SMB Investment Glossary
Essential terms and definitions for small business acquisition, search funds, and entrepreneurship through acquisition (ETA).
Financial Metrics
Add-Back
An expense added back to reported earnings to calculate adjusted EBITDA, typically representing one-time costs or owner-related expenses that won't continue post-acquisition.
EBITDA
Earnings Before Interest, Taxes, Depreciation, and Amortization - the primary profitability metric used to value small businesses, typically resulting in 3-5x EBITDA purchase price multiples.
Seller's Discretionary Earnings (SDE)
A cash flow metric used to value small businesses, calculated as net income plus owner compensation, benefits, and discretionary expenses.
Working Capital
The operating liquidity of a business, calculated as current assets minus current liabilities. In M&A, working capital targets determine post-closing adjustments.
Deal Structures
Asset Purchase vs Stock Purchase
Two fundamental M&A structures: asset purchases buy specific business assets/liabilities while stock purchases acquire entire corporate entities, each with distinct legal, tax, and risk implications.
Earnout
A contingent payment structure where sellers receive additional consideration based on future business performance, typically used to bridge valuation gaps and share risk between buyer and seller.
Investment Structures
Bolt-on Acquisition
A smaller, complementary acquisition added to an existing platform company to expand capabilities, geography, or product offerings.
Co-Investment
Direct investment alongside a search fund or private equity manager in a specific portfolio company, typically offering lower fees and higher alignment than traditional fund structures.
Platform Company
An initial acquisition that serves as the foundation for a buy-and-build strategy, with bolt-on acquisitions added to create scale and value.
Search Fund
An investment vehicle where a searcher raises capital to find, acquire, and operate a single small business, typically generating 3-5x returns over 5-7 years.
Self-Funded Search
A search model where entrepreneurs fund their own search for an acquisition target, often using personal savings or debt, rather than raising capital from investors.
People & Roles
Business Broker
A professional intermediary who facilitates the sale of small businesses, typically earning 8-12% commission on completed transactions.
Searcher
An entrepreneur who systematically searches for, acquires, and operates a small business, typically through a search fund or self-funded search model.
Fund Operations
Capital Call
A formal request from a fund manager for investors to contribute a portion of their committed capital, typically issued when investments are made.
Dry Powder
Uncommitted capital available for investment, representing the funds that private equity firms have raised but not yet deployed.
Vintage Year
The year a private equity fund makes its first investment or closes on capital, used to benchmark fund performance against peers from the same time period.
Fund Economics
Carried Interest (Carry)
The share of investment profits paid to fund managers as performance compensation, typically 20% of profits above a preferred return hurdle.
Management Fee
An annual fee charged by fund managers to cover operational expenses, typically 2% of committed capital during the investment period and 2% of invested capital thereafter.
Preferred Return (Hurdle Rate)
The minimum annual return LPs must receive before the GP earns carried interest, typically set at 8% in private equity funds.
Deal Process
Confidential Information Memorandum (CIM)
A detailed document prepared by sellers or brokers providing comprehensive information about a business for sale, including financials, operations, and growth opportunities.
Deal Flow
The pipeline of investment opportunities available to a buyer or fund, sourced through brokers, direct outreach, networks, and proprietary channels.
Due Diligence
The comprehensive investigation process where buyers verify business information, assess risks, and validate assumptions before completing an acquisition, typically taking 30-60 days.
Escrow
A neutral third-party arrangement where funds or documents are held until specific conditions are met, commonly used in M&A to hold purchase price deposits and holdbacks.
Exclusivity Period
A contractual period (typically 60-90 days) during which the seller agrees to negotiate only with one buyer, allowing focused due diligence without competition.
Indication of Interest (IOI)
A preliminary, non-binding proposal from a buyer expressing interest and approximate valuation range, typically submitted before receiving detailed financials.
LOI (Letter of Intent)
A preliminary agreement between buyer and seller outlining key deal terms including price, structure, timeline, and conditions before formal due diligence and definitive purchase agreement.
Proprietary Deal
An investment opportunity sourced directly without broker involvement, typically resulting in less competition and better pricing for the buyer.
Due Diligence
Data Room
A secure repository for sharing confidential documents during M&A due diligence, typically organized by category with controlled access and activity tracking.
Quality of Earnings (QoE)
A comprehensive financial analysis that verifies the accuracy, sustainability, and cash generation ability of a target company's reported earnings, identifying adjustments that impact valuation and deal structure.
Financing
Debt Service Coverage Ratio (DSCR)
A lending metric measuring a business's ability to pay its debt obligations, calculated as cash flow divided by total debt service. SBA loans typically require 1.25x minimum.
Personal Guarantee
A legal commitment where a business owner agrees to be personally liable for business debt if the company cannot pay, commonly required for SBA loans.
SBA Loan
Government-backed financing that covers 70-90% of small business acquisition costs at below-market rates, requiring 10-15% buyer equity and personal guarantees from borrowers.
Seller Financing
A deal structure where the business seller provides a loan to the buyer for 10-30% of the purchase price, typically offering better terms than traditional financing while ensuring seller confidence in the business.
Valuation
Enterprise Value
The total value of a business including both equity and debt, representing the price a buyer would pay to acquire 100% of the company's operations.
Multiple
A valuation metric expressing business value as a multiplier of earnings (EBITDA or SDE), commonly ranging from 2-6x for SMB acquisitions.
Deal Structure
Holdback
A portion of the purchase price held in escrow after closing to cover potential post-closing adjustments, indemnification claims, or seller obligations.
Rollover Equity
When a seller reinvests a portion of sale proceeds into the acquiring entity, maintaining ownership stake and alignment with the buyer's success.
Stock Purchase
An acquisition structure where the buyer purchases ownership shares directly from shareholders, acquiring all assets and liabilities of the entity.
Transition Period
The time after closing when the seller assists the buyer in transitioning the business, typically 30-90 days but can extend to 12+ months for complex businesses.
Legal
Indemnification
Contractual protection where the seller agrees to compensate the buyer for losses arising from breaches of representations, warranties, or specific known issues.
Non-Compete Agreement
A contractual restriction preventing the seller from competing with the acquired business for a specified time and geographic area, typically 3-5 years.
Non-Disclosure Agreement (NDA)
A legal agreement protecting confidential business information shared during M&A discussions, required before accessing detailed company data.
Performance Metrics
Internal Rate of Return (IRR)
A metric measuring investment performance as an annualized rate of return, accounting for the timing and size of all cash flows. Search funds target 25-35% IRR.
J-Curve
The typical return pattern of PE funds showing initial negative returns as fees exceed gains, followed by positive returns as investments mature and exit.
Multiple on Invested Capital (MOIC)
A performance metric showing total return as a multiple of original investment, calculated as total value divided by invested capital. Search funds target 3-5x MOIC.
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