Enterprise Value vs. Equity Value: What’s the Difference?

Reviewed by Margaret JamesFact checked by Suzanne KvilhaugReviewed by Margaret JamesFact checked by Suzanne Kvilhaug

Enterprise Value vs. Equity Value: An Overview

Enterprise value and equity value are two common ways by which a business may be valued in a merger or acquisition. Both can be used in the valuation or sale of a business but each offers a slightly different view. Enterprise value gives an accurate calculation of the overall current value of a business, similar to a balance sheet. Equity value offers a snapshot of both current and potential future value.

A stock market investor or someone considering buying a controlling interest in a company will rely on an enterprise value in most cases. It provides a fast and easy way to estimate the value. Equity value is commonly used by owners and current shareholders to help shape future decisions.

Key Takeaways

• Enterprise value and equity value may both be used in the valuation or sale of a business but each offers a slightly different view.
• Businesses calculate enterprise value by adding the market capitalization, or market cap, plus all the debts in the company.
• Enterprise value provides a fast, easy way to estimate value.
• The calculation for equity value adds enterprise value to redundant assets and then subtracts the debt net of cash available.
• Equity value is often used by owners and shareholders.

Enterprise Value

Enterprise value constitutes more than just outstanding equity. It theoretically reveals how much a business is worth which can be useful in comparing firms with varying capital structures because the capital structure doesn’t affect the value of a firm.

An acquirer would have to assume the acquired company’s debt in the purchase of a company along with the company’s cash. Acquiring the debt increases the cost to buy the company but acquiring the cash reduces the cost of acquiring the company.

Businesses calculate enterprise value by adding the market capitalization, or market cap, plus all the debts in the company. Debts may include interest that’s due to shareholders, preferred shares, and other such things that the company owes. Subtract any cash or cash equivalents that the business currently holds and you get the enterprise value.

Think of enterprise value as a business’s balance sheet, accounting for all its current stocks, debt, and cash.

Equity Value

Equity value constitutes the value of the company’s shares and any loans that the shareholders have made available to the business. The calculation for equity value adds enterprise value to redundant assets or non-operating assets and then subtracts the debt net of cash available. Total equity value can then be further broken down into the value of shareholders’ loans and both common and preferred shares outstanding.

Important

Equity value and market capitalization are often considered similar and they’re even used interchangeably but there’s a key difference. Market capitalization only considers the value of the company’s common shares.

Preferred shares and shareholders’ loans are considered debt and equity value includes these instruments in its calculation. It uses the same calculation as enterprise value but adds in the value of stock options, convertible securities, and other potential assets or liabilities for the company.

It considers factors that may not currently impact the company but can at any time so equity value offers an indication of potential future value and growth potential. Equity value can fluctuate on any given day due to the normal rise and fall of the stock market.

What Is a Controlling Interest in a Company?

A controlling interest gives an investor or another company some measure of control over the company. Investors must typically hold more than half the voting shares to achieve a controlling interest but this isn’t always the case. Fewer shares can be required if all the others are divided among numerous holders.

What Is a Capital Structure?

The term capital structure refers to how a company balances its debts and equity to meet its expenses. These typically include both acquisitions and expenditures. The structure may be in a debt-to-equity ratio or a debt-to-capital ratio. Capital structures can vary by industry.

What Are Preferred Shares?

Preferred shares are those that award ownership rights to an investor. Holding preferred shares gives them a claim on assets and earnings. They’re first in line when dividends are paid and they have some protection if the company goes bankrupt.

The Bottom Line

Both equity values and enterprise values are used to gauge the value of a business. Equity value focuses on current and future values. Enterprise value is a snapshot of current value and it tends to be a faster, easier calculation. Investors usually rely more on enterprise value but it’s important to understand and look at both if you’re considering investing in a business.

Read the original article on Investopedia.