What is enterprise value? Definition, formula and example

This is for owners who got an offer and want to know what they will really take home, and for buyers comparing prices. By the end you will know what enterprise value means, how to work it out, and why it differs from the cash a seller gets.

The definition in plain words

Enterprise value is what the operating business is worth. It is the value of the trucks, staff, customers, systems and profit, before anyone asks how the business is funded.

Think of a house. Whether the owner has a large mortgage or none, the house is worth the same. The mortgage only changes how much the owner keeps. A business works the same way. Its enterprise value stays the same however much debt it carries. What changes is the equity value, the part that belongs to the owner.

Wikipedia's enterprise value entry describes it as the value of the whole business, not just its shares.

The formula

The basic formula is short:

Enterprise value = equity value + debt − cash

Turn it around and you get what the seller keeps:

Equity value = enterprise value − debt + cash

Bigger companies add more items, such as preferred stock and minority interests. Wall Street Prep's enterprise value guide lists them. For most small and mid-sized businesses, debt and cash are the items that matter.

Multiples work from enterprise value too. When someone says a business sold for "5x EBITDA," they mostly mean enterprise value divided by EBITDA. EBITDA is profit before interest, so it belongs to lenders as well as owners. Enterprise value is also measured before debt, so the two go together.

Worked example: one price, two sellers

Here are two businesses with the same profit and the same offer. The numbers are made up but they add up. Both sell at an enterprise value of 4.5x EBITDA.

Business A: $3,600,000 − $0 + $200,000 = $3,800,000. Business B: $3,600,000 − $900,000 + $0 = $2,700,000.

The headline price is the same. The owner of Business B takes home $1,100,000 less, because the loans are paid off at closing. The gap comes from the balance sheet, not from what the business is worth.

Where it shows up in a deal

Most small-business offers are made on a "cash-free, debt-free" basis. The buyer pays the enterprise value. The seller keeps the extra cash and pays off the debt at closing. Wall Street Prep's cash-free, debt-free explainer shows how the price moves from enterprise value to the amount the seller is paid.

You will see enterprise value in a few places:

1. The letter of intent. The price in a letter of intent is usually enterprise value. Check that the LOI says "cash-free, debt-free," and lists what counts as debt.
2. The working capital peg. Buyers expect a normal level of working capital to stay in the business. If there is less at closing, the price goes down. See our note on the working capital peg.
3. Deal structure. In an asset sale, the buyer usually takes on no debt, so the seller pays it off from the proceeds.
4. Comparing deals. Buyers and roll-up investors compare businesses by enterprise value to EBITDA, whatever their debt.

In more than ten years advising buyers and sellers, Moran Pober has seen this mix-up often. An owner plans around the headline number, then the closing statement takes off loans, leases and a working capital shortfall. Do this math before you sign the LOI.

Common mistakes

Treating the headline price as take-home cash. The price is enterprise value. Take off debt, add excess cash, adjust for working capital, then take off fees and tax. Ask a CPA to model the after-tax number.

Forgetting debt-like items. Buyers often count more than bank loans as debt. Equipment leases, unpaid taxes, customer deposits and deferred pay for staff may all be taken off the price. Agree on the list early, with help from a lawyer.

Mixing the two values in a multiple. Dividing equity value by EBITDA gives a wrong multiple. Enterprise value goes with EBITDA. Equity value goes with net profit after interest.

Draining cash or working capital before closing. The working capital peg catches this, and the price drops by the shortfall.

If you are pricing a business to buy, start with our how to buy a business guide. If you are an owner checking an offer, you can book a free first call.