Quick answer: Enterprise value is the price of the whole business before considering how it is financed. Equity value is what remains for the owners after subtracting debt and debt-like items and adding cash, with adjustments for working capital. A headline price quoted as enterprise value is almost never the amount an owner takes home.
Key points
- Most offers are quoted on a cash-free, debt-free basis, which means the buyer pays for the business and the seller keeps the cash and pays off the debt.
- Debt-like items are obligations that behave like debt even though they are not loans, such as unpaid bonuses, deferred compensation and certain customer deposits. Their definition is negotiated.
- A working capital target, called the peg, adjusts the price up or down depending on how much working capital is delivered at closing.
- Fees, escrows and taxes reduce the cash at closing further, so read each term of the offer, not just the headline number.
Two numbers that get confused
Every business sale produces two prices. Enterprise value is the value of the operating business: what a buyer pays for the right to own and run it, regardless of how the company has been funded. Equity value is the portion of that value that belongs to the owners after the claims of lenders and other creditors are settled.
The distinction matters because owners tend to focus on the first number and spend the proceeds from the second. A business with a large loan, a lot of idle cash or a swing in working capital can have the same enterprise value as a similar business and an entirely different equity value.
The bridge, step by step
The calculation is simple to state and detailed to apply.
- Start with enterprise value. This is typically adjusted EBITDA multiplied by an agreed or estimated multiple. The guide to EBITDA add-backs explains why the earnings figure is itself negotiated.
- Subtract debt. Bank loans, lines of credit that are drawn, notes payable, loans from shareholders and finance lease obligations.
- Subtract debt-like items. Obligations that a buyer would treat as debt. These are discussed below.
- Add cash. Cash the seller leaves in the business, or that is counted in the closing calculation.
- Adjust for working capital. If the working capital delivered at closing is above or below the agreed target, the price moves by the difference. The working capital peg guide covers how the target is set.
- Result: equity value at closing. Transaction expenses, escrows and taxes then reduce the amount of cash the owner has in hand.
What counts as debt, and what is debt-like
The list of formal debt is usually uncontroversial because it appears on the balance sheet. The disagreement is over everything else. Buyers commonly look for these items.
- Accrued but unpaid compensation. Bonuses, commissions and vacation earned before closing and paid after.
- Deferred compensation and unfunded retirement obligations. Promised payments to current or former employees.
- Income and other taxes owed for periods before closing. Particularly when the buyer will inherit the entity.
- Customer deposits and deferred revenue. The seller has been paid for work the buyer will have to perform. How these are treated depends on the business and is often negotiated.
- Deferred capital spending. Equipment that has been run past its useful life and will need replacement.
- Pending legal or regulatory matters. Settlements or fines that have been agreed but not paid.
- Earnout or purchase price obligations from earlier acquisitions. Amounts still owed to previous sellers.
The test a buyer applies is whether paying the item after closing means funding something the seller’s ownership period caused. Sellers argue that ordinary operating liabilities, such as normal trade payables and routine accruals, belong in working capital and should not be double counted as debt.
An example of the full bridge
Illustrative example: From a $16,200,000 enterprise value to cash at closing
Continuing the add-back example, assume a buyer agrees to an enterprise value of $16,200,000 on a cash-free, debt-free basis. The numbers below are invented to show how the bridge works and are not a benchmark.
| Step | Amount |
|---|---|
| Enterprise value | $16,200,000 |
| Less bank debt | ($2,800,000) |
| Less equipment finance leases | ($400,000) |
| Less accrued owner bonuses unpaid at closing | ($300,000) |
| Plus cash left in the business | $1,100,000 |
| Plus working capital delivered above the target | $200,000 |
| Equity value at closing | $14,000,000 |
| Less advisory, legal and other transaction expenses | ($600,000) |
| Less indemnity escrow held back | ($800,000) |
| Cash to the owners at closing, before taxes | $12,600,000 |
The headline price was $16,200,000. The check at closing, before taxes, is $12,600,000. The escrow is not lost: it is paid later if no claims arise.
Why cash-free, debt-free is the default
Most offers for established businesses are written this way. It gives both sides a common basis for comparing proposals and lets the buyer fund the business as it chooses. It also pushes the work of negotiation into the definitions: what is debt, how much cash counts, and what working capital the business must deliver.
Sellers who compare offers should compare them on the same basis. An offer that looks higher may define debt more broadly, require more working capital, or defer more of the price into an escrow, an earnout or a note. The letter of intent guide lists the terms to compare.
Taxes and structure
Taxes sit below equity value and depend on how the deal is structured, the legal form of the business and the owner’s situation. An asset sale and a stock sale can leave an owner with different after-tax proceeds from the same headline price, and buyers often price that difference into their offers. The comparison of asset and stock sales explains the mechanics. Tax outcomes are specific to each seller, and this guide is not tax advice, so owners should model their own situation with a tax advisor before agreeing to a structure.
Common mistakes
- Treating the letter of intent price as the amount that will arrive in the owner’s account.
- Comparing offers without comparing how each defines debt, cash and working capital.
- Leaving surplus cash in the business at closing without confirming how it will be credited in the price.
- Ignoring obligations that are not on the balance sheet, such as promised bonuses or unpaid taxes, until the buyer’s accountants find them.
- Forgetting that transaction expenses are paid out of proceeds.
A transactional valuation prepared before a sale carries the analysis through to equity value, not just enterprise value, so that the owner sees an estimate of proceeds and the items most likely to change it. The overview of what a transactional valuation is describes how that fits together.
Frequently asked questions
What does cash-free, debt-free mean?
The price is set for the business as if it had no debt and no surplus cash. The seller uses the proceeds, or the cash in the business, to pay off the debt and keeps whatever cash remains. Because it applies to the price, the headline number and the check the seller receives are always different.
Is enterprise value the same as the purchase price?
Often they are the same number in the letter of intent, but the amount that changes hands at closing is adjusted for debt, cash, working capital and sometimes other items. The purchase agreement defines those adjustments, so the final figure is not known until closing.
Who decides what counts as debt-like?
The buyer and seller negotiate it. Buyers press for broad definitions that capture anything that looks like a financing obligation. Sellers try to keep ordinary operating liabilities inside the working capital calculation. A valuation done before a process lets the owner see the likely points of disagreement early.
Why do buyers subtract unpaid bonuses and similar accruals?
If the business earned a bonus in the period before closing but pays it afterward, the buyer ends up funding something the seller’s period created. Buyers treat that as a debt owed to employees and deduct it from price, unless it is already inside the working capital target.
Need a valuation you can use in a sale or acquisition decision?
The Impetus Group prepares transactional valuations from the standpoint of strategic and financial buyers. A valuation is a standalone engagement with its own scope and fee, and it can be the first step before a sale or acquisition process.
Related guides
- EBITDA Add-Backs: What Buyers Accept and What They Reject: Learn which EBITDA add-backs buyers accept in a sale, which they reject, and how adjusted EBITDA changes enterprise value, with a worked illustration.
- Net Working Capital Peg: How the Working Capital Adjustment Works: The working capital peg sets the level of working capital a seller must leave in the business at closing. See how it is calculated, negotiated and adjusted.
- How to Read a Letter of Intent: The Terms That Decide What You Receive: A plain-language guide to the letter of intent in a business sale: price, structure, working capital, exclusivity, diligence and the terms that move your proceeds.
- Asset Sale vs. Stock Sale: How Structure Changes Your Proceeds: In an asset sale the buyer picks the assets and liabilities it takes. In a stock sale it buys the owner’s shares. See how each affects taxes, risk and proceeds.
- Transactional Valuation: What It Is and How It Works: A transactional valuation estimates what a strategic or financial buyer would pay for a business. Learn what goes into one and how it differs from an appraisal.
- Quality of Earnings Report: What It Is and What Buyers Test: A quality of earnings report tests whether a company’s reported profit is real and repeatable. See what buyers examine, how it affects price and how sellers prepare.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.