Buying and Selling a Business – Key Terms You Need To Know

If you’re considering buying an existing business, or selling your own business, you will need to familiarise yourself with some of the main terms that are used in the buying and selling process. For instance, do you understand EBITDA valuations? What are Heads of Terms and what is their role in the buying process? What is Due Diligence and why is it important? These are terms used by valuers, brokers and solicitors and which have special meaning within the business transfer trade. But they actually refer to fairly straightforward processes. Taking on a business can be daunting enough without feeling intimidated by a lot of technical jargon. Understanding these terms and the processes they refer to will make the buying and selling process easier and less stressful. It will also give you greater confidence in taking the step of successfully buying a business.

Here is our guide to understanding these key terms.

What are EBITDA Valuations?
EBITDA stands for Earnings Before Interest Tax Depreciation and Amortisation.

EBITDA valuations are an industry standard method of valuing companies in order to ascertain their ‘true’ profitability to incoming purchasers. This is the standard form of valuing small and medium businesses, and is the basis of our valuations at Axis Partnership.

The advantage to a buyer of this standard method of valuation is that it allows different businesses to be directly compared as investment propositions. Since most businesses, especially small and medium businesses, are often highly unique, it can be hard to really compare businesses. Looking at EBITDA valuations allows an initial overall comparison to be made, before looking at the business in more detail.

However, many recognise that EBITDA valuations do not tell you everything you might want to know about a business. At Axis we go further into detail on the profit & loss accounts of our clients to ensure any one off costs or personal costs linked to the departing directors are identified, ensuring they receive the maximum value for their company.
As experienced business brokers we are also able to assess other aspects of the business and make sure that buyers are made fully aware of all the strengths of a business, including aspects which perhaps do not appear in EBITDA valuations.

What are Heads of Terms?
Heads of Terms (HoTs) is a document which summarises the deal agreed by buyer and vendor. It puts in writing what may have only been discussed verbally at this point in discussions, enabling both sides to see the whole deal in detail.

It includes the details of the parties in question, the total consideration offered and on what basis (i.e. shares or assets), the payments terms (i.e. if there are any deferred or performance related elements), the target completion date, details of any handover or future employment, confidentiality clauses and an exclusivity period of typically 30-45 days (Note).

If the sale is being brokered by a business transfer agent such as Axis, the broker will draw up the Heads of Terms document for both sides to inspect and agree. The major advantage of drawing up Heads of Terms, apart from helping to firm up the agreement between buyer and seller, is that solicitors are not yet involved in the process. This means that neither party starts to incur costs until the deal is agreed and the document signed by both parties.  Only when both parties are happy with the deal are the Heads of Terms then forwarded to the solicitors to use as a basis for drafting the relevant paperwork. In particular it feeds into the formal legal documentation including the Sales Purchase Agreement (SPA) or Business Purchase Agreement (BPA).

What is Due Diligence?
Due Diligence is a process carried out by a prospective buyer of a business prior to committing to a deal. It involves making a series of checks regarding the business, taking reasonable care to ensure that various aspects of the company are as claimed by the vendor.  The main areas to be checked are:

Financial: For a small business, this may be as simple as looking at the last two year’s accounts in detail. For a large business this may involve looking at order books, details of any contracts in place, terms of any loans outstanding, wage bills and any bonus arrangements, supplier credit terms, and so on. It is absolutely vital that the buyer understands the financial position of the company they are considering buying, rather than leaving it to someone else. A buyer needs to work with an existing financial officer, or a trusted accountant to achieve this.

Legal: Acquiring a company means acquiring all legal liabilities associated with that company. The buyer’s solicitor or in-house legal department will need to carry out a check of all legal activity of the target company, based on documents filed at Companies House.

Property: If the business transfer includes premises, there will need to be checks on the value and status of the property. Freehold property will have searches carried out by a solicitor. Leasehold property will require permission from the landlord to transfer to a new tenant. The buyer will also want to check the terms of the lease, especially the time remaining and any restrictions regarding use.

Operational and Commercial: The buyer needs to attend the premises of the business and find out how the business runs on a day to day basis. Buyers should make themselves aware of all aspects of the company’s running which they would expect to have responsibility for when then take over. This includes aspects such as staff contracts, client contracts, complaints procedures, health & safety, office lease agreements. While the buyer must carry out these checks in person, it is advisable to do so under the guise of an external audit to ensure that staff do not become aware of the proposed sale.

While it is important for buyers or their trusted advisors to actually carry out Due Diligence for  themselves, Axis can help advise buyers what to look for and how to deal with any issues arising out of the Due Diligence process. For instance, an unexpected finding may result in a buyer wishing to adjust the deal in some way before making a final agreement.

For more information on buying or selling a business, please contact us.