Chapter 06

McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Small Business Entry

Paths to Full-Time Entrepreneurship

Learning Objectives

LO1 Describe five ways that people get into small business management

LO2 Compare the rewards with the pitfalls of starting a small business

LO3 Compare the opportunities with the pitfalls of purchasing an existing business

LO4 Explain four methods for purchasing an existing business

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Learning Objectives

LO5 Compare the advantages with the disadvantages of buying a franchise

LO6 Explain the issues of inheriting a family-owned business

LO7 Describe how hired managers become owners of a small business

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Five Paths to Business Ownership

You may start a new business You may buy an existing business You may franchise a business You may inherit a business You may be hired to be the professional

manager of a small business

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The Five Paths to Business Ownership

Franchise – A legal agreement

that allows a business to be operated using the name and business procedures of another firm.

Start-up – A new business that

is started from scratch.

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Survival Rate ofStart-up Businesses

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Figure 6.1

Starting a New Business

Advantages of start-ups Begin with a clean slate Use the most up-to-date technologies Provide new, unique products or

services Can be kept small deliberately to

limit the magnitude of possible losses

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Starting a New Business

Disadvantages of start-ups No initial name recognition Require significant time Very difficult to finance Cannot easily gain revolving credit May not have experienced managers

and workers

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Starting a New Business

Cash flows– The actual receipt

and spending of cash by a business.

Asset– Something the

business owns that is expected to have economic value in the future.

Revolving credit– A credit agreement

that allows the borrower to pay all or part of the balance at any time; as the loan balance is paid off, it becomes available to be borrowed again.

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Top 12 Indicators ofStart-up Success

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Exhibit 6.1

Special Strategies for Starting from Scratch

Home-based businesses– Businesses that are operated from the

owner’s home Partnering

– the process of two or more entities agreeing to work together for a common goal

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Special Strategies for Starting from Scratch

Because of the contributions of the partner, the founder of the start-up may either:

Reduce the amount of personal investment in time and money required to make the business succeed

“Leverage” the contributions of the partner to provide faster growth and higher returns on the investment made in the start-up

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Buying an Existing Business

Advantages of purchasing an existing business

Established customers Business processes are already in

place Often requires less cash outlay

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Buying an Existing Business

Disadvantages of purchasing an existing business

Finding a successful business for sale that is appropriate for you

Existing employees may resist change Reputation Facilities and equipment may be obsolete

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Finding a Business to Buy

First problem is finding a business for sale

Should be in an industry in which you have experience

Product or service that has demand and high margins

Adequate financing Contact business brokers

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Steps to Follow When Acquiring a Business

1. Conduct extensive interviews with the sellers of the business.

2. Study the financial reports and other records of the business.

3. Make a personal examination of the site (or sites) of the business.

4. Interview customers and suppliers of the business.

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Steps to Follow When Acquiring a Business (cont.)

5. Develop a detailed business plan for the acquisition.

6. Negotiate an appropriate price for the business, based upon the business plan projections.

7. Obtain sufficient capital to purchase and operate the business.

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Question

What is due diligence?A.An agreement between the buyer and the

seller B.Process of separating part of an operating

business into a separate entityC.Process of finding an existing business to

purchaseD.Process of investigating a business to

determine its value

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Due Diligence

Due diligence– process of

investigating a business to determine its value

Caveat emptor– Latin: let the buyer

beware

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Purposes of Due Diligence

1. You are attempting to find any wrongdoing: (1) fraud, (2) misrepresentations of the sellers and (3) missing information

2. You are trying to find any inefficiencies, unnoticed opportunities, waste, and mismanagement.

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Determining the Value of the Business

Discounted cash flows – Cash flows that have been reduced in

value because they are to be received in the future

Book value– The difference between the original

acquisition cost and the amount of accumulated depreciation.

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Determining the Value of the Business

Net realizable value– The amount for

which an asset will sell, less the costs of selling.

Replacement value– The cost to acquire

an essentially identical asset.

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Determining the Value of the Business

Comparable Sales Financial Ratios

– Earnings multiple Industry Heuristics

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Structuring the Deal

4 ways to buy Buy out seller’s interest Buy in Buy key assets Takeover

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Franchising A Business

Trade name franchising– agreement that provides to the

franchisee only the rights to use the franchisor's trade name and/or trademarks

Product distribution franchising– agreement that provides specific brand

name products which are resold by the franchisee in a specific territory

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Franchising A Business

Conversion franchising– agreement that provides an organization

through which independent businesses may combine resources

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Franchising A Business

Business format franchising– agreement that provides a complete

business format, including trade name, operational procedures, marketing and products or services to sell

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Question

All of the following are advantages of franchising, except:

A.Marketing, product placement, advertising, and promotion is all controlled for you

B.Often less risky than starting or acquiring a business

C.Franchisor often sets policiesD.Receive training and management support

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Legal Considerations

If and how you can transfer the franchise license to someone else

How you may terminate the contract How the franchisor may terminate

the contract What disclosures you are required to

make

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Inheriting a Business

Family Businesses Succession Developing a Formal Management

Structure Succession Issues for the Founder Succession Issues for the Successor Ownership Transfer

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Professional Managementof Small Business

A professional manager of a small business is one who has the experience and skills to use a systematic approach to analyzing and solving business problems.

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