I've seen a few businesses being bought at equity value instead of EV.
From the buyers' perspective, why would this be the case - in what cases do you leave discard debt and cash away from valuation?
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Not sure what you mean - every purchase has an implied equity and enterprise value. You will always pay both although of course the equity purchase price is the actual consideration transfered
Hi - I'm talking basically about the valuation being implied in SPA. So in some cases - the equity value is the actual cash transferred to the seller as result of the transaction instead of the EV.
I've asked them on the spot and it still didn't make sense to me (they basically said it's because the company will have upcoming contractual payments which will destroy cash for the buyer). I thought they were wrong (why would you discard certain parts of opex??) but didn't say anything as we are paying less. Just would like to see if there are sensible / unbiased reasons why this might be the case, and whether it is a widely understood concept?
I'm assuming you mean "cash-free / debt-free", which just means the seller is responsible for taking care of all existing debt at closing using the proceeds and excess cash on the balance sheet.
Enterprise value is fundamental value of the operating business itself. The excess cash sitting in the bank is incremental to the enterprise value, and the debt the company owes is essentially a claim on the "pool" of value from enterprise value + cash.
So, in a deal, a buyer and seller could agree that the operating business is worth $1,000. Let's say the company has $500 of debt and $200 of cash.
From the acquirer's perspective, enterprise value or equity value don't matter. Either way, they are paying $1,000 to receive an operating business with no debt nor excess cash on the balance sheet at closing.
From the seller's perspective, before closing, they take the $200 of cash and pay down $200 of debt, so there is $300 debt outstanding with no excess cash after. At closing, when they receive the $1,000, they then pay down the remaining $300, so they are left with $700 in proceeds (equity). They are then transferring a business without the $500 of debt nor the $200 of cash to the acquirer. So from the seller perspective, they received $1,000 for their enterprise, but only $700 that ultimately goes into their (i.e., the equityholder) pockets (i.e., equity value).
The idea is that this makes it easier to negotiate value because you are isolating the core intrinsic value of the business from the existing capital structure, which may be suboptimal. The owner of the business can make whatever capital structure decisions they want and hold however much debt and cash it wants, but it can't "choose" how the core business performs. That's why in a DCF for example, you are using unlevered FCF to assess a fundamental intrinsic value (enterprise value) of the business.
I'm assuming the "upcoming contractual payments" are either debt or debt-like items, so between signing and closing, most of the excess cash will already be going towards those payments.
Great example and the last two paragraphs were critical for me to understand this issue. Thanks chief. Hope you win a lottery
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