This episode of Cascade Conversations translates M&A jargon into language we can all understand. There really is a different language to these transactions, and Raj Kothari, Cascade Managing Director and Justin Klimko, Butzel Long President and CEO, help clarify what it means.


Video Transcript

Rajesh Kothari – Cascade Partners Founder and Managing Director
Thank you for joining us today. We’re going to have a conversation about M&A and all of the crazy m&a jargon, terms and dynamics that we use in the M&A world.

My name’s Raj Kothari with Cascade Partners. And joining me today is Justin Klimco from Butzel Long. Justin is a shareholder and President of Butzel Long, a leading law firm here in Metro Detroit.

He’s a Duke Law graduate who spent his entire career helping provide exceptional advice and counsel to organizations, both public companies and private companies in corporate transactions, corporate finance, securities, law, M&A and overall success in growing a business. Justin’s work has been recognized with a lifetime achievement award for his service in investment banking and mergers and acquisition by Crain’s magazine.

Welcome, Justin.


Justin Klimco – Buztel Long President and CEO: Thanks, Raj. And Raj is the managing director and founder of Cascade Partners. He has three decades of experience as an investor, as an entrepreneur and as a financial advisor. And a fun little fact; he’s also a commander of the Michigan wing of the Civil Air Patrol, which is affiliated with the U.S. Air Force.

As you will find out from this discussion, Raj is a very effective communicator. Not all investment bankers can claim to have that talent, but Raj has the ability to break down and communicate to you what may be seem like foreign or complicated ideas and make them very understandable to the listener.


Rajesh Kothari: Thanks. Well, as you can see, a key part of doing a great deal is having a great team of advisors and professionals that are helping you think through and execute the transaction. And an M&A legal team is one of those great team members, right? And they are a team in and of themselves because you’ve got to bring a range of skills to bear that develop on a transaction. Everything from tax, employment benefits, environmental and the transaction overall. And, really, you need a strong M&A team, on the legal side, because you want to make sure the deal that you think you’re cutting matches up with what’s in the document.

And really, at the end of the day, a transaction is about risk allocation, and the documents really help define who bears the risk for what, when and where. And it’s not like negotiating a regular contract or your regular business-to-business activities. It is really a specialized transaction and requires a very specialized skilled legal team to help walk you through that process.


Justin Klimco: And on the flip side, I have clients who ask me, “Why do I need an investment banker?” And there are a number of answers to that question. But the process of selling your company is a complicated one, and one that you only get one chance to get correct. You need someone with the experience to be able to tell you: What is your business worth? What is the offer that you’re getting worth? And who should I sell to? How do I find a potential buyer?

An investment banker has the experience and the contacts to get you through that process. They also are going to help you manage the dual track phenomenon of trying to sell your company while at the same time running your company. And this is a big deal! Selling your company takes a lot of effort and time, and that’s time that takes away from your day-to-day operation of your business. And of course, if you fail to run your business while you’re selling it, it may affect your ability to sell it or the price that you can get when you sell it. And your investment banker is going to keep the sale process right on track and help you understand what needs to be done at any particular juncture and how you get through that process.


Rajesh Kothari: So, once you start getting into this process and you start working with the teams, we start throwing out all kinds of m&a jargon. And so, we thought we’d take a minute and talk about some of those terms.

One of the first ones that almost everybody talks about is EBITDA, Earnings Before Interest Tax, Depreciation and Amortization. What does that mean? It’s really about a measure of cash flow. How much cash flow is the business throwing off? And it’s really built off of earnings, but taking away those non-cash charges—depreciation and amortization—non-cash expenses and taking out the unique dynamics of someone’s personal tax structure or business structure. So, that’s why we take out interest and taxes because, depending on how you’re set up, those numbers can can skew.

And this gets to, “What’s a real cash flow?” Now, there’s lots of adjustments around this, but at the heart, that’s what EBITDA is and that’s the basis for most businesses using as at least some form of the valuation and methodology.


Justin Klimco: So, Raj, when a seller hears someone talks about a multiple, does that relate to EBITDA?


Rajesh Kothari: Usually it relates to a multiple of EBITDA. There’s a multiple of revenue and there can be other multiples, but it really the EBITDA becomes the base and the multiple becomes the range of valuation. So, the stronger companies get a higher multiple, weaker companies get a lower multiple, but within a range in their same industry or business segment.


Justin Klimco: So, another term that you will hear often somebody say, “Well, have you signed an NDA?” People say, “Well, what’s an NDA?”

Simply, the letters stand for Non-disclosure Agreement, but it’s typically the very first document that will be signed in connection with a transaction. It’s really something your investment banker will insist on potential buyers signing before they get any information at all, even the identity of your company, because you need to make sure that both the confidential information about your company, that’s going to be shared is part of the process of deciding whether to buy, as well as the fact that you’re going through this process, remains confidential because you don’t want that information on the street, generally speaking. You don’t want your competitors and your employees and others, your customers, to know that this is going on before the right time because it can have a negative effect on your ability to move forward.


Rajesh Kothari:
But, Justin, clients often come to us and say, “Well look, everybody knows. We’ve already been having conversations with them. Why is this NDA, the non-disclosure agreement, so important to them?”


Justin Klimco: Because it will govern the process by which you disclose information because it’s going to be confidential information that’s disclosed throughout the course of trying to sell your company. And it binds the potential buyer to keep that information confidential and to use it only for the purpose of the transaction. So, they can’t use it for any other purpose.

So, without an NDA, you will not move forward and your investment bank will make sure you don’t, and your lawyer will too. Although, I will tell you that it’s not unusual for us to get involved in a process after the NDA has been signed. We didn’t get a chance to look at it, which is not ideal, but that happens.


Rajesh Kothari: Because again, it’s like all legal agreements on a transaction. The NDA and a M&A transaction doesn’t necessarily look and smell like a regular NDA.


Justin Klimco: That’s absolutely correct.


Rajesh Kothari: Well, once that NDA is signed, then information starts flowing. And most advisors use two main documents to start that process. One is a teaser, and that’s typically a short one or two page document that describes the business without naming the client, without necessarily giving an easy path to figure out who the business is. And this is typically used in the marketing and the early marketing phases that are not under an NDA.

The big document called the Confidential Information Memorandum, the CIM or the SIP, is a document that basically tells the story of your business in writing. It’s the main document that’s used to engage the interest of other parties, highlight the strengths of your company in your organization, the talent on the team, the financial results. It becomes the core document that a buyer is going to use to assess the value of your business and their overall interests.

So, you got to share enough to get them excited, but not share too much that you’re giving away the farm. And that’s what we call a CIM or a SIP.


Justin Klimco: And Raj, what role do you play in both putting that document together and deciding who it’s going to be sent to?


Rajesh Kothari: Right. So, it’s a collaboration, it’s a partnership. We’re working hand-in-hand with our client to understand all the details about their business and identifying multiple points of value and making sure those get highlighted in this document. It’s where we put our hat on and say, “If we were going to buy this business, what would get us excited? What would make us nervous?”

When we’ve worked with other businesses in the same sector, we’re drawing on that experience to build a document that will create a compelling opportunity for a potential buyer while highlighting the strengths and, in some cases, identifying the challenges so folks know upfront. Let’s weed out the chaff early on and not waste our time if they’re not interested in X, Y or Z a business has. And you can’t change the fact, for example, a client has got one customer. That’s it. Let’s lay that out. Let’s talk about why that’s not a problem. But if folks don’t like that, let’s get them out of the way early on.

And it’s the same with identifying who those go to. So, that’s a very collaborative process of identifying.

Sometimes the clients have been approached. Someone’s approached them, someone’s talked to them, they’ve had conversations many times. Clients are like, “Oh, well, we know all the players.” And, really, what we find is they don’t. And so, the next part is us doing our research and saying, “Well, all of those value propositions, who’s excited about those things and who’s excited about those today?”

Many times people say, “Oh my gosh, we’re industry experts. We know all the players.” But if you haven’t talked to them in the last three or four months, what they were doing six and nine months ago can change dramatically just by them completing a transaction or business. So, you’ve got to do very ground-level research to say who’s excited today about these attributes and characteristics that’s playing in the sector, the industry and the business that the targets in to really extract the best value both domestically and internationally.


Justin Klimco:
And Raj just made a very important point, which is that secrets or surprises are bad. But trying to hide something that you think is negative about your company is never going to work. It’s going to come out eventually in due diligence or elsewhere, and it can kill your deal. So, you’ve got to get your cards on the table upfront and just be honest about what you’re selling, and if you’ve got warts, you’ve got to deal with those.


Rajesh Kothari:
Well, and that’s what we said, right, Justin? It’s a team project. So, your lawyer is here and your investment bankers are there to help figure out, “Okay, this is the problem, how do we address it legally? Maybe there’s a way we can contain it and box it,” and Justin’s team can come up with that. And there’s also our job of, “Well, how do we present that? How do we position that in the marketplace? How do we take a weakness and make it go away by disclosing it upfront, by creating the other counter points around it, or taking this weakness and creating an advantage out of it?”

And all these things go into driving the value. Before you ever go to market, you better have a sense of what the value is and make sure, “Yes, at that value I’m comfortable.” A lot of our work is done giving a client a reasonable assessment of generally where is the market today and the business based on the information that’s known. And that information is the EBITDA—we talked about earlier, or revenue. And growth—what’s the strength of that team? How diverse is that customer base? How how defensible is the business?

A lot of different elements come in to creating the range of where the valuation is going to be. The more of those positive attributes you have, the higher the end of the range. The fewer that you have, the lower at the end of the range you are. And those are the things that we’ve got to develop, extracting that information from our clients, working with our clients, develop even the projections—what does the real growth profile look like over the next 3 to 5 years? Because every buyer that’s buying a business has to have it grow, otherwise they don’t get a return on their investment.

So, putting those pieces together are all elements that help understand the value. Not that you go to the market like you do in real estate and say, “Well, this this house is worth $10, but you have to have those attributes if you have to know what the expectations are. Just like we don’t want surprises, the transaction doesn’t want to surprise, shareholders and company owners don’t want surprises either.


Justin Klimco: So, moving on in our jargon discussion, the next term that you’re likely to hear in connection with the sale is LOI or letter of Intent. The letter of intent is a document usually created early in the process, but it’s not always used. There are many deals that happen without LOIs, and the LOI outlines the terms of the transaction in abbreviated fashion, not nearly as in-depth as the actual sale document will be ultimately.

And the LOI will generally say that it is non-binding, so this document is used as an outline for moving forward with the deal. But it’s not the agreement to sell the company, it’s not a contract. It’s a document that aids the parties in moving forward.


Rajesh Kothari: But we use them differently than an IOI, or an indication of interest. Maybe compare those those two, and why do we sometimes use both and how they’re different?


Justin Klimco: So, an IOI is even more preliminary than an LOI. An indication of interest is simply a response, and it’s usually done in connection with a process that’s being run by an investment banker, asking potential bidders to put your cards on the table a little bit. What are you willing to, at least initially, say you’ll buy this company for?

And the IOI is very much qualified. It’s a very short document—usually just a page long—and it will say, “Based on a bunch of assumptions and subject to a bunch of conditions, we would potentially be willing to buy the company for this amount of money.” It helps start weeding the process.

The LOI is something that you sign once you’ve found a buyer or you’ve chosen a party to move forward with. An IOI may come from a number of bidders. You might have several bidders giving an IOI, and you use the IOI to say, “Okay, which of these bidders do we want to actually move forward with?” And the process in which there’s actually multiple potential buyers, the LOI is the first document that would be entered into with a party that you selected and say, “This is the party we want to move forward with.”

Your investment banker has said, “This is the best offer of the ones that you’ve got, and so let’s put something on the page to show what the general outline of the other terms of the deal are going to be.” So it’ll talk about more than just price and the fact that it’s non-binding.

People will say, “Well, why do I want to bother with something that’s non-binding?” That’s a legitimate question. And, as I said, it’s not the case that every deal has an LOI, but it’s a good barometer for the deal, it helps keep the parties focused on what they’ve agreed to in principle and it’s a sort of moral suasion. When somebody tries something later in the deal to put something in, you say, “Wait a minute, that’s not what the LOI says. And the LOI helps guide the parties as the definitive documentation is drafted.

And the last point is that, although the LOI will say that it’s non-binding, in fact, there’s usually a couple parts of the LOI that are in fact binding. That would be, for instance, a confidentiality obligation, perhaps an exclusivity agreement that says that you, the seller, are not going to try to sell the company to somebody else during some defined period while this buyer is moving forward to try to buy the company.

So, there are usually a few provisions in an LOI that, although it’s otherwise not binding, those provisions are in fact binding.


Rajesh Kothari: And I know we often work with you to to incorporate really critical points or issues that are important to a client or that deal by defining that moral ground if you will, inside the LOI so there’s no re-trading or minimal re-trading later on.


Justin Klimco: Right, right. And it’s inevitable in a deal that there’s going to be some back and forth because you don’t know everything you need to know at the LOI stage. But you’re right, it helps set the parameters, the guidelines, the rails in which you’re going to proceed to negotiate this deal. So, it can be a very valuable document. But, as I say, it’s not the case that some some transactions move right away into definitive documentation.


Rajesh Kothari: And really, you’re taking out four pages or five pages of a letter of intent and turning it into 100 pages of we shall not, they shall not and no one shall document. So, there’s still lots of room to negotiate.


Justin Klimco: Rules apply to all the representations and warranties, and the covenants, and the indemnification provisions—all of that stuff. None of that is going to be detailed in the LOI. It might be mentioned. You might mention what anticipated limit on indemnification is, but the real nitty gritty is in the transaction document that will come later.

So, the next step after the LOI is the due diligence.

Okay, what is due diligence? Where did that term even come from? So, everybody’s heard the term “due diligence.” It sounds kind of funny because people use it as a verb—I’m doing due diligence. Or as a noun—I’m going to do due diligence. And sometimes as an adjective. I use it in a lot of different ways.

But due diligence simply refers to the buyer’s investigation of the company to make sure it knows what it’s getting—it’s buying what it thinks it’s buying. And that involves review of a lot of documentation, that involves sitting down with management and asking a bunch of questions, and that involves usually the counsel for the buyer putting together some sort of a report for its client to tell them what what’s been in the documentation they’ve looked at. But it helps the buyer understand what it’s buying so that when you move to the transaction document—the purchase agreement—the buyer can know what provisions it needs to include to protect against whatever it’s found in due diligence. And due diligence is a process that goes on at the various levels and with various parties.

Your lawyers will be looking obviously at legal documentation. They’ll look at things like lawsuits that are outstanding, corporate documentation, things related to employee benefits and employment, environmental matters. But the investment banker will be involved too, in looking at financial matters. And your accountants may be involved in looking at tax and accounting matters. So, there will be several layers of due diligence review.


Rajesh Kothari: Well, you said the people use it as a as a noun and as a verb. I think I’ve used this as an expletive at times, but really this is a tough one for many business owners, because sometimes they feel attacked and vulnerable or it’s an insult and it’s, as you describe, really making sure the buyer is getting what they thought they’re getting. How do you talk about that part of it? Because sometimes people get really offended.


Justin Klimco: So, I think in part, a seller needs to put himself or herself into a buyer’s shoes and say, “If I was buying this company, what would I want to know and what would I want to guard against?” Okay? And one thing I like to tell sellers is before you ever get to the stage of due diligence with a potential buyer, do due diligence on yourself. Know what you want, because it’s amazing how often you find a selling company that knows very little about some areas of its business, and it’s going to be asked about those things. And rather than say either “We don’t know” or “Oh my god, we just found that out,” doing that process in advance will help you be ready for the questions that you’re going to get asked in due diligence, and the negotiations that will go around things that come out of due diligence.

So, it’s a very important fundamental process. It’s a little bit tedious, boring and time consuming, and parties don’t understand why you got to spend so much time doing that. And it’s very often we’ll make requests if we’re representing a buyer for instance, that the seller will say, “Well, why do you need to know that? And we have to answer that question, but there are things that just need to be disclosed and you’ve got to be ready for those questions to be asked, and due diligence is where it happens.


Rajesh Kothari: Well, I know due diligence drives towards things that go into the purchase agreement—we call them APAs (Asset Purchase Agreements) and stock purchase agreements. But a big part of it is driving to representations and warranties. How does that play out and how does what we call rep and warranty or RWI— rep and warranty insurance—play into this and into the market today, much more in the due diligence process and the legal documents?


Justin Klimco: So, the purchase document will have a number of representations and warranties that the sellers make to the buyer. So, essentially what the buyer is saying, I’m buying your company based on certain assumptions, and the assumptions are what are in the representations and warranties—I’m assuming that you formed your company properly. I’m assuming that you issued your shares correctly. I’m assuming that you have no labor and employment issues you haven’t told me about. I’m assuming that your employee benefit plans have been properly put together.

There is a number of typical representations and warranties that go into the document that are the assumptions for the deal, and there will be a provision in the document that says, “If we find out, after we’ve completed the transaction, that some of these were untrue, we can come back and ask you for more money or ask for some of the money back.” There may be an escrow that secures that, but the process of helping to secure the buyer to buy what they think they’re buying is done through those representations and warranties. And the representations and warranties themselves are driven by what the buyer finds in due diligence.

So, if the buyer discovers, for instance, that there is a lawsuit out there, that could be a big problem. They will ask for a specific representation about that or an indemnity related to that. And that comes out of what they discover in the process of investigating the company.


Rajesh Kothari: Well, I hope this helped provide a little bit of insight to some of the jargon, terms and things that are happening and accelerating the M&A environment today. Again, there was great presentation from Justin Klimco, shareholder and President at Butzel Long. Again, I’m Raj Kothari with Cascade Partners.


M&A Jargon Recap


EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortization. It’s really about a measure of cash flow—how much cash flow is the business throwing off. EBITDA is built off of earnings, but taking away those non-cash charges (depreciation and amortization) and taking out the unique dynamics of someone’s personal tax structure or business structure.



NDA stands for Non-Disclosure Agreement. An NDA is an agreement in which a person commits to keeping company information confidential.



LOI stands for Letter of Intent. An LOI is a document outlining the understanding between two or more parties that they intend to formalize in a legally binding agreement.



IOI stands for Indication of Interest. An IOI is a brief letter or notice that expresses a buyer or companies interest in acquiring another company.


Due Diligence

Due diligence is a process of verification, investigation or audit of a potential deal or investment opportunity to confirm all relevant facts and financial information.


Representation and Warranties (a.k.a. reps and warranties)

Representation – an assertion of facts given to induce a party to enter into an agreement
Warranty – a promise that the fact(s) are or will be true along with an implied promise of indemnity if false.

Learn more about representation and warranties in our Cascade Conversations on reps and warranties, part 1 and part 2.


Thank you and I hope you’ll join us for another Cascade Conversations about what’s happening in the M&A marketplace.