Redefining Fundraising Dynamics: Harnessing Enterprise Value Strategies

Whether you’re fundraising or looking for an M&A deal, enterprise value strategies play a significant role.

The Enterprise Value (EV) calculates the company’s value and is a more comprehensive overview. Experts may also use the metrics to base other financial ratios to gauge performance.

Similar to other valuation strategies and methods, EV takes market capitalization into account. However, it also includes factors like the balance sheet’s cash balances or cash equivalents.

The startup’s short-term and long-term debts also feature in the enterprise value.

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Estimating the startup’s EV provides a precise understanding of its credibility and, thus, influences negotiations during funding and M&A. Potential investors and partners evaluate the startup as a good candidate for backing with capital. Enterprise value is the startup’s total value and a key metric for acquirers wishing to purchase the company.

Several factors can determine the EV, which is dynamic and changes depending on its operational performance and overall market conditions. Investment-related activities that result in the founder ceding equity in exchange for capital can also affect the startup’s value. However, a negative asset flow that attracts funding from investors need not be a downside. Read ahead in detail to understand enterprise value strategies.

Enterprise Value Strategies – Key Components

Enterprise value strategies deploy statistics from the company’s financial statements and current market pricing. Here are some of the key components:

• Total Debt: The total of the long-term and short-term debts. The EV calculation factors in the debt since it raises the amount the buyer would need to invest to purchase the company.
• Market Cap: The total value of the outstanding common and preferred stock. Overall market conditions and participants determine the market cap. It does not represent the company’s book value.
• Cash and Cash Equivalents: The total amount of cash in the company’s books. This figure also includes money orders, certificates of deposit, drafts, money market funds, and commercial paper. Any Treasury bills and short-term government bonds also count toward cash balances. Marketable securities could be excluded from the cash assets.
• Minority Interest: In the case of subsidiaries with less than 50% ownership, the minority interest is also an asset and features in the EV calculations.
• Pension Payments: Companies must set aside a portion of the capital to make pension payments. This portion is also added to the market cap when calculating the EV.

Calculating the Enterprise Value

Experts must meticulously analyze industry indicators specific to the targeted company when calculating enterprise value. They must also factor in the data gathered from its financials.

Each business is unique, and the results of the analysis will vary according to the objective of the analysis, for instance, whether a sale or investment. It’s advisable not to view the EV as a measure of the startup’s success. This value relies on several factors, and market variables influence the numbers significantly. Instead, business owners should conduct valuation as an ongoing exercise.

Analyzing and arriving at figures from time to time helps owners assess the company’s progress and sets up benchmarks. You can revisit the numbers regularly at fixed intervals. These figures especially come in handy when you’re deploying new strategies. The EV will help you evaluate whether the approaches are achieving the desired outcomes and KPIs or Key Performance Indicators. Essentially, enterprise value is calculated using this formula:

Enterprise Value = Market Capitalization + Total Debt – Cash/Cash Equivalents Or

Enterprise Value = Equity Value – Non-Operating Assets + Liability + Equity Items Owned By Other Investors

To calculate the market capitalization, you can use this format:

EV = Number of Outstanding Shares x Current Stock Price + Total Debt – Cash/Cash Equivalents

Why Enterprise Value Strategies Are Helpful

Since the enterprise value is significantly different from typical market capitalization, investors may prefer to rely on the numbers. The EV is essentially a more precise representation of the company’s value because it indicates how much buyers would have to pay to acquire the company.

Sometimes, if a company is not using its assets efficiently, the EV could be negative. It may have spare cash and cash equivalents that add up to a higher total of its market cap and debts. Using this cash to cover distributions, R&D, employee salaries and bonuses, and paying off debts could raise the value. The company can also undertake expansion, maintenance, and buybacks that can again improve its performance.

Investors also use enterprise value strategies to evaluate the company’s performance. The figure accounts for EBITDA or the Earnings Before Interest, Taxes, Depreciation, and Amortization. The EBITDA indicates the company’s ability to generate earnings and revenues.

EBITDA = Net Income + Interest Expense + Taxes + Depreciation + Amortization

Although investors may use the EBITDA figure as an alternative to the net income, it can be inaccurate and misleading. That’s because it disregards the cost of capital purchases the company may have made to acquire equipment, machinery, and premises.

To cover this downside, some investors may use the EBIT figure instead to eliminate depreciation and amortization costs. These costs could be related to premises, plant, equipment, machinery, and tools.

Comparing Enterprise Value vs. EBITDA

Analysts and investors comparing companies within the same industry use these enterprise valuation strategies. The EV/EBITDA metric is a valuation method that compares the company’s value and its debt to its cash earnings, but after deducting its non-cash expenses. This calculation is helpful when valuing capital-intensive companies that have a high number of fixed assets like tools and equipment. Assets like these have high levels of depreciation and amortization.

However, keep in mind that even though the earnings per share (EPS) are negative, EBITDA typically remains positive consistently. On the flip side, the EBITDA factors in the cash flows from operations (CFO) or operational cash flows (OCF). If the working capital is increasing, the EBITDA will also be higher. The working capital is calculated as:

Cash/Accounts Receivables/Customers’ Outstanding Bills + Inventories/Raw Materials + Finished Goods – Accounts Payable + Debts

Calculate the EV vs. EBITDA factors in the free cash flow against capital expenses or CapEx. The analysis is accurate only if the CapEx is equivalent to the depreciation costs.

Comparing Enterprise Value vs. Market Capitalization

As explained earlier, the market capitalization is the total value of the common and preferred stock. The share value cannot accurately value the company since this figure doesn’t account for its cash reserves and debt.

Enterprise value strategies go one step further than market capitalization. They include information about the cash and debt when arriving at precise values that investors and acquirers can rely on.

Let’s try an example. Two companies, Produxo and Technovier, have the same stock price of $3.5 per share. Both companies also have a market capitalization of $3.5M.

Let’s assume that Company Produxo has cash and cash equivalents worth $500K and a total debt of $300K.

As a result,

its Enterprise Value (EV) = $3,500,000 + $500,000 – $300,000 = $3,700,000.

On the other hand,

let’s say Technovier has cash and cash equivalents worth $750K and a total debt of $400K.

As a result,

its Enterprise Value (EV) = $3,500,000 + $750,000 – $$400,000 = $3,850,000.

As you can see, although both companies have an identical share price, the enterprise value indicates a marked difference. Investors looking for a viable investment opportunity will want to go with Technovier. However, potential acquirers may want to go with the company Produxo since they’ll pay a lower price.

Of course, several other factors may influence the negotiations, but the EV is a good starting point.

Comparing Enterprise Value vs. Price to Earnings Ratio (P/E) Ratio

The price-to-earnings ratio (P/E) compares the company’s current share price to the earnings per share (EPS). The price-to-earnings ratio is also termed the earnings multiple or price multiple. This value again falls short when arriving at a precise valuation figure. That’s because it does not account for the debt standing in the company’s financials. However, the share value is a crucial component when calculating the enterprise value.

Comparing Enterprise Value vs. Sales

Yet another of the enterprise value strategies analysts use is the enterprise value to sales ratio or EV/Sales. This metric is more reliable than the Price per share or PPS/Sales ratio because it accounts for the debt the company must pay off at some point. A lower EV/Sales multiple is a positive indicator, demonstrating that the company is viable or undervalued. This figure can also be negative if the company has higher cash reserves than its debt and market capitalization. It tells investors and potential acquirers that the company can pay off its obligations.

Where Enterprise Value Strategies Fall Short

Although enterprise value strategies can be significantly helpful in determining the viability of a company, they have their limitations. For instance, the EV includes the total debt a company carries. But, how it acquired the debt is the more crucial factor.

In the case of capital-intensive verticals like life sciences and oil and gas, the company may have purchased assets. For instance, premises, equipment, lab space, tools, R&D inventory, and other fixed assets. These expenses are crucial for the company’s growth and allow for the potential of rich returns. However, other sectors like financial services, digital marketing, and consultancies don’t require major startup capital investment.

As a result, investors and acquirers will want to examine the debt more closely. This is why enterprise value varies between verticals. The objective for analyzing and arriving at EV metrics is also a consideration. Acquirers evaluating the company are likely to focus on the debt and payables it carries in its financial statements. Their goal is to assess the debts they’ll pay off after the acquisition or merger.

Investors looking for viable opportunities are more concerned with the company’s future prospects and overall performance. Since the EV for companies in similar industries can also vary significantly, investors will examine each component of the EV more closely for performance indicators.

Why Enterprise Evaluation is Crucial for Startups

For multiple reasons, analyzing enterprise value and getting an accurate estimate is crucial for startup owners. They get an overview of the company’s performance and growth trajectory. Setting milestones for its internal operations to align its goals and value creation objectives is easier. Identifying the areas that need improvement, the essential skill sets needed to push growth, and the key resources in which to invest. These are only some aspects in which EV analysis helps.

Owners can negotiate more favorable terms when raising capital or considering an M&A deal using the values. Assessing the company’s true financial worth enables owners to make sound decisions when it comes to equity distribution and planning for its long-term financial status. Strategic partners and investors use the metric to evaluate the company’s credibility. The more favorable the EV, the higher the number of potential collaborations offered to owners.

Not just internal analysts, third-party evaluators, and consultants are also interested in the company’s EVs as sources of critical data. They use the metrics to provide well-informed guidance and advice to owners on managing their operations and decision-making.

The Takeaway!!

Company owners can consider retaining the services of professional valuation teams to evaluate it. Enterprise value strategies can help you get comprehensive insights into the company’s performance. The figures give a precise perspective of its financial standing. Assessing the EV from time to time against evolving macroeconomic and enterprise-specific factors is crucial for long-term sustainability. Companies can adapt and remain agile in response to the changes in the economic and investor ecosystems. Most importantly, company owners can design strategies that ensure profitability and scalability, ensuring success and growth.