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Enterprise value

Enterprise value is the value of a business's operations as a whole, regardless of how it is financed. Adjusting it for cash, debt and working capital gives the equity value the owners receive.
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Definition

Enterprise value is the value of a business's operations as a whole, regardless of how it is financed. It is roughly what the business would be worth with no cash and no debt, which is why a multiple of EBITDA usually produces an enterprise value. Adjusting enterprise value for cash, debt and, often, working capital gives the equity value that the owners receive.

EBITDA

EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.

Working capital

Working capital is the money tied up in running a business day to day, mainly stock and money owed by customers, less money owed to suppliers. A sale needs to agree how much of it comes with the business.

Worked example

Pinecrest Tooling Ltd is a fictional Canadian manufacturer with adjusted EBITDA of C$1,000,000. Buyer and seller agree a multiple of 4, so enterprise value is C$4,000,000.

On the completion date, the company holds C$300,000 of cash, owes C$900,000 on a bank loan and owes C$100,000 on equipment leases.

Equity value = C$4,000,000 + C$300,000 minus C$900,000 minus C$100,000 = C$3,300,000.

The shareholders receive C$3,300,000 for their shares, even though the headline value is C$4,000,000.

Adjusted EBITDA

Adjusted EBITDA is EBITDA after normalising adjustments, showing what a business would earn with a paid manager in the owner's seat. Larger small-business deals are usually priced on it.

Why buyers care

Price discussions often mix up enterprise value and equity value. If a seller hears C$4,000,000 and expects to receive that for the shares, while you mean enterprise value, you are C$700,000 apart before diligence starts. Say clearly in your letter of intent whether the price is on a cash-free, debt-free basis with a normal level of working capital.

Agree what counts as debt, too. Finance leases, unpaid tax, customer prepayments and overdue supplier bills can all be argued to be debt-like items that reduce what the seller receives.

Due diligence

Due diligence is the investigation a buyer carries out before committing to a purchase, testing the finances, contracts, legal position and operations against what the seller has described.

Letter of intent

A letter of intent sets out the main terms on which a buyer proposes to acquire a business, before due diligence and the full purchase agreement. In the UK the equivalent is usually heads of terms.

  • Equity value

    Equity value is what belongs to a company's owners once debts are deducted and cash is counted. In a share sale it is broadly what the sellers receive for their shares.

  • Cash-free, debt-free

    Cash-free, debt-free is a pricing basis in which the headline price assumes the business changes hands with no cash and no borrowings. The seller keeps the cash, repays the debt and leaves a normal level of working capital behind.

  • Working capital peg

    A working capital peg is the agreed level of working capital a business must contain at completion. The price moves up or down by the difference between the actual figure and the peg.

  • EBITDA

    EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.

  • Valuation multiple

    A valuation multiple expresses a price as a number of times a financial measure, such as SDE, adjusted EBITDA or ARR. It only means something once you know what it is applied to.

  • Asking price

    The asking price is the price a seller or broker puts on a business when it is listed. It is an opening position, not a valuation, and what it includes varies from listing to listing.

  • Working capital, inventory and what the price includes

    Why the headline price is rarely the amount that changes hands, and how working capital pegs, inventory at cost and cash-free, debt-free terms decide what you actually pay for.

    10 minutes to read
  • How small businesses are valued

    Most small businesses are valued as a multiple of their earnings. This guide explains how the earnings basis is chosen, why size and quality move the multiple, and why an asking price is not a sale price.

    11 minutes to read
  • From first call to letter of intent

    The steps between spotting a listing and signing a letter of intent, what to learn at each one and what a sound letter of intent should cover.

    10 minutes to read
  • Payables stretched ahead of a sale

    Paying suppliers late before a sale builds up cash the seller can take out and leaves you to pay the bills. A working capital adjustment usually fixes it.

    Severity: fixableFinancials
  • Customer prepayments already spent

    When customers have paid in advance and the seller has spent the cash, you inherit the work of delivering without the money that paid for it.

    Severity: price it inCustomers and revenue
  • See a low, likely and high value from the figures you have, and whether the asking price holds up.

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