Companies look to “enterprise value” when they need a formula to determine what a publicly traded business is worth. It’s a direct valuation metric that is often the starting point — and sometimes the endpoint — for calculating how much to offer when purchasing 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 terms of its financing. It includes both the current share price (market capitalization) and the cost to pay off debt (net debt, or debt minus cash). Combining these two figures helps establish the company’s enterprise value, indicating the neighborhood you need to be in to buy the company.
Enterprise Value = Market Cap + Debt - Cash
- Enterprise value calculates the potential cost to acquire a business based on the company’s capital structure.
- To calculate enterprise value, take current shareholder price — for a public company, that’s market capitalization. Add outstanding debt and then subtract available cash.
- Enterprise value is often used to determine acquisition prices. It’s also used in many metrics that compare the relative performance of different companies, such as valuation multiples.
Enterprise Value Explained
The first time people see the enterprise value formula, most have the same reaction: Huh? Why would you add money a company owes to its value and subtract cash on hand? After all, a company with more cash should be more valuable than one with less, all other things being equal — and that’s true.
But remember: Enterprise value is a financing calculation — the amount you would need to pay to 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 buying the company, you have to pony up for the stock and then pay off the debt, but you get the company’s cash reserves upon acquisition. Because you receive that cash, it means you paid that much less to buy the company. That’s why you add the debt but subtract the cash 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 need to spend to acquire a public company outright. In reality, it typically takes a premium to EV for an acquisition offer to be accepted. This is for a few reasons:
The company’s board might demand a premium to its current share price, otherwise why should they sell?
Supply and demand:
When an acquirer starts buying stock, the economic principles of supply and demand typically kick in, driving up the share price — all other things being equal.
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 account company 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. This sometimes makes for great entertainment, but the actual price of a share of a stock is meaningless in terms of understanding a company’s value without additional data, particularly how many shares are outstanding. Multiplying the share price by the number of outstanding shares gives you the company’s market capitalization — the total dollar value of the company’s outstanding shares.
As a simple example, Company A’s stock may trade at $100 per share while Company B’s stock trades at $20. But if Co. A has 100 million shares outstanding and Co. B has 500 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, rather than simply its value in terms of market capitalization. If two companies have the same market cap but one has significant debt while the other has significant cash reserves, the company without the debt would cost less to acquire.
However, EV doesn’t consider how companies make use of the debt they carry. A software company with significant debt and few cash reserves may be a less attractive investment than a company with similar market cap and no debt, but the investment decision wouldn’t be as clearcut when deciding between different industries. A utilities company or auto manufacturer — or any other capital-intensive industry — would likely need to incur a significant amount of debt to finance the capital needed to generate revenue.
Similarly, EV is more useful when comparing companies at similar stages of growth — companies in 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 more thorough calculation that provides clearer insight than market cap into the real value of the business. As the table below illustrates, companies with identical market caps may have vastly different enterprise values based on their cash and debt positions.
Market Cap vs. Enterprise Value Example
|Market Cap||+ Debt||- Cash||= EV|
Now let’s use two real-world market cap and enterprise value calculations to illustrate the point.
In Nike’s case, the company’s enterprise value is very close to its market cap because its debt and cash are very similar. Nike’s July 2020 10-K filing showed $9.66 billion in outstanding debt and $8.79 billion in cash and equivalents, so its enterprise value would be roughly $870 million more than its market cap ($9.66 - $8.79). That may sound like a large number, but it’s less significant once you calculate Nike’s market cap. On the same day it filed that 10-K, Nike shares traded for $98.43, and 1,559,888,549 shares were outstanding. Therefore, Nike’s market cap was $153.54 billion. Adding $870 million of net debt (debt-cash) gets Nike an enterprise value of $154.41 billion — less than 1% 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 $31.48 billion in outstanding debt and $2.13 billion in cash—which means adding $29.35 billion in net 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 $224.70 billion. In other words, Home Depot’s enterprise value was 15% greater than its market cap ($224.70 billion vs. $195.35 billion) because Home Depot had significantly more debt than cash on hand.
Market Cap vs. Enterprise Value Real-World Example
|Market Cap||+ Debt||- Cash||= EV|
How to Use Enterprise Value as an Acquirer
If you’re contemplating purchasing a public company, enterprise value gives you a sense of the debt and short-term assets associated with the business and how they might influence your offer.
Consider two public companies that are equally attractive to you as an acquirer. Company A has a market cap of $400 million, while Company B’s market cap is $460 million, so you would expect to have to pay $60 million more for Company B. But as you work through the enterprise value formula, you find that while neither company has debt, Co. A has $20 million in cash reserves, and Co. B has $80 million. Thus, their enterprise values are equal. You could still justify offering $60 million more for Co. B, however, because its balance sheet would offset the higher price.
Using Enterprise Value as an Acquirer
|Market Cap||+ Debt||- Cash||= EV|
How to Use Enterprise Value When Evaluating Acquisition Offers
This is where things get interesting. If you’re evaluating several acquisition proposals, and the offers are for stock, not cash, you really need to compare the value of the stock offers to the enterprise value of each potential buyer. Specifically, if a would-be acquiring company has a lot of debt on its balance sheet and minimal cash this would increase the enterprise value. In addition, some industries are more capital intensive than 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, you need to push back and demand more shares, or shares plus cash, to achieve a deal based on the buyer’s enterprise value.
This becomes more important if the acquiring company is small-cap — that is, its market capitalization is between $300 million and $2 billion — and its shares are only lightly traded. Such shares are less liquid: You may not be able to sell them as easily as a larger company’s shares, or at the price you expect. If a company is being acquired and can’t sell stock right away, then the financial strength of the acquiring company should matter, but enterprise value doesn’t indicate that.
It’s also worth noting that unless the acquired company remains a separate legal entity, it does not share responsibility for debt. The corporate entity as a whole owns the debt. 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 analysis exercise 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 when looking 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 a commonly 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 your organization in “How to Use EV and Valuation Multiples to Drive Business Value.”
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 acquiring a business, and because the cash the business has on hand would effectively go to the new owner, 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 EV serves as the cost to acquire a business, debt would be an added cost to the acquisition while 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, or companies 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 when they have different capital structures. Because EV accounts for more than just its outstanding by adding debt and subtracting cash from the cost, it allows for companies to determine how much a company is worth.