Have you ever tried to substitute diet soda for regular soda? It’s just not the same. Diet soda can leave a bad taste in your mouth if you are not prepared for it. Similarly, if you fail to understand the difference between enterprise value and equity value, you could also end up with a bad taste in your mouth when trying to understand what a company is worth.
This can be particularly painful when trying to sell your business. Investment bankers will commonly talk in terms of enterprise value. Enterprise value represents the value of operations of a business. This can be appropriate when you are looking to purchase a company. However, as a business owner, the more meaningful number to you will be equity value. Equity value reflects the actual value of the stock owned.
What’s the difference?
The difference is derived from the capital structure of the business. A business can be funded either through debt or equity. Enterprise value considers the total value of the operations of the company. That is both the value to the debt holders and the value to the equity holders combined. On the other hand, equity value only considers the value of the company available to the shareholders of the company.
A good way to think of it is assume you are a shareholder of ABC, Inc. with an enterprise value of $2.0 million and has a market value of debt outstanding of $1.0 million. Theoretically, if you were to sell the business, the buyer would pay $2.0 million. The buyer will typically know or figure out how they want to finance the purchase but will expect you to pay off any interesting-bearing at closing. Therefore, you would then have $2.0 million in sale proceeds, but you would also have $1.0 million of debt outstanding. Paying off the debt would leave you with $1.0 million or the equity value of the business.
Also, if you were to sell your business, you would first remove any excess cash, investments or non-operating assets (cars, personal effects, etc.) not related to the operations of the business. Your equity value will include the value of these assets, but the enterprise value would not, since they are not related to the operation of the business and would be removed before sale.
It’s not uncommon to confuse equity value and enterprise value. They are both a measure of business value, just from a different prospective. Understanding the difference is important to truly understanding the value of your business. Contact me today to discuss the value of your business.