What is Enterprise Value
An Enterprise value is a number representing the total value of a business to a potential buyer.
Let’s look at how this works in practice.
Bob, the owner of Bob’s Corner Candy Shop. Bob’s business is doing well, but Bob is considering selling the business and moving to Florida for retirement.
To figure out what price he will demand for his business, Bob goes through different ways of looking at the business, and reaches an end result: 2 million dollars for the whole business.
For 2 million dollars, the buyer will get all of the candy store’s inventory, possession of the rent for the Corner Candy Store, sole possession of the company Name – a trusted local brand for candy, the cash in the cash register, ownership of the bank account, the candy machines in the back and the old candy truck – everything goes.
Robin comes along and pays Bob his asking price: 2 million dollars. That same day, Old Bob is boarding a plane to Miami.
As Robin enters the shop, he finds $500,000 in the cash register – money that some client paid for Candy. That cash effectively reduces Robin’s paying price to 1.5 million dollar. Robin couldn’t be happier.
The next day, Robin goes to the bank to introduce himself. At the bank, Robin finds Bill, who informs him that a one-million-dollar loan was forwarded recently to the Corner Candy Shop, but since the bank does not know who Robin is the business is kindly requested to terminate the loan.
Robin is surprised by the findings, but since he did buy the the business as a whole he brings in another one million dollars and repays the loan.
Robin sits down to calculate the total cost of buying Bob’s Corner Candy Shop:
2 million dollars for Bob – for 100% stockholdings in Bob’s Corner Candy Shop. Minus Half a million Cash robin found in the cash register Plus one million for extinguishing the Debt.
Total – 2.5 million dollars – the total expenditure made to buy the whole business, all-inclusive.
Total Market Cap (which is all stocks outstanding multiplied against their asking price) Minus any cash on the balance sheet, Plus all debt on the balance sheet – (short and long term).
This may occasionally create anomalies – situations where Enterprise Value (called EV) will dramatically deviate from Market Cap.
Here are two examples:
a. A company with depressed share price, without Debt, but who has a lot of cash on the Balance sheet might have a negative Enterprise value. Meaning there is more cash than market cap.
b. Another anomaly might be a small cap company with market cap of 200 million dollar, who has a 4 billion dollar Enterprise Value because its owner just completed a 3.8 billion dollar debt-fueled takeover of a competitor.
For investors trying to grasp the amount of value a business has, in contrast to its price, Enterprise value is a better starting point than a Market Cap that totally ignores the effect of Debt and Cash on the business Value.
Enterprise value, especially when compared to other metrics, can provide a great starting point to detect value creation for investors who take the time to understand the fundamentals of the business in the companies they consider investing in.« Back to Glossary Index