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Glossary
Glossary of selected financial terms
A
Agency theory Theory which considers the divergence of goals between shareholders (principals of the company) and directors (their agents, who run the company).
Anchoring Behavioural bias whereby we estimate numbers based on a stimulus number perceived earlier, whether or not this is relevant.
Annuity Receipt or payment of the same sum of money each year for a given number of years.
Anti-dilution clause Clause in a venture capital term sheet which provides that the VC investor cannot be diluted by a down-round.
B
Basis point 0.01 per cent.
Beta Measure of volatility compared to the market. The equity beta is the beta of the company’s share. The asset beta reflects the business risk.
Bond Long-term negotiable debt.
Bonus issue Issue of shares to existing shareholders made by capitalizing retained profits. No cash is transferred, and shareholders end up holding the same proportions of the company as they did before the issue.
Business angel An individual investing venture capital.
Business risk Risks related to the volatility of operating results, before financing.
Buy-back Also known as a share repurchase, this is where the company acquires its own shares.
C
CAPM (Capital Asset Pricing Model) Method of calculating a company’s cost of equity by using the risk-free rate, the company’s beta and the market premium.
Carried interest A way of rewarding private equity and venture capital general partners, entitling them to a percentage of the investment returns above a certain level.
Carve-out Where a listed company restructures by floating part of a subsidiary and retaining the rest.
Convertible Financial instrument that starts as a debt or preference security, but gives the holder an option to convert into ordinary shares instead of being repaid.
Corporate venturing Venture capital investment done by a commercial company rather than an investment fund, generally with a strategic business aim.
Cost of capital An average of a company’s costs of equity and debt (and other forms of finance such as preference shares), weighted in accordance with their relative values in the capital structure.
Coupon Stated yield of a debt, calculated based on its nominal value.
Covenant Clause in a loan agreement giving the lender the right to call in the loan if conditions are breached.
D
Delisting Opposite of flotation – when a listed company goes private.
Depository Receipt Certificate representing the rights to share ownership, but not the ownership itself. An American Depository Receipt (ADR) represents a non-US company and is traded in the USA; a Global Depository Receipt (GDR) is traded outside the USA, representing any company trading not in its home exchange country.
Discounted cash flow (DCF) A way of evaluating a stream of future cash flows as if they all took place immediately – it allows for the fact that money in the future is worth less than money now.
Discount rate Rate used to discount future cash flows. Often a company’s cost of capital, suitably risk adjusted, used as the discount rate.
Dividend growth model (DGM) Method of calculating a company’s cost of equity capital by taking the dividend yield and the expected future growth in dividends.
Down-round Where later venture capital investments are done at a lower price than earlier investments, because the company has lost value.
Due diligence Investigatory work undertaken by a prospective acquirer or lender prior to an investment being made.
E
Earn-out Mechanism for rewarding the vendor of a business with additional consideration if the acquired business meets stated targets in the initial period after the sale.
EBIT, EBITDA Earnings Before Interest and Tax [and Depreciation and Amortization]. EBIT is the operating profit of the business, before finance charges. Depreciation and amortization are non-cash expenses, based on company’s accounting policies, and EBITDA is often used as a proxy for cash profit.
EBIT multiple Enterprise value divided by the EBIT. The EBIT multiple is used in valuation on multiples.
Economic profit Surplus earned after deducting all expenses, including the cost of capital.
Enterprise value Total value of a company, represented by the market values of its debt and equity (and other forms of finance).
Envy ratio In a leveraged transaction, the ratio of the private equity capitalization to the management’s capitalization of the company. Capitalizations are calculated as the amount invested by each party, divided by their percentage share of the equity.
Eps (earnings per share) Profits available to the ordinary shareholders divided by the number of ordinary shares outstanding. If calculated using the number of shares that could ultimately be issued, it is known as diluted eps.
Exercise price Price at which an option may be exercised. Also known as the strike price.
F
Financial risk Risks related to a company’s financial structure. (See ‘gearing’.)
Flotation Listing a company on a public stock market. Also known as an Initial Public Offering (IPO).
Fundamental value Value of a share calculated based on its fundamentals: projected cash flows discounted at a risk-adjusted cost of capital.
G
GAAP (Generally Accepted Accounting Principles) Accepted set of rules and standards for preparing financial statements in the USA.
Gearing Relationship between a company’s debt and equity. Also known as Leverage.
H
High-yield debt Also known as ‘junk bonds’, this is debt which is rated below investment grade.
I
IFRS (International Financial Reporting Standards) Accepted set of rules and standards for preparing financial statements in many countries around the world.
Intrinsic value Difference between an option’s exercise price and the price of the underlying security. Could be ‘in-the-money’, ‘at-the-money’, or ‘out-of-the-money’ depending on whether the exercise price is below, the same as, or above the asset price.
IPO (Initial Public Offering) Another term for flotation.
IRR (internal rate of return) Discount rate which when applied to all of the cash flows to be generated by a project results in a net present value of zero. If the IRR exceeds the company’s criterion discount rate, this is an indication that the company is returning greater than its target rate.
J
Junk bonds High-yield bonds, with a credit rating lower than BBB – (Standard and Poor’s rating) or Baa (Moody’s rating).
L
LBO (leveraged buyout) Private equity acquisition of a company, financed with a significant element of debt.
Leverage Gearing.
LIBOR (London Inter Bank Offered Rate) Benchmark rate used in determining corporate interest rates.
Liquidation preference Mechanism whereby venture capital investors can obtain repayment of their initial investment (or a multiple thereof) in precedence to other investors.
M
Market capitalization The market value of a company’s equity, calculated as the current share price multiplied by the number of shares outstanding.
MBO (management buyout) Transaction in which the company’s management acquire the company, often financed by private equity.
N
Nominal Including inflation.
NPV (net present value) Sum of the present values of all positive and negative cash flows associated with a project. A positive NPV implies that the project is making a return in excess of the discount rate used, and so is worth undertaking.
O
Operating leverage Ratio of fixed costs to total costs in a business.
Option The right, but not the obligation, to do something. A call option gives the holder the right to buy a given security at an agreed price at a specific time; a put option gives the right to sell. Options which have a specific date on which they can be exercised are known as European options; those which can be exercised over a given period are known as American options.
P
Pay-out ratio Dividend paid to ordinary shareholders as a proportion of the profits available for ordinary shareholders. (Pay-out ratio = 1 – retention ratio.)
P/E Price/earnings ratio is the company’s current share price divided by its earnings per share. If calculated on past earnings it is the historic P/E; on anticipated earnings it is the prospective P/E.
Perpetuity Receipt or payment of the same sum every year for ever.
Perpetuity value of a share Value justified by the current level of earnings per share.
Poison pill Specific bid defence tactic which makes the target company less attractive to the bidder.
Post-money valuation Value of a venture capital-backed company after the venture capital investment has been made.
Pre-emption rights Where a company issuing new shares is obliged to offer those shares first to the existing shareholders (see rights issue).
Preference gearing Use of preference shares in a private equity transaction in order to increase management’s proportion of the equity.
Pre-money valuation Value of a venture capital-based company just before the venture capital investment has been made. Generally calculated as the post-money valuation less the sum invested.
Present value Equivalent in today’s money of a sum due to be paid or received in the future. Calculated by discounting, generally at the cost of capital.
PVGO (present value of growth opportunities) Amount of the current share price that is not supported by existing earnings.
R
Ratchet A means to increase or decrease management’s proportion of the equity in a private equity transaction based on the achievement of certain results.
Real Excluding inflation; at constant prices.
Retention ratio The retained profits of a company as a proportion of the profits earned for ordinary shareholders. (Retention ratio = 1 – pay-out ratio.)
Return on equity (RoE) Profits available for ordinary shareholders divided by the company’s equity.
Return on investment Profits before financing charges (and often before tax) divided by the total funds (debt and equity) invested in the business.
Rights issue An issue of shares to existing shareholders, generally at a price below current market value.
Risk Volatility in the expected return.
S
Securitization Process of converting assets or future cash flows into a marketable security.
Security (1) A financial instrument.
Security (2) Lenders can gain security by taking a charge over assets such that the assets can be used to repay their loan if the company fails.
Spin-off Company reconstruction whereby the shares in a subsidiary business are distributed to the shareholders of the holding company.
Steady state Company in steady state which is neither growing nor contracting. This is a theoretical construct, unlikely ever to occur in practice.
T
Tax shield Reduction in the company’s tax burden due to debt interest being tax deductible. Calculated as the interest charge multiplied by the tax rate.
Term sheet Document setting out the terms of a venture capital deal, from which the final deal documentation will be derived.
Total shareholder return (TSR) Percentage return to shareholders in a period based on the dividends received and the increase in the share price over the period.
U
Underwriting Arrangement whereby a financial services company agrees to acquire the shares in a listing if they are not taken up by other shareholders.
Up-round Where later venture capital investments are done at a higher price than earlier investments, because the company has gained in value.
V
Value driver The seven value drivers suggested by Alfred Rappaport are: increase sales growth; increase operating profit margin; decrease cash tax rate; decrease fixed assets as a percentage of sales; decrease working capital as a percentage of sales; increase timescale of competitive advantage; decrease cost of capital.
Value multiple Market value of a share divided by its fundamental value.
W
WACC (weighted average cost of capital) See Cost of Capital.
Y
Yield Payment received from an investment which does not reduce the capital balance.