Last time, I discussed the difference between Equity Value and Enterprise Value, and I mixed in a couple theoretical examples to bring home why some items are added (debt, for example) and some items are subtracted (cash, for example) when going from Equity to Enterprise.

Now, let’s get more specific. Here, I’m going to propose a more comprehensive formula for going from Equity Value to Enterprise Value.

To get from Equity Value to Enterprise Value, take Equity Value:

• Less: Cash
• Less: Equity Investments (where the target company owns less than 50% of another company)
• Less: NOLs; Recall that you must tax effect a target’s NOLs first before subtracting; do not take the entire NOL value.
• Plus: Term Debt/Preferred Stock/Short Term Debt/Mezzanine Debt /Revolvers/etc. Recall that convertibles are a special situation…they may or may not count toward Enterprise Value…
• Plus: Minority Interests. Recall that Minority Interests are where the target owns MORE THAN 50% of another company; you must add back the un-owned portion to get to Enterprise Value).
• Plus: Other Liabilities/Obligations (such as pensions (the unfunded portion), environmental costs, litigation, capitalized leases, future restructuring costs, etc.)

That’s it. But a couple items (hardly a comprehensive list) that your friendly neighborhood M&A practitioner frequently confronts deserve special consideration:

• Options/Warrants: Don’t forget that options need to be considered when figuring out fully-diluted Equity. And recall that in addition to the dilutive effect on Equity, there is also a cash effect.
• Convertible Debt: Like Options/Warrants, Convertibles are a (potentially) dilutive instrument that will impact both Equity and Enterprise Values.
• Deferred Taxes: Deferred tax liabilities are almost always written down in an M&A deal, so an acquirer doesn’t have to pay anything extra as a result of DTLs.
• Deferred Revenue: Deferred revenue is also not something that an acquirer would typically have to pay off in an acquisition – it is recognized by the company in its ordinary course of operations. Adding back Deferred Revenue to get to Enterprise Value would be like adding Accounts Payable – there’s no reason to do it because the company pays it organically over time as it continues to operate.

Okay, that’s really it in a nutshell. But, why go through all this hassle distinguishing Equity Value from Enterprise Value? Answer: It is going to be necessary to know the difference when considering valuations that are calculated as multiples of cash flow. And in the real world of corporate M&A, that’s the most frequently used and ultimately the most reliable means of valuation. Period.

Next time, more about different types of cash flow…

Posted by: Mory Watkins