Companies look to “enterprise value” when they need a formula to determine what apublicly traded business is worth. It’s a direct valuation metric that is often thestarting point — and sometimes the endpoint — for calculating how much to offerwhenpurchasing a company or how much you might get when selling your own.
What Is Enterprise Value (EV)?
As its name implies, enterprise value (EV) is the total value of a company, defined in termsof its financing. It includes both the current share price (market capitalization) and thecost to pay off debt (net debt, or debt minus cash). Combining these two figures helpsestablish the company’s enterprise value, indicating the neighborhood you need to bein to buy the company.
Enterprise Value = MarketCap + Debt - Cash
Key Takeaways
- Enterprise value calculates the potential cost to acquire a business based on thecompany’s capital structure.
- To calculate enterprise value, take current shareholder price — for a publiccompany,that’s market capitalization. Add outstanding debt and then subtract availablecash.
- Enterprise value is often used to determine acquisition prices. It’s also used inmany metrics that compare the relative performance of different companies, such as valuationmultiples.
Enterprise Value Explained
The first time people see the enterprise value formula, most have the same reaction: Huh? Whywould you add money a company owes to its value and subtract cash on hand? After all, acompany with more cash should be more valuable than one with less, all other things beingequal — and that’s true.
But remember: Enterprise value is a financing calculation — the amount you would needto payto those who have a financial interest in the firm. That means everyone who owns equity(shareholders) and everyone who has loaned it money (lenders). So, if you’re buyingthe company, you have to pony up for the stock and then pay off the debt, but you get thecompany’s cash reserves upon acquisition. Because you receive that cash, it means youpaid that much less to buy the company. That’s why you add the debt but subtract thecash when you calculate an acquisition target’s enterprise value.
What Does EV Tell You?
Conceptually, enterprise value gives you a realistic starting point for what you would needto spend to acquire a public company outright. In reality, it typically takes a premium toEV for an acquisition offer to be accepted. This is for a few reasons:
Deal premium:
The company’s board might demand a premium to its current share price, otherwise whyshould they sell?
Supply and demand:
When an acquirer starts buying stock, the economic principles of supply and demand typicallykick in, driving up the share price — all other things being equal.
Competitive bidding:
Sometimes, multiple bidders emerge, leading to a significant premium.
Enterprise Value (EV) Formula and Calculations
A company’s enterprise value is not reflected solely in its shareholder contribution,the amount of money contributed to a business by shareholders; it also takes into accountcompany debt, both short- and long-term, and cash reserves. While “debt” and“cash” are clear and simple terms, market cap deserves a bit of explanation.
Pundits often discuss a company’s stock price and whether it has gone up or down. Thissometimes makes for great entertainment, but the actual price of a share of a stock ismeaningless in terms of understanding a company’s value without additional data,particularly how many shares are outstanding. Multiplying the share price by the number ofoutstanding shares gives you the company’s market capitalization — the totaldollarvalue of the company’s outstanding shares.
As a simple example, Company A’s stock may trade at $100 per share while CompanyB’s stock trades at $20. But if Co. A has 100 million shares outstanding and Co. B has500 million shares outstanding, then their market caps are precisely the same: $10 billion.
100 million shares x $100 = 500 million shares x $20
The Limitations of Enterprise Value
The main limitation of enterprise value appears when comparing dissimilar companies.Enterprise value holistically quantifies how much a company would cost to take over, ratherthan simply its value in terms of market capitalization. If two companies have the samemarket cap but one has significant debt while the other has significant cash reserves, thecompany without the debt would cost less to acquire.
However, EV doesn’t consider how companies make use of the debt they carry. A softwarecompany with significant debt and few cash reserves may be a less attractive investment thana company with similar market cap and no debt, but the investment decision wouldn’t beas clearcut when deciding between different industries. A utilities company or automanufacturer — or any other capital-intensive industry — would likely need toincur asignificant amount of debt to finance the capital needed to generate revenue.
Similarly, EV is more useful when comparing companies at similar stages of growth —companiesin a phase of high growth are less likely to have as much debt as a more mature company.
How Is Enterprise Value Different From Market Cap?
For businesses with either material cash reserves or debt, enterprise value is a morethorough calculation that provides clearer insight than market cap into the real value ofthe business. As the table below illustrates, companies with identical market caps may havevastly different enterprise values based on their cash and debt positions.
Market Cap vs. Enterprise Value Example
| Market Cap | + Debt | - Cash | = EV | |
|---|---|---|---|---|
| Company A | $10B | $2B | $0 | $12B |
| Company B | $10B | $0 | $2B | $8B |
Now let’s use two real-world market cap and enterprise value calculations to illustratethe point.
In Nike’s case, the company’s enterprise value is very close to its market capbecause its debt and cash are very similar. Nike’s July 2020 10-K filing showed $9.66billion in outstanding debt and $8.79 billion in cash and equivalents, so its enterprisevalue would be roughly $870 million more than its market cap ($9.66 - $8.79). That may soundlike a large number, but it’s less significant once you calculate Nike’s marketcap. On the same day it filed that 10-K, Nike shares traded for $98.43, and 1,559,888,549shares were outstanding. Therefore, Nike’s market cap was $153.54 billion. Adding $870million of net debt (debt-cash) gets Nike an enterprise value of $154.41 billion —less than1% more than its market cap.
For Home Dept, though, the difference was more significant. Home Depot’s last 10-K was filed in March 2020 and showed $31.48billion in outstanding debt and $2.13 billion in cash—which means adding $29.35billion innet debt to the company’s market cap to calculate enterprise value.
Home Depot’s market cap when it filed the 10-K was $195.35 billion (price per share of$181.76 times 1,074,741,592 shares outstanding). This yields an enterprise value of $224.70billion. In other words, Home Depot’s enterprise value was 15% greater than its marketcap ($224.70 billion vs. $195.35 billion) because Home Depot had significantly more debtthan cash on hand.
Market Cap vs. Enterprise Value Real-World Example
| Market Cap | + Debt | - Cash | = EV | |
|---|---|---|---|---|
| Nike | $153.54B | $9.66B | $8.79B | $154.41B |
| Home Dept | $195.35B | $31.48B | $2.13B | $224.70B |
How to Use Enterprise Value as an Acquirer
If you’re contemplating purchasing a public company, enterprise value gives you a senseof the debt and short-term assets associated with thebusiness and how they might influence your offer.
Consider two public companies that are equally attractive to you as an acquirer. Company Ahas a market cap of $400 million, while Company B’s market cap is $460 million, so youwould expect to have to pay $60 million more for Company B. But as you work through theenterprise value formula, you find that while neither company has debt, Co. A has $20million in cash reserves, and Co. B has $80 million. Thus, their enterprise values areequal. You could still justify offering $60 million more for Co. B, however, because itsbalance sheet would offset the higher price.
Using Enterprise Value as an Acquirer
| Market Cap | + Debt | - Cash | = EV | |
|---|---|---|---|---|
| Company A | $400M | $0 | $20M | $380M |
| Company B | $460M | $0 | $80M | $380M |
How to Use Enterprise Value When Evaluating Acquisition Offers
This is where things get interesting. If you’re evaluating several acquisitionproposals, and the offers are for stock, not cash, you really need to compare the value ofthe stock offers to the enterprise value of each potential buyer. Specifically, if awould-be acquiring company has a lot of debt on its balance sheet and minimal cash thiswould increase the enterprise value. In addition, some industries are more capital intensivethan others, so companies in those industries tend to be highly leveraged.
If the acquirer is trying to use its share price at face value in its acquisition offer, youneed to push back and demand more shares, or shares plus cash, to achieve a deal based onthe buyer’s enterprise value.
This becomes more important if the acquiring company is small-cap — that is, its marketcapitalization is between $300 million and $2 billion — and its shares are onlylightlytraded. Such shares are less liquid: You may not be able to sell them as easily as a largercompany’s shares, or at the price you expect. If a company is being acquired andcan’t sell stock right away, then the financial strength of the acquiring companyshould matter, but enterprise value doesn’t indicate that.
It’s also worth noting that unless the acquired company remains a separate legalentity, it does not share responsibility for debt. The corporate entity as a whole owns thedebt. Enter the deal only if you’re confident that the debt can be serviced.Obviously, each situation is different, but make sure you’ve worked through a scenario analysisexercise with your financial and legal advisors before signing a deal.
Why Does This Matter for Your Business?
Understanding enterprise value can be helpful in a number of situations, especially whenlooking for potential acquisitions or when evaluating stock-based acquisition offers.It’s also an important concept when looking at calculations for valuation multiples.EV to EBITDA(earnings before interest, taxes, depreciation, and amortization), for example, is acommonly used multiple for comparing the performance of different but similar businesses,and EV is used in many other multiples as well. Explore more ideas for applying EV in yourorganization in “How to Use EV and Valuation Multiples to Drive Business Value.”
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Enterprise Value FAQs
Why do businesses deduct cash from enterprise value?
Enterprise value is commonly used as a metric that defines the prospective cost of acquiringa business, and because the cash the business has on hand would effectively go to the newowner, it lowers the relative cost to acquire it.
Why do businesses add debt to enterprise value?
Adding debt to enterprise value works on a same principle as deducting cash. Because EVserves as the cost to acquire a business, debt would be an added cost to the acquisitionwhile cash would be deducted from that cost.
Can enterprise value be less than equity value?
Enterprise value can be less than the equity value for companies with net negative debt, orcompanies with a cash balance greater than its debt.
Why do businesses use Enterprise Value?
Businesses use enterprise value to gauge the cost of acquiring a company, particularly whenthey have different capital structures. Because EV accounts for more than just itsoutstanding by adding debt and subtracting cash from the cost, it allows for companies todetermine how much a company is worth.
