The value of private businesses in the United States

The vast majority of businesses in the United States are privately held, and approximately 99 percent meet a common government definition of "small." However, we know surprisingly little about the market values of these organizations. In this paper, we estimate the market value of privately held firms in the United States from sources on earnings, assets, and reported market value of multiple forms of business entities, including corporations, partnerships, LLCs, and sole proprietorships. We discuss various theoretical and practical methods of valuing assets, including those arising from economics, neoclassical finance, portfolio theory, and tradition. Concluding that most of them are not appropriate for valuing private firms, we use insights from dynamic programming and ratio analyses from traditional technique to produce a new estimate based on reported taxable earnings, net worth, and tax filing status. Using this approach, we estimate that privately held U.S. firms had earnings that exceeded those of publicly held firms in two recent years by a significant margin. Moreover, the market value of these firms exceeded that of publicly traded firms. We also conclude that policymakers, perhaps grossly, underestimate the true scale of "small" and privately held firms in the economy.

Keywords: valuation, small business, private business

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The market values of publicly traded companies are tracked on a daily basis by millions of investors, and "the stock market" is the subject of intense and nearly continuous media exposure. However, privately held companies employ the majority of workers in the United States, and produce the majority of the output. We know surprisingly little about the market values of these organizations, especially when compared with their publicly held counterparts. Such ignorance places policymakers, investors, and workers at risk when they make vital decisions about the economy in general and their individual roles within it. In particular, this lack of knowledge compromises the ability to make informed decisions in all the following matters: entrepreneurial management decisions; lending decisions where private firms (or firms that may become private) are involved; investment decisions by portfolio managers; pension decisions by both pensioners and pension fund managers; actuarial projections that involve private firm investments; public policy debates over "social security" and other assets available over the long term to fund retirement income; economic development policies for states and regions; and national tax and economic policy.

Ignorance of the market value of privately held companies also undermines many of the practices of modern finance, in which the stock market is used as a proxy for the total value of investment assets. In particular, the Capital Asset Pricing Model (CAPM) and other descendents of the mean-variance framework rely heavily on a simplifying assumption about investments: that the stock market serves as a valid proxy for the universe of equity investments available, and therefore the risks and returns of publicly traded stocks are the relevant focus of portfolio decisions by these investors. This will be discussed further below.

In this paper, we assemble data from a variety of sources on the assets, revenue, and earnings of privately held firms. Using these data, and employing a mixture of techniques, we estimate the market value of privately held firms in the United States, which may be the most important economic statistics for which there are no direct empirical data. We also demonstrate a methodology to revise this estimate in the future, and offer some suggestions for improving it.

In Section 1 of this paper, we assemble data on the number of business entities operating in the United States, define "privately held" companies, and distinguish them from other "business" entities. We also review stylized facts about "small" businesses. In Section 2. we survey the numerous classes of entities that file business tax returns, and categorize them into publicly held firms, privately held firms, and nonfirm business entities. In Section 3, we review the few available indicators of the value of businesses in the United States, including the Flow of Funds, stock market indices, and the Survey of Consumer Finances. Finally, in Section 4. we use all the foregoing material to estimate the market value of private firms, using several methods. We also compare our estimate with available direct and indirect estimates of the value of public and private firms. Section 5 closes with conclusions, some possible extensions, empirical tests of the findings, and limitations. We also include an appendix that surveys the valuation methods.

1. Information on Privately Held and Publicly Traded Firms

Most news media provide daily news about the major stock markets in the United States. However, the "stock market" includes only a small fraction of the firms in the United States. These are generally, though not always, larger and longer-established firms that have chosen the corporate form of organization for the advantages it offers to professionally managed firms that need capital investments on a large scale. As we will demonstrate below, far more firms, with larger earnings, are outside this well-publicized subset of American businesses. We start our analysis of privately held firms by looking at the available data on firms and their value.

What makes a successful business person? Business people who are tops in their field have a lot in common, and art professionals can learn a lot from

I have a theory on doing business. If my business is good, it's not because of the weather, the time of year or the economy. It's because of me. I'm doing something right. If my business is bad, it's not because of the weather, the time of the year or the economy. It's because of me. I'm doing something wrong. Somebody is always buying something from somebody, so how can I make them buy from me?

First of all, you need confidence in yourself and your merchandise with clear goals and knowledge of the products you are selling. Only then can you inspire dedication from your staff and a willingness to buy from customers.

Successful business people, no matter what their industry, have been found to share similar traits. Today's world is no longer satisfied with simply success--we want to know how the successful get to the top. The Russians developed a concept called "anthropomaximology," in which they try to answer the question of why some individuals outperform others. Through the years I've done some anthropomaximology of my own and found there are certain qualities that describe successful business people. Here are a few:

1 They constantly set higher goals Successful business people are mountain climbers who, having climbed one peak, look beyond to the next highest. They are the retailers who send 1,500 mailers to their customers and yield a good turnout of 100. But instead of being satisfied with 100, they ask how they can increase that number to 150 the next time.

For example, Donald Kelley of Kelley Frame and Art Galleries, with locations in Minnesota and Wisconsin, continually tries to improve his e-mail list. "My goal is to collect 150 new e-mail names every month and send out a new e-mail message to this list every two weeks."

2 They avoid "comfort zones" To a successful person, standing still feels like going backwards. People who stay in their comfort zones do what they did before because it's "the way we've always done it:" They run the same ads, buy the same merchandise in the same way and avoid anything new, different or unusual because they feel they might do something wrong. They blame any lack of business on the weather, the time of the year, the economy--anything except for themselves.

Successful gallery owners attend art shows, read catalogs and visit other galleries in their travels. They are always searching to find unique art exclusive to their galleries. They take control of their own destiny and market their businesses as exciting destinations.

3 They are driven by accomplishments, not money

Successful people follow the theory of Apple Computer's founder Steve Jobs, who said, "The journey is the reward." They are customer focused, not product focused. Their thrill is not the ringing of the register but the crowds responding to their mailing. For them, there is no greater high than a line outside the store before the doors open.

4 They solve problems rather than place blame

A telephone pole blocked the view of Ron Bishop's Canadian gallery. He knew it would be difficult, if not impossible, to have the telephone pole moved. His solution was to paint the pole with an Impressionistic theme. Once it was finished, the local paper came, took a picture and wrote a story about it. "It was great publicity," said Bishop. "And then the calls started coming, asking, 'Is it for sale?'"

Successful gallery owners do not waste their time looking at problems and saying, "It's not our fault" or "Why didn't we ..." They say, "Let's look at what went wrong and realize it was a learning experience and figure out how we can make it work next time."

When a customer hears it will take a week or longer to have their art framed, and says, "Sorry, that's too long," do you shrug your shoulders and say, "Well, that's how long it takes." Or do you think, "Hmmmm, if that's what the customer wants, how can I solve their problem?"

5 They look at the worst possible scenario

"What's the worst possible result if we follow this plan?" they ask themselves. Then, knowing that, they decide if the risk-taking is practical.

However, once they make the decision, they proceed with the confidence, knowledge and expertise necessary to make it work.

They understand the most harmful result and then decide if they can live with the outcome. If they can, they move ahead. Confidently.

Galleries that concentrate on one type of art often decide to reach into an unrelated area. Sometimes a gallery will fail in an attempt to broaden their focus, but successful performers understand even defeat is a learning experience.

"Every time I fail," said Thomas Edison, "I learn something." He tried 1,114 times to find a filament to stay lit in a bulb. He failed 1,113 times.

6 They rehearse the future as they see it

"I believe our future is a one-stop shop for decorating. In addition to limited-edition prints and posters, we now offer collectibles, gift items and small occasional furniture pieces," said Christine Knoll of the Art Gallery of Hog Hollow in Chesterfield, Mo.

Successful people move towards the pictures they create in their mind. They can rehearse coming actions or events as they "see" them. They are like chess players who can "feel" the next move of their opponent and have half a dozen responses ready when their time comes to move.