Purchase Price in M&A Deals: Equity Value Versus Enterprise Value
In this tutorial, you’ll learn why the real price paid by a buyer to acquire a seller in an M&A deal is neither the Purchase Equity Value nor the Purchase Enterprise Value… exactly.
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Equity Value Versus Enterprise Value – “Financial Modeling Training And Career Resources For Aspiring Investment Bankers”
Equity Value Versus Enterprise Value – Table of Contents:
4:29: Problem #1: The Treatment of Debt
8:03: Problem #2: The Treatment of Cash
11:45: Recap and Summary
Equity Value Versus Enterprise Value – Common questions:
“In an M&A deal, does the buyer pay the Equity Value or the Enterprise Value to acquire the seller?”
“What does it mean in press releases when they say the purchase consideration ‘includes the assumption of debt’? Does that mean the price is the Enterprise Value?”
Equity Value Versus Enterprise Value – The Basic Definitions
Equity Value: Value of ALL the company’s assets, but only to common equity investors (shareholders).
Enterprise Value: Value of ONLY the core business operations, but to ALL investors (equity, debt, etc.).
So when you calculate Enterprise Value, starting with Equity Value…
Add Items When: They represent other investors (Debt investors, Preferred Stock investors, etc.) or long-term funding sources (Capital Leases, Unfunded Pensions)
Subtract Items When: They are not related to the company’s core business operations (side activities, cash or excess cash, investments, real estate, etc.)
The Confusion
The problem is that many sources say Enterprise Value is what it “really costs to acquire a company.”
But that’s not exactly true – yes, sometimes Enterprise Value is closer, but it depends on the deal terms and the items in Enterprise Value.
We know, WITH CERTAINTY, that if you acquire 100% of a company, you must pay for 100% of its common shares.
So the Purchase Equity Value is sort of a “floor” for the purchase price in an M&A deal.
But should you really add the seller’s Debt, Preferred Stock, and other funding sources, and subtract 100% of the seller’s cash balance to determine the “real price”?
There are many problems with that approach, but we’ll look at two of them here:
PROBLEM #1: Does Debt really increase the purchase price?
It depends, because debt can be either “assumed” (kept) or “refinanced” (replaced with new debt or paid off).
Debt is Assumed: Does not increase the amount the buyer “really pays” for the seller.
Debt is Repaid with the Buyer’s Cash: Does increase the amount the buyer “really pays”.
Existing Debt is Replaced with New Debt: Increases the amount the buyer “really pays,” but the buyer still isn’t paying more cash.
PROBLEM #2: Does Cash really reduce the purchase price?
A buyer can’t just “take” a seller’s entire cash balance following a deal – all companies need a certain “minimum cash balance” to keep operating, paying the bills, etc. That portion of cash is actually a core business operating asset.
Enterprise Value: As a simplification, we ignore the minimum cash and subtract all cash instead.
So if a company operating by itself always needs some minimum amount of cash, it certainly still needs a minimum amount of cash in an M&A deal.
Other Complications
Transaction Fees: These always exist, and will always increase the price the buyer pays (lawyers, accountants, bankers, etc.).
Unfunded Pensions, Capital Leases, etc.: These don’t necessarily have to be “paid” or “repaid” upon change of control… so they may not even affect the price, even though they factor into Enterprise Value.
Extra Cash: What if the buyer’s cash + seller’s cash are used to fund the deal? Then the real price paid may not even be comparable to the seller’s Equity Value or Enterprise Value.
The Bottom Line
You have to distinguish between the *valuation* of a company or deal and the *actual price paid*.
Equity Value and Enterprise Value are useful for valuation, but less useful for determining the real price paid.
The real price paid may be between Equity Value and Enterprise Value, above them, or even below them, depending on the terms of the deal – due to the treatment of debt and cash, fees, and liabilities that don’t affect the cash cost of doing the deal.
When you see language like “Including assumption of net debt,” that means the approximate Purchase Enterprise Value for the deal, because they are calculating it as Purchase Equity Value + Debt – Cash.
But it’s still not what the buyer actually pays – it’s just a way to value the deal and get multiples like EV / EBITDA.
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