On a recent episode of The Second Stage, we had the good fortune of speaking with Dr. Carl Sheeler, Managing Director at Berkeley Research Group and author of Equity Value Enhancement: A Tool to Leverage Human and Financial Capital While Managing Risk. During our conversation, Mr. Sheeler addresses the difference between a business valuation and value creation. While these are two very distinct processes, as a small business private equity firm, we believe that these are crucial concepts for business owners to understand, and not only in definition, but in relation to the effect they have on one another.
Let’s begin our discussion with third party definitions of each.
Valuation is described as follows, according to divestopedia.com
A valuation is the process of determining the fair market value of a company in a notional context meaning that the valuation is a) time specific, b) there is no negotiation, c) there is no exposure to the open market. Valuations are highly subjective calculations that aim to determine the fair market value of a company. There are many common situations when valuations are required including business reorganizations, expropriations, employee share or stock option plans (ESOPs), mergers & acquisitions M&A), and shareholder disputes.
Value Creation is described as follows, according to Reference for Business
Value creation is the primary aim of any business entity. Creating value for customers helps sell products and services, while creating value for shareholders, in the form of increases in stock price, insures the future availability of investment capital to fund operations. From a financial perspective, value is said to be created when a business earns revenue (or a return on capital) that exceeds expenses (or the cost of capital). But some analysts insist on a broader definition of “value creation” that can be considered separate from traditional financial measures. “Traditional methods of assessing organizational performance are no longer adequate in today’s economy,” according to ValueBasedManagement.net. “Stock price is less and less determined by earnings or asset base. Value creation in today’s companies is increasingly represented in the intangible drivers like innovation, people, ideas, and brand.”
With these definitions as reference points, Dr. Sheeler describes valuation as an assessment of risk associated with an asset’s ability to generate free cash flow. However, there is some gray area, who is assessing the risk?, what period of time are they looking at?, etc… Now, with a valuation in writing (whether you agree or not), you have a “baseline” as to where you are today and a decision to make. Are you satisfied with this valuation of your business? Does it meet your goal(s)? If it falls short, you have the opportunity to put a strategy in place to get you to the valuation that satisfies your wants and needs. This is value creation.
During our discussion, Dr. Sheeler puts a unique framework around value creation, which he calls “GRRK” or Governance, Relationships, Risk and Knowledge. He describes governance, relationships and knowledge as assets of the company, which all impact the risk or the value of the business. Important takeaways for business owners from this discussion include:
– Both tangible and intangible assets affect value creation;
– and you have the opportunity to create value in your business (bridging the difference between your current valuation and your desired valuation) by establishing AND executing a strategy or vision for your business with specific, measurable goals.
If an interest in exploring this topic further, I would encourage you to listen to our discussion with Dr. Sheeler in its entirety here.
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