The difference between Enterprise value and Equity value

Enterprise valuation bases for business acquisitions

Typically, the valuation of a business will be driven by the buyer’s expectations of the target’s current and/or future profits and discounted cash flows. A frequently quoted measure of profits is Earnings before Interest, Taxes, Depreciation and Amortisation, referred to as “EBITDA”.

Based on detailed analysis of the figures, the non-recurring expenses and income are removed. This analysis results in a “normalised EBITDA”. This EBITDA-number is multiplied by a “pricing multiple” to arrive at the “Enterprise value” of the target.

Example

For a particular company takeover, the initial bid price is €40 million based on a normalised EBITDA of €5 million and an EBITDA multiple of 8.0x. The €40 million headline price is commonly referred to as the “Enterprise value”.

The Enterprise value should take into account various factors, including:

• The risks and uncertainties associated with the transaction
• The sustainability and expected growth in the company’s earnings
• The buyer’s cost of capital and required rate of return
• Competitiveness of the sale
• Anticipated synergies arising from the acquisition.

Enterprise value vs. Equity value

A typical headline Enterprise value is based on the underlying business, irrespective if the timing of the transaction and the level of funding required or existing in the business. Therefore, a buyer’s offered Enterprise value will typically be predicated on the following assumptions:

1. The acquisition will be on a “cash-free and debt-free” basis; and
2. The business will be acquired with a normal level of working capital.

The assumptions above will require adjustments to the Enterprise value to the extent there is cash or debt in the business and if there is a difference between the actual working capital and its “normal” level at completion.

This can be expressed as an Enterprise value to Equity value bridge, as shown below, which also illustrates the material impact these items can have on the final price: