Accretion

Net increase in earnings per share resulting from an acquisition. 

Amortization

Expense related to goodwill arising in a purchase transaction. 

Anti-dilution Provisions

Provisions in a security with an equity feature, which protect the holder’s investment from dilution as the result of later issues of stock at a lower price than the investor paid by adjusting the option price or conversion ratio. 

Auction

A method for selling an asset to the highest bidder. 

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Basket

In effect, a deductible tied to the indemnification of the buyer by the seller.  The basket is meant to cover unexpected liabilities – up to a pre-negotiated limit – which arise after a sale is completed and for which the seller would otherwise be liable. 

Beta

A statistical measure of a security’s volatility as compared to the overall market (a beta lower than 1 would indicate less volatility than the general market; a beta of greater than 1 more). 

Black-Scholes Formula

A statistical method of estimating the present value of stock options or warrants based upon the exercise price, fair market value of the underlying security, the length of the exercise period of the option or warrant, and the volatility of the underlying security. 

Burn Rate

The rate at which a company spends capital to finance operations before generating a positive cash flow from operations. 

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Call Option

Option to buy an asset at a specified exercise price on or before a specified exercise date. 

Cap

The seller’s total potential limit of liability associated with his indemnification for incorrect representations and warranties. 

Capitalize

To classify a cost, most often software development and R&D expense in the technology industry, as a long-term investment, rather than charging it to current operations. 

Capitalization Rate

The discount rate used to determine the present value of a stream of future earnings. Equals normalized earnings after taxes divided by present value, expressed as a percentage. 

Collars

In a transaction where the consideration is being paid in the buyer’s stock, the two sides may agree to lock in a stock price range – known as a collar.  This protects the deal value as the stock price fluctuates within the collar during due diligence and negotiations. However, if the deal value moves outside of the collar, the deal value will either increase or decrease. 

Comment Letter

A letter prepared by an examiner at the SEC setting forth the SEC’s questions and comments with regard to a filing with the SEC, such as a registration statement. 

Conversion Parity

The equal dollar relationship between the price of a convertible security and that of the underlying security into which it can be converted.  As an example, if a $1,000 debt instrument is convertible into 50 shares of common stock, conversion parity occurs when the common stock price is at $20.00 per share.  If the prevailing common stock price is other than $20.00 per share, conversion parity does not exist. 

Cumulative Dividend

A dividend that accumulates if not paid in the period when due and must be paid in full before the other dividends are paid on the company’s common stock. 

Cumulative Preferred Stock

A form of preferred stock that provides that if one or more dividends is omitted, those dividends accumulate and must be paid in full before other dividends may be paid on the company’s common stock. 

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Death Spiral Deal

A convertible security where the conversion price if tied to the market price (frequently at a fixed percentage discount) at the date of conversion.  Also known as a “Toxic Convert”. 

Debenture

A note or bond usually backed only by the general credit of a company, and not secured by specific property. 

Demand Registration Rights

The contractual right of a security holder to require an issuer to file a registration statement to register the holder’s securities so that the holder may sell them in the public market without restriction. 

Dilution 

Net decrease in earnings per share resulting from an acquisition.

Discount Rate

The interest rate used in discounting future cash flows to determine the current value of an acquisition candidate. 

Discounted Cash Flow (DCF) Analysis

A method of evaluating an acquisition by estimating future cash flows and taking into consideration the time value of money. 

Down Round

A round of equity financing at the valuation lower than prior rounds of financing. 

Drag-Along Rights

Contractual rights pursuant to which minority shareholders are required to sell their securities in connection with a sale by the majority shareholders.  Such rights typically apply in connection with an acquisition transaction such as a sale of all the shares of stock or a sale of all or substantially all the assets of a company. 

Dribble Out Rules

For sellers receiving stock as consideration for their company, dribble out rules (under Rules 144 and 145 of the Securities Code) allow the sale of stock on a public market subject to volume limitations.  These volume limitations are on the amount that can be sold within any three-month period (no more than 1% of the buyer’s total number of outstanding shares or the average weekly volume of the stock during a previous four-week period.) 

Due Diligence

The process of investigation, performed by buyers, into the details of a seller’s operations, such as an examination of financials, contracts, management and the verification of material facts. 

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Earnings Multiple

A valuation method which applies a market multiple to a firm’s profit to arrive at a company value. The profit used may be the EBIT, operating profit, or net income, among others. 

Earnings Multiplier

A company’s estimated price/earnings ratio, adjusted for the current level of interest rates; used for purposes of valuation. 

Earnings Yield

Earnings per share for the most recent 12 months divided by current price per share.  The reciprocal of the price/earnings ratio. 

Earn-out

An arrangement in which sellers of a business receive additional future payment, usually based on achievement of pre-determined and pre-negotiated profitability hurdles. 

EBIT

Earning Before Interest and Taxes 

EBITDA

Earning Before Interest, Depreciation and Amortization. 

Economic Value Added (“EVA”)

Equals return on total capital minus cost of capital, multiplied by total capital. 

Economic Value

The value of an asset deriving from its ability to generate income. 

EPS

Earnings Per Share 

Enterprise Value

Includes the equity value of the company plus any long term debt outstanding. 

Escrow Requirements

A requirement where the buyer holds back a certain percentage of a deal’s value for a pre-defined period to cover unexpected expenses arising from the operations of the business.  The escrow ties indirectly into the seller’s representations and warrantees. 

Equity

Common stock and preferred stock.  Often used to refer to common stock only. 

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Fair Market Value

The amount at which property would change hands between a willing seller and a willing buyer when neither is under compulsion and when both have reasonable knowledge of the relevant facts. 

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Goodwill

AN intangible asset which from an accounting perspective represents the competitive advantage acquired as part of a deal.  In an acquisition, goodwill arises on the balance sheet of an acquirer in the amount by which the purchase price exceeds the net tangible assets of the acquired company. 

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Hedge Fund

A fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including selling short, leverage, program trading, swaps, arbitrage, and derivatives.  Since they are restricted by law to less than 100 investors, the minimum investment is typically $1million.  The general partner usually receives performance-based compensation. 

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Incentive Stock Options or ISOs

Stock options available only to full time employees that are entitled to special tax treatment under the USA Internal Revenue Code. The employee who exercises the option does not have to pay tax until the employee actually sells the stock. However, the employee may be subject to alternative minimum tax.  The company does not get a tax deduction.  

Indemnification

A legal commitment by either of the parties in a deal to compensate the other party for losses or damages related to breaches of representations and warrantees. 

Indemnification Terms

Defines the duration, dollar limits, and procedures associated with indemnification provisions. 

Indemnity Bucket

See “Basket” 

Initial Public Offering (IPO)

The first sale of equity by a company to the public markets.  This may be done to gain access to capital for investment and R&D, to provide liquidity for shareholders, to pay down debt, or to take care of general corporate purposes. 

Internal Rate of Return (IRR)

Discount rate at which investment has zero net present value.  Employed to ascertain the attractiveness of an investment; typically, an IRR that exceeds a company’s cost of capital will be deemed to be a worthy investment.  This may apply to the acquisition of another company, a capital investment, etc. 

Intangible Asset

An asset such as goodwill, technical expertise, trademarks, and patents. Intangible assets are generally amortized over a period of several years and flow through the income statement as a non-cash to earnings. 

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Leveraged Buyout (LBO)

Transaction by which investors gain full ownership or a controlling interest in a company using a significant amount of borrowed funds.  These funds are generated by borrowing against the company’s receivables and inventory (senior term secured debt), and by borrowing against the company’s expected future cash flows (unsecured subordinated debt).  The equity structure is completed with the equity piece (usually 30% or less of the total purchase price). 

LIBOR

The interest rate that the largest international banks charge each other in the London inter-bank market for loans. 

Liquidation Preference

A right typically attached to preferred stock under which, upon liquidation, maybe widely defined holders of preferred stock receive payment of a specified amount, typically at least equal to the amount at which the preferred stock was originally issued, in priority over payments to other investors. 

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Market Capitalization

The total equity value of a company; calculated by multiplying the share price by the number of shares and options outstanding. 

Market Discontinuities

Inefficiencies that result from imperfect or insufficient information available to investors.  Can result in mis-valued securities that provide the opportunity  for above average gains. 

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Net Present Value (NPV)

A calculation designed to assess the attractiveness of a project or investment.  If discounting a series of investment and income cash flows back to the present at the company’s cost of funds generates a positive number; the project will generally be deemed to be worthwhile. The discount rate that makes the NPV=0 is the IRR. 

Normalized Earnings

Earnings adjusted for one-time and other special charges and gains that distort the true underlying performance of the business.  Also referred to as adjusted earnings. 

Net Margin

Net profit divided by revenues, expressed as a percentage.  Used to assess the return on revenues that a company generates after all operating and non-operating expenses (e.g., other income/expense, interest and taxes) have been taken into account. 

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Operating Margin

Operating income divided by revenue, expressed as a percentage.  Used to measure the performance of a company’s underlying business before any expenses related to capital structure (e.g., interest income, interest expense) and taxes.  This measure is particularly effective in comparing the performance of two similar businesses with differing capital structures. 

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Participating Preferred Stock

Preferred stock that entitles the holder not only to its stated dividend and liquidation preference, but also allows the holder to participate in dividends and distributions declared on common stock. 

Payment in Kind (PIK)

A feature of a security permitting the issuer to pay dividends or interest in the form of additional securities of the same class.  

Piggy Back Rights

Rights given to a seller who receives unregistered stock in a deal.  Piggy Back rights mean that the seller can tie his stock to any registration statements filed by the buyer so that his stock thereby becomes freely tradable on a public market. 

PIPE

A private investment in a publicly traded company (literally, ‘private investment public equity’). 

Pre-Emptive Right

The right of an investor to participate in a financing to the extent necessary to ensure that, if exercised, its percentage of ownership of the company’s securities will remain the same after the financing as it was before. 

Pre-Money Valuation

The valuation of a company immediately before investors put new funding into the company.  Used as the basis for calculating the investors’ price per share and percentage of the equity for the new investment. 

Price/Earnings Ratio (P/E)

A popular ratio that is used to get an indication of the market’s expectations for a company or sector.  The calculation consists of dividing a company’s share price by earnings per share (or, similarly, by dividing market capitalization by net income), and can be based on both a past or future twelve month basis.  Generally, a high P/E indicates high growth expectations, although one-time gains, write-offs and other special charges can distort this ratio. 

Pooling of Interests

A method of accounting for a company merger in which stock in the acquiring company is exchanged for 100% of the stock of the acquired company in a tax-free transaction. In this method of accounting, the balance sheets of the two companies are combined and no goodwill is created. These transactions are only allowed under certain circumstances. 

Present Value

Calculated by discounting the value of future cash flows expected to be generated over the life of an investment to the present.  For example, at a straight 5% interest rate, an investor may be indifferent to $1.00 today or $1.05 a year from now.  Present value is effective for comparing the attractiveness of disparate projects with disparate cash flows by bringing all data back into single numbers in the present that can then be compared. 

Proforma

Projected or hypothetical balance sheet and income statement based on a specific set of assumptions.  Often used to demonstrate how a company will look or perform in the future independently or as part of a new entity.  

Proxy

A written authorization given by a shareholder for someone else, usually the company’s management, to cast his/her vote at a shareholder meeting or at another time. 

Put Option

Option to sell an asset at a specified exercise price on or before a specified  exercise date. 

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Registration Rights

Rights given to a seller by the buyer when the form of consideration is unregistered (i.e., restricted) stock of the buyer.  Registration rights usually allow the seller to require the buyer to file a registration statement with the SEC, which, in turn, allows the shares to be traded on a public market. 

Rights of First Refusal

The right of a party to match the terms of a proposed contract with another party. 

Rights Offering

Usually used to refer to an option granted for a short period of time to existing stockholders to purchase additional securities on a pro rata basis to their holdings. 

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Spread

Difference between the price at which an underwriter buys an issue from a firm and the price at which the underwriter sells it to the public.  

Sub S Corporation

A form of corporation allowed by the IRS for most companies with 35 or fewer shareholders, which enables the company to enjoy the benefits of incorporation but to be taxed as if it were a partnership. 

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Tag-Along Agreement

A contractual agreement by management stockholders, typically in connection with a venture capital investment, that they will not sell any of their stock in the company without giving the investors the right to participate in the sale of the management sellers pro rata to their holdings. 

Tangible Assets

Physical assets such as plant, machinery, and offices, as well as cash, accounts receivable, and other financial assets. 

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Underwriter

Firm which buys an issue of securities from a company and resells it to investors, absorbing the risk of holding these securities over an interim period. 

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Valuation

The process of determining the value of an asset or company. 

Valuation Reserve

Allowance, created by a charge against earnings, to provide for changes in the value of a company’s assets.  Examples include accumulated depreciation and allowance for bad debts. 

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Warrant

Long term call option issued by a company, usually in conjunction with an equity share, that is exercisable within a certain period of time and at a certain price into a share(s) of the company’s equity.  Generally warrants are issued to generate capital while mitigating the effects of dilution.