Debt free cash free: why is it used in business valuation?

Given that debt free cash free business valuation differs from shares or equity value, it’s easy for confusion to result. For example, the letter a buyer writes offering for a business might contain a debt free cash free offer of 100 million. However, as shown previously (when we looked at the difference between DFCF and equity valuation), the 100 million debt free cash free valuation differs from the 70 million the seller expects to receive for their equity/ shares. Why is debt free cash free used in business valuation at all? Here are some possible explanations.

DFCF business valuation helps with comparability

Debt free cash free provides a common basis for comparing offers for businesses. Debt levels in a business are likely to fluctuate up until the day the business is sold. By focussing on debt free cash free valuation we have a consistent way of measuring business value, irrespective of how debt levels fluctuate up until completion.

Business valuation: the buyer’s perspective

DFCF is a business valuation that takes the purchaser’s perspective. In the equity valuation chart, the buyer of the business is going to have to purchase the shares in the company for 70 million, plus make sure that banks are prepared to lend 30 million of debt. The buyer of the business is responsible for making sure a total of 100 million of financing is in place. DFCF takes the buyer’s perspective: the total 100 million of funding the purchaser is responsible for.

Business valuation & deal inflation

Perhaps people working on business transactions would rather talk about higher values rather than lower values. An adviser might prefer to tell another potential client that they have just sold a business at a 100 million valuation, because that’s a higher number than 70 million! The business owner, after the deal is done, might prefer to tell their friends at the golf club that they’ve just sold their business at a 100 million valuation!

A business valuation convention

DFCF is a convention in business valuation. We have already seen how DFCF valuation reconciles to shares/ equity value, with the bridge between the two net debt. Because we can reconcile between the two, it doesn’t really matter where we start. Convention means that debt free cash free is often used in business valuation.

Continue with the valuation course

The valuation course continues on to consider what might happen in a sale and purchase agreement.