Enterprise Value is the value of a business without taking its financing structure into account, usually calculated using the DCF method or a market multiple. Equity value is the amount the seller actually receives for their shares: de ondernemingswaarde minus net interest-bearing debt. In a business acquisition, this difference determines what you actually pay.
When entrepreneurs want to buy or sell a business, I often find that confusion arises because the terms enterprise value and equity value are mixed up.
It is important to understand the conceptual difference:
Enterprise value(Enterprise Value) is the value of the company without regard to its financing structure. In effect, it is the operational value of the business. This value is often calculated through the Discounted Cash Flow Method or through a Market Multiple.
Equity Value is the amount the seller actually receives for the sale of its shares. In other words; de ondernemingswaarde less net interest-bearing debt.
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What is the impact of the financing structure?
I often compare this to buying a house. Suppose you have a house with an appraised value of 500k, and this house is financed with a mortgage of 400k. The appraiser values the house without taking the mortgage into account (enterprise value). However, the actual proceeds from a sale are only 100k (share value), because the seller must first pay off the 400k mortgage upon sale.
In principle, this also applies to a business acquisition. However, it is important that this is actually agreed upon. Suppose the business has an EBITDA of 100k. If you buy the house for 500k and there is no longer a mortgage on it, you are effectively paying 5x EBITDA. But if you buy the house for 500k and also take over the existing 400k mortgage, then you’re not paying 5x but 9x EBITDA!
What does “cash and debt-free” mean in the context of a business acquisition?
The starting point for a business acquisition is therefore usually a debt-free company. When it is agreed to adjust de ondernemingswaarde for net debt, this is also referred to as “cash and debt-free.” Incidentally, this naturally means that the total financing requirement for a business acquisition involves not only the purchase price of the shares but also any refinancing of all outstanding bank loans.
In the case of a “cash and debt-free” offer, it is still important to provide clarity in the offer terms regarding the assumptions in this area. For example, what is meant by “debt”? Does this also include provisions that will result in a payment in the short term? In addition, it is very important to specify the minimum required working capital at the time of the transaction. For example, due to the working capital adjustment, the seller has an incentive to keep this as low as possible at the time of the transaction.
The easiest way to do this is, for example, to collect as much of the accounts receivable as possible, drastically reduce inventory, and allow accounts payable to accumulate. A buyer who does not critically examine the normal working capital positions pays too much and, above all, runs the risk of facing liquidity problems immediately after the acquisition.
What is the formula for calculating stock value?
To summarize, the difference between enterprise value and equity value can also be presented in formula form.
Enterprise value (e.g., 5x EBITDA)
+/+ liquid assets -/- interest-bearing debt (= net interest-bearing debt)
+/+ current working capital position -/- normalized working capital position= Equity value
Check out our tips on how to calculate the value of a business here:
Transparent
My advice is to always make a cash and debt free offer on a business. This takes into account the existing net debt position and makes a transparent comparison on the level of de ondernemingswaarde. It is then still important to make clear agreements in the offer letter about, for example, the definition of interest-bearing debt and the minimum or normalized level of working capital. Indeed, the impact on the final price can be significant because the net debt is settled euro for euro.
Frequently Asked Questions About Enterprise Value and Share Value
What is the difference between enterprise value and share value?
Enterprise value is the operational value of a business, without taking its financing structure into account. Equity value is the amount the seller actually receives for their shares: de ondernemingswaarde minus net interest-bearing debt.
How do you calculate share value based on de ondernemingswaarde?
Share value = enterprise value + cash and cash equivalents − interest-bearing debt (together, net interest-bearing debt), adjusted for the difference between the current and normalized working capital position.
What does “cash and debt-free” mean in the context of a business acquisition?
A cash-and-debt-free bid assumes a debt-free company: de ondernemingswaarde is adjusted for net debt. This means that the financing requirement for an acquisition involves not only the purchase price of the shares but also any refinancing of existing bank loans.
Why is it important to reach agreements on working capital during an acquisition?
Due to the working capital adjustment, a seller has an incentive to keep working capital as low as possible at the time of the transaction, for example by collecting accounts receivable quickly, reducing inventory, or allowing accounts payable to accumulate. A buyer who does not scrutinize this closely will pay too much and runs the risk of facing liquidity problems immediately after the acquisition.
Why is a cash-and-debt-free offer advisable?
A cash-and-debt-free offer takes the existing net debt position into account and ensures a transparent comparison at the de ondernemingswaarde level. However, it is important to include clear agreements in the offer letter regarding the definition of interest-bearing debt and the normalized level of working capital, as these can have a significant impact on the final price.
