Enterprise Value vs Equity Value - what is the difference?

If you are selling your business, the amount you ultimately receive is likely to be your main concern. However, the headline price stated in an offer letter or sale agreement may differ significantly from the amount you actually receive once all adjustments, costs and other deductions have been taken into account.

In order to understand the true purchase price for a business, it is important to understand what is meant by the terms ‘Enterprise Value’ and ‘Equity Value’, and how they differ. We explain these terms and how they affect the amount you can expect to receive from an offer for your business.

We commonly advise and assist clients negotiating the sale of their business. Alongside legal expertise, we draw on our commercial understanding of business valuations and deal structures to help clients assess offers and negotiate terms. Please call or email to discuss how we can help.

Enterprise Value v Equity Value

Broadly, Enterprise Value represents the value of the business’s operations, while Equity Value represents the value attributable to its shareholders after taking account of relevant adjustments, including cash, debt and working capital. Offers are commonly expressed as Enterprise Value, with adjustments then made to calculate Equity Value.

A higher Enterprise Value may make an offer appear more attractive, but the adjustments used to calculate Equity Value can materially affect the amount ultimately payable to the seller. It is therefore important to look beyond the headline figure.

As well as understanding the difference between Enterprise Value and Equity Value, understanding a sale on a ‘cash-free, debt-free’ basis can help you assess the amount you are likely to receive.

Note: The valuation of your company for the purpose of calculating the purchase price differs from a valuation for tax purposes. Tax valuations follow specific fiscal rules and may take account of factors that are not used to calculate Enterprise Value or Equity Value. Details of the valuation methods used for tax purposes are here.

Enterprise Value

The majority of private company sales begin with a purchase price calculated as the Enterprise Value. This is commonly assessed using a multiple of a financial performance measure, such as EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) or EBIT (Earnings Before Interest and Taxes), although other methods, including discounted cash flow (DCF) and revenue-based measures, may be used.

Enterprise Value generally reflects the business independently of its financing structure. The purchase price is therefore often agreed on a ‘cash-free, debt-free’ basis, with adjustments made to account for the company’s actual cash and debt position.

Cash Free, Debt Free

A sale on a cash-free, debt-free basis generally means that the seller is expected to leave the business with an agreed level of cash and debt, with the purchase price adjusted to reflect the position at completion. In practice, it may not be possible or appropriate to clear all debt or extract all cash before completion. Instead, the agreed calculation will typically deduct relevant debt and debt-like items and add qualifying cash and cash equivalents on a pound-for-pound basis.

The parties must agree which items fall within the definitions of cash, cash equivalents, debt and debt-like items. Cash may include bank balances, petty cash and certain cash equivalents. Debt-like items may include bank loans, shareholder loans, overdrafts and declared but unpaid dividends. The treatment of items such as rent deposits, card payments in transit, escrow balances and potential tax liabilities depends on the circumstances and the terms negotiated. Trade debtors are not usually treated as cash equivalents.

These definitions are often heavily negotiated. It is important to examine the company’s financial position and the proposed sale terms carefully, as the classification of particular liabilities or assets can materially affect the final price.

Working capital

The purchase price calculation will often include a working capital adjustment. The buyer will generally expect the business to retain sufficient working capital to continue trading normally after completion. The parties agree a target level of working capital, with an adjustment made for any excess or shortfall against that target.

The appropriate target depends on the business’s trading patterns and operating requirements. An average based on the previous 12 months may be suitable for some businesses, but seasonal businesses may need a different approach to reflect fluctuations in working capital requirements throughout the year.

Calculating a business equity value

After the agreed cash, debt and working capital adjustments have been applied to Enterprise Value, the result is Equity Value. This is the value attributable to the shareholders, subject to the transaction terms and any other relevant adjustments. The calculation is commonly expressed as:

‘Equity Value = Enterprise Value + cash – debt +/- working capital adjustment’.

Equity Value may be higher or lower than Enterprise Value, depending on the agreed adjustments. The final figure may not be known until completion accounts have been prepared and agreed, but you should understand in advance how the adjustments will operate and how they may affect the proceeds.

If you receive competing offers for your business, it may be worth negotiating the definitions of cash, cash equivalents, debt and debt-like items, together with the target working capital, at an early stage. Agreeing a worked example or pro forma Equity Value calculation can also help avoid disputes later in the transaction.

How we can help

We understand where disagreements can arise over purchase price adjustments and can help you assess offers, negotiate the relevant definitions and protect your commercial position, reducing the risk of disputes threatening the transaction.

If you are in the process of selling your business, or are thinking of doing so in the future, please do get in touch.