The unexpected cost of entrepreneurship: An examination of investor penalties as reflected in P/E ratios

This study examined the P/E ratio of privately held businesses and publicly traded firms. The comparison was made based on an assumption that investors would consider the small businesses to be a higher risk investment and would require a larger required rate of return than from investments considered less risky, such as publicly traded firms. The larger required rate of return would be indicated by significantly lower P/E ratios in small businesses. The mean P/E ratio from a sample of small businesses was compared to the mean P/E ratios of samples from the Russell 2000 and the S & P 500. A t test indicated a statistically significant difference between the groups. The results of this study indicate that the small business market and that of the publicly traded firms is distinctly different. The findings of this study strongly suggest that entrepreneurs who intend to sell their businesses must overcome the perceptions of investors relative to risk in order to obtain more than a modest selling price for their business. Investor risk perceptions can be lessened by development of systems and providing information; these actions could increase the desirability of entrepreneurial investments and would thus effect positive social change.