The question: does an investment with negative equity, but positive cash flows, mean positive or negative value for the investor? Using the earnings multiple valuation method, if net debt is greater than EV, then equity value is negative for the investor. However, it also seems intuitive that if FCF is positive (after interest payments are deducted), then the investment should have a positive value. So, which one is correct?

This is a similar issue that VCs have with investees that don’t have positive earnings (or only slightly positive earnings). If they use an earnings multiple to arrive at EV (and hence equity value), then often they will see negative equity value. But, there’s usually value in patents or technology or products or people or distribution channels or other IP. VCs deal with this concept on a daily basis, but private equiteers don’t (well, they do now), so it all seems quite foreign to them.

The simple solution is to use another valuation method, such as DCF, comparables, or revenue multiples. But, this seems like finding a solution to give a desired outcome. Maybe, these investees are really worth nothing. Maybe, the inherent risk in them has a greater cost than the PV of the cash flows. Maybe, these cash flows represent a return less than the required return to the investor. In all honesty, I’m not feeling the need to change valuation methods; if the numbers are poor enough to show negative equity but positive cash flows, then I think I’d leave it for another investor or another day.