Enterprise value

Two companies with the same share value can be very different purchases if one carries heavy debt. Enterprise value removes the effect of financing choices, so businesses can be compared on what they earn. It is also the figure that valuation multiples apply to, such as EV to EBITDA (profit before interest, tax, depreciation and amortisation) or EV to recurring revenue. In the example above, EBITDA of €400,000 gives a multiple of 5.5.

Multiples differ by sector, size and growth, so one company's number says little about another's. In small deals the price is often agreed "cash-free, debt-free", which is enterprise value in practice: the seller keeps the cash and clears the debt.

• Work out the enterprise value of every offer before comparing them, so debt and cash are treated the same way each time.
• Use the multiple buyers in the same sector actually pay, based on profit or, for subscriptions, on recurring revenue.
• Raise it from the inside. Recurring revenue, low churn, clean books and documented processes all lift the multiple, because less of the value depends on one person.

Enterprise value is what it would cost to buy the entire business, not only the part owned by shareholders. The usual shortcut is equity value plus debt, minus cash. Debt is added because a buyer takes on those obligations. Cash is subtracted because it comes with the company and can pay them down.

Say a company's shares are worth €2.0 million. It owes the bank €300,000 and holds €100,000 in cash. Its enterprise value is €2.0 million plus €0.3 million, minus €0.1 million, which is €2.2 million.

• Treating revenue as value. A business with high revenue and thin profit is worth far less than the revenue suggests.
• Using a multiple from a much larger company.
• Counting all cash as spare, when some of it runs the business day to day.