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New Model for Small Businesses to Aid Investments Decisions
25 June 2012
Leicester, University of
Revolutionary ROI model for SMEs formulated by University of Leicester academics
Two academics from the University of Leicester's Institute of Finance - part of the School of Management - have proposed a new model for allowing Small and Medium businesses (SMEs) to evaluate financially their business opportunities. The suggested model considers that in SMEs, unlike those who run larger businesses, entrepreneurs who manage the firm are also the principal investors in their enterprise, which makes typical financial investment models for a return on the investment irrelevant.
Indeed, a standard financial investment model considers the risks of investing in a diverse portfolio of businesses. In SMEs, however, the entrepreneur is invested solely in their own business, with little ability to diversify the risks because of their personal huge involvement in their venture. In addition, the alternative solution of looking at the accounting figures as reported in the financial report does not sort out the problem since accounting figures are not supposed to be a tool to work out the expected return for the entrepreneur. Finally, SMEs are more than just an investment to their founders.
The University of Leicester's Dr. Andrea Moro and Dr. Sandra Nolte have developed a new mathematical model that is specifically aimed at SMEs to counteract this problem. In it, they identify the three major determinants of the risk incurred by the entrepreneur:
• the survival rate of SMEs in the appropriate ‘business cluster’
• the history of the entrepreneur’s previous successes
• the fact that entrepreneurs are not diversified.
Dr. Moro said: “The remuneration entrepreneurs have to ask has to compensate for these risks. Thus, by utilising these three factors, the formula allows SME entrepreneurs to calculate the minimum return entrepreneurs have to expect when they invest in a venture in order to be exactly compensated for the risk they incur.”
Dr. Nolte added: “This fairly simple model uses information widely accessible to those wishing to invest in SMEs and the entrepreneurs themselves, making their work easily applicable to small enterprises and readily available to investors.