You have been putting time and effort into your business for years, and you are now ready to take the next step. Maybe you’re considering a sale, or you want to attract an investor. But how do you know you’re getting a fair price? One of the most important things to consider when purchasing or selling a company is determining the right value. In this context, you often hear terms such as enterprise valuation and share valuation. These may appear to be the same, but there is an important distinction between the two. This difference is what we refer to as the bridge.
From enterprise valuation to share valuation
In order to go from an enterprise valuation to a share valuation, a number of adjustments must be made. The following are the most important changes:
- Financing entries: Entries that relate to the way in which the company is financed must be eliminated.
- Non-operating balance sheet entries: Entries that do not affect the core business activities, but do appear on the balance sheet, must be included in the share valuation. These entries have no operating cash flows, but they are part of the business.
Examples of adjustment entries that are also included in the bridge include:
- Interest-bearing debts (debited);
- Unrestricted cash and cash equivalents (credited);
- Surplus/shortage of “normal” working capital (credited/debited);
- Claims against a shareholder (credited)
- Provisions resulting in an outflow of cash and cash equivalents (debited).
Cash and debt-free value
Draft deeds of purchase often use the term “Cash and debt free value”. This means, simply put, that the enterprise value is corrected for the interest-bearing debts, surplus cash and cash equivalents and other “cash- and debt-like” items. This thus concerns share value, as stated before.
This bridge can also be applied if the enterprise value was calculated not via de DCF method but via multiples, for example.
Why is the bridge so important?
Many parties focus first and foremost on enterprise valuation. Many potential buyers and sellers think that the sales price will be easy to determine once the enterprise value has been established. However, as you have read above, many corrections could be necessary. Think, for example, of what “normal working capital” actually is. This could significantly affect the final sales price.
Normal working capital
The normal working capital is often determined using a reference point, such as the average of the previous 12 months before closing. However, this could be different for companies with seasonal factors. It is important not to include future cash flows in the valuation, since these are already included in the enterprise valuation.
Discussion may also arise on which entries must be considered normal working capital and which entries are cash and debt-like and must therefore be corrected. It is essential to correct non-operating entries during the bridging process.
The small print makes the difference
Small details can make a big difference. In draft deeds of purchase you can often find the term “locked box”. This means that the business is put in a “box” between the “effective sales date” and transfer before the civil-law notary. During this period, no money may flow out of the business, for example due to increased management fees, salary adjustments, rent increases or dividend distributions. Any withdrawals that were not discussed will always be corrected on the purchase price.
For more information about the “locked box” you can also read our previous article: Locked Box and Closing.
In conclusion
If you have any questions about the value of your enterprise or shares, or want a more detailed explanation about the bridging process between enterprise and share valuation, please contact us. We are happy to be of service!