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Subtracting excess cash to arrive at enterprise value?


widenthemoat
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Quick question for the board regarding the subtraction of cash from the market cap to get to enterprise value. The general idea behind this is that the cash is not necessary to run the business and therefore could be distributed to the owners upon an acquisition of the entire business. Why is it that nobody takes into consideration the taxes that would have to be paid when this distributions occurs?

 

Say you have a company that only has cash of $1,000,000 in the bank. Let's just assume for simplicity that a distribution of this $1,000,000 would not be considered a return of capital and therefore would be taxable at 15%. Nobody would pay the full $1,000,000 because they could only receive the $850,000 net of the taxes paid upon distribution. Is this not the same type of logic that should be applied in an enterprise value calculation?

 

Thanks in advance.

 

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Because in an M&A deal you're not paying taxes on your purchase.  Company A is purchasing company B's assets, of which cash is one.  There isn't sales tax like purchasing a car or a good.

 

Think of it like this.  You're looking to purchase a nice two drawer cabinet.  In the top drawer is $500, in the bottom are Elon Musk's Top Secret Plans Part x.  You care about the secret plans, not the cash.  You offer $5k for the cabinet.  You are really buying the plans and the fact that you receive some cash and furniture is ancillary.  Once you close the deal you now have $500 in cash reducing your purchase price to $4500, this is your enterprise value.  The "business value" are the secret plans.  There are no taxes in this scenario as well.

 

You can't pay taxes on purchasing cash unless you somehow purchase it at a discount and resell it.  If I have $1 and you pay me $1 for my dollar there was no gain or loss, it's a fair exchange.

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I guess the taxes become relevant, if one would liquidate the theoretical 1m-cash company after paying the cash out as dividend. But since most companies are valued as "going-concern", the cash will be still "there" in one way or another, like working-capital. A future potential buyer would value it the same way one did in the beginning when buying it.

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Because in an M&A deal you're not paying taxes on your purchase.  Company A is purchasing company B's assets, of which cash is one.  There isn't sales tax like purchasing a car or a good.

 

Think of it like this.  You're looking to purchase a nice two drawer cabinet.  In the top drawer is $500, in the bottom are Elon Musk's Top Secret Plans Part x.  You care about the secret plans, not the cash.  You offer $5k for the cabinet.  You are really buying the plans and the fact that you receive some cash and furniture is ancillary.  Once you close the deal you now have $500 in cash reducing your purchase price to $4500, this is your enterprise value.  The "business value" are the secret plans.  There are no taxes in this scenario as well.

.

 

You can't pay taxes on purchasing cash unless you somehow purchase it at a discount and resell it.  If I have $1 and you pay me $1 for my dollar there was no gain or loss, it's a fair exchange.

 

 

A $ in my own pocket, is worth more than a proportionally owned $ in a companies pocket, I own shares in. So, I think cash on a balance sheet should be discounted to some extend, how much depends on the quality of the management

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One way to look at it is at what time will the cash either be used for a cash flow generating, distributed or included as a part of a transaction.  (I am assuming that since you said excess cash that the cash will not be used to cover losses.)  Depending upon when you think these events will occur a discount for cash is applicable.  If the company has a history of holding onto excess cash & has no intention to distribute then a 30% discount is not unheard of but it really depends upon the situation.

 

Packer

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