Understanding Equity Value vs. Enterprise Value: What's the Difference?
Business owners need to understand the distinction between equity and enterprise value when selling a business. Although these terms are sometimes used interchangeably, they refer to different things. This article aims to clarify the differences between these two valuation concepts and explain why they are crucial for valuation purposes.
Equity value represents the value of a company's shares. For public companies, the equity value or market capitalization is calculated by multiplying the outstanding shares by the market price per share. For private companies, the fair market value of the company’s equity can be derived by discounting the projected future dividends of a company, also known as a Dividend Discount Model (DDM).
Here are some ways to compute Equity Value:
Equity Value = Number of Outstanding Shares x Market Price per Share (for public companies)
Equity Value = Enterprise Value - Total Net Debt
Dividend Discount Model (for private companies)
In M&A, the equity value represents the purchase price or the value shareholders would receive if the company were sold.
Enterprise value measures a company's total value, including debt. It represents the amount of money that would need to be paid to acquire the entire company, assuming all its debt obligations. The enterprise value of a public company is calculated by adding its market capitalization to its net debt. Private companies can obtain the enterprise value through a discounted cash flow analysis (DCF) or comparable company valuation multiples.
Here are some ways to calculate Enterprise Value:
Enterprise Value = Equity Value + Total Net Debt
Discounted Cash Flow Analysis (for private companies)
Comparable Company Valuation Multiples (for private companies)
Enterprise value is a more comprehensive measure than equity value as it considers debt. This means that enterprise value is capital structure neutral, making it suitable for relative valuation and comparisons among different companies. For this reason, enterprise value is widely used in valuation multiples, while equity value multiples are used to a lesser extent. The limitation of equity value multiples is that financing decisions directly impact them, which can distort them due to capital structure differences rather than operating performance.
As a business owner, it is essential to understand the concepts of enterprise value and equity value in an M&A transaction. These two concepts are related and can provide different perspectives on your business's value. A good understanding of these concepts will be helpful when dealing with an M&A transaction.