What is an Enterprise Value to Equity Value Bridge and why is it needed?

Author: Khaleem Ali, Senior Associate, Heligan Corporate Finance

The Enterprise Value to Equity Value bridge (“EV-EV Bridge”) is an essential component of any M&A deal, ensuring the final shareholder consideration accurately reflects the combination of the operating value of a business and balance sheet adjustments at completion.

To illustrate the point, when a buyer submits an indicative offer to acquire a company, the value quoted will be the Enterprise Value, based on multiplying a market multiple to EBITDA. This is the gross value of a business assuming that the company has zero cash, zero debt and no working capital adjustments at completion. The Enterprise Value therefore represents the valuation of a business based on its underlying profitability and ignoring the composition of the balance sheet.

The Equity Value however represents the value of the company after adjusting for the company’s specific balance sheet items, at a point in time, including cash, debt and working capital. Following these adjustments, Equity Value is the net consideration that will be received by the shareholders.

As an equation: Equity Value = (Enterprise Value + cash – debt +/- working capital adjustments). The buyer wants to acquire a business with a ‘clean’ balance sheet and so any cash generated prior to the deal or incurred debt is for the vendor. Adjustments are also made for working capital (one for another day!).

Why not just directly quote an Equity Value?

Primarily this is because the Buyer doesn’t have enough information. Indicative Offers are generally submitted based on an Information Memorandum which has relatively high-level information. Firstly, the Buyer has not had have access to the target company’s detailed accounts when they make an initial offer so cannot accurately make the adjustments. Secondly, they have not undertaken Financial Due Diligence (“FDD”) to provide comfort that the information and the processes to support those figures are accurate and robust.
 

A couple of examples illustrating the importance of EV-EV bridges are below:

1. Target Company A has an Enterprise Value of £10 billion.  Six months’ before the deal the business had a cash pinch so took out a very large loan facility, it now has Net Debt of £4 billion. If the buyer acquires the company for consideration of £10 billion, they are also encumbered with £4 billion of debt which needs to be repaid by them. This leaves the vendor with £10 billion in their pockets and free of debt, while the buyer essentially has an operating business worth £10 billion but now also owes £4 billion in debt, effectively having purchased an asset worth £6 billion for £10 billion, a bad deal indeed.
    
2. Target Company B has an Enterprise Value of £10 billion and had done extremely well over the last few years whereby they generated Net Cash of £15 billion which sits on the balance sheet. There is no debt. The buyer acquires the business for £10 billion and now also owns £15 billion of cash, effectively acquiring an asset worth £25 billion for £10 billion and the vendor receives consideration of £10 billion but did not benefit from the £15 billion cash generated in the past. Brilliant for the buyer, paying £10 billion for £25 billion of assets, but terrible for the vendor.

Through these examples you can see that without the EV-EV bridge, deals would not be fair, highlighting how essential this mechanism is to a fair deal.
 

EV-EV Bridge Framework: Completion Mechanisms

So, how do we administer these adjustments, from which point in time do we measure the balance sheet, do we have certainty over the final Equity Value before the completion date? These are all valid questions, and the actual framework for applying these EV-EV adjustments can be chosen through selecting a type of Completion Mechanism.

Completion Mechanisms such as locked boxes and completion accounts, define how these adjustments are made, accounting for financial changes between the initial agreement and the completion date. This structured approach protects both buyers and sellers from unexpected fluctuations, ensures transparency and fairness, and builds trust, making the complex process of buying or selling a business smoother and more predictable.

Keep an eye out for the next article where we will explore Completion Mechanisms and explain why they are critical and can be make or break moments in deals.