Do a small number of entrepreneurs create very valuable companies while most create companies that are largely worthless, or do a large number of people create companies of modest value? The answer, at least according to one set of data, appears to be the former.
To address this question, I commissioned a special tabulation from the U.S. Census to see what level of sales the different companies in single cohort of start-ups achieves at age six. I picked age 6 since that seems to be an age at which most sophisticated angels and venture capitalists are trying to exit their investments.
I had to look at a fairly old cohort (1996) because I needed sales data six years later and Census hasn’t yet released the 2007 data that would permit analysis of a later cohort.
Census provided me with the count of the number of new single establishment businesses started in 1996 and the number that had reached following sales levels in 2002:
between 1 and $99,999;
between $100,000 and $499,999;
between $500,000 and $999,999;
between $1,000,000 and $4,999,999;
between $5,000,000 and $9,999,999;
between $10,000,000 and $49,999,999;
between $50,000,000 and $99,999,999;
and $100,000,000 plus.
Most exits of companies are by sale to another private company. So I used Pratt’s Stats estimates of the price-to-one-year-sales multiple for sales of private companies over the period to calculate the value of six year old businesses.
The median (typical) company was worth nothing at age six. But the value of six year old companies is incredibly skewed. The table below shows the proportion of start-ups accounted for by companies with different levels of sales and the proportion of the value created by businesses of that sales level.
The 83 percent of companies that have less than $500,000 in sales at age six account for only 4 percent of the value of the cohort of companies. By contrast, the 1.6 percent of the companies that had sales of $5,000,000 or more accounted for 54.2 percent of the value of the cohort. In fact, just the 175 companies that had reached $100,000,000 in sales or more in year six accounted for 14.5 percent of the value of the 1996 cohort of start-ups.
Generating significant financial value is something done by a very small percentage of start-ups, but a handful that do generate a lot of value.
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About the Author: Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of eight books, including Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.