Business Glossary
Business valuation, tax strategy, entity formation, partnership, and succession planning terms explained in plain English — by a CPA and business advisor with 30+ years of practice.
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Add-Backs
Expenses added back to net income when calculating SDE or adjusted EBITDA because they wouldn't exist under new ownership. Legitimate add-backs include owner perks, one-time legal fees, and above-market rent to a related party. Inflated add-backs are the #1 deal-killer in small business sales.
Asset Sale
A transaction where the buyer purchases specific assets (equipment, inventory, contracts, IP, goodwill) rather than the entity itself. The seller keeps the legal entity and its liabilities. Buyers prefer asset sales for liability protection and tax benefits (stepped-up basis). Sellers often prefer stock sales to avoid double taxation.
Arbitration
A private dispute resolution process where a neutral arbitrator hears evidence and makes a binding decision. Faster than court (3–9 months vs 1–3 years) and usually confidential, but limited appeal rights. Many operating agreements require it.
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Community Property
California's default property regime for married couples: anything earned or acquired during the marriage belongs equally to both spouses. A business started or grown during the marriage is presumptively community property, even if only one spouse runs it. This is the central issue in business-owner divorce.
C-Corporation
A business entity taxed separately from its owners at the corporate rate (21% federal). Profits are taxed at the corporate level, then again when distributed as dividends (double taxation). Despite this, C-Corps are standard for venture-backed companies (investors require it) and businesses planning IPO or seeking QSBS exclusion.
California Franchise Tax
California's annual tax on the privilege of doing business in the state. Every entity (LLC, S-Corp, C-Corp) pays a minimum of $800 per year — regardless of profit or activity — for as long as it exists. S-Corps owe an additional 1.5% of net income (minimum $800). C-Corps owe 8.84% of net income. LLCs also owe a separate gross receipts fee ($900–$11,790) on top of the $800 minimum. The franchise tax is the single most expensive 'cost of existing' for California entities.
Capital Gains Tax
Federal tax on profit from the sale of a capital asset (stock, real estate, business interest). Long-term rate (held over 1 year): 0%, 15%, or 20% based on income, plus 3.8% Net Investment Income Tax for high earners. Short-term rate: ordinary income rates up to 37%. California adds an additional 1-13.3% — California does NOT have a preferential capital gains rate, taxing it as ordinary income. The combined federal + California rate on long-term capital gains for high earners reaches 37.1%.
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Enterprise Value (EV)
The total value of a business including equity and debt, minus cash. Used as the starting point for most business acquisitions because it reflects what a buyer actually pays to take control of the operating business, regardless of how it's financed.
EBITDA Multiple
The ratio of enterprise value to earnings before interest, taxes, depreciation, and amortization. A tech company selling at 8x EBITDA means a buyer pays $8M for $1M in annual EBITDA. Multiples vary dramatically by industry, growth rate, and deal size.
Earn-Out
A portion of the purchase price contingent on the business hitting performance targets after the sale. Common when buyer and seller disagree on value. The risk: sellers stay involved but lose control, and the buyer can manipulate results. Structure carefully or avoid entirely.
Estate Tax
Federal tax on the transfer of a deceased person's estate. Current exemption: $13.61M per person (2024). The exemption is scheduled to be cut roughly in half in 2026, making estate planning urgent for business owners with estates over $7M. California has no state estate tax, but the federal rate is 40% above the exemption.
Equity Value
The value of a company attributable to its equity holders, calculated as enterprise value minus net debt (debt minus cash). When a buyer 'pays $5M for the business' in a stock sale, that $5M is the equity value — the buyer also assumes any debt. In a typical purchase agreement, the headline price is enterprise value, but the cash actually received by sellers is equity value minus transaction costs and any holdbacks.
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Fiduciary Duty
The legal obligation to act in the best interest of another party. Business partners owe each other fiduciary duties of loyalty, care, and good faith. Board members owe them to shareholders. Breach of fiduciary duty is the most common legal claim in partner disputes and the strongest one in court.
FICA (Self-Employment Tax)
Federal Insurance Contributions Act tax — Social Security (6.2%) plus Medicare (1.45%) — paid on wages by both employee and employer (total 15.3%). Self-employed individuals (sole props, single-member LLCs, partnerships) pay both halves themselves as self-employment tax. Social Security portion caps at $168,600 (2024); Medicare has no cap but adds 0.9% on income above $200K single / $250K joint. Avoiding FICA on the distribution portion of income is the #1 reason high-earning service businesses elect S-Corp status.
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Goodwill
The portion of a purchase price that exceeds the fair market value of identifiable tangible and intangible assets. It represents brand reputation, customer relationships, workforce, and other value that can't be separated and sold independently. In an asset sale, goodwill is amortized over 15 years by the buyer.
Gift Tax & Annual Exclusion
Federal tax on transfers of property for less than full value. Annual exclusion: $18K per recipient (2024). Lifetime exemption: $13.61M (2024), but scheduled to drop to ~$7M in 2026. For family business transfers, annual gifting of ownership interests is a core strategy — but valuation discounts and timing matter enormously.
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Letter of Intent (LOI)
A non-binding (usually) document outlining the key terms of a proposed acquisition — price, structure, timing, contingencies. It's not a contract, but it sets the framework for negotiation and typically includes a binding exclusivity period of 60–90 days.
Limited Liability Company (LLC)
A flexible business entity that provides liability protection without the formality of a corporation. Can be taxed as a sole proprietorship, partnership, S-Corp, or C-Corp. Default taxation is pass-through. In California, LLCs pay an $800 minimum franchise tax plus a gross receipts fee ($900–$11,790) that catches many owners off guard.
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Personal Goodwill
Goodwill attributable to the individual owner rather than the business entity — their personal relationships, reputation, and skills. Critical in both business sales (can be structured as a separate payment taxed as capital gains) and divorce (personal goodwill is NOT community property in California).
Pereira Method
A California divorce accounting method used when a spouse's separate property business increased in value during marriage primarily due to community labor. The separate property owner gets a fair return on their initial investment; everything above that is community property. Favors the non-owner spouse.
Proposition 13 (California Property Tax)
California's 1978 constitutional amendment capping property tax at 1% of assessed value with annual increases limited to 2%. Properties owned for decades may be assessed at a fraction of fair market value, creating enormous embedded tax savings. The catch: 'change in ownership' triggers reassessment to current market value. For businesses, transferring real estate to a new entity, selling a corporation that owns real estate, or transferring partnership interests above 50% can all trigger reassessment — potentially increasing property taxes 5-20x overnight.
Prenuptial Agreement
A written agreement signed before marriage that defines property rights and financial responsibilities during and after marriage. Under California Family Code §1610-1617, prenups can designate a business as separate property, waive community property claims, and limit spousal support. Requirements for enforceability: independent counsel for both parties, full financial disclosure, signed at least 7 days before the wedding, and not unconscionable. For business owners, a properly executed prenup is the single most effective protection against losing the business in divorce.
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Quality of Earnings (QoE)
A financial due diligence report prepared by an independent CPA firm during an acquisition. It verifies that the seller's reported earnings are real, recurring, and sustainable — not inflated by one-time events or aggressive accounting. Costs $15K–$50K and is now standard for deals over $2M.
Qualified Business Income (QBI) Deduction (Section 199A)
A 20% deduction on qualified business income from pass-through entities (S-Corps, LLCs, partnerships, sole props). Phases out for specified service trades at $191K single / $383K joint (2024). Complex rules, but for eligible businesses, it effectively reduces the top federal rate on business income from 37% to 29.6%.
Qualified Small Business Stock (QSBS) Exclusion
Section 1202 allows exclusion of up to $10M (or 10x basis) in capital gains on the sale of qualified small business stock held for 5+ years. The business must be a C-Corp with under $50M in gross assets. One of the most powerful tax benefits available to founders and early employees of tech companies.
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Right of First Refusal (ROFR)
A contractual right giving existing owners the opportunity to match any outside offer before an ownership interest can be sold to a third party. Standard in most operating agreements and partnership agreements. Without it, a partner could sell their share to anyone.
Reasonable Compensation
The salary an S-Corp owner-employee must pay themselves before taking tax-advantaged distributions. Must be comparable to what the role would pay on the open market. Set it too low and the IRS reclassifies distributions as salary (plus penalties). Set it too high and you lose the tax benefit. Getting this number right is the core of S-Corp tax planning.
Representations and Warranties
Contractual statements by the seller in a purchase agreement about the condition of the business — accuracy of financials, ownership of assets, absence of undisclosed liabilities, compliance with laws. Breaches discovered post-closing are the basis for holdback claims and indemnification demands.
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Seller's Discretionary Earnings (SDE)
Net income plus owner's salary, benefits, and non-recurring expenses added back. The standard profitability measure for businesses under $1M in earnings, because it shows what a new owner-operator would actually take home.
Stock Sale (Equity Sale)
A transaction where the buyer purchases the ownership interests (stock or membership units) of the entity itself. The buyer inherits all assets AND all liabilities. Sellers prefer stock sales because proceeds are typically taxed as capital gains. Buyers bear more risk.
Separate Property
Property owned before marriage, or acquired during marriage by gift or inheritance. A business started before marriage is separate property, but its increase in value during marriage may be partly community — that's where Pereira and Van Camp come in.
Shotgun Clause (Russian Roulette Clause)
A buy-sell provision where one partner offers to buy the other out at a stated price, and the other partner must either accept the offer OR buy the first partner out at that same price. Forces fair pricing because the offeror doesn't know which side of the deal they'll end up on. Effective but brutal.
S-Corp Election
An IRS tax election (Form 2553) allowing a corporation or LLC to pass income through to owners' personal returns, avoiding corporate-level tax. The key benefit: owners who are also employees can split income between salary (subject to FICA) and distributions (not subject to FICA), saving 15.3% on the distribution portion. The #1 tax-saving structure for profitable small businesses.
Stepped-Up Basis
When assets are inherited at death, their tax basis resets to fair market value at the date of death, eliminating all built-in capital gains. Critical for succession planning: transferring a business at death can be more tax-efficient than gifting during life. Also relevant in asset sales where buyers get a stepped-up basis on purchased assets.
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Van Camp Method
A California divorce accounting method used when a spouse's separate property business increased in value primarily due to the character of the business itself (market forces, brand value, external factors) rather than the owner's personal labor. The community gets reasonable compensation for the owner's labor; everything above that stays separate. Favors the owner spouse.
Valuation Discount (DLOM / DLOC)
Reductions applied to the fair market value of a business interest to reflect lack of marketability (DLOM, typically 15–35%) and lack of control (DLOC, typically 15–25%). Used in gift and estate tax planning to transfer more value within exemption limits. Discounts on minority interests in family businesses are a powerful succession planning tool but face increasing IRS scrutiny.