When talking about the “value” of a business, there are a number of different value references that one will come across and it is easy to be confused by what they all mean. From a litigation standpoint, the primary concepts are fair market value and fair value but within each of these, care should be taken when considering a valuation conclusion to understand whether the conclusion refers to enterprise value or equity value.
Enterprise value relates to the fair market value of the business prior to considering how that business is financed. It is determined through the consideration of pre-interest cash flows or earnings. As a result, it may be referred to as a “debt free” valuation conclusion. The enterprise value of a business may be financed with either debt, shareholder equity/contributions or, more commonly, a combination of debt and equity. Enterprise value is generally a more suitable measure for comparing similar businesses as it is not impacted by discretionary financing decisions.
The formula for calculating Enterprise Value (EV) is:
EV = Market Value of Equity + Total Debt
Equity value refers to the value of a business or the shares of a corporation. It is a component of enterprise value that is often calculated by deducting the market value of financing-related debt from the enterprise value. Stated another way, equity value is equal to enterprise value less the market value of financing-related debt. It should be noted that only financing-related debt is deducted. Debt that relates to the normal operations of the business, such as amounts owed to suppliers, is included in both equity and enterprise value conclusions.
The formula for calculating Equity Value is:
Equity Value = Market Price per Share × Total Shares Outstanding; where market price per share is determined by us using core valuation methodologies and principles.
We should also point out that there is a valuation approach that bypasses the determination of enterprise value and goes straight to the determination of equity value. We don’t see this approach utilized very often in practice since it tends to be a more complicated approach but in theory, the result should be the same.