When it comes to valuing a company, it’s crucial to understand the difference between equity value and enterprise value. At their simplest, the two concepts can be defined as follows:
- Enterprise value is the value of a company’s core business operations that is available to all stakeholders (debt providers, equity investors, preferred stock holders, minority interests etc.). In other words, it’s the value of the whole business, regardless of its capital structure.
- Equity value is the total value of a company that is available to only equity investors (i.e., shareholders). In public markets, it’s also often referred to as the “market value” or “market capitalization” of the company. It reflects the residual enterprise value of the business after any payment to creditors, minority shareholders and other non-equity stakeholders. In essence, it expresses the value of shareholders’ claims on the business after all third parties are accounted for – in short, it’s the value of the firm’s equity to the owner/s.
A company’s equity value can be calculated in two ways, which are outlined below.
- A share price multiple
The first (simple) method is to multiply the company’s share price by its number of shares outstanding, i.e.
Equity Value = Share Price x Number of Shares Outstanding
This method is most often used for publicly traded companies, where both share price and number of shares outstanding data is readily available.
- Using Enterprise Value as a starting point
The second method, more commonly used for smaller private companies, is to start with the Enterprise Value and work backwards from there, i.e.
Equity Value = Enterprise Value + Cash/Cash Equivalents - Debt, Preferred Stock & Minority Interest
- Cash and cash equivalents: These are added in, since any cash that is left over after paying off other third party creditors or preferred stock holders investors is available to common shareholders.
- Debt, preferred stock and minority interest: These amounts represent liabilities that are due to other outside investors, so they are subtracted. In most cases, only interest-bearing debts (and other debt-like obligations) are included here.
So, which definition of value – enterprise or equity – should you use when valuing a business? The reality is that both are important, as they provide different perspectives.
The advantages of using Enterprise Value are:
- It avoids the influence of capital structure on the business’s value, which makes it useful when comparing two businesses with different capital structures
- Differences in accounting policy can be minimized
- It’s a comprehensive calculation
- It’s easier to apply to cash flow
The advantages of using Equity Value are:
- It’s more relevant to equity valuations
- It can be seen as more accurate by business owners
- It’s a more familiar calculation to investors (and/or popular media) who deal in publicly traded stocks
In summary, both Equity Value and Enterprise Value are worth looking at when valuing a company in different ways: while Equity Value is the value only to the shareholders, Enterprise Value is the value of the business from the perspective of both the shareholders and the debt holders combined. The key point is to know which is which!