Value Creation and the Entrepreneurial Business

The need to finance high growth and manage the interests and needs of investors makes value creation a critical concern for entrepreneurial businesses. Almost any financial endeavor, such as attracting new investors or making investment decisions, necessitates the consideration of the equity value created by the endeavor. The perceived value creation, for example, has a direct effect on the percentage of the firm outside investors will require if they are to invest in the business. Measuring the value created by publicly traded businesses, depending on the assumptions made, is relatively straightforward. If public markets are at least semi-strong form efficient (i.e., equity prices reflect all publicly available information regarding a business’s true underlying value), then the closing price on a large, publicly-traded company should accurately reflect that enterprise’s value. In other words, public markets take individual investors’ beliefs of the magnitude, timing and riskiness of the business’s expected future cash flows and incorporate them into the actual equity value reported at closing. Like the managers of large companies, the entrepreneur should think market value, rather than just accounting profits, when making economic decisions. Unfortunately, the major problem of measuring the value of an entrepreneurial business is that many are either privately-owned or are publicly-traded in very thin secondary markets, subsequently market assessment of the true value of the business’s equity is not readily available. This unavailability of market information makes the value creation assessment process more difficult for entrepreneurial companies, but certainly not any less important. Thus, information about the correlation of readily available performance measures with a true market value creation measure is worthwhile. This study statistically examines the relationship of non-market measures of value creation with a true market value creation measure for a sample of small publicly-traded companies (i.e., less than $100 million). We restricted the size of the companies we examined to make our sample more representative of entrepreneurial businesses, which are more likely to be either privately-held or traded very thinly in public markets. For the purposes of this study the market value creation measure utilized was shareholder return. Each company’s shareholder return was estimated using stock price and dividend information. Three different dimensions of non-market value creation measures were utilized. These three dimensions were accounting profitability, cash flow performance, and growth. Our investigation revealed that relationships between certain non-market measures of value and small entrepreneurial types of businesses existed. Statistically significant positive correlations were found between shareholder return and the earnings profitability measures of return on equity, return on assets and return on invested capital. These relationships were found to exist only for companies that reported positive earnings. Stronger relationships were found to exist between shareholder return and the cash flow performance measures of earnings growth and sales growth. Furthermore, the sales growth measure was found to be correlated for companies that had positive earnings and companies that reported negative earnings.