Equity Value

What is equity value?

Equity value (German: Eigenkapitalwert) denotes the value that belongs to the owners of a company as a whole, that is, the value of all shares. It is usually derived from the enterprise value, the value of the operating business.

Formula: equity value = enterprise value minus financial liabilities minus debt-like items + freely available cash and cash equivalents

A house worth EUR 500,000 that still carries a mortgage of EUR 300,000 brings its owner EUR 200,000 on sale. The house value corresponds to the enterprise value, the amount after repaying the mortgage to the equity value.

The term appears in three contexts. In a company sale, the equity value is the purchase price for the shares, while offers are usually stated as enterprise value (cash-free/debt-free). Which amount reaches the shareholders is shown by the reconciliation between the two values, the equity bridge. In a funding round, pre-money valuation and post-money valuation are equity values. For listed stock corporations, the equity value corresponds to the market capitalisation, the product of share price and number of shares.

Two routes to equity value: indirect and direct

Equity value can be determined indirectly or directly. On the indirect route, the operating business is first valued independently of its financing. Common methods are the discounted cash flow (DCF) method and multiples on revenue or EBITDA, earnings before interest, taxes, depreciation and amortisation. This valuation yields the enterprise value, which belongs to equity and debt providers together. The owners' share is supplied only by the reconciliation; valuation theory calls this route the gross method or entity approach.

On the direct route, only the surpluses that flow to the owners after interest and repayment payments are discounted, and at their required return, the cost of equity (net method or equity approach). This includes the capitalised earnings value method (Ertragswertverfahren) widespread in Germany under the valuation standard IDW S 1 of the Institute of Public Auditors (Institut der Wirtschaftsprüfer). Expert opinions under this standard call their result “enterprise value” (Unternehmenswert), but what is meant is the value for the owners, that is, an equity value. With identical assumptions, both routes lead in principle to the same result. Anyone comparing such an opinion with a purchase offer based on enterprise value must first bring both figures to the same level.

What stands between enterprise value and equity value

The reconciliation typically follows this scheme. Which items belong to it in an individual case is set in the purchase agreement and is the subject of negotiation on the equity bridge.

• Enterprise value
• minus financial liabilities: bank loans, shareholder loans, bonds and venture debt (growth loans for venture-backed companies), in each case including accrued interest and the costs of early repayment
• minus debt-like items, that is, obligations that act economically like debt: for example pension provisions, taxes for periods before closing, sale-related bonuses and the company's transaction costs
• plus freely available cash and cash equivalents, excluding rent deposits, pledged balances and funds of foreign subsidiaries that can be repatriated only with taxes or costs
• plus or minus the deviation of net current assets (working capital) from an agreed target value, to the extent the purchase agreement provides for it
• minus shares of other shareholders in subsidiaries, if the enterprise value is based on consolidated figures
• plus non-operating assets, such as an unused property

Financial liabilities less freely available cash and cash equivalents give the net financial debt (net debt), in a company purchase usually in a broad definition including the debt-like items. If cash exceeds financial liabilities, there are net financial assets, and the equity value is higher than the enterprise value. Shortly after a funding round, this is often the case. The fresh capital increases the equity value in a sale to the extent that it is freely available; if the company is still making losses, however, buyers often treat part of it as necessary for operations.

When the items are measured is determined by the price mechanism of the purchase agreement: under a locked box, at a balance sheet date before signing; under completion accounts, at the closing date.

Equity value, purchase price and value per share

The equity value does not always coincide with the total purchase price. In a sale, shareholder loans are often assigned to the buyer together with the shares. The equity value is then lower by the loan, but the seller receives its nominal amount as a separate purchase price for the receivable; the total it receives does not change. An earn-out comes in addition as a conditional part of the purchase price. Convertible loans are either converted into shares before closing or deducted as a liability, never both.

The value per share is obtained by dividing the equity value by the number of shares on a fully diluted basis (fully diluted). This number includes promised options and existing conversion rights. For the GmbH (German limited liability company), the calculation refers to the nominal amounts of the shares in the company. Claims from virtual participation programmes are either deducted from the equity value as a debt-like item or taken into account in the distribution of proceeds like shares, never in both ways at once.

Equity value in funding rounds and the distribution of proceeds

In a funding round, founders and investors negotiate directly about the equity value. The pre-money valuation is the equity value before the capital increase, the post-money valuation the value immediately afterwards, that is, pre-money valuation plus newly paid-in capital. Because the fresh capital initially sits as liquidity in the company, part of the post-money valuation consists of precisely this cash; the implicit enterprise value is correspondingly lower.

How the equity value is distributed among shareholders in a sale is determined by the distribution of proceeds in the shareholders' agreement. Liquidation preferences, that is, investors' priority rights to part of the proceeds, do not change the amount of the equity value but the order and shares with which investors and founders participate in it. The value per share is therefore initially an arithmetical figure; what an individual shareholder receives can be above or below it.

Worked example: calculating equity value from a purchase offer

A software GmbH receives a purchase offer which, in the letter of intent, states an enterprise value of EUR 48.0 million on a debt-free and cash-free basis. The share capital consists of 50,000 shares with a nominal amount of EUR 1 each; no conversion rights are outstanding. One investor holds 15,000 of these shares (30%) and has a simple, non-participating liquidation preference over its contribution of EUR 15.0 million. It receives either this amount or its percentage of the proceeds, whichever is higher.

• Financial liabilities: bank loan EUR 2.5 million, venture debt including accrued interest and repayment fee EUR 3.5 million, shareholder loan EUR 1.0 million, together EUR 7.0 million
• Debt-like items: tax provisions for prior years EUR 0.6 million, payments from the virtual participation programme triggered by the sale including employer contributions EUR 2.4 million, the company's transaction costs EUR 0.5 million, outstanding bonuses EUR 0.3 million, together EUR 3.8 million
• Cash and cash equivalents: bank balance EUR 5.3 million less a rent deposit on a blocked account of EUR 0.3 million, freely available EUR 5.0 million
• Equity value: 48.0 minus 7.0 minus 3.8 plus 5.0 = EUR 42.2 million
• Value per share: EUR 42,200,000 divided by 50,000 = EUR 844
• If the shareholder loan is sold along with the shares, the buyer pays a total of EUR 43.2 million: EUR 42.2 million for the shares and EUR 1.0 million for the loan receivable
• Distribution of proceeds: the investor's percentage is 30% of EUR 42.2 million = EUR 12.66 million and is below its preference; it therefore receives EUR 15.0 million
• For the remaining 35,000 shares, 42.2 minus 15.0 = EUR 27.2 million remains, that is, around EUR 777 per share instead of the arithmetical EUR 844
• If the buyer additionally treats customer prepayments of EUR 1.5 million as a debt-like item, the equity value falls to EUR 40.7 million, arithmetically EUR 814 per share

The offer of EUR 48.0 million thus becomes EUR 42.2 million for the shareholders, in the less favourable case EUR 40.7 million. Whether the deduction of the prepayments is justified depends on whether they are already reflected in the target value of net current assets. For the founders, what counts in the end is the amount after the distribution of proceeds: here it is around 8% below the arithmetical value per share, although nothing changes in the equity value.

Distinctions: equity value, enterprise value and book value

• Enterprise value: the value of the operating business for all providers of capital. The equity value is the part of it that falls to the owners after deducting the claims of debt providers and comparable items.
• Equity bridge: the reconciliation from enterprise value to equity value and the subject of negotiation on the individual items. The equity value is its result, that is, the value concept.
• Book equity: the book value according to the balance sheet under Section 266(3) of the German Commercial Code (Handelsgesetzbuch, HGB). It rests on historical values and says little about the market value of the shares.
• Market capitalisation: the equity value of a listed stock corporation at the current share price. Takeover offers are often above it because they include a control premium.

Common mistakes

• Offers placed side by side on different bases. An offer based on enterprise value and one for the shares become comparable only when both are converted into the same equity value.
• Debt-like items identified too late. If tax risks, participation programmes or transaction costs are first named in the buyer's due diligence, the other side determines their classification.
• Book value confused with market value. The book equity of a growth company is often small or consumed by losses and is no yardstick for the value of the shares.
• Distribution assumed pro rata. Liquidation preferences change how much the founders receive of an equity value, especially for proceeds close to the amounts paid in.
• Dilutive instruments forgotten. Options and conversion rights change the value per share even if the equity value stays the same.

Frequently asked questions

What is the difference between equity value and enterprise value?

Enterprise value values the operating business for all providers of capital, equity value only the owners' share. Between the two stand mainly financial liabilities, debt-like items and cash and cash equivalents; the calculation path from one to the other is the equity bridge.

How is equity value calculated?

Financial liabilities and debt-like items are deducted from the enterprise value, and freely available cash and cash equivalents are added. EUR 48.0 million enterprise value, EUR 10.8 million of debt and debt-like items and EUR 5.0 million of liquidity thus become EUR 42.2 million.

Can equity value be negative?

Arithmetically yes, economically no. If debt exceeds the enterprise value, the shares are worthless because of limited liability, but not negative. A sale is then usually possible only at a symbolic price and with concessions from the creditors.

How is the value per share calculated?

The equity value is divided by the number of shares on a fully diluted basis, or, where nominal amounts differ, by the sum of the nominal amounts. For payments to individual shareholders, the distribution of proceeds in the shareholders' agreement also applies.

Does venture debt reduce equity value?

Yes, in a sale by the amount required for repayment, including interest and fees. Venture debt has a dilutive effect only through option rights, which lenders often receive in addition.

The Roemer Capital view

If several purchase offers are on the table, we translate each into the equity value and then into the amounts per shareholder after the distribution of proceeds. Only on this basis can offers with different assumptions on debt, liquidity and net current assets be weighed against each other, and each shareholder sees what actually reaches them.

If there are liquidation preferences or a virtual participation programme, we work through the distribution of proceeds for several possible equity values even before approaching buyers. This shows early from what price a sale makes economic sense for founders, investors and employees, and the shareholders enter the negotiation with a shared price expectation.