Just as in other industries, professionals in the private equity and M&A industry have created their own set of industry jargon that many newcomers will find perplexing. Many professionals use these terms with such regularity they might assume the terms to be common knowledge to everyone.
We know that many business owners, management teams, lenders, and others out are looking to do their homework on their private equity investors. Thus, we have prepared the following as a "Pocket Translator" for those in need the next time you're at a board dinner and the VP starts [unknowingly] jargon-dropping.
2-horse race. Occurs when multiple buyers are asked to complete diligence and legal documentation in parallel to each other at the LOI stage of a sell-side auction process. This instead of awarding the single buyer with a LOI, multiple buyers are completing diligence and legal in parallel until one of them distinguishes themselves.
Addback. Also known as Adjustments, this describes a non-recurring expense, excess costs or one-time costs, that are not expected to occur again. They are presented to show what historical profitability could have been in various financial periods if the company in had new ownership. An example would be if the company had spent $100,000 last year in severance costs for a former employee, but had never incurred severance costs for anyone before.
Adjusted EBITDA. Used as a proxy for profit, starts with EBITDA and increases with addbacks and other normalized adjustments. This is the number that Buyers and Lenders are expected to base valuation upon, and therefore is the most hotly contested financial metric with any transaction.
Bake-off. When multiple investment bankers are invited to pitch the business owner to represent them.
Blue Ocean. A term beloved by former consultants, this describes how a company has massive growth potential due to the vast size of its market.
Bolt-on. The acquisition of a smaller company made by a larger company, often times with minimal integration or disruption involved.
Buy-and-build. A strategy of acquiring multiple companies under the same platform company to create a larger, diversified market-leading company.
Cap Table. Short for “capitalization table”, which is another way of saying list of owners and percentage ownership held by each.
CAPEX. Short for “capital expenditures”, meaning the amount of property, plant and equipment investments the company has to make on a periodic basis. Usually factored into valuation and leverage covenants along with Adjusted EBITDA
Carry. Short for “carried interest”, which is the term to describe the share of investment profits that private equity firms earn from their limited partner investors. Generally 20% of the investment profits.
Carve-out. This could have two meanings: 1) a legal provision that is deemed to be an exception to other provisions discussed in that document, and 2) when a division, product line or select assets are acquired away from a larger entity. Most PE investors use this to refer to #2.
Catch-up. Most commonly refers to how investment profits are shared by private equity investors. The limited partners are entitled to a return of their capital plus a preferred return, but thereafter the general partner (i.e. the private equity investment team) could be eligible to receive 75% or 80% of incremental investment profits until they have received 20% of total profits. This period in which they receive a higher percentage is known as the catch-up.
Clawback. Refers to money paid out that then has to be returned. Most commonly refers to carried interest profits paid to the private equity fund, but then as assets are revalued then an amount is returned back to the fund. Could also refer to a return of funds improperly paid out in a bankruptcy proceeding.
Covenants. Lenders require the companies to achieve a certain financial level to remain in compliance, including minimum EBITDA, total leverage ratios, and non-financial covenants as well including timely filings of monthly reports, insurance renewals, and audits. Companies care deeply about being in covenant compliance, because a covenant breakage results in default and could lead to adverse consequences (minimum of which is the lender charging a fee and higher interest).
Cradle to Grave. Used to describe the life cycle of a deal from initial investment date to exit. Most frequently refers to the involvement of an investment professional who was involved from the sourcing and closing of a deal, all the way to its exit, to signify that this professional had a role in the entirety of the investment's success.
Drag Along. A legal term used in a shareholder agreement, saying that if the majority shareholder wants to sell their shares then they can force the minority shareholder to sell their shares also.
Earnout. A form of transaction consideration in which the selling shareholder receives additional portions over time. Usually connected to either specific financial performance such as revenue or EBITDA, but might also be tied to non-financial factors such as remaining employment.
EBITDA. A financial acronym that means Earnings Before Interest, Taxes, Depreciation and Amortization, and probably the most commonly quoted private equity term! EBITDA is intended to show the company’s profits, prior to any balance sheet factors. This is used for valuation purposes (along with Adjusted EBITDA, defined above) but also leverage covenants and employee profit sharing plans.
Evergreen. A term for a private equity fund or structure that continues in perpetuity, meaning it doesn’t have a finite hold period due to fund life. The benefit to this structure is that the private equity partner doesn’t need to sell the company just to return capital (so that it can raise more capital and invest in more companies). Instead, it has the option of holding the investment for a very long time (i.e. decades) if it so chooses.
Family office. A private equity investor who is backed by a single wealthy family or multiple families. They often hire a team of investment professionals and might act similarly to other private equity investors, but pursue investments directly from the family’s balance sheet. Could either be direct investors in a company, or invest through committed funds or alongside independent sponsors.
Go-shop. This is a provision that allows a seller to seek additional offers, even after it has a signed agreement to sell to a party. This is popular in public company transactions, and/or in cases where the Seller isn’t convinced that the Buyer’s offer is the best possible available.
Going Concern. A polite way to describe a business experiencing financial or operational hardship, but still has a promising enough business model to continue its operations. Frequently used in a bankruptcy sale process.
Goodwill. This is a balance sheet term that describes purchase price in excess of the assets acquired. Since companies are valued based more on EBITDA than balance sheet figures, the goodwill calculation becomes more of a plug than a relevant financial metric.
Hurdle Rate. Mostly commonly used to describe a required rate of return for investors, after which carried interest or stock options are considered in the money. This is quoted as a percentage and compounds annually, so knowing a time period is needed to calculate this accurately.
Independent sponsor. A private equity investor that doesn’t manage a committed fund. Generally is an experienced investor or operator who finds a deal, and then connects with other capital providers to fund the transaction. The independent sponsor can earn a management fee paid by the company, and a percentage of its co-investor’s profits. One of the most popular asset classes over the last 10 years.
Keepwell. If the company achieves lower EBITDA than is required to ensure covenant compliance, lenders will allow the private equity owner to contribute more capital into the company and treat that contribution as EBITDA for purposes of the covenant. This practice is known as a “keepwell.”
Lehman formula. The most popular way of calculating how the fee owed to an investment banker, and applies a declining marginal percentage to each tier of incremental enterprise value.
Leverage. A term that calculates interest-bearing debt such as senior debt and subordinated debt, and excludes working capital liabilities. Usually expressed as a ratio to EBITDA.
Lipstick on the pig. This describes how investment bankers and sellers try to make the business being sold as pretty as possible, even if it has blemishes.
Management Fee. A monthly or quarterly fee collected by a private equity firm or independent sponsor from a company in which they are invested. Generally based on a percentage of EBITDA, but with a floor or ceiling amount. This same term also describes a fee that committed funds charge to their limited partners to pay its ongoing administrative expenses.
Mezzanine. An investor that is somewhere between a lender and majority equity investor. Mezzanine firms invest in high-interest subordinated debt plus equity, and generally think like long-term patient capital investors as opposed to lenders. Mezzanine firms are generally willing to provide more debt than a senior lender would, and since its interest is tax-deductible, private equity investors realize that the prudent use of mezzanine helps to enhance their equity returns.
MOIC. An acronym for Multiple on Invested Capital, and is another way of calculating how successful an investment is/was. Investors will say they earned a 3x MOIC on a deal, for example, which means they tripled their money. IRR is quoted as a percentage and is depending on time period (because it compounds annually), whereas MOIC is simply a ratio of how much was invested to how much was received back.
Multiple Expansion. This occurs when you sell a business for a higher EBITDA multiple than you had acquired the business for years ago. This can happen when businesses become larger and more diversified, or when they mitigate certain risks through acquisition or growth (such as customer concentration or key person risk), or they run a highly-competitive sell-side auction process. This is a major boost to PE returns.
Normalized. Usually used as part of a discussion of EBITDA addbacks or adjustments, to describe something as “normalized” means this is a new reality going forward. Can be used to describe a price increase or significant cost improvement, new customer contract, or other such wins that aren’t fully apparent in a TTM EBITDA calculation.
Pro Forma. Also used as part of a discussion of addbacks or adjustments, this turns Adjusted EBITDA into a hypothetical number of certain factors were different. This can occur when you compare what an owner is actually earning vs what a market salary for his/her replacement would be, if a price increase had taken effect at beginning of the year instead of mid-year, or to show a full-year performance of a new product, division or store location that only has a few months of actual performance.
QoE. Acronym for Quality of Earnings, which is a report completed by third-party accounting firms in nearly every lower middle market transaction after going under LOI. The objectives of the QoE are to confirm the accuracy of a company’s adjusted EBITDA, validate the legitimacy of the presented addbacks, ensure that no material changes have occurred in revenue recognition or other accounting policies, and so forth. Sometimes the private business owner follows cash basis accounting instead of accrual, has personal expenses running through the business, or omits details about why performance changed between years. Even with honest sellers, this is a critical aspect of diligence because of how reliant valuation and leverage are on Adjusted EBITDA. Increasingly sellers are performing QoE reports as part of their sale process to offer buyers even greater transparency, and therefore expedite a closing timeline.
Roll-up. Similar to a buy-and-build. This is a strategy in which the private equity investor acquires a "base" or "platform" company (perhaps with size or an existing management in place) then proceeds to aggressively pursue add-on acquisitions in the same space and then integrate them into a combined entity. There are many different reasons why a private equity sponsor might pursue this strategy, but the most common reason is that multiple companies can create customer diversification, management depth and cost savings through operating synergies, resulting in a higher and more diverse EBITDA, and therefore a higher exit multiple.
Run-rate. A special type of pro forma or normalized adjustment that takes recent performance of something, and assumes that performance would have occurred on an annualized basis. An example is that if two months ago a Company completed a cost cutting initiative that will save $120,000 on an annual basis, then the TTM Adjusted EBITDA should be enhanced by $100,000 ($20,000 savings already being in the last 2 months of performance, but now incorporating the remaining full-year of savings).
SBIC. Stands for Small Business Investment Company, and describes a certain type of private equity or mezzanine firm that participates in a government-backed program to incentivize small business investing. These firms generally desire to invest both subordinated debt and equity in the same companies.
Special situations. A euphemism for a company that is experiencing some sort of financial or operational distress, or part of a complicated situation. Frequently used to describe a company either in bankruptcy or on the verge, and can also describe messy carveouts of a corporate division.
Stalking horse. This describes the Buyer who is the front-runner in a bankruptcy sale process in which the business is being sold as a going concern. The Buyer is publicly named, and all other parties have to outbid this party by a certain amount in order to prevail through the bankruptcy sale process.
Strategic Buyer. A corporate buyer, usually a competitor or other industry participant. When they are backed by a private equity firm, they are referred to as “quasi-strategic.”
Synergies. This is the most revered term in private equity beyond Adjusted EBITDA! Synergies most commonly refers to cost savings and efficiencies following the acquisition of another company, which results in additional Adjusted EBITDA and makes the returns spreadsheet look even prettier.
Tag Along. Used similarly to drag along rights, this is a legal term in a shareholder agreement that says if a majority shareholder wants to sell their shares, then the minority shareholder can attach their shares to the sale process as well.
True-up. This term can have multiple meanings, but most commonly refers to a calculation of net working capital (current assets excluding cash, minus current liabilities excluding debt) that occurs after closing date. Most purchase agreements include an agreed upon target for how much working capital a Seller will deliver to Buyer on the closing date. A true-up can then occur either on a closing date, at which time there is either an increase or decrease to cash paid to Seller at closing based on whether Closing Date Net Working Capital is higher or lower than the target. Most times the closing date calculations are just estimates, however, and the actual amount is not known until 30-90 days after closing. The calculation of the Actual (i.e. final) Closing Date Net Working Capital to the Estimated Closing Date Net Working Capital is known as a final “true-up”, and most often results in one party owing the other party some funds.
TSA. This stands for Transition Services Agreement, which is an agreement in which a Seller legal entity will continue to perform certain functions for the Buyer legal entity post-closing. Sometimes a TSA is an administrative arrangement, sometimes for warehouse and logistics, and more.
Tuck-in. Similar to a bolt-on, a tuck-in is an acquisition of a smaller company by a larger company that involves minimal disruption to the larger company.
Value creation. This is the #3 term used by private equity professionals behind Adjusted EBITDA and synergies. Value creation is a fancy way of saying how equity value can grow over time if the company completes a series of strategic initiatives, whether that be to hire people, improve operations, grow revenue, and/or complete acquisitions.
Waterfall. A financial term used to describe how some investors receive payment preferences to others. Common practice is for senior secured lenders to be paid first, then subordinated debt lenders, then preferred equity shareholders, then common equity shareholders. Within each class of loan or investment there is also payment priority determining who gets paid what.
Working capital. Also known as net working capital, this is used to describe current assets excluding cash, minus current liabilities excluding debt. These are the operating accounts of the balance sheet (vs investments or debt/equity). All things equal businesses want to operate with lower net working capital, so that they don’t have to sacrifice as much cash to achieve revenue growth. As mentioned in the “true-up” definition above, nearly everyone purchase agreement has a reference to how much net working capital a Seller is required to deliver to Buyer on the closing date, and if there is deviation to those amounts in either direction then one party will owe the other party.
Workout. This is kind word to describe a company experiencing financial or operational distress, frequently where covenant defaults have occurred and business is dramatically lower than prior periods, and the lenders (and their consultants) and/or private equity investors need to aggressively tackle cost cutting and preserve liquidity. Best case scenarios is that a company can recover and improve over time. Other times the business descends into bankruptcy to either be sold or liquidated.
If you find yourself immersed in jargon-land and unable to understand, do not despair. Just continue to consult your Pocket Translator and then ask your local PE professional some follow-up questions. Hopefully they offer an explanation similar to the ones offered above! And if not, then perhaps the market has evolved again and/or regional dialects have been created. Minnehaha Equity and its founder David Shuler has been investing in small companies for 20+ years, is fluent in PE speak, and happy to chat abut your business and serve as a translator.