How to Calculate Enterprise Value

The formula

Enterprise value is what the whole operating business is worth before its capital structure — the value of the operations to whoever owns them, however they are financed. Equity value is what the shares are worth after that financing: what a seller actually receives for them. The two are connected through the balance sheet.

Enterprise value = equity value + debt and debt-like items − cash and cash-like items. Debt and debt-like items less cash and cash-like items is net debt, so the formula is usually written as enterprise value = equity value + net debt. Rearranged, equity value = enterprise value − net debt.

The bridge exists because a buyer of the shares inherits both the company's debt and its cash. Two businesses with identical operations have identical enterprise values; if one is financed with debt and the other with equity, their equity values differ by exactly that debt. Valuing the operations and valuing the shares are different questions, and the bridge is the only thing between them.

The bridge in both directions

You cross the bridge in both directions during a deal. From equity to enterprise value: take an asking price for the shares, add the debt and debt-like items, subtract the cash, and you have the enterprise value on which a multiple can be quoted and compared with other deals. From enterprise to equity value: take a headline price agreed on a cash-free, debt-free basis, deduct the net debt at completion, and you have the sum the seller receives for the shares. The enterprise value calculator does the arithmetic either way and shows the formula at every step; the judgement is in what goes on each line.

What counts as debt-like

Debt is anything the company owes that a buyer would have to settle or service after completion and that is not part of normal working capital. The definition in a share purchase agreement is negotiated line by line, and much of the real argument about price happens there rather than in the headline. The usual candidates:

• Bank loans, overdrafts, invoice finance drawn, asset finance and hire purchase, including the portion due within a year
• Loans from directors, shareholders and related parties, which are often the largest item in a private company
• Accrued interest, and any early-repayment cost the change of control triggers
• Corporation tax and VAT that is overdue or relates to periods before completion, and dividends declared but unpaid
• Deferred consideration or earn-outs still owed from the company's own past acquisitions
• Pension deficits, unfunded bonuses, customer deposits that must be delivered against, and provisions for known liabilities
• Preference shares that behave like debt, and minority interests in subsidiaries

What counts as cash-like

• Cash at bank and in hand, and cash equivalents
• Short-term deposits and readily realisable investments
• Not restricted cash: money held on trust for customers, rent deposits, cash pledged as security, or cash that cannot be moved out of a subsidiary without cost
• Not the cash the business needs to operate. A buyer will argue that some minimum balance is working capital rather than surplus, and that argument is a negotiation, not a formula

Cash-free, debt-free pricing and the completion mechanism

Most private-company deals are priced on a cash-free, debt-free basis: the headline price is an enterprise value, offered as though the business had no debt and no cash, and the equity price paid for the shares is that figure adjusted for the net debt actually present at completion. The offer states the enterprise value; the letter of intent states the basis; the share purchase agreement defines every line.

Because net debt moves every day, the mechanism has to fix it at a point. Under completion accounts, a balance sheet is drawn up as at completion, net debt and working capital are measured against it after the event, and the price is adjusted up or down once the figures are agreed. Under a locked box, the price is fixed on a historical balance sheet and the seller undertakes that no value has leaked out of the business since. Either way there is usually a working-capital adjustment: a normal level of working capital is agreed as a target, and the price moves pound for pound if the business is delivered with more or less than it, so that a seller cannot hand over the company having collected every debtor and paid no creditor. Which mechanism suits a deal, and how each line is defined, is a matter for the lawyers and accountants on the transaction.

A worked example

Why multiples are quoted on enterprise value

EBITDA is earned by the operations before interest, so it belongs to everyone who has financed the business — lenders and shareholders alike. Dividing it into a value that belongs only to shareholders mixes a whole-business earnings figure with a part-business value, and the result changes with the debt rather than with the business. Enterprise value is the whole-business value that matches the whole-business earnings, which is why EV/EBITDA can be compared across deals with different financing, and why the EBITDA multiple calculator asks for the bridge before it reports a multiple. Equity multiples exist — price to earnings after interest and tax is one — but they are a different measurement and must be compared only with each other.

Common errors

• Quoting a multiple on the price for the shares and comparing it with EV multiples from other deals
• Using net debt from the last filed balance sheet as though it were net debt at completion
• Leaving out the current portion of loans, director loans, unpaid tax, declared dividends or deferred consideration from past acquisitions
• Counting restricted or trapped cash as surplus cash
• Treating leases as debt in the bridge while using a multiple drawn from businesses that excluded them, or the reverse
• Agreeing a cash-free, debt-free price without a working-capital target, and discovering at completion that the debtors have been collected and the creditors stretched
• Forgetting that the equity value, not the enterprise value, is what the seller compares with their expectations — and that a large director's loan can make the two very different

From the bridge to a price

The bridge turns a valuation into a cheque, and for a buyer that cheque is what returns are struck on. In TrueValue the valuation engine reports enterprise value, net debt and equity value explicitly for every method, and the deal economics take the price through the funding plan, the transaction costs and the working capital the business absorbs to the equity actually invested and the return on it. For the methods that produce the enterprise value in the first place, see business valuation methods used in M&A and how to value a private company in the UK.