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TABLE 2
Sources of Financing for EOY Firms: 1995

Financing Source Used: Percentage of Funding
Banks, Lending institutions 42%
Customers 16%
Family, friends, self 18%
Public offering(s) 9%
Private investors 2%
Vendors/suppliers 2%
Venture capitalists 1%
Other 11%

Operating profitability Unfortunately we did not have access to operating profits so our measure of return on investment relies on the ratio of after-tax net income to total assets. However, we are able to approximate the median after-tax operating return on total invested capital for the EOY firms and the industry sample. Our results are presented in Table 3. An explanation of the process used is as follows:

1. We begin with the median net income per $100 in sales-$3.00 for the EOY firms and $2.50 for the industries, as determined by the respective net profit margins.
2. Given the asset turnover ratios, we calculated the total assets for every $100 in sales.
3. From the debt-equity ratios, we computed the amount of debt used by the median firm and paired industry comparisonC57 percent debt to assets for the EOY firm and 38 percent for the industry.
4. We assumed an interest rate on debt of 12 percent for the entrepreneurial firms and 10 percent for the publicly-traded firms.
5. We assumed a 34 percent effective tax rate to convert from after-tax profits to before-tax profits.
6. We computed the earnings before interest and taxes as earnings before taxes plus interest expense.
7. Using the 34 percent tax rate, we estimated the operating profits after taxes-without including the tax benefit of the interest expense since it is recognized in a firm's cost of capital.
8. Finally, we calculated the operating return on total capital as operating profits after taxes divided by the total assets.

TABLE 3
After-tax Operating Return on Total Capital

  EOY Firms Industries
Net income per $100 sales $3.00 $2.50
Total assets per $100 sales $35.46 $60.24
Total debt per $100 sales $20.24 $23.06
Assumed interest rate 12% 10%
Implied interest expense $2.43 $2.31
Earnings before taxes $4.55 $3.79
Earnings before interest and taxes $6.97 $6.09
Operating profits after taxes $4.60 $4.02
     
After–tax operating return on capital 13.00% 6.70%

The resulting after-tax operating return on capital provides a crude estimate of what each group earns on a dollar of capital after taxes without regard of the source of the financing. Based on these results the EOY firms earn roughly twice as much on their invested capital as the large publicly-traded firm.

Sustainable growth rate Across firms and years, the entrepreneurial firms experienced sales growth averaging 30 percent per year, with a median of 19 percent. Since we did not have access to sales growth rates for the matching industry data, we were unable to compare these growth rates to those of their publicly-traded counterparts. However, we do know that the median growth rate for Fortune 500 companies is something less than nine percent. Also, we were able to compare EOY firms and publicly-traded firms based on their sustainable growth rates. The sustainable rate of growth for a firm is the rate at which its sales can grow without forcing the firm to alter its financing mix or issue new common stock. The sustainable rate of growth is calculated as the product of the firm's return on equity and the earnings retention rate. The resulting average sustainable rate of growth for the EOY sample is 29.5 percent, compared to only 6.2 percent for the publicly-traded firms ( 17.6 percent and 8.5 percent for the respective medians). The difference in these growth rates for the two groupings is statistically significant in both the parametric and non-parametric tests. The reason for this impressive difference is twofold: As already noted, the entrepreneurial firms are twice as profitable as their industry counterparts and, second, they retain and reinvest a higher portion of their profits. As shown in Table 1, the average earnings retention rate for the EOY firms is 96 percent (100% median), compared to 82 percent (79% median) across the paired industries.

With the foregoing comparison of the financial profiles of entrepreneurial firms relative to large publicly-traded companies within the same industries, we now turn to examining the NCER survey results for any possible insights as to the reasons for these differences.

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