EV

Enterprise Value is the best metric to describe the value of a company.  Enterprise Value is a single metric that describes how valuable a company is.  It combines the value of a company’s equity(sock), revenues, profitability, cash, debt, and other factors into a single metric.  It can be used for SaaS and other software companies.   Product managers should care about Enterprise Value.

What is Enterprise Value?

Enterprise Value (EV) is the measure of a firm’s total value and factors in the entire market value instead of just the equity value. It includes considerations like cash, debt, and other factors.  A company’s value is often described as a ratio involving Enterprise Value.  Enterprise Value/Revenue (ttm) is a common metric.  It describes how Enterprise Value is a multiple of its trailing twelve months revenue.  According to the Software Equity Group’s research, in Q2 2021 the median SaaS company had an EV/Revenue ratio of 14.3x. In other words, the median enterprise Value was 14.3 times the size of the prior twelve months’ revenues.   EV/EBITDA is another common metric.  In Q2 2021 the median EV/EBITDA ratio for SaaS companies was 63.8x.

The formula for calculating Enterprise Value has seven steps::

  1. + common equity at market value (this line item is also known as “market cap”)
  2. + debt at market value (here debt refers to interest-bearing liabilities, both long-term and short-term)
  3. cash and cash equivalents
  4. + minority interest at market value, if any
  5. + preferred equity at market value (preferred shares/liquidation preferences)
  6. +unfunded pension liabilities and other debt-deemed provisions
  7. value of associate companies

Common equity is the value of a company’s stock.  For public companies, it is often referred to as market capitalization.  It is equal to the number of shares outstanding multiplied by the share price.

Debt is equal to the cost to repay any existing debt the company has.  This can include prepayment penalties.

Cash and cash equivalents are cash and marketable securities that can be turned into cash in less than a year.

The value of minority interests are investments a company has in another company where they own less than 50% of the company.  Facebook’s 2020 $5.7 billion in India’s Reliance Jio is an example.

Preferred Equity is the value of a company’s preferred shares.  Often preferred shares have liquidation preferences.  A liquidation preference is designed so that preferred shareholders (the investors) receive their money back before any of the common shareholders (employees and founders).

Unfunded pension liabilities are pension payments that a company is obligated to make, but the funds have not yet been reserved for future retiree payments.

The value of associate companies is subtracted because it reflects the claim on assets consolidated into other firms.

Usually, only three of the seven components in the Enterprise Value formula come into play – the value of common equity, cash and cash equivalents, and debt.

How Do You Calculate the Enterprise Value of a Public Company?

Since public companies are required to file detailed financial statements regularly, it is easy to calculate their enterprise value.  Most stock reporting services do it automatically.  Here is Google’s Enterprise Value from Yahoo Finance:

Google Enterprise Value
Google’s Enterprise Value from Yahoo Finance:

How Do You Calculate the Enterprise Value of a Private Company?

Calculating the Enterprise Value of private companies is hard.  First, there is no market data for the value of a company’s equity/stock.  The price of a public company’s stock is priced every day in a transparent manner.  There is no stock market for private company stock.  While venture capital financing can give you an indication, it is not definitive.  The stories of VC-backed companies that failed are legendary, like WeWork and Theranos.  Check out 210 Of The Biggest, Costliest Startup Failures Of All Time from CB Insights. Finally, private companies do not publicly release audited financial statements, certified under Sarbanes-Oxley.  This makes it impossible to determine cash levels, debt provisions, etc.

Given these challenges, you can only estimate a private company’s Enterprise Value.  A three-step process is used:

  1. Estimate the Company’s Revenues
  2. Apply industry-standard for  Enterprise Value/Revenue Multiples
  3. Discount Valuation for Being Private versus Public Company.

To learn more about each of these steps check out How to Calculate the Enterprise Value of a Private Company.

To give you an idea of current EV/Revenue and EV/EBITDA multiples for SaaS companies heck out the Software Equity Group’s (SEG)  excellent free research.  SEG provides monthly, quarterly, and annual updates on SaaS company valuations and M&A transactions.  Here is a summary from their recent Q2 2021 report:

Software Equity Group Q2 2021 EV metrics
Software Equity Group

Why Product Managers Should Care About Enterprise Value

Enterprise Value is the best metric to describe a software business.  Product managers track all types of metrics, like the infamous Pirate Metrics (acquisition, activation, retention, referral, and revenue).  Successful products should help a company increase its Enterprise Value.  Increased Enterprise Value combines many important items:

Increased Revenue & Revenue Growth

Revenue and revenue growth are key components of how contemporary software companies are valued.

Increased Profitability

EBITDA or profitability is another important component.  While many highly valuable companies are not profitable, eventually the most successful become profitable.  While Google was unprofitable in its early years, now 28 years after it was founded it has a 28.57% operating profit margin.  In the past year Google generated $75 billion in EBITDA on over $220 billion in sales.  Zoom, which just went public this year had a profit margin of over 25% and produced $973 of EBITDA on $3.2 billion in sales.

Increased Valuation Multiples

.Strong companies command high EV/Revenue and EV/EBITDA multiples. Take a look at the top 25 most valuable SaaS companies in the SEG SaaS Index:

Software Equity Group Q2 2021 EV metrics
Software Equity Group

Summary

Understanding Enterprise Value can help a product manager in many ways. First, it can help you understand how your product contributes (or doesn’t contribute) to your company’s overall success.  Second, it can help you justify more investment in your product when you can explain how the investment will grow Enterprise Value. Finally, Enterprise Value is a concept that is important to your executives and investors.  Many executives’ incentive compensation plans are tied to increasing enterprise value.


Also published on Medium.

By John Mecke

John is a 25 year veteran of the enterprise technology market. He has led six global product management organizations for three public companies and three private equity-backed firms. He played a key role in delivering a $115 million dividend for his private equity backers – a 2.8x return in less than three years. He has led five acquisitions for a total consideration of over $175 million. He has led eight divestitures for a total consideration of $24.5 million in cash. John regularly blogs about product management and mergers/acquisitions.