Abstract
This article focuses on valuation issues and methods that are related to a closely held entrepreneurial enterprise. This focus is motivated by the fact that the number of small, closely held business start-ups, which we refer to broadly by the term “entrepreneurial enterprises,” continues to grow year on year, and new business ventures remain the primary source for employment growth in the USA and most industrialized nations. Also, the topic of valuation of entrepreneurial enterprises has for the most part been ignored. The traditional approaches to valuation of small, closely held entrepreneurial enterprises are, in our view, wanting in a number of important respects. Simply, traditional valuation methods are modeled in a manner that is applicable to a going-concern business with a history of sales and revenues. That is not the case for an entrepreneurial enterprise as we define it, and thus use of traditional valuation methods is questionable.
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Notes
This article draws directly, with permission, from Audretsch and Link (2012).
A closely held business is one for which the ownership is held by one or more individuals. There is no publicly traded stock.
Hébert and Link (2009) write that the historical literature in economics offers at least a dozen somewhat overlapping characterizations of who the entrepreneur is and what he or she does. These characterizations of an entrepreneur include: the person who assumes the risk associated with uncertainty, the person who supplies financial capital, an innovator, a decision-maker, an industrial leader, a manager or superintendent, an organizer and coordinator of resources, the owner of an enterprise, an employer of factors of production, a contractor, an arbitrageur, and an allocator of resources among alternative uses.
According to Hébert and Link (2009), Schumpeter’s entrepreneur was the motivating force of economic change. The talented few who carry out innovations by devising new technologies, discovering new products, and developing new markets account for the short and long cycles of economic life. Schumpeter saw economic development as a dynamic process, a disturbance of the status quo. He viewed economic development not as a mere adjunct to the central body of orthodox economic theory, but as the basis for reinterpreting a vital process that had been crowded out of mainstream economic analysis by the static, general equilibrium approach. The entrepreneur is a key figure for Schumpeter because he is, quite simply, the persona causa of economic development, and economic development occurs in industrial and commercial life by carrying out of new combinations in production. It is accomplished by an entrepreneur who is first foremost an innovator.
Whereas Schumpeter’s entrepreneur brought about disequilibrium, Schultz’s entrepreneur is an economic agent who has the ability to deal with that disequilibrium.
Hébert and Link (2009, p. 105) address this distinction by posing the following question: “Does it matter whether the entrepreneur is the person who provokes change or merely [the person who] adjusts to it? If we rely on the most elemental features of entrepreneurship—perception, courage [to take on risk], and action—the answer is probably not. Entrepreneurial action means creation of opportunity as well as response to existing circumstances.”
In our opinion, Nollsch (2010) correctly states that “Valuation is a tricky subject for early-stage entrepreneurs raising capital. With a limited performance history of the business, how do you accurately determine valuation?” He also states, “The best thing an entrepreneur can do to increase their chances of funding and improve their valuation is to focus on lowering the risk profile [being] executed on the business plan…. Ultimately, valuation for early stage companies is a negotiation exercise and requires a bit of haggling back and forth.” We disagree that the best thing an entrepreneur can do is focus on lowering the risk profile of his or her enterprise, and we argue that it is possible—for a technology-based enterprise in particular—to conduct a systematic valuation using traditional valuation tools.
Acs and Mueller (2008) present empirical information that suggests that the average effective life of an entrepreneurial start-up is short, perhaps not longer than 5 years.
There are births and deaths of small businesses every year. In 2009, the turnover rate (i.e., total deaths divided by total births) in the USA was 0.90 (US Small Business Administration 2009). This statistic does not imply that 90% of all small businesses that started in 2009 also died that same year. Rather, the total number of small firms started in previous years that died in 2009 was 90% of the total of small firms that were started in 2009. Even dying firms might be in need of valuation, if for no other reason than to determine a fair market liquidation value.
Regarding the population of small businesses in the USA, the following statistics emphasize the number of small-sized firms with fewer than 20 employees in operation. In total, 89.4% of the over 6 million firms in the USA in 2007 had fewer than 20 employees (US Census Bureau 2007).
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Audretsch, D.B., Link, A.N. Valuing an entrepreneurial enterprise. Small Bus Econ 38, 139–145 (2012). https://doi.org/10.1007/s11187-011-9409-5
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DOI: https://doi.org/10.1007/s11187-011-9409-5