Enterprise Value or Equity Value? I just want to know the value of the Business!

May 18, 2017 - contributed by Christine Baker

In our last post we discussed how the characteristics of each valuation project can and do impact the valuation conclusion. In a nutshell, there is no one number that will be appropriate for a business owner in every scenario. In this post we’ll talk about one of the most important distinctions to be clarified when we’re honing in on we’ve been asked to value.

Here is a common vagueness that comes up often throughout thousands of client interactions:  What is the value of my company? Why do you sometimes say “enterprise value” and other times you say “equity value”? Or sometimes you don’t mention either one? There’s just one number, right?

Valid questions. This is a great topic for today’s post because nailing down this distinction really does matter. Sometimes even valuation advisors neglect to specify this one. 

Let’s cut to the chase and state unequivocally that The Value of the Company is Enterprise Value… whereas The Value of What the Shareholders Own is Equity Value. Yes, they’re two different things.

When we discuss this topic we often use a real estate analogy to bring it all into focus. Many of us understand there is a difference between the selling price of a home and what the homeowners have left after their mortgage. The market value of a property, or what it might sell for, is one “value” while the homeowners’ equity remaining after their mortgage is another “value.” Frequently the two are very different. When we apply this illustration to the value of a business, Enterprise Value is akin to the value of the house; Equity Value is akin to homeowners’ equity.

If we think back to a prior blog post we recall that characteristics of our client assignment drive some of the fundamental assumptions that play into the valuation process. When we advise a business owner going through a sale (or an acquisition), we tend to focus on negotiating Enterprise Value in order to transfer a bundle of business assets to an acquirer. Alternatively, when a business owner is looking to transition ownership to family, employees, or is involved with a valuation dispute, we tend to focus on Equity Value. Because think about it – the corporate entity (pretend for a minute it’s okay to use “corporate” for partnerships and LLCs too) owns the assets, employs employees and develops intangible value, incurs expenses and can borrow from a bank – but the owners own the stock (or partnership interests or membership units) of the Company. The owners own the shell that houses the business operations.

In general, we determine Enterprise Value in every business valuation project and from there we can determine Equity Value (when needed). The fundamental formula looks something like this:

Enterprise Value

+ Cash

+ Any “non-operating” assets

± Other unique assets or liabilities

= Value of Invested Capital (“MVIC” or “TIC”)*

- Interest-bearing debt

= Equity Value

In future blog posts we’ll look further into the topic of non-operating assets, unique booked and unbooked items that can impact equity value, as well as characteristics of the equity itself (e.g. voting rights or guaranteed distributions to name several) that can impact the value of equity held by the owners. 

* “MVIC” = market value of invested capital and “TIC” = total invested capital. MVIC tends to be used by business appraisers/valuators while TIC tends to be used by investment bankers. These terms generally reflect the same thing.

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Christine Baker is an Accredited Senior Appraiser (”ASA”) and leads the business valuation practice at Charter Capital Partners. She has completed more than 1,000 accredited appraisals in over 20 years for a wide variety of purposes, most of which do not involve “going to market.” She has served on the AICPA Business Valuation Committee, the AICPA Forensic and Valuation Services Executive Committee, the AICPA Accredited in Business Valuation (“ABV”) Committee.

Welcome to the Valuation Matters Blog

April 12, 2017 - contributed by Christine Baker

I’m going to be honest. We generate a heck of a lot of valuation computations in our offices and we prepare them for a wide variety of purposes. If there’s one thing we’ve learned over time it’s this:  every situation is unique. Sure, each business has its own value drivers, but did you know that the purpose and context of the valuation project also impact the number? 

Our clients don’t come to us unless they have an issue to tackle – sometimes it involves going to market; sometimes it involves raising capital. It could be related to gift or estate tax, divorce court, selling to employees, buying out an unfriendly shareholder, or rewarding key executives. These different types of issues require different perspectives about “value.”

What approach the appraiser of a business (or a business ownership interest) takes is dependent upon the purpose behind the valuation analysis and the subject of the valuation analysis. A preliminary step in every valuation process is identifying the purpose and scope of the valuation assignment. The appraiser is required to identify and define the standard of value, the effective date of the appraisal, and the business, business ownership interest, or security to be valued, as well as the purpose and use of the valuation (Standards Rule 9-2 Business Appraisal – Development, Uniform Standards of Professional Appraisal Practice).

A common misconception is that the “fair market value” of a share of a closely held corporation [or partnership or membership interest] is a singular figure which is valid for a variety of purposes. Initial decisions involving various premise and assumption choices are probably the most important part of the valuation process… The purpose of the appraisal and the underlying assumptions will materially impact the final results. Every valuation must begin with an answer to the question: “value of what, to whom, and for what purpose?” in order for a supportable analysis to be developed. It is crucial that the specific facts and circumstances underlying each unique transaction are clearly understood and properly reflected in the quantitative analysis. (Randall B. Whilhite, The Effect of Goodwill in Determining the Value of a Business in Divorce, Family Law Quarterly Vol. 35 No. 2 (Summer 2001) pp. 351-381, referring to Mark Maxon, Valuation of Closely Held Securities – Avoiding Common Pitfalls and Misconceptions, Deloitte & Touche Valuation Notes (June 1991))

We’ll talk more about “standard of value” and “premise of value” in future posts but for now let’s identify some of the decisions that need to be made before even beginning the number crunching. Does our client need an enterprise value number or an equity value number? Are we considering a few shares of the company, or the business as a whole? Are there limitations on the ability of the owner to exert unilateral control? Are there limitations on the transferability of the equity shares we’re looking at? Are we assuming we’re going to market in a competitive bid process, or are we valuing the business (or business interest) as is in the hands of its current owner? Answers to questions such as these can and often do impact the final number.

The moral of this story is that, unfortunately, there is no one number that will be appropriate in every scenario a business owner may need to address. But we’re prepared for this. In future posts we’ll touch on some of the considerations we watch for with every valuation matter.

To be notified as new articles are posted, please visit our Contact Us page and subscribe to Valuation Matters.

Christine Baker is an Accredited Senior Appraiser (ASA) and leads the business valuation practice at Charter Capital Partners. She has completed more than 1,000 accredited appraisals in over 20 years for a wide variety of purposes, most of which do not involve “going to market.” She has served on the AICPA Business Valuation Committee, the AICPA Forensic and Valuation Services Executive Committee, the AICPA Accredited in Business Valuation (ABV) Committee. 
 

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