Enterprise Value vs Equity Value Explained | IBV™

Two identical cafés can earn the same profit from the same customers in the same location. One has a $400,000 bank loan; the other has none. The business each owner operates is equally valuable—a buyer would pay much the same for either operation—but the owners do not hold equally valuable interests, because one owner owes the bank.

Separating the operating value from the funding structure lets a valuer compare businesses fairly and apply market evidence consistently. Funding is then dealt with explicitly, so nothing is counted twice and nothing is forgotten.

Loans between a company and its shareholders must be identified separately. A loan owed by the company may reduce equity value, while a shareholder loan receivable may increase it if recoverable and not already included elsewhere. Repayment arrangements, loan terms and any Division 7A consequences require separate consideration. These balances are common in Australian private companies and easy to misread.

Getting these balances wrong can shift the equity value by more than any debate over the earnings multiple. Our Division 7A valuation page explains when a valuation is needed for these arrangements.

A fictional engineering company has normalised EBIT supporting an enterprise value of $2,000,000. Illustrative figures only.

Equity value: $1,500,000. A pro-rata 50% allocation would be $750,000, but the value of a specific 50% interest may differ depending on the rights attached to the shares and the applicable valuation basis. It is not $1,000,000, which is what many owners would assume by halving the business value.

The example assumes that every adjustment is separately identifiable, appropriately valued and not already reflected in enterprise value or another adjustment. The $150,000 owed to the founder is also a separate creditor interest: where that founder holds the 50% parcel, the loan claim sits alongside the shareholding rather than inside it.

Equity value for the whole company is still not necessarily the value of your shares. A 25% holder usually cannot appoint the board, set dividends or force a sale; a 75% holder usually can. The shareholders' agreement or constitution may set out how shares are valued on exit, whether discounts for lack of control apply, and who may buy.

That is why a valuation must define its subject precisely—the whole business, all the shares, or a specific parcel—and the share and unit valuation service starts with those documents. The ATO's market valuation guidance similarly expects the interest being valued and its rights to be identified.

Working capital is the money tied up in day-to-day trading. Debtors plus stock less creditors is a common shorthand, but other operating balances may also be relevant depending on the business and the agreed transaction definition. A business cannot earn its profits without it, so enterprise value assumes a normal level stays in the business.

Working-capital adjustments compare actual operating working capital with an appropriate normal level. Differences in debtors, inventory and creditors may affect equity value, but recoverability, cash movements and the treatment of each balance must be considered to avoid double-counting. Unusually high debtors do not automatically represent additional economic value—a late-paying customer can create a cash-flow problem and the receivable may be impaired—so higher receivables are assessed alongside cash balances and any doubtful debts before any adjustment is made.

The normal level is usually estimated from monthly balances over the past year or two, which smooths out seasonal swings. Retailers before Christmas, agricultural suppliers at harvest and builders near the end of a large project can all show balances that look very different from their average. In a sale, this becomes the "working capital target" or "peg" in the contract, and the price is adjusted up or down on completion for any difference. Owners who understand the concept before negotiating avoid a surprise reduction at settlement.

Assets that do not contribute to operating earnings sit outside enterprise value and are added separately at their own value. Common examples in Australian private companies include an investment property, surplus land, a share portfolio, cash held for a future project, or a holiday house owned by the company.

Premises used by the business need careful handling. Where a trading company owns its premises, one approach is to assess operating earnings after a supportable market rental charge and value the property separately, often with a report from a registered property valuer. The two components must then be reconciled consistently to avoid double-counting. The appropriate treatment depends on the valuation approach and the ownership interest being assessed, so it is not a mandatory calculation in every case. Our business and property valuation service coordinates both elements so they reconcile.

A clear report states which value it concludes on, shows the bridge line by line, explains the evidence for each adjustment, and identifies the rights attached to the interest valued. If the bridge is missing, ask for it: it is often the most useful page in the report for a sale, buy-out or restructure. For purposes where others will rely on the conclusion, a Limited Scope Conclusion of Value is usually the starting point; our Fixed Professional Fees page explains each engagement.