the company s risk profile. A classic way to determine the CoE is by applying the CAPM. M&A jargon demystified 43
48 CoE = RF + Beta x MRP + Alpha > CAPM / Capital Asset Pricing Model: the model for approximating the CoE, which is based on the assumption that an investor will require a return that is at least equal to the return on a risk-free investment, plus an adjusted premium to compensate for the risk that investments are made in equity and a premium for other specific risks associated with the investment. The formula is as follows: CoE = RF + Beta x MRP + Alpha > RF / Risk Free Rate: the return on a risk-free investment. A long-term investment in government bonds is often used as a reference for this. > MRP / Market Risk Premium: market risk premium. A premium that an investor requires on top of the risk-free rate as compensation for the fact the investment is in shares. It is generally assumed that this premium amounts to approximately 5%. > Beta (levered/unlevered): the beta is the adjustment factor that we apply to the MRP. The beta adjusts the MRP for two risk factors. The first is for the sector in which the company operates, because, for example, a biotech company is not comparable to a real estate company in terms of risk profile. The second is for the debt level of the company, because it is assumed that a company with more debts runs more risks than a company with less debts. The beta that contains the adjustment factor for the debt level is called the levered beta, whereas the beta not containing this adjustment factor is the unlevered beta. > Alpha: the risk premium that is added to the CoE because of specific risks associated with the company. The most common example of this is the small firm premium. This is a risk premium that is added because a small company is subject to more risks than a large company. > Multiple: the multiple method or market method is a valuation method that is often used to support the results of a DCF(F) method. In this method, the company is compared with other companies whose value is known. This is done using a multiple. Sector peers, for example, are valued at 6 times EBITDA. 44 M&A jargon demystified
49 Two methods can be applied to discover the value of comparable companies, specifically CoCo and CoTrans. > CoCo / Comparable Company: if a comparable company is listed on a stock exchange, we can determine the market capitalization of the company based on the share price multiplied by the number of shares. > CoTrans / Comparable Transaction: if a comparable company has recently been sold, we can take the transaction price (if known) as a measure of the value. > EV / Enterprise Value: this is the debt and cash free value of a company. Both the DCF(F) method and many multiples initially result in an EV, which must be adjusted for the cash and debts. Only then is it possible to arrive at a value of the shares. > Discount / Premium: adjustments are still applied to the value of shares if the transaction relates to a minority interest, a majority interest, a holding company through which ownership is acquired indirectly, or shares without voting rights, etc. Studies of the level of the historical market risk premium going back to before the First World War are available. M&A jargon demystified 45
50
51 Buy-out 8 1. Overeenkomsten
52 Given the sharp growth in the activity of investment funds, it essential to have a separate chapter on the sometimes very specific use of language in the investment fund world. For clarity, we have made a distinction between the terms associated with funds and the capital side of the investment and the terms associated with debt financing. 8.1 PERSPECTIVE OF THE FUND In a buy-out, the management often also invests on more favorable terms than the fund. > Business Angels: investors who invest in a company at a very early stage. This type of investor is often an individual or a small group of individuals. > Venture Capital: this term is used for all investment funds. However, to make a clear distinction between investment funds active in start-ups or technologically uncertain companies and investment funds active in mature cash flow generating companies, the term venture capital is being used to indicate the first type of investment funds to an increasing extent. Buy-out funds and private equity relate to the second type of investment funds. The remuneration of the fund management usually consists of a management fee plus a fee related to the return achieved by the fund, which is known as carried interest 48 M&A jargon demystified
53 > Private Equity (PE) fund: an investment fund active in mature cash flow generating companies that also attracts debt financing for the acquisitions and actively involves management in the acquisition. > Buy-out fund: see also private equity. > Hedge funds: funds that, unlike PE funds, also invest in assets other than shares. > Vulture funds: funds that are specialized in acquiring distressed companies. > Special situation funds: in view of the negative connotations associated with the reference to vultures in the term vulture fund, these funds refer to themselves more neutrally as special situations funds. > Turn-around funds: see also vulture fund or special situations fund. This name places the emphasis on the value created by restructuring the acquired companies and making them profitable again (i.e. turning them around) > MBO / Management Buy-out: a transaction in which the existing management and an investment fund become co-owners of a company. > MBI / Management Buy-in: a transaction in which a new management group and an investment fund become co-owners of a company. > LBO / Leveraged Buy-out: a buy-out partly financed with debt. > Sweet Equity: to encourage management and bring its interests into line with those of the investment fund, management is given the opportunity to invest in the target company under special conditions. In this context, the relative contribution per share is often lower for management than the amount paid by the investment fund. The ratio of the effective price paid by management to the price paid by the investment fund for their respective investments is sometimes also called the envy ratio. M&A jargon demystified 49
54 > Ratchets: ratchets are systems that are used to determine and change the ratios of the shareholdings between different groups of shareholders. A ratchet can make it possible, for example, for management to increase its share in the equity of a company if the company performs well. On the other hand, ratchets can be used to ensure that the investment fund achieves a maximum return if the company does not perform well. > LP / Limited Partnership: Anglo-Saxon funds are often set up as tax transparent limited partnerships with limited liability for the investors (the limited partners). These limited partnerships are often offshore partnerships for maximum legal flexibility. > GP / General Partner: in order to maintain the limitations in liability as a limited partnership, a fund must also have a general partner who has unlimited liability. The general partner is associated with the management company of the investment fund. > Investment horizon: the period for which the fund intends to invest. There are two types of funds in terms of horizon: open-end and closed-end. > Closed-end fund: a fund with a limited investment horizon. Often, a few years will be allocated for investing: several years for the growth of the company, and several years for its sale. Closed-end funds seek to complete this entire cycle in 6-12 years. > Open-end fund: a fund without a specific investment horizon. > Co-investment: an investor who also invests in a specific buy-out alongside the investment fund, in principle under the same conditions as the investment fund. > Carried interest: the management of a PE fund is usually paid a management fee and a percentage of the added value that the fund realizes for its investors. The percentage is usually paid after the investors have realized a specific return ( see also Hurdle). The fund s share in the return is called the carried interest. 50 M&A jargon demystified
55 The exit is already considered at the time the investment is made. > Hurdle: the return that a fund must realize for its investors before the management of the investment fund can share in the added value of the fund. > Committed capital: the total amount that investors commit to the fund in order for it to make investments during a specific period. > Drawdown: once a fund has decided to proceed with an investment, the investors are called upon to make the necessary money available. The drawdown refers to the actual provision of money already been promised to the fund (committed capital). > Distribution: the payment of the returns achieved by the fund to the investors. > Exit: when a fund steps down as an investor, this is referred to as exiting. At the time of its investment in a company, the PE fund already considers how it could sell back its shares in the company. > Secondary buy-out: if one PE fund sells its investment to another PE fund, this is known as a secondary buy-out. > Club deals: an agreement in which various funds pool money with a view to an investment that would not be possible on an individual basis because of the amount involved or specific investment restrictions. M&A jargon demystified 51
56 8.2 DEBT FINANCING For a leveraged buy-out, debt financing is required in addition to a private equity component. The debt financing of an acquisition is also a good source of specific jargon used by bankers, investors and their advisors. > Leverage: the degree of debt financing used for an acquisition. > Acquisition finance: a specific term used for the debt financing of the acquisition of a company. > Stapled / debt package: a package of loans in various forms and with different degrees of subordination, ranging from mezzanine to junior and senior debt. > Mezzanine: an intermediate form of financing that has some of the characteristics of capital and some of the characteristics of debt. This can technically take the form of convertible debt, preferred shares or debt with warrants. > Junior debt and senior debt: a subordinated loan that is lower (junior) or higher (senior) in priority, where the subordination refers to the order of repayment in the event of the company s bankruptcy. > PIK / Payment in Kind: fixed-income securities that generate interest in the form of additional debt instead of a sum of money. The final interest is only payable on the final maturity date. Mezzanine exists in many forms. It is important to analyze the instrument properly and understand what happens in which situation. 52 M&A jargon demystified
57 For a leveraged buy-out, debt financing is required in addition to a private equity component. The debt financing of an acquisition is also a good source of specific jargon used by bankers, investors and their advisors. > Bulletloan: a form of debt in which the interest payment and the debt redemption take place in full at the end of the loan. > Grace period: the period during which no interest payments and/or debt repayments need to take place. > Debt syndication: if several banks underwrite the debt financing, they can form a syndicate and as a result act jointly. > Headroom: this term is sometimes used to refer to the difference between the current performance of the company and the covenants. > Covenants: the parameters used by banks to assess whether repayment is threatened. > Breach: if a covenant is not met and therefore a breach of covenant occurs, the loan agreements may stipulate that the debt is immediately due and payable or repayable. > Euribor / Euro Interbank Offered Rate: This is a reference interest rate often used as the basis for a variable interest rate. > Basis points: hundredths of one percent of interest. The interest on a loan is often expressed as EURIBOR plus a number of basis points. > Hedging of interest risk: derivative financial instruments, such as interest rate swaps, are used to convert a variable interest rate into a fixed interest rate. M&A jargon demystified 53
58 > Crowdfunding: the funding of a project or company by a group of individuals rather than professional institutions, in which the internet is used as the main means of communication. On some crowd funding websites, the invested money does not go directly into the project; the entrepreneur only receives the money when 100% (or more) of the foreseen investment has been placed. If this 100% is not achieved, the investors get their money back. > FFF: Family, Friends and Fools. Financing form for young start-ups by means of loans (subordinated or otherwise) from friends, acquaintances, or family members.mille. 54 M&A jargon demystified
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