Vernacular of business valuation

April 23, 2018

Last month I talked about the value of private companies, marketability of a handful of privately held shares and other fun valuation concepts.

Unfortunately, the “fun” valuation concepts are not well understood as there is lots of weird language to wade through.

A client recently said to me “you have a mysterious vernacular”. He went on to explain that we all create fancy jargon to define things that only our own profession understand.

Maybe we use uncommon vocabulary to entice questions from the unassuming and basically be pretentious.

Whichever doesn’t bother me. That client has inspired the MVV – the mysterious vernacular of valuers. Here goes with a couple of our my most pretentious favourites:

Enterprise Value

  1. The total value of the equity plus debt of a business, less excess cash
  2. The net value of business related assets and liabilities: working capital, fixed assets, goodwill, intangible assets, employee provisions
  3. The value of the business, ignoring the way assets and liabilities are funded

Synonym: business value

Example:

Operating profit (ignoring tax and interest) 1,000,000
Multiple of operating profit 4x
Enterprise Value 4,000,000

Equity Value

  1. The total value of the business to its shareholders (or owners)
  2. Enterprise Value less debt of a business, plus excess cash

Synonym: company value

Example:

Enterprise Value 4,000,000
Less: bank debt (1,000,000)
Plus: excess cash 200,000
Equity Value 3,200,000

OR

Operating profit 1,000,000
Less: tax and interest (360,000)
Net profit after tax 640,000
Multiple of net profit 5x
Equity Value 3,200,000

Shown another way, these concepts are represented by the Balance Sheet as follows:

Debtors 1,200,000
Stock 700,000
Fixed assets 1,250,000
Goodwill and intangible assets 1,375,000
Creditors (400,000)
Taxes (75,000)
Employee provisions (50,000)
Enterprise Value 4,000,000
Excess cash 200,000
Bank debt (1,000,000)
Equity Value 3,200,000

Enterprise Value and Equity Value are often confused. I have seen examples in several shareholder agreements where the concept of enterprise value is used to determine the share price for a departing shareholder.

In the above example, if I were a departing shareholding owning 25%, I will stand to be paid $1,000,000 (25% of $4 million) rather than $800,000.

More of the MVV another time.

If you can’t explain it simply, you don’t understand it well enough.” Albert Einstein

Lachie McColl
BV Specialist