The Equity Bridge From Enterprise Value To Equity Value

• Published date: 02 October 2023
• Subject Matter: Corporate/Commercial Law, Tax, M&A/Private Equity, Sales Taxes: VAT, GST, Withholding Tax
• Law Firm: Aabo-Evensen
• Author: Mr Hans Kristian Nygaard

Preamble

The article The equity bridge deals with which tax items and other accounting items should be taken into account when calculating from enterprise value to equity value when selling a business.

The article explains what is meant by correcting for deviations from normalized working capital (NWC), including the significance of choosing closing accounts as opposed to a locked box balance as the basis for the calculation of working capital. Then it is discussed how to correct for net debt (net debt) and surplus liquidity (cash / cash equivalents).

Finally, the article considers how to calculate enterprise value using the EBITDA x multiple, below how to calculate the multiple mathematically using a modified Gordon's valuation model.

Keywords: The equity bridge, enterprise value, equity value, normalized working capital, closing accounts, locked box, Gordon's valuation model.

1. INTRODUCTION

When you are selling a business, you will find that the advisers on both the buyer's and the seller's side use words and expressions that at the start of the transaction may seem foreign and unfamiliar to the person who is selling their business. The article The equity bridge deals with which tax items and other accounting items should be taken into account when calculating from enterprise value to equity value when selling a business. However, as the sales process progresses, the seller will experience that what were initially foreign and unfamiliar words and expressions turn out to be precise formulations of critical elements when determining the purchase price. Examples of such expressions are the equity bridge, and from enterprise value to equity value, which describes which tax items and other accounting items must be taken into account when calculating the final value of the company (purchase price).

In this article, we will address three critical components that directly affect how much money the seller will receive for their shares. The three components are closely linked, but are nevertheless three different factors that influence the purchase price, and they are:

• Deviation from normalized working capital (normalized working capital / NWC);
  
  
• Net debt (net debt); and
  
  
• Cash / cash equivalents / surplus liquidity (cash / cash equivalents)

The three components together make up the equity bridge, and can be shown as follows.

We will start by getting an overview of where we are in the process of selling the company.

2. ENTERPRISE VALUE

2.1 Enterprise value as a starting point for the share value

Enterprise value (EV) is the fair value of all assets in the business, i.e. the fair value of all assets in the entire group.

There are many reasons why almost all M&A transactions are based on enterprise value. Firstly, enterprise value will show the value of the entire business, not just the equity. Secondly, enterprise value ignores how the business is financed, i.e. it ignores the capital structure in the balance sheet. Thirdly, the use of enterprise value will make it easier to compare your sales with the sales of other similar businesses, as when calculating enterprise value , one ignores individual circumstances to a certain extent linked to the businesses, such as tax matters, pensions and dividends.

Enterprise value can be calculated on the basis of a number of different valuation models depending on the business the company operates, the phase the company is in and the industry it is in. The valuation models are often divided into profit and cash flow-oriented models (normal profit, EBITDA x multiple, net discounted cash flow, etc.), and balance sheet-oriented models (accounting value, net asset value method, etc.).

One of the simplest models used to calculate enterprise value is to multiply group EBITDA by a multiple, where the multiple is either calculated from multiples from comparable actually completed transactions (pure-play companies), or calculated based on a modified Gordon's valuation model.

2.2 Enterprise value, operating capital and normalized working capital

Enterprise value consists of operating capital and working capital. Working capital is the fair value of all the assets in the business that are used to produce goods and services, such as machinery and other operating assets. Working capital is net assets that are critical to the liquidity of the business, such as accounts receivable, goods, accounts payable, operating credit and overdraft.

In practice, determining the fair value of the company's working capital will not present particular difficulties. linked to the businesses, such as tax matters, pensions and dividends. But when it comes to working capital, or more precisely, normalized working capital, and the relationship to net debt, and excess liquidity (cash / cash equivalents), the picture becomes more complex.

3. NORMALIZED WORKING...