Enterprise Value vs Equity Value
Understanding enterprise value vs. equity value helps in interpreting business valuations. While both metrics give insight into the value of a business, they differ in a key way: enterprise value denotes the entire value of a business without considering its capital structure, and equity value describes the value that belongs to shareholders.
This post will dive into enterprise and equity values, and how each is applied.
Enterprise Value vs Equity Value: A Simple Analogy
Looking at real estate financing provides a useful analogy for comparing enterprise value vs equity value. The total value of the house, or its enterprise value, does not depend on the property’s mortgage size. Let us use this example below:
House A:
Total price of house: $750,000
Mortgage size: $300,000
House B:
Total price of house: $750,000
Mortgage size: $200,000
In this example, both houses have the same enterprise value. If both owners were to sell, the homes would in theory sell for the same price. But the previous owners of house A would receive $450,000 in equity value, whereas the owners of house B would receive $550,000 in equity value. This example illuminates how equity value depends on capital structure, whereas enterprise value does not.
Enterprise Value
To understand the difference between enterprise value (EV) and equity value, let us first describe EV. Simply put, enterprise value is what a third party would pay for the business in question. The metric does not reflect the company’s capital structure— in other words, its combination of debt and equity financing. Different companies often have different capital structures; while one company may be funded with more equity— or even have no debt at all— another may have relatively more debt.
Using EV can be useful for comparing companies of differing capital structures. Because it does not take capital structure into account, it provides an equal playing field of sorts to compare companies’ market values.
Types of Debt
There are multiple kinds of debt that can make up the debt portion of a company’s capital structure. Among these are senior debt, seller notes, and mezzanine debt. While these forms of debt differ, they are all considered debt and not equity.
Enterprise Value Formula
The formula to calculate enterprise value (EV) is below.
EV= Equity Value – Cash + Debt
Debt and equity value are added together because debt and equity make up a company’s overall capital structure. Cash is subtracted because the company’s cash and cash equivalents will be inherited by the buyers in an acquisition, reducing the total cost of the acquisition.
Equity Value
Equity value is the value of the business that belongs to shareholders after subtracting debt and other liabilities. Equity value is useful for determining how much shareholders of a selling company will receive from the acquisition. Debt is subtracted from the formula because debts must be paid off before the sellers can pocket the proceeds. Cash is added because this liquid asset belongs to the shareholders.
Equity Value Formula
The formula for equity value is below:
Equity Value= Enterprise Value (EV) – Debt + Cash
Enterprise Multiple
You may have also heard of the enterprise multiple, or the EV/EBITDA ratio. Another word for the enterprise multiple is the EBITDA multiple. You can read more about EBITDA multiples and company valuations here. Essentially, the enterprise multiple is equivalent to a company’s enterprise value (EV) divided by its EBITDA. In an equation, this looks like:
Enterprise Multiple= (Enterprise Value)/EBITDA
In Summary
Enterprise value and equity value are both useful in determining a company’s worth. However, enterprise value is more helpful than looking at only equity value for analyzing the bigger picture of a company’s value, as it takes debt into account.
Understanding your company’s enterprise value is a smart first step if you are considering selling. If you would like to discuss what your company’s enterprise value might be, please contact us. We would love to learn more about your company and discuss how we may be able to work together.
