Addressing the confusion between Enterprise Value and Equity Value.
Business Owners often struggle to understand how much their business is worth and, over the years, I have found much of this relates to their misunderstanding of “Enterprise Value” and a confusion with “Equity Value”.
In this Article I hope to alleviate this confusion.
Enterprise Value is the measure of a company’s total value – or value a market attributes to the whole business.
Equity value is the value attributable to shareholders of the business.
The descriptions sound similar, but they are different and to understand these differences lets look at an example where a business making an EBITDA of £1,000,000 is given a multiple of 5.
This results in an Enterprise Value of £5,000,000 – but in most cases this is not the amount which the shareholders’ are entitled to.
This is because:
Enterprise Value = Equity Value – DEBT + Free Cash
Going back to our example let’s say the company has £2,000,000 of long-term debt and no free cash (free cash is excess cash which is not required to fund the working capital cycle).
This results in:
£5,000,000 = Equity Value – 2,000,000 + 0
Equity Value = £3,000,000
I appreciate this still may be confusing for some so let us look at a simpler analogy.
Say you have a house valued at £500,000 with a mortgage of £100,000.
The house is the “enterprise value” and the mortgage is the “debt”
The equity value you have is £400,000 – this is the maximum amount of cash you will get towards your next property.
We hope this simple article helps alleviate some confusion and focus business owners’ minds on, not only increasing EBITDA, but also understanding the level and timing of debt to bring in to grow their business.