Finance Things Nobody Explains (pt. 1): Enterprise v. Equity Value

Finance Things Nobody Explains (pt. 1): Enterprise v. Equity Value HAVE YOU EVER COMPANY GETS ACQUIRED FOR A BILLION DOLLARS, BUT NOBODY ACTUALLY RECEIVES A BILLION THAT CONFUSES A LOT OF PEOPLE, SEE THE HEADLINE, IT SOUNDS LIKE JUST GOT SOME BILLION DOLLAR CHEQUE THEM. BUT THAT'S NOT HOW ACQUISITIONS WORK. THE REASON COMES DIFFERENCE BETWEEN ENTERPRISE AND EQUITY VALUE. AND HONESTLY, OF THE MOST IMPORTANT CONCEPTS IN ALL OF FINANCE. LET'S SAY A COMPANY GETS ACQUIRED FOR $1 BILLION. MOST PEOPLE ASSUME SHAREHOLDERS THEN RECEIVE $1 BILLION. BUT WHAT IF THAT COMPANY HAS $300 MILLION OF DEBT? WELL, WHOEVER BUYS THE COMPANY IS ALSO TAKING RESPONSIBILITY NOW FOR THAT DEBT. SO THE BUYER ISN'T JUST PAYING FOR THE EQUITY, THEY'RE PAYING FOR THE ENTIRE BUSINESS. THAT'S WHY WE USE ENTERPRISE VALUE. ENTERPRISE VALUE REPRESENTS THE VALUE OF THE ENTIRE COMPANY, REGARDLESS OF HOW IT'S FINANCED. THINK OF IT AS THE COST TO ACQUIRE ABSOLUTELY EVERYTHING. THE OPERATIONS, THE ASSETS, THE DEBT, THE WHOLE PACKAGE. SO IF THE ENTERPRISE VALUE IS A BILLION DOLLARS, EXAMPLE AND THE COMPANY HAS 3 300 MILLION OF DEBT, THE EQUITY HOLDERS AREN'T GETTING A BILLION DOLLARS, THEY'RE GETTING ROUGHLY 700 MILLION. NOW, LET'S FLIP THAT EXAMPLE. WHAT IF THE COMPANY HAS $300 MILLION OF CASH AND NO DEBT? IN THAT CASE, THE SHAREHOLDERS COULD ACTUALLY RECEIVE MORE THAN WHAT YOU EXPECT BECAUSE THAT CASH, OR EXCESS CASH, BELONGS TO THEM. THAT'S WHY YOU'LL OFTEN HEAR FINANCE PROFESSIONALS SAY THINGS LIKE ENTERPRISE VALUE EQUALS EQUITY VALUE PLUS DEBT MINUS CASH. AND THIS CONCEPT MATTERS EVERYWHERE. IT MATTERS IN INVESTMENT BANKING. IT MATTERS IN PRIVATE EQUITY. IT MATTERS IN VALUATION, M&A, CORPORATE FINANCE, YOU NAME IT. ACCOUNTING. BECAUSE WHEN BUYERS EVALUATE BUSINESSES, THEY'RE USUALLY VALUING THE OPERATIONS OF THE COMPANY, NOT JUST THE STOCK. SO THE NEXT TIME YOU SEE SAYS A COMPANY SOLD FOR $1 BILLION, JUST REMEMBER IT DOESN'T NECESSARILY MEAN THE SHAREHOLDERS OR THE OWNERS OR WHOEVER ELSE GOT A BILLION DOLLARS. THE FIRST QUESTION FINANCE PEOPLE ASK IS, WAS THAT ENTERPRISE VALUE OR EQUITY VALUE? BECAUSE THOSE TWO NUMBERS ARE VERY, VERY DIFFERENT. IF YOU WANNA SEE MORE, HIT THE CLICK THAT LINK IN MY BIO.