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.
Financing structure
I often make the comparison with buying a house. Suppose you have a house with an appraisal value of 500k and financed with a mortgage of 400k. The appraiser values the house without considering the mortgage (enterprise value). However, the actual net realizable value at sale is only 100k (equity value) because the seller must first pay off his 400k mortgage when he sells.
In a business acquisition, this is basically how it works as well. But 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 more mortgage on it, you actually pay 5x EBITDA. But if you buy the house for 500k and you also take over the existing mortgage of 400k then you don't pay 5x but 9x EBITDA!
Cash & debt free
The starting point in a business acquisition is therefore usually a debt-free company. When it is agreed to correct de ondernemingswaarde for the net debt, this is also referred to as cash and debt free. Of course, this does mean that the total financing requirement for a business acquisition is not just the purchase price of the shares, but also any refinancing of any outstanding bank financing.
In a cash-and-debt-free offer, it is still important to clarify the assumptions in this area in the offer conditions. For example, what is meant by debt? Does it include, for example, provisions that will lead to payment in the short term? In addition, it is very important to make a statement about the minimum required working capital at the time of transaction. The seller, for example, by correcting the net debt, has an incentive to get it as low as possible at transaction time.
For example, the easiest way is to collect as much as possible from the accounts receivable, drastically reduce inventory and increase accounts payable. A buyer who does not look critically at normal working capital positions pays too much and, above all, runs the risk of facing liquidity problems immediately after acquisition.
Formula
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.
