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:
+ 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.