Many Ways to Define Business Value

“Our business is worth $10 million,” they said.  So the buyer only needed $6 million cash to buy it.

There are many ways to talk about what a business is worth.  In the above example, $10 million can be Business Enterprise Value, while $6 million is the value of equity.  The buyer assumed a $4 million bank loan.

Here are some key definitions you will run into when talking about business values.

General Business Valuation

The Business Enterprise Value (“BEV”) is the value of everything or total assets net of current operating liabilities.  It reflects all operating free cash flows the business will ever generate.  BEV can be viewed as best aligned with what we expect the business value to represent.

The Market Value of Invested Capital (“MVIC”) looks at the business value from the standpoint of the capital necessary to finance it.

The Enterprise Value (“EV”) is BEV less cash.  Subtracting an entire cash balance does not always make economic sense since few businesses can operate without keeping a certain amount of cash captive. Still, this definition is commonly used (e.g., calculating market multiples) since it helps with comparisons among comparable companies.

The Equity Value represents the amount one has to pay to buy all equity shares (or votes) of the company.  Of course, the controlling stake can be less than 100%.

The Market Capitalization is closest to Equity Value.  It represents the value of all issued and outstanding publicly traded shares.  Market capitalization does not always represent the Equity Value.

Acquired Business Value

More confusion can be found in conversations about the purchase price of the business.

The Purchase Price represents cash consideration paid to acquire equity and to pay off debt.  It also includes the value of assumed debt or contingencies.

The Purchase Consideration represents the value of the total assets of the company, including newly acquired intangibles and goodwill.  It is Purchase Price plus operating liabilities.

The Excess Consideration includes only intangible assets and goodwill.

Headline Valuation

Finally, startup valuation is usually a lot less than what’s reported following a financing round (let’s call them “Headline Valuations”).  In fact, the number is often meaningless.

Headline Valuations are derived by multiplying the total shares outstanding by the share price of the last round.  It tries to do what we do with market capitalizations of publicly traded companies, but it fails.

Headline Valuations imply that all shares in a multilayered equity capitalization table are the same.  Yet, they are not since different financing rounds created shares with different economic rights.  The fair market values of legacy startup shares are typically lower than that of the latest round.  Thus, multiplying all shares by the value of the most privileged share materially overstates equity value.

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