Enterprise value vs equity value: a worked example

By Evident Valuations

A business described as being worth $2 million does not necessarily leave $2 million for its shareholders. You first need to know whether the figure represents the operating business or the shareholders’ interest after relevant financing and other adjustments.

Enterprise value and equity value help distinguish those questions. Understanding the difference makes valuation reports and transaction discussions easier to compare.

What is enterprise value?

In a common transaction framework, enterprise value describes the value of the operating business before allocating that value between debt providers and shareholders. The precise convention must be stated, including how cash, leases and working capital are treated.

A multiple applied to an operating earnings measure such as EBITDA often produces an enterprise-level indication. That does not mean every EBITDA multiple is suitable, or that the resulting figure is automatically the price of the shares.

What is equity value?

Equity value is the value attributable to the equity holders. A simplified bridge from an enterprise value may add surplus cash and other non-operating assets, then deduct debt and other relevant claims. The adjustments must be consistent with what the starting value already includes.

A hypothetical $2 million business

Assume an assessment gives an enterprise value of $2,000,000. For this example only:

• The operating business includes a normal level of operating working capital.
• There is $200,000 of surplus cash that is not required for operations and is not included in enterprise value.
• There is $500,000 of bank debt to deduct.
• There are no other non-operating assets, debt-like items, preference claims or adjustments.

Equity value = $2,000,000 + $200,000 − $500,000 = $1,700,000.

The $300,000 difference reflects the net effect of the assumed surplus cash and debt. It does not mean the operations have suddenly become less valuable. The example simply moves from one definition of value to another.

Why cash needs closer examination

A bank balance is not necessarily all surplus cash. Some cash may be needed for ordinary operations, be restricted or support obligations not otherwise captured. Adding every dollar in the bank to a value that already assumes necessary operating cash would overstate the bridge.

Ask which assets support the earnings or cash flows used in the valuation. An asset that already contributes to those financial benefits should not also be added separately without considering double counting.

What else can affect the bridge?

Depending on the assignment, the analysis may need to address owner loans, lease obligations, non-operating investments, contingent liabilities or different classes of capital. Lease treatment must be consistent with the earnings measure and comparable evidence used. It should not be changed in one part of the calculation while leaving the rest unchanged.

A sale agreement may also adjust the amount paid for actual working capital at completion or use other agreed price mechanics. Those provisions are transaction-specific; the simplified example above is not a settlement calculation.

What about a 25% shareholding?

Twenty-five per cent of $1,700,000 is $425,000. That is an arithmetic starting point, not automatically the value of a particular parcel of shares. Voting rights, distribution rights, restrictions and the required valuation basis need consideration. Do not apply a minority discount or control premium simply because a holding falls above or below a chosen percentage.

Also distinguish equity value from the owner’s net cash proceeds. Tax, transaction costs, payment timing and other deal terms can affect the amount ultimately received.

Start by defining the number

Before comparing offers or reports, ask: Is this enterprise value or equity value? What cash, debt and working-capital assumptions apply? What ownership interest and valuation date does it address?

Read how valuation methods differ or explore our M&A and transaction valuation services. To clarify the value question in your circumstances, request a consultation.

Technical reference

The International Valuation Standards, IVS 200 discuss business interests, financial measures and valuation adjustments. The worked example above is illustrative and uses its own stated assumptions.

Related reading

• How business valuation methods differ
• When might a shareholder transaction need an independent valuation?

General information only. The appropriate valuation approach and requirements depend on the circumstances, agreed scope and intended use. This article is not a valuation of a particular business or individual legal, tax or financial advice.

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