Enterprise value to equity value

"Walk me through the difference between enterprise value and equity value" is one of the most common technical questions at every level. It sounds abstract, but the idea is simple once you picture who owns what. This lesson builds the bridge between the two, step by step.

Two ways to value a company

Equity value is what the shares are worth: the value belonging to shareholders. For a listed company, it is the share price multiplied by the number of shares, often called market capitalisation.

Enterprise value (EV) is what the operating business is worth to everyone who funds it: shareholders and lenders together. It is the value of the core operations, regardless of how they are financed.

A house makes the idea concrete. Suppose a house is worth £400,000 and has a £300,000 mortgage. The house itself is worth £400,000, which is like enterprise value. Your stake in it is £100,000, which is like equity value. If you also keep £20,000 of cash in a drawer, a buyer of the whole package would effectively pay less for the house, because the cash could pay down the mortgage.

The bridge

To go from equity value to enterprise value, add the claims of other capital providers and subtract assets that are not part of the operations.

Debt and cash together are often shortened to net debt, so the simplest version is enterprise value = equity value + net debt. The other items follow one principle: the numerator and denominator of any multiple must match. EBITDA includes 100% of subsidiaries the company controls, even if it owns only 80%, so the 20% belonging to outside owners, the non-controlling interest, is added to EV. Profits from associates, where the company has significant influence but not control, are not in EBITDA, so their value is taken out.

Some items are debatable. UK analysts often treat a defined benefit pension deficit as debt-like, because the company must fund it. Items that are part of day-to-day operations, such as trade payables, stay out of the bridge: they are already reflected in the value of the business.

Why enterprise value stays put

Enterprise value depends on the operations, not on how they are financed. So a pure financing decision leaves it unchanged, while equity value can move.

• Borrowing £50m and keeping the cash: debt and cash both rise, net debt is unchanged, and neither value changes
• Paying a £50m dividend from cash: equity value falls by £50m, net debt rises by £50m, and EV is unchanged
• Issuing £50m of new shares for cash: equity value rises by £50m, net debt falls by £50m, and EV is unchanged

These assume the market does not change its view of the business, and ignore fees and taxes. In reality a big change in leverage can alter risk and therefore value, which is a good nuance to mention if you have time.

Counting diluted shares

Equity value should use diluted shares, which include shares that could be created from options, warrants and convertible bonds. The treasury stock method handles options.

• Only count options that are in the money, where the exercise price is below the share price
• Assume they are exercised, creating new shares
• Assume the company uses the exercise cash to buy back shares at the current share price
• Add only the net new shares to the basic share count

Convertible bonds need a judgement call. If the conversion price is below the share price, holders would rather convert, so treat the bond as extra shares and leave it out of debt. If it is above, treat it as debt. Counting it in both places is a classic mistake.

A good interview answer

Keep it short and structured. Enterprise value is the value of the core business to all capital providers. Equity value is the part that belongs to shareholders. You get from equity value to EV by adding net debt and other non-equity claims such as preference shares and non-controlling interests, and subtracting non-operating assets. If asked why, say that EV is independent of capital structure, which makes it better for comparing companies with different amounts of debt.