The operator’s glossary.

Plain definitions of 66 terms that founders meet when they sell a software business. No legal language.

Email a short overview How the process works

Contents12.1Which terms should a founder know?1 / 6

§ 12.1

Which terms should a founder know?Start with five.

Fig. 12.1Short answer

Know how your revenue is counted (MRR, churn and retention), how your profit is measured (SDE or EBITDA), and how an offer is paid (cash at close, earn-out and escrow). These decide most of what you receive.

Retention: the share of revenue that a group of customers keeps paying.
SDE: profit before the owner’s pay and personal expenses.
Earn-out: part of the price paid later, only if targets are met.

§ 12.2

Revenue and retention.How recurring revenue is counted.

Monthly recurring revenue (MRR): The monthly value of active subscriptions, without one-time charges. An annual plan counts as one twelfth of its price each month.
Annual recurring revenue (ARR): Recurring revenue on a yearly basis, often MRR multiplied by twelve. It is a run rate, not revenue already received.
Run rate: Current results projected over a year. A run rate can hide seasonality, so compare it with the last twelve months.
Trailing twelve months (TTM): The results of the last twelve completed months. It shows what happened, not what might happen.
Customer churn: The share of customers who cancel in a period. Monthly churn and annual churn are different measures; do not mix them.
Revenue churn: Recurring revenue lost in a period from cancellations and downgrades, as a share of the revenue at the start of the period.
Gross revenue retention (GRR): The share of recurring revenue that a starting group of customers still pays after a period. It counts cancellations and downgrades, but not upgrades, so it cannot exceed 100%.
Net revenue retention (NRR): Like gross revenue retention, but it also counts upgrades and expansion from the same customers. It can exceed 100%.
Cohort: A group of customers who started in the same period. Following a cohort over time shows retention more clearly than an average of all customers.
Expansion revenue: Extra recurring revenue from existing customers, from upgrades, more seats or more usage.
Concentration: The share of revenue that comes from the largest customers, one channel or one platform. High concentration means one loss can change the business.
Refund rate: Refunds as a share of the money collected from customers in a period.
Chargeback: A card payment that the customer’s bank reverses after a dispute. Payment providers watch chargeback rates closely.

§ 12.3

Profit and value.How the cash is measured.

Gross margin: Revenue minus the direct cost of delivering the product, such as hosting, payment fees and third-party services, as a share of revenue.
Seller’s discretionary earnings (SDE): Profit before the owner’s pay and personal expenses, interest, tax, depreciation and amortisation. Small owner-run businesses are often priced on SDE.
EBITDA: Earnings before interest, tax, depreciation and amortisation. Unlike SDE, it normally includes the cost of paying someone to run the business.
Add-back: An expense added back to profit because a new owner would not have it, such as a one-time legal bill. Each add-back needs evidence.
Normalisation: Adjusting the accounts to remove one-time items and to show the costs that will continue. It turns past results into a fair base for a price.
Buyer-adjusted operating surplus: Our term for profit after paying a fair cost for the founder’s work, maintenance, support and shared services. It tests whether the business can pay for the people it needs.
Free cash flow: Cash from operations after tax, investment and changes in working capital, before any borrowing. It is the cash that the business can actually return.
Deferred revenue: Cash received for service not yet delivered, such as annual plans paid in advance. A buyer takes on the duty to deliver that service.
Working capital: Short-term assets minus short-term liabilities. A purchase agreement often sets a target level and adjusts the price if the actual level differs.
Valuation multiple: The price divided by a measure such as SDE, EBITDA or ARR. A multiple only means something when you know which measure it uses and what the price includes.
Headline price: The total price in an offer. It can include deferred or conditional payments, so compare offers by what you receive and when.

§ 12.4

Deal terms.The words in an offer and an agreement.

Fig. 12.4aDeal terms in the order a founder meets them

Indication of interest (IOI): An early, non-binding note that a buyer is interested, often with a price range.
Letter of intent (LOI): A document that sets out the main proposed terms of a sale. Most of it is not binding, but clauses such as exclusivity and confidentiality usually are.
Term sheet: A short summary of proposed terms. In small sales, people often use the term for a letter of intent.
Exclusivity: A period in which the seller agrees not to negotiate with other buyers. It is also called a no-shop clause. Check its length before you sign.
Asset sale: The buyer purchases chosen assets, such as code, domains, accounts and customer contracts, instead of the company itself. It is common for small software businesses.
Share sale: The buyer purchases the shares of the company, with its history, contracts and liabilities. It is also called a stock sale.
Purchase agreement: The binding contract for the sale. It sets the price, the payment terms, the statements each side makes and what happens if they are wrong.
Signing and closing: Signing is when both sides agree the contract. Closing is when ownership moves and payment is made. They can happen on the same day or weeks apart.
Cash at close: The part of the price paid when ownership changes. It is the part of an offer with the least uncertainty for the seller.
Earn-out: Part of the price paid later only if the business meets agreed targets. Check who controls the results that decide the payment.
Seller financing: Part of the price paid over time by the buyer, like a loan from the seller. It is also called a seller note.
Escrow: Part of the price held by a third party for a period, to pay any valid claims under the agreement.
Holdback: Part of the price that the buyer keeps for a period, for the same reason as escrow.
Rollover equity: Part of the price paid as shares in the buyer or the business, so that the seller keeps a stake. Its value depends on a later sale or on dividends.
Representations and warranties: Statements of fact that the seller makes about the business in the agreement, such as ownership of the code or the accuracy of the accounts.
Indemnification: A promise to pay for losses if a statement in the agreement is wrong. Agreements usually set limits and time periods.
Disclosure schedule: A list of known exceptions to the seller’s statements. Disclosing a problem here usually protects the seller from a later claim about it.
Non-compete: A promise by the seller not to start a competing business for a period. Its scope and length must be reasonable to be enforceable.
Transition services: Help that the seller gives after closing, for an agreed time, such as answering questions or handing over support.

§ 12.5

Due diligence.How a buyer checks the business.

Due diligence: The buyer’s review of the business before a binding commitment: finances, customers, code, contracts and operations.
Non-disclosure agreement (NDA): A contract to keep shared information confidential. Agree one before you share sensitive records, not in a first email.
Data room: A secure place where the seller shares documents with a buyer during the review.
Revenue reconciliation: Matching billing records to payment-provider settlements and bank deposits. It shows whether the revenue figures are real.
Quality of earnings: An independent review of how reliable and repeatable the profit is. Larger deals often use an accounting firm for it.
Evidence grade: Our label for how well a number is supported: verified, corroborated, reported by the seller, or unknown.
Technical review: A review of the code, the infrastructure, the dependencies, the security and the deployment process.
IP assignment: Documents that show the business owns the code and designs made by founders, employees and contractors.
Licence review: A check that the open-source and third-party components in the product are used within their licences.
Key-person risk: The risk that the business depends on one person, often the founder, for work that nobody else can do.
Platform risk: The risk that a platform the business depends on, such as an app store or a search engine, changes its rules or its prices.

§ 12.6

Transition and operations.What happens after the sale.

Transition plan: A written plan for the handover: responsibilities, knowledge transfer, customer continuity, the founder’s role and the first changes.
Knowledge transfer: Moving the founder’s know-how to the new owner: how the product works, how it is deployed and how customers are supported.
Customer continuity: Customers keep the service they rely on through a change of ownership.
Activation: The moment a new customer first reaches the product’s useful outcome. Each product defines its own activation.
Time to value: How long a new customer takes to reach activation.
Customer acquisition cost (CAC): The cost of winning a new customer, such as advertising and sales costs divided by new customers.
Payback period: How long a new customer takes to pay back the cost of winning them, from the profit they generate.
Lifetime value (LTV): The profit a customer generates over the whole relationship. Estimates of future value are less certain than observed value.
Attribution: Connecting a customer to the channel that brought them. It is often uncertain, so treat it as evidence, not proof.
Experiment: A controlled test that compares a change with the current version, so that the result shows whether the change helped.
Entitlements: The rules for what each plan can access. Clear entitlements make pricing changes safer.
Support load: The time that customer support takes each week. It is part of the real cost of running the business.

1This guide is general information. It is not legal, tax or financial advice. Talk to your own advisers before you sign anything. ↩

End of guide 12

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