Enterprise Value and Equity Value

This topic separates students who memorised answers from students who actually understand valuation. Nail the distinction and the rest of the curriculum becomes much easier.

The one-sentence definition

• Equity Value is the value of a company to its shareholders.
• Enterprise Value is the value of a company's core operating business to all capital providers — debt and equity.

That's it. Everything else is a consequence of those two sentences.

Equity value

Also called market capitalisation (for a public company):

Equity Value = Share price × Diluted shares outstanding

Use diluted shares, not basic. Diluted includes the impact of in-the-money options, restricted stock units, and convertibles — anything that will become common stock if the company continues. The treasury stock method is the standard way to calculate this for options.

Equity value is what you pay as a minority shareholder buying one share in the market. It is not what you would pay to acquire the whole company.

Enterprise value

Enterprise Value = Equity Value
                 + Debt
                 + Preferred stock
                 + Non-controlling (minority) interest
                 − Cash and cash equivalents

Each term has a reason:

• + Debt: an acquirer inherits the target's debt (or has to refinance it). Either way, debt is part of the price.
• + Preferred stock: another claim senior to common equity. Same logic as debt.
• + Non-controlling interest: when a parent owns more than 50% of a subsidiary, the parent consolidates 100% of the sub's revenue, EBITDA, etc. on its financials. To match the EV to that consolidated EBITDA, you must include the minority stake you don't own.
• − Cash: an acquirer gets the target's cash and could use it to pay down the debt on day one, so it's effectively a discount on the purchase price.

Why the cash subtraction trips people up

Think of buying a house for £500k where the seller left £50k in a safe inside. Your real cost is £450k. Cash is the same — it comes with the deal, so you net it out.

The mental model

Enterprise value represents the value of the operating business — the value that sits above the capital structure. Equity value represents the residual claim on that operating business after debt holders are paid.

If you find yourself confused, ask: "Who does this value belong to?"

• Only shareholders? → Equity value.
• All capital providers? → Enterprise value.

Why this matters for multiples

The rule everyone forgets under pressure:

Match the numerator to the denominator.

• EV / EBITDA — EBITDA is earnings before interest, so it's a pre-debt-service cash flow that belongs to debt + equity. Match it with EV.
• EV / Revenue — revenue is pre-interest, pre-tax, pre-everything. It belongs to debt + equity. Match it with EV.
• P / E — net income is after interest and taxes, so it belongs to equity holders only. Match it with equity value.

Mixing them (e.g. EV / Net Income) is wrong because you'd be dividing a capital-structure-neutral number by a capital-structure-specific number. The multiple would be meaningless.

Common traps

• Using basic shares instead of diluted.
• Forgetting minority interest when the target has consolidated subsidiaries.
• Subtracting all cash instead of cash in excess of operating needs (more nuanced — in interviews, subtract all cash unless told otherwise).
• Using P / EBITDA or EV / Net Income. Both are wrong.

What you should be able to do after this lesson

• Define equity value and enterprise value without notes.
• Write the EV bridge formula from memory.
• Explain why each line is in the bridge.
• Match any multiple to the right denominator in under two seconds.