Definition
Enterprise value is the value of a business's operations as a whole, regardless of how it is financed. It is roughly what the business would be worth with no cash and no debt, which is why a multiple of EBITDA usually produces an enterprise value. Adjusting enterprise value for cash, debt and, often, working capital gives the equity value that the owners receive.
EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.
Working capital is the money tied up in running a business day to day, mainly stock and money owed by customers, less money owed to suppliers. A sale needs to agree how much of it comes with the business.
Worked example
Pinecrest Tooling Ltd is a fictional Canadian manufacturer with adjusted EBITDA of C$1,000,000. Buyer and seller agree a multiple of 4, so enterprise value is C$4,000,000.
On the completion date, the company holds C$300,000 of cash, owes C$900,000 on a bank loan and owes C$100,000 on equipment leases.
Equity value = C$4,000,000 + C$300,000 minus C$900,000 minus C$100,000 = C$3,300,000.
The shareholders receive C$3,300,000 for their shares, even though the headline value is C$4,000,000.
Adjusted EBITDA is EBITDA after normalising adjustments, showing what a business would earn with a paid manager in the owner's seat. Larger small-business deals are usually priced on it.
Why buyers care
Price discussions often mix up enterprise value and equity value. If a seller hears C$4,000,000 and expects to receive that for the shares, while you mean enterprise value, you are C$700,000 apart before diligence starts. Say clearly in your letter of intent whether the price is on a cash-free, debt-free basis with a normal level of working capital.
Agree what counts as debt, too. Finance leases, unpaid tax, customer prepayments and overdue supplier bills can all be argued to be debt-like items that reduce what the seller receives.
Due diligence is the investigation a buyer carries out before committing to a purchase, testing the finances, contracts, legal position and operations against what the seller has described.
A letter of intent sets out the main terms on which a buyer proposes to acquire a business, before due diligence and the full purchase agreement. In the UK the equivalent is usually heads of terms.