The M&A statistics for the third quarter of 2009 are in and show the vast majority of the deals getting done are strategic.  The economic crisis and concerns over deal financing continued to significantly hold down the number and value of deals when compared to the same period last year.  Today, a Wall Street Journal article by Peter Lattman reports that leverage is out and equity is in.  Although these numbers are grim, there is reason for hope.  A number of big name deals, such as Kraft-Cadbury and Disney-Marvel, have injected the market with some much needed optimism.  These types of deals are evidence that strategic deals are going to lead the way to recovery with private equity to follow – not the other way around.

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I was asked the other day about the meaning of “enterprise value”. We have two different terminologies that are used in the marketplace: enterprise value and equity value. Enterprise value is the value of a business including its debt. Equity value is the value of the business debt free.

In some situations, you might be buying a company while also assuming its debt. That would be its enterprise value. Equity value says: “I’m going to pay you a price, but I want it debt free. You pay off the debt, do whatever you want with it, but I want to buy your company debt free.”

In today’s M&A markets, the predominant transaction type is equity value. The exception would be if a company has a capital structure that is very favorable, and the seller therefore has reason to assume it. This is not a whole lot different from buying a house and assuming someone else’s mortgage. There aren’t a lot of fees associated with it — you just slip right in. Sign a few papers and you’re done!

In the commercial world, if I can buy a company and they have very good debt I might be glad to take it on. A common example is an industrial development bond from the local government that is on very favorable terms. As a buyer, that’s most likely something that I’m going to want to keep in place. Why would we want a low-cost loan paid off? On the contrary, we could use that as part of the deal structure. So, the primary reason for selecting enterprise value would be if the buyer can secure a deal structure that’s such that the existing debt provides a benefit. If the debit is not favorable, then as a buyer I would probably opt for equity value and bring in my own debt structure.

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