Enterprise Value

What is enterprise value?

Enterprise value (German: Unternehmenswert) denotes the value of a company's operating business, that is, of what it earns its money with: products, customers, employees, assets and know-how. Bank balances and debts are left out. The value belongs to all providers of capital of the company together, owners as well as banks and other lenders. The value of the shares, the equity value (equity value), is derived from it.

Formula: enterprise value = equity value + net financial debt + third-party minority interests + debt-like items (depending on methodology) minus non-operating assets; net financial debt = financial liabilities minus cash and cash equivalents

A photovoltaic system on a roof delivers the same amount of electricity every year, whether its owner paid for it from savings or with a bank loan. Its value results from this yield; how much of it belongs to the owner personally depends on how much of the loan is still outstanding.

The term belongs to the basic vocabulary of business valuation. In a company sale, buyers as a rule state their offers as enterprise value. Valuation multiples, that is, rules of thumb such as “eight times operating profit”, also refer to it. In German valuation theory it is called Gesamtkapitalwert (total capital value); methods that first determine it and derive the value of the shares from it are called gross methods (Bruttoverfahren, entity approach). It is confusing that expert opinions under the valuation standard of the Institute of Public Auditors in Germany (Institut der Wirtschaftsprüfer, IDW S 1) also call their result “enterprise value” (Unternehmenswert). What is meant there is the value for the owners, that is, an equity value.

Why enterprise value is independent of financing

Two companies with the same business, the same margins and the same growth have the same enterprise value, even if one is debt-free and the other is financed with bank loans. Financing only determines how this value is split between lenders and owners. The owners of the debt-financed company are left with a lower equity value, because part of the total value belongs to the banks.

This separation makes companies comparable. A buyer values the operating business without first dealing with a capital structure that it will rearrange after the acquisition anyway. Financing is not entirely without influence, however: interest reduces the tax burden, and high debt increases the risk of insolvency. Both affect the value and enter the DCF method, described further below, through the cost of capital.

Calculating enterprise value with multiples

In practice, enterprise value is usually derived through multiples: a metric of the target company is multiplied by a factor taken from comparable companies or transactions. Widely used is the EBITDA multiple, based on earnings before interest, taxes, depreciation and amortisation. Alongside it stands the EBIT multiple, based on earnings before interest and taxes. For growth companies without meaningful profit, the revenue multiple is used, for subscription models often based on annual recurring revenue.

Consistency of numerator and denominator

A multiple is only meaningful if numerator and denominator belong to the same group of capital providers. EBITDA, EBIT and revenue are figures before interest that belong to owners and lenders together; they are related to enterprise value. The price-earnings ratio, by contrast, relates the equity value to net income, that is, to profit after interest and taxes. Anyone who mixes the two levels obtains factors that fluctuate with the comparable company's debt rather than with the quality of its business.

Listed comparable companies

For listed comparable companies, enterprise value is derived from the stock market value. The starting point is the market capitalisation, that is, share price times number of shares. To this are added the net debt (financial debt less cash and cash equivalents) and the shares of minority shareholders in subsidiaries, depending on the methodology also other debt-like items such as pension provisions. The factor obtained in this way reflects the valuation that investors apply on the stock exchange to small, freely tradable blocks of shares. For a smaller, unlisted target company, discounts for size and limited tradability are discussed in practice.

Comparable transactions

Multiples from earlier company sales (precedent transactions) already include a premium for the buyer acquiring the majority and thus control (control premium). In part, synergies are also priced in, that is, benefits that only this buyer draws from the combination. Such multiples are therefore often above stock market multiples. Their informative value depends on whether timing, interest-rate environment and business model are comparable and whether the underlying metrics are known.

Enterprise value in the DCF method

The DCF method (discounted cash flow) determines enterprise value as the present value of future free cash flows before financing. Present value means: future payments are discounted to today, later ones count for less than early ones. Free cash flows are the cash surpluses of the operating business after taxes on operating profit, after investments and after changes in working capital, but before interest and repayment payments. Discounting uses the weighted average cost of capital (WACC). It combines the return requirements of owners and lenders according to their share in the financing.

Because the detailed forecast usually covers three to five years, a large part of the value falls on the terminal value after that. Small changes in the long-term growth rate or cost of capital therefore shift the result considerably. The standard IDW S 1 describes the DCF methods as well as the capitalised earnings value method (Ertragswertverfahren). With identical assumptions, both lead in principle to the same equity value: the capitalised earnings value method determines it directly, the DCF method via the detour of enterprise value.

Enterprise value in a company sale and a funding round

In a company sale, enterprise value is the figure bidders compete over. Offers usually follow the cash-free/debt-free principle and are thus calculated as if the company had neither bank balances nor financial debt. The amount paid for the shares is only shown by the reconciliation (equity bridge). The stated value and the amount that reaches the sellers can therefore be far apart.

In funding rounds, by contrast, the value of the shares is negotiated. If one deducts the cash and cash equivalents from the post-money valuation, the value of all shares immediately after the round, and adds financial debt, a calculated (implicit) enterprise value results. With a post-money valuation of EUR 25 million, EUR 9 million in bank balances and no financial debt, it is EUR 16 million. For technology companies it is often well below the post-money valuation, because a considerable part of the equity value consists of freshly paid-in cash. For comparison with revenue multiples of listed companies, this implicit value is the appropriate figure.

Worked example: calculating enterprise value and applying it to a GmbH

A listed software company (Aktiengesellschaft, AG) serves as the benchmark for an unlisted target GmbH (German limited liability company).

• Market capitalisation of the comparable company: EUR 30 share price × 30 million shares = EUR 900 million
• Net debt: EUR 250 million financial liabilities minus EUR 100 million cash and cash equivalents = EUR 150 million
• Minority interests in subsidiaries: EUR 30 million
• Enterprise value: 900 + 150 + 30 = EUR 1,080 million
• EBITDA of the comparable company EUR 120 million, giving EV/EBITDA = 1,080 / 120 = 9.0
• For the smaller, unlisted target company, the parties apply a factor of 7.0 after a discount
• Enterprise value of the target company at EBITDA of EUR 4 million: 4 × 7.0 = EUR 28 million
• Less its net debt of EUR 3 million: equity value EUR 25 million, before further items of the equity bridge

If the market capitalisation is mistakenly divided by EBITDA instead of the enterprise value, the result is 900 / 120 = 7.5. With the same discount of 2.0 points, this would become a factor of 5.5 and an enterprise value of the target company of 5.5 × 4 = EUR 22 million. The error thus costs the sellers EUR 6 million, although nothing about the business is different. For a comparable company with net financial assets, that is, with more cash than financial debt, the error would be the reverse and the value too high.

Distinctions: enterprise value, market capitalisation and goodwill

• Market capitalisation: the stock market value of all shares of a stock corporation and thus an equity value. It is the starting point, not the result of deriving enterprise value.
• Pre-money and post-money valuation: equity values of a funding round before and after payment of the new capital. Enterprise value can be derived from them only indirectly.
• Goodwill: the part of a purchase price that exceeds the value of the acquired assets less the debts. It is a balance sheet item after the acquisition, not a valuation benchmark.

Common mistakes

• Numerator and denominator mixed. An equity value is related to EBITDA or revenue, or an enterprise value to net income. The factors are then not comparable.
• Leasing treated inconsistently. Comparable companies reporting under international accounting standards (IFRS 16) show an EBITDA without lease expense, whereas a target reporting under the German Commercial Code (Handelsgesetzbuch, HGB) usually shows an EBITDA after lease expense. Without adjustment, an unsuitable factor is transferred.
• Adjusted and reported figures mixed. A multiple from reported metrics is applied to a heavily adjusted EBITDA and overstates the value.
• Double counting of non-operating assets. Income from them remains in EBITDA, and the assets are additionally added in the reconciliation.
• Outdated comparables. Multiples from an environment with a different interest-rate level are transferred to the current transaction without adjustment.

Frequently asked questions

Is enterprise value the purchase price?

No. It is the value of the operating business. The purchase price for the shares arises only after deducting debt and adding free cash and other adjustments.

How is enterprise value calculated?

In two ways. Starting from the equity value, for listed companies the market capitalisation, net debt and third-party minority interests are added: in the worked example 900 plus 150 plus 30 = EUR 1,080 million. Starting from the operating business, a metric such as EBITDA is multiplied by a multiple, for example EUR 4 million × 7.0 = EUR 28 million. Alternatively, the value results as the present value of the free cash flows.

What is the difference between enterprise value and equity value?

Enterprise value is the value of the operating business that belongs to owners and lenders together. Equity value is the part that falls on the shares after deducting net debt and other items. If a company has more cash than financial debt, the equity value is above the enterprise value; for technology companies this is often the case after a funding round.

Do non-operating assets belong to enterprise value?

No. It captures only the operating business. An unused property or a financial investment is valued separately and added in the transition to equity value.

Which multiple suits a company without profit?

As a rule a revenue multiple, for subscription models based on recurring revenue. It must be supported by growth, gross margin (the share of revenue left after direct costs) and customer retention, because revenue alone says nothing about future earning power.

Why do the DCF value and the multiple-based value differ?

Because they answer different questions. The DCF method values the company's own plan, the multiple the current market price of comparable companies. Large deviations point to ambitious planning assumptions or an unusual market environment.

The Roemer Capital view

For a company sale, we derive the valuation range from two directions: from multiples of listed comparable companies and earlier transactions, and from a DCF. The basis of the DCF is the financial model, which maps at least three years with a base case, a cautious case and an optimistic case. If the two approaches are far apart, we clarify the cause before a buyer finds it.

Before a funding round, we convert the targeted pre-money valuation into an implicit enterprise value and set it against revenue and growth. This shows early whether the founders' price expectation withstands a comparison that investors will make anyway.