In what sense is enterprise value the value of a firm
From what I understand, enterprise value is the amount a buyer would need to put up to buyout a company. I don't understand why debt is part of it -- when we buyout a company, why are we liable to the debt? Aren't equity holders shielded from that?
10M equity value, 3M debt outstanding. I need to putup 10M to buyout the company--100% equity. Why isn't that the end of the story? In what sense is this company worth 13M to me?
Think it of it terms of the balance sheet. The excess of assets over liabilities is equity. The liabilities represent the assets of the company that are owed to debtholders. if you want to buy the whole company, assets and all, you will either have to buy the debt out or if you're just interested in the equity (the value of the assets that isn't associated with a liability) then you would refinance, or keep existing debt on there.
In layman’s terms- If you buyout 100% of the equity you own the company right? Okay, now considering you own the company, who needs to pay off the debt?
You.
That’s why it’s included in the price of the company.
In most loan agreements, a change of control provision will allow the bank to "call the loan" which requires the borrower to pay off the loan in full immediately (i.e., lender won't just roll over their debt to a new person who buys the company). In the majority of LBOs, the old lender group is taken out of the cap structure. New debt providers are used to re-lever the company which "juices" equity returns. This also resets the maturity of all debt in the capital structure at the same time a new owner is taking over which can be very important especially for cyclical businesses.
Since you buy out the equity and debt holders in an LBO, that's why EV is the price.
And that's why there are castles in England for 1 pound. You have to pay their royal debt
So I guess I’ve only been thinking equity = “ownership”.
Assets = Equity + Debt
To own all assets, you need to put up the amount on the RHS. If you only pay equity, technically cash generated goes to debtholders first. So even though you “own the company” you don’t have a first claim to assets
We subtract cash because it doesn’t generate returns directly in terms of core ops, and we can either pay that to debtholders or to equityholders as dividends.
Is it pretty much as simple as that?
We subtract cash to arrive at net debt because we operate under the assumption that any cash or cash equivalent is available to service / repay any outstanding debt. Nothing to do with dividends etc as far as I've known
Simply put, when you buy a company you are assuming not only equity ownership but also all outstanding liabilities (which may often times not be debt but legal or environmental obligations which can contribute to huge value leakage if not identified). So the EV represents the whole of what you would need to pay in order to fully acquire the target along with it's outstanding obligations.
With your example - yes you can gain equity ownership with the 10M in equity, but think about the capstack. You can't buy the firm without providing its credit-holders with either a refi or liquidity event and if the value of the outstanding debt (simplistically) is 3M, you will be responsible for meeting that obligation along with the equity value of 10M
I use a somewhat different definition when it comes to enterprise value. It’s not really the amount you buy a company with. It’s the value of the operating assets of the company. Now it becomes much easier to explain because operating assets are funded by both debt and equity. That’s why you need to add both. Why subtract cash? That’s because cash is non operating.
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