- Best practices in measuring, building and protecting ownership value;
- Assisting closely-held owners in navigating family and multi-generational dynamics; and
- Data and trends of owners and the private capital markets.
Case In Point - One Value Enhancing ToolA case in point was a session led by Rob Slee, Chris Snider and Sean Hutchinson on one of my favorite topics - Economic Value (EV). The concept of EV has been widely used by public companies for decades as a tool to help insure company decisions are enhancing and not eroding shareholder value. When implemented correctly, it can be a powerful conduit that focuses an entire organization on value creating activities. But EV is rarely applied to middle market private companies.
Economic value is defined as the value created in excess of the required return expectation of the company’s capital providers (shareholders and lenders). Put another way, it is the profit of the firm remaining after subtracting out the cost of capital (debt and equity) employed to produce the profit.
The return expectation of debt lenders is relatively easy to determine, but what are the return expectations of equity by privately held business owners? Or more importantly, what should the equity return expectations be? One measure of equity expectation is a recent Pepperdine Private Capital Markets report that states the compounded annual return expectations for business owners should range between 20 percent to 43 percent based on the size and risk profile of the company. Thus, owners should expect at a minimum, that the annual return of their ownership should yield somewhere in this range based on their company’s profile.
How does a business owner achieve these returns? The tool Slee, Snider and Hutchinson suggest applying is EV. EV increases the value of a company in three ways:
- The EV metric can assess if the company, product lines, or projects are building or destroying ownership value;
- EV can correctly allocate a company’s limited capital to the best value building activities or ownership distributions; and
- The EV metric can fully align management with ownership objectives by using EV in management incentive plans, project performance evaluations, and business line measurements.