SME and startup finance glossary

Plain language definitions of the finance terms owners, buyers and investors encounter. No jargon, no fluff.

Burn rate

Burn rate is the net cash a business consumes each month to operate. Gross burn adds up all cash going out; net burn subtracts cash coming in, and it is net burn that matters for survival. Tracked month by month, it shows whether the business is moving towards or away from breakeven. Combined with available cash, it gives you the runway directly.

Cap table

The cap table is the schedule that records who owns what in a company: shares, options, convertibles and their percentages. It shows how ownership is split between founders, employees and investors, and the effect of future rounds. A clean, current cap table is essential before any transaction; a messy one scares investors away. It is always read by distinguishing the current position from the fully diluted one.

Cash free debt free

This is the most common pricing convention in SME and startup deals: the seller keeps the cash and clears the financial debt at completion. The buyer pays enterprise value for a business with no debt and no cash, then adjusts for the actual net debt found. This basis keeps the price from depending on when the business happened to collect or pay out. It almost always comes with a normalized working capital mechanism.

Churn

Churn is the rate at which customers or recurring revenue fall away over a given period. In a subscription business, high churn forces you to keep running just to replace what leaves, eroding growth and profitability. Customer churn and revenue churn are measured separately; revenue churn can even turn negative when retained customers spend more. It is the number one health metric for any recurring model.

Contribution margin

Contribution margin is what a unit sold earns once you strip out the costs that vary with volume. It measures how much each sale contributes to covering fixed costs. It is the key tool for deciding a price, a promotion or whether to drop a product line. As long as contribution margin is positive, an extra sale improves the result, even if net margin looks thin.

Covenant

A covenant is a clause in a loan agreement that requires the borrower to keep within certain ratios or conditions, for example a maximum leverage or a minimum DSCR. As long as they hold, the relationship runs smoothly; a breach is a technical default, even if the company is paying on time. The lender can then renegotiate, tighten terms or demand repayment. Tracking your covenants before they get tight is part of serious financial management.

Customer concentration

Customer concentration measures how much revenue depends on a small number of customers. When a single client carries a large share of sales, its loss can threaten the whole business, which weighs heavily on valuation. Buyers and lenders always examine this, because it reveals a risk that headline figures hide. Diversifying the customer base before a sale raises both the price and the resilience of the business.

Days sales outstanding (DSO)

DSO measures how many days it takes the business to collect a sale once it has invoiced. You compute it by dividing trade receivables by average daily revenue. A high DSO points to slow paying customers or weak collection, and it locks up cash. Cutting DSO by a few days often frees more liquidity than a margin improvement.

Debt capacity

Debt capacity is the maximum amount of debt a business can comfortably repay from its cash, including in a bad year. It is not the same as what a bank is willing to lend, which depends on collateral. You estimate it from stable operating cash flow, a stress test and a safety cushion. Knowing your own limit before negotiating is one of the best protections an owner can have.

Debt service coverage ratio (DSCR)

The DSCR compares the cash available for debt service to the payments due over the period, both principal and interest. A DSCR of 1 means the business just covers its payments, with no safety margin. Lenders typically want a cushion, often around 1.25 or more, to absorb a bad year. It is the single most telling ratio for judging whether debt is genuinely affordable.

Deferred revenue

Deferred revenue is money already collected for a service not yet delivered, such as an annual subscription paid up front. On the balance sheet it is a liability: the business still owes the service. The cash helps liquidity but only becomes revenue as the service is delivered over time. In an acquisition you always check the future cost of this obligation, because the buyer inherits it.

Dilution

Dilution is the fall in a shareholder’s ownership percentage when the company issues new shares, for instance in a funding round. Holding a smaller slice of a larger business can still be a good outcome if total value grows faster than the dilution. The danger is stacking up poorly priced rounds and ending with a token stake. The fully diluted cap table exists precisely to anticipate this effect.

Due diligence

Due diligence is the in depth review a buyer runs before completing an acquisition. It covers the financial, legal, tax, employment and commercial angles, checking that reality matches what was presented. Its purpose is not only to confirm the price but to surface hidden risks that justify a warranty or an adjustment. A well prepared target sails through this stage; a poorly prepared one often loses price in it.

Earn out

An earn out is part of the price paid later, conditional on the future performance of the business. It bridges the gap when seller and buyer disagree about prospects. The seller only receives it if defined targets (revenue, EBITDA, milestones) are met over the agreed period. It is a useful tool but a frequent source of disputes: the criteria must be simple, measurable and shielded from the buyer’s own decisions.

EBITDA

Earnings before interest, taxes, depreciation and amortization. It measures operating profitability independent of how the business is financed and how it depreciates its assets. It is widely used as a valuation base (a multiple of EBITDA) and as a proxy for the cash a business can devote to servicing debt. Remember that EBITDA is not cash: it ignores working capital movements and capital expenditure.

EBITDA bridge

An EBITDA bridge links reported EBITDA to normalized EBITDA by laying out each adjustment, step by step. You start from accounting profit, then add or remove each item: adjusted owner pay, one off costs, exceptional income, up to the figure used for valuation. This presentation makes the negotiation transparent and lets each adjustment be debated on its own. It is the standard tool for defending an adjusted EBITDA to a buyer.

Enterprise value vs equity value

Enterprise value is the price of the business itself, regardless of how it is financed. Equity value is what the shareholder actually receives: enterprise value minus net debt. In practice you apply a multiple to EBITDA to get enterprise value, then subtract debt and add cash to reach the price of the shares. Confusing the two is the most common mistake in any price discussion.

Exit readiness

Exit readiness is how prepared a business is for sale, well before it goes to market. A ready business shows clean accounts, limited dependence on the owner, a diversified customer base and contracts in good order. Working on these points in advance shortens diligence, reduces price adjustments and widens the pool of serious buyers. Readiness is built over one to three years, not in the weeks before an offer.

Free cash flow

Free cash flow is the cash left over after the business has funded its operations and the investment needed to stay in the same shape. You take the cash generated by operations and subtract the capital expenditure required to maintain the business. This is the money actually available to repay debt, pay dividends or fund growth. A company can be profitable on the income statement yet produce negative free cash flow if it ties up too much working capital.

Goodwill

Goodwill arises when a company buys another for more than the book value of its identifiable assets. It represents what the buyer pays beyond tangible assets: brand, customer base, know how, market position. It sits on the acquirer’s balance sheet and must be tested regularly; if it proves overvalued, an impairment is booked. Large goodwill on a balance sheet often signals growth by acquisition.

Gross margin

Gross margin is what remains of revenue after the direct cost of the goods or services sold. Expressed as a percentage, it shows how much each euro of sales leaves to cover fixed costs and produce a profit. A strong gross margin gives room to invest and absorb shocks; a thin one leaves the business dependent on volume. It is the first number an investor looks at to judge the quality of a model.

Leverage (multiple of EBITDA)

Leverage expresses net debt in years of EBITDA: net debt of 3 million on EBITDA of 1 million is leverage of 3 times. The higher the leverage, the more exposed the business is to a downturn, because debt payments fall due whatever happens. Prudent levels depend on how stable the business is: a recurring revenue business can carry more leverage than a cyclical one. Above 4 or 5 times the risk becomes significant for most SMEs and startups.

Leveraged buyout (LBO)

A leveraged buyout is the acquisition of a company financed largely with debt, which is then repaid from the target’s own cash flow. The buyer puts in only a fraction of the price as equity, which amplifies the return if things go well. The downside is that the debt payments make the business more fragile in a downturn. The structure relies on a target with steady, predictable cash flow.

Net debt

Net debt is total financial debt minus available cash. It measures the real indebtedness of the business once you net off the cash it already holds. It is the figure that links enterprise value to equity value in a price calculation. A company can show a lot of gross debt yet modest net debt if it holds plenty of cash.

Normalization (add backs)

Normalizing earnings means adjusting them to reflect the recurring performance of the operation. You add back one off or personal expenses, adjust an owner salary that is off market and strip out exceptional income. The aim is to show a buyer what the business truly earns in a normal year. Every adjustment must be documented and defensible, otherwise it will be challenged in diligence.

Owner cash flow (SDE)

Seller’s Discretionary Earnings measures the total financial benefit a small business delivers to a single full time owner. You start from profit, then add back the owner’s salary, personal expenses run through the company and one off items. It is the standard yardstick for valuing very small businesses where the owner works in the business. Above a certain size you switch to EBITDA, which assumes a salaried management team.

Quality of earnings

A quality of earnings review tests whether reported profit is real, recurring and backed by cash. It scrutinizes the nature of revenue, the basis for add backs, working capital and any understated costs. It is the standard financial deep dive before an acquisition, more cash focused than a classic statutory audit. A serious buyer almost always commissions one before confirming the price.

Runway

Runway is the number of months a business can operate before it runs out of cash at the current rate. You compute it by dividing available cash by net monthly burn. It is the survival metric for any startup that is not yet profitable, and it sets the timing of fundraising. Below six months the pressure becomes real and negotiating leverage drops.

Search fund (ETA)

A search fund is a vehicle through which an entrepreneur raises money from investors to find, acquire and then run an existing business. It is the best known form of Entrepreneurship Through Acquisition, the path of becoming an owner operator by buying rather than founding. The searcher often spends one to two years sourcing a profitable, durable target, then typically acquires it with debt and the backing of its investors. The model appeals to operators who want to lead without starting from scratch.

Term sheet

A term sheet sets out the main conditions of an investment or acquisition before the final contracts are drafted. It fixes the price or valuation, the amount, the governance and the protections the investor wants. Most of its terms are not binding, but a few, such as exclusivity and confidentiality, are. It is the document where most of the negotiation is decided: what is not in it is far harder to obtain later.

Valuation multiple

A valuation multiple relates the price of a business to a performance measure, most often EBITDA or revenue. Saying a business sells for 5 times EBITDA means its enterprise value equals five years of EBITDA. The multiple reflects expected growth, the recurrence of revenue, the quality of earnings and risk. Depending on these factors, one business can be worth twice as much as another with the same EBITDA.

Working capital

Working capital is the cash tied up in the operating cycle: inventory plus money owed by customers, minus money owed to suppliers. When it grows it consumes cash, even when the business is profitable. It is often the blind spot of fast growing companies, which must fund ever larger inventory and receivables. Managing it means invoicing fast, collecting fast and negotiating sensible supplier terms.