Equity Bridge

What is an equity bridge?

Equity bridge (German: Überleitung vom Unternehmenswert zum Eigenkapitalwert) denotes the calculation that leads, in the sale of a company, from the value of the business operations to the purchase price for the shares. The full English term is enterprise value to equity value bridge. The starting point is the enterprise value (enterprise value): the value of the ongoing business, calculated as if the company had neither debt nor bank balances. Debt and debt-like obligations are deducted from it, and freely available cash is added. The result is the equity value (equity value), that is, the value that belongs to the owners.

Formula: equity value = enterprise value minus net financial debt minus debt-like items + (working capital at the reference date minus target value) minus third-party minority interests + non-operating assets; net financial debt = financial liabilities minus freely available cash and cash equivalents

The calculation is built like a payslip that leads line by line from gross to net. Here it leads from the figure in the purchase offer to the amount the sellers receive for their shares.

The calculation is needed above all in a share deal, the purchase of the shares in the company, in which the company changes owner with all its balances and debts. Buyers first value the ongoing business and then negotiate which items stand between this value and the purchase price for the shares. The figures come from the financial due diligence, in which the buyer's advisers examine financial statements, planning and financial position and propose a classification account by account. Every euro that is classified differently in the bridge changes the sellers' proceeds by the same amount.

Structure of the equity bridge

What is deducted is what belongs to providers of capital outside the circle of owners, such as banks, or what costs the buyer money after closing without being reflected in the enterprise value. Closing (Vollzug) is the day on which shares and purchase price actually pass. What is added is what the buyer receives in addition to the ongoing business, above all freely available cash. No law regulates the allocation of the individual items; it is negotiated.

Financial liabilities

Financial liabilities are debts arising from borrowed money. These include bank loans including drawn credit lines, shareholder loans (loans from the shareholders to their own company), bonds and comparable instruments, and the interest accrued up to the reference date and not yet paid. Prepayment penalties are added. These are compensation payments for lost interest that banks demand when loans with a fixed interest rate are repaid early at closing. If the freely available cash and cash equivalents are deducted from these items, the result is the net financial debt (net debt).

Debt-like items

Debt-like items are obligations that are not shown as financial debt but act like it economically. After closing they lead to payments that are not reflected in the value of the ongoing business. Common ones are:

• Pension provisions: amounts for future company pensions of employees. Disputed are often the interest rate at which they are valued and whether the deduction is reduced by the tax saving that later pension payments bring.
• Tax liabilities for periods before the reference date: income taxes from the seller's time that are paid only later. Risks from future tax audits are usually covered by a separate tax indemnity, that is, the seller's promise to reimburse such additional payments.
• Deferred investments: omitted replacement or maintenance investments that the acquirer must make up for.
• Bonuses and transaction costs: sale-related special payments, payouts from participation programmes and advisers' fees, to the extent the company bears them.
• Lease liabilities: Under the German Commercial Code (Handelsgesetzbuch, HGB), it is usually the lessor who recognises the asset, and no liability appears for the lessee. A deduction must therefore be expressly agreed. Under the international standard IFRS 16, by contrast, lease liabilities must in principle be recognised.
• Customer prepayments received: advance payments from customers for services that are to be rendered only after the reference date. They are treated either as debt-like or as part of working capital, that is, the capital tied up in day-to-day business, never as both.

Cash and cash equivalents

Only cash and cash equivalents that the acquirer can freely dispose of after closing are added. Restricted are, for example, pledged rent deposits, security accounts, earmarked grants and balances of foreign subsidiaries that cannot readily flow to the parent company. Buyers also often treat a minimum cash balance as restricted, that is, a base amount of money that ongoing operations need at all times.

Working capital, non-operating assets and minorities

Working capital (net current assets) is, in simplified terms, inventories and outstanding customer receivables less outstanding supplier invoices. Enterprise value assumes that the company is handed over with a normal level of working capital for its business. If the value at the reference date deviates from this, the working capital adjustment compensates for the difference.

Non-operating assets, such as an unused property, are added, unless they are carved out before closing. Third-party minority interests in subsidiaries are deducted. The reason: the valuation rests on the combined (consolidated) result of the group, which includes these subsidiaries in full, but the acquirer is entitled only to its share in them.

Where the equity bridge is regulated

The principles already appear in the first, non-binding offer (indicative offer) and in the letter of intent (LOI), whose commercial parts are usually likewise non-binding. There the buyer states the enterprise value and describes which categories it wants to deduct. The more precise this description is, the less room there is for later renegotiation.

The bridge becomes binding in the company purchase agreement. It defines financial liabilities, cash, debt-like items and working capital and sets the accounting principles for determining them.

Equity bridge under locked box and completion accounts

When the items are measured depends on the price mechanism of the purchase agreement. Under the locked box mechanism, the bridge is prepared as of a balance sheet date before signing, and the purchase price is fixed at signing. The buyer is protected by the prohibition of value leakage to the seller between the reference date and closing (leakage).

With a purchase price adjustment after a closing-date balance sheet (completion accounts), the bridge is calculated twice: with estimated values at closing and then with the figures of financial statements as of the closing date. The difference leads to an additional payment or a refund.

Equity bridge in funding rounds

In a funding round, the bridge is usually of secondary importance. The pre-money valuation, the agreed value of all shares before the round, is already an equity value. The bridge becomes relevant if the company has taken on venture debt (growth loans for venture-backed companies) or shareholder loans. Investors then ask whether the loans are repaid from the round, converted into shares or continued. Capital that serves to repay debt does not flow into growth.

Worked example: calculating the equity bridge from offer to purchase price

A buyer offers an enterprise value of EUR 40 million for a software company. This is eight times the adjusted EBITDA of EUR 5 million, that is, earnings before interest, taxes, depreciation and amortisation without one-off special effects. As of the reference date, the due diligence yields the following items:

• Enterprise value: EUR 40.00 million
• Financial liabilities: bank loan including accrued interest EUR 6.20 million, shareholder loan EUR 2.00 million, prepayment penalty for repaying the bank loan EUR 0.15 million, together EUR 8.35 million
• Freely available cash and cash equivalents: EUR 5.00 million bank balance minus EUR 0.30 million pledged rent deposit minus EUR 0.50 million agreed minimum cash = EUR 4.20 million
• Net financial debt: 8.35 minus 4.20 = EUR 4.15 million
• Debt-like items: pension provisions EUR 1.10 million, income taxes for periods before the reference date EUR 0.60 million, sale-related bonuses EUR 0.40 million, together EUR 2.10 million
• Working capital: EUR 3.10 million at the reference date minus EUR 3.50 million target value = minus EUR 0.40 million
• Equity value: 40.00 minus 4.15 minus 2.10 minus 0.40 = EUR 33.35 million

The purchase price for the shares is thus EUR 6.65 million below the figure in the offer. For perspective: with an EBITDA of EUR 5 million, every million euros that is classified differently has the same effect as a change in the multiple of 0.2 points. If the seller succeeds in having the minimum cash treated as freely available, the equity value rises to EUR 33.85 million.

Distinctions: equity bridge, equity value and cash-free/debt-free

• Equity value: the result of the bridge, that is, the value concept. The equity bridge is the calculation path to it and the subject of the negotiation.
• Net financial debt: usually the weightiest item of the bridge, but only one part of it. Debt-like items, working capital and minorities are added.
• Cash-free/debt-free: the price mechanism under which offers are made on the basis of enterprise value and calculated through the bridge to the share purchase price. The equity bridge is its arithmetical implementation.

Common mistakes

• Double counting. Prepayments received or provisions are included both in working capital and as a debt-like item. The purchase agreement should allocate each balance sheet position to exactly one category.
• Account balance equals available liquidity. Sellers include the entire bank balance although parts of it are restricted, and are surprised by the reduction in the due diligence.
• Vague principles in the offer. Wording such as “less customary debt” in the LOI shifts the actual price negotiation into the contract phase, in which the seller is usually bound exclusively to one bidder.
• Adjustment without a counter-item. If an expense, for example for ongoing litigation, is stripped out of the adjusted EBITDA, the related obligation belongs in the bridge. Otherwise the buyer bears a burden that has not reduced the valuation multiple.
• Forgetting transaction costs. Fees and sale-related bonuses that the company bears itself arise only at closing and are therefore missing from every historical financial statement.

Frequently asked questions

Are shareholder loans deducted in the equity bridge?

Yes, as a rule as a financial liability. Economically, the seller loses nothing as a result if the loan is repaid at closing or assigned to the buyer together with the shares and separately compensated. The deduction merely prevents the buyer from paying the same amount twice.

How is the equity bridge calculated?

Net financial debt and debt-like items are deducted from the enterprise value, then the deviation of working capital from the target value is adjusted. In the worked example this gives 40.00 minus 4.15 minus 2.10 minus 0.40 = EUR 33.35 million.

How is the minimum cash determined?

From the liquidity needs of the ongoing business; there is no fixed rule. Buyers usually argue with the lows of the bank balance over the course of the month, sellers with available credit lines that absorb short-term fluctuations.

Who calculates the equity bridge?

Both sides. The buyer relies on its financial due diligence, the seller on its own schedule. This often comes from a vendor due diligence, a review that the seller commissions itself before the sale. Without its own figures, the buyer's classification can hardly be refuted.

What is an equity bridge facility?

A bank loan that shares only the name with the reconciliation calculation. The facility (also equity bridge loan or equity bridge financing) comes mainly from project finance. It pre-finances equity that the shareholders have committed but not yet paid in, and is repaid with that payment.

The Roemer Capital view

Before we open a sale process, we prepare with the client our own equity bridge from the seller's perspective. We clarify disputed items such as pension provisions, tax liabilities or restricted balances early with the client's tax adviser and law firm, so that they do not surface for the first time in the buyer's due diligence.

In the offer phase, we convert every offer into equity value. Two bidders with the same enterprise value can mean very different proceeds if they delimit debt, minimum cash and working capital differently. Only this comparison shows which offer is actually worth more to the shareholders, and it forms the basis of the further negotiation.