Entrepreneural Issues

Chapter 1
Shareholder Wealth Maximization

Entrepreneurial finance deals with the financial issues facing small businesses—an important sector of the North American economy. Small business firms may be organized as sole proprietorships, partnerships, or corporations. In Canada, almost 98 percent of all business firms are considered small. These firms account for the majority of private sector employment and nearly all of the recent net growth in new jobs.

It is difficult to arrive at a precise definition of a small, or entrepreneurial, business. However, the characteristics of small business firms can be identified. In general, small businesses are not the dominant firms in the industries in which they compete, and they tend to grow more rapidly than larger firms. Small firms have limited access to the financial markets, and they often do not have the depth of specialized managerial resources available to larger firms. Small firms also have a high failure rate.

In our discussion of the goals of the firm, we concluded that the predominant goal of financial managers is to maximize shareholder wealth, as measured by the price of the firm’s shares. Many entrepreneurial corporations are closely held, and their shares trade infrequently, if ever. Other entrepreneurial firms are organized as sole proprietorships or partnerships. In these cases, there is no readily accessible external measure of performance. Consequently, these firms often rely more heavily on accounting-based measures of performance to track their progress. Accounting-based measures of performance are discussed in Chapter 3. In spite of the lack of an objective, readily available measure of performance, the fundamental decisions made by entrepreneurs are unaltered. That is, the firm should invest resources in projects expected to earn a rate of return at least equal to the required return on those projects, considering the project’s risk. However, because many entrepreneurs are poorly diversified with respect to their personal wealth (that is, they have a large proportion of their personal wealth tied up in the firm), these owners are often more concerned about avoiding risks that could lead to financial ruin than are managers of public corporations.

As discussed earlier, in the large modern corporation, there is a concern that a firm’s managers may not always act in the interests of the owners (the agency problem). This problem is less severe in many entrepreneurial businesses because managers and owners are one and the same. An entrepreneur who consumes “excessive” perks is merely reducing his or her ability to withdraw profits from the firm. To the extent that the manager is the owner, there is no owner-manager agency problem. Of course, the potential for agency-related conflicts between entrepreneurs and lenders still exists and may be greater in the closely held firm. As a consequence, many small firms find it difficult to acquire capital from lenders without also giving the lender an option on a part of the ownership of the firm or having the entrepreneur personally guarantee the loan.

Throughout this book we will identify situations where the entrepreneurial financial management of small businesses poses special challenges. In general, we find that small firms often lack the depth of managerial talent needed to apply sophisticated financial planning techniques. Also, because significant economies of scale are often associated with using sophisticated financial management techniques, these techniques are frequently not justified on a cost-benefit analysis basis in many entrepreneurial companies.

[For more information on small business visit the SME centre at
www.cga-canada.org/eng/sme/default.htm]

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