1. Can someone please explain me why the buyer has to pay the enterprise value in a M&A transaction? Does the seller really receive the enterprise value? I do not understand the logical thought behind it.
2.If the existing debt is assumed by the buyer and is not refinanced, what purchase price must the buyer pay?
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Most larger M&A deals are done on what’s known as a “cash-free and debt-free basis.” So if a company has $50M of debt and $50M of equity, you could structure the deal in at least these two ways:
1. Assume the Debt: You buy the equity of the company for $50M and the debt stays the same. You owe $50M and are in the same position as the seller. Makes sense.
2. Cash-Free, Debt-Free: You pay the seller $50M and pay the seller’s lender $50M for a total of $100M. This is the enterprise value. Then, if you like, you can borrow $50M on the company, so at the point you have bought the company for $50M, but you still have $50M in debt, so this is identical to the first example from a balance sheet perspective.
The Enterprise Value formula is good to memorize, so here it is:
Enterprise Value = Equity + Debt + Preferreds + Noncontrolling Interest - Non-Operating Cash
We’ve already explained equity and debt, so that should make sense. Preferred stock works basically the same as debt except that it pays a preferential dividend instead of interest, so it works identical to debt. Noncontrolling interest is a separate topic which is explained well here (https://corporatefinanceinstitute.com/resources/valuation/minority-inte…).
Cash is the last piece of the formula. Enterprise Value is trying to get at the operating value of the business if you owned it, lock, stock, and barrel, and wanted it completely free and clear. As an extreme example, if you were buying a child’s lemonade stand that made $300 in EBITDA every year, and it also had $10M sitting in a bank account, you’d probably just say “this cash isn’t required to run the business. Let me buy the lemonade stand for a 5x EBITDA multiple and you keep the $10M.” The value of the lemonade stand itself as an operation is ~$1,500. How much cash you keep on hand is a FINANCING, not an operating decision.
It’s a bit complicated, so you should do some more reading, read some more examples, and maybe revisit this comment a few times.
Good answer but you mixed up NCIs w Associate investments
+1 SB. I said less than 50% when I ought to have said more than 50%. The key is that the P&L of the whole 100% of the subsidiary is booked on the parent company, so you should be factoring in 100% of the value of the subsidiary, even if it is not fully known.
The better thing to do from an investing perspective is to strip the noncontrolling interest out of the P&L and forget about it entirely if you can get the data to do it, but that is beyond this introductory question. Thanks again.
Thanks for the explanation! But I read that the buyer must ALWAYS pay the enterprise value, even if he assumes the existing debt. But you say that in this case we pay only the equity value or did I misunderstand?
So, let’s think about what the buyer pays in both my examples.
1. Assume the Debt: Here, the buyer pays the seller $50M upfront and still owes $50M, so in time, the buyer will have paid $100M if they want this thing free and clear (assuming no interest paid).
2. Cash-Free, Debt Free: Unlike the prior example, the buyer pays $50M to the seller AND $50M to seller’s lender, so $100M cash outlay upfront, with no future debt payments.
In both cases, the buyer has to ultimately pay $100M to get the company free and clear; the difference is in the timing of repaying the debt (at some point in the future or at time of acquisition).
It’s not true that a buyer must pay the full enterprise value upfront; you just have to buy the equity, and anything extra is paying down debt on the business.
Again, thanks for your answer. That means if we take over the debt, we only pay 50M to the owner and the other 50M will be paid off over time by paying off the debt (to the lender), right?
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