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  1. 1. Because learning changes everything.® Chapter Six Small Business Entry: Paths to Entrepreneurship Copyright 2021 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
  2. 2. © McGraw-Hill Education 2 Planning a Path into Business Causal or predictive reasoning is a useful technique regardless of whether you want a full-time or a part-time business. An entrepreneur uses effectual reasoning when they imagine what can be accomplished with the resources at hand. • Affordable loss is the practice of bringing your product/service to market with the minimum expenditure of capital, effort, and time. • Strategic partnerships can be either formal or informal with others who provide support to your efforts at starting your business. • Leveraging contingencies is another way of saying “recognizing and using opportunities.”
  3. 3. © McGraw-Hill Education 3 Bootstrapping, Bricolage, and Lean Business Practices These three ideas fit into both the causal and the effectual approaches. • Bootstrapping is finding a low-cost, or no-cost way to do something. • Bricolage is the practice of using whatever you have at hand. • Lean business practices mean eliminating waste and producing a minimum viable product. Both lean operations and bootstrapping share three ideas: • Waste not, want not. • Create, standardize, repeat. • Keep in touch. The key ideas of bootstrapping are simple: • Do without as long as you can and cut all expenses to the bone. • Borrow, barter, rent or lease rather than buy and consider offering equity if you must buy. • Borrow money from yourself first. • Minimize debt and limit credit card balances. • Always keep track of your cash.
  4. 4. © McGraw-Hill Education 4 The Five Paths to Business Ownership The entrepreneur can start a completely new business. They can purchase franchise rights to an existing business. They can purchase a fully operating business. They can work in a small business and eventually gain ownership. They can inherit a business from a family member.
  5. 5. © McGraw-Hill Education 5 Starting a New Business The riskiest path, but promises the greatest rewards. 87% of start-ups using an incubator are still in operation after 5 years. Not all businesses that close are a failure. Access text alternative for this image.
  6. 6. © McGraw-Hill Education 6 Advantages and Disadvantages of Start-Ups • You can “do it your way.” • You begin with a clean slate. • You can use the most up-to- date technologies. • You can provide new, unique products/services. • You can keep the business small to limit losses. • You may take the time to perfect your product/service and processes. • There will be no initial name recognition. • A start-up requires significant time to get established. • Difficult to finance with no assets, sales, or cash flow. • Cannot easily gain revolving credit from suppliers or banks. • A start-up may lack experienced mangers and workers. • You must train employees and garner management support.
  7. 7. © McGraw-Hill Education 7 Starting a New Business in an Existing Field Most start-ups are “me-too” enterprises. • Customers are familiar, offering some protection from failure. • But it can be difficult to differentiate your business from others. • Often the only competitive advantage is location. • The concept leading to a start-up usually comes from the experience of the person starting the business. • The best predictors of success is the level of experience of the founders.
  8. 8. © McGraw-Hill Education 8 Increasing the Odds of Start-Up Success 1. Start the business in an incubator or accelerator. 2. Take part in a mentoring program. 3. Have a detailed start-up budget. 4. Produce a product/service with a proven demand. 5. Secure outside investment. 6. Start with more than one founder for synergy. 7. Have experience managing small firms. 8. Have industry experience. 9. Have previous experience in creating a start-up business. 10. Choose a business that produces high margins. 11. Start the business with established customers – can be a spin-off, competition, or subcontracting. 12. Build trust in your “story.”
  9. 9. © McGraw-Hill Education 9 Franchising a Business – What Is Franchising? A franchise is an agreement between the franchisor who sets conditions and grants permissions, and the franchisee, who pays a fee and agrees to the conditions and standards. Four elements of a franchise agreement. • The franchisor grants the legal right to sell the company’s products. • The franchisor provides marketing. • The franchisee can use the branding. • The franchisee pays a fee for rights. The agreement is valued by: • The rights granted. • Cash flow potential to the franchisee. Four forms of franchising. • Trade name franchising. • Product distribution franchising. • Conversion franchising. • Business format franchising. Some companies sell master franchises which may sell sub-franchises.
  10. 10. © McGraw-Hill Education 10 Franchising a Business: Advantages, Opportunities, and Legal Considerations Perhaps the single greatest advantage is that it comes as a complete business system – some are actually “turnkey.” Finding a franchise is easy. • Entrepreneur magazine lists the top 500 franchises. • Government resources include the FTC and the SBA. • There are franchising associations. Once you have the franchise, perform due diligence, same as for any other business. • Consider interviewing current franchisees. Before you sign, study: • The franchise agreement. • The uniform franchise offering circular (UFOC). You want to know: • If/how you can transfer the license to another. • How you (or franchisor) can end the contract. • What disclosures you are required to make.
  11. 11. © McGraw-Hill Education 11 Buying an Existing Business Advantages include: established customers and immediate cash inflows; having business processes in place; and lower cash outlay required. Disadvantages include: • Finding a successful firm for sale. • Determining a firm’s worth. • Existing staff may resist change. • The firm may have a bad reputation. • The firm may be in decline due to changes in technology. • Facilities or equipment may be obsolete or in need of major repair. Use multiple sources to find the right business to purchase. • Make some calls. • Consider a broker. • Networking. • Trade journals. • The internet. • Local businesspeople and associations. • Your employer.
  12. 12. © McGraw-Hill Education 12 Buying an Existing Business: Performing Due Diligence Due diligence is the process of investigating to determine the full and complete implications of buying a business - nothing is taken for granted. • Conduct extensive interviews with the sellers of the business. • Study the financial reports and other records of the business. • Make a personal examination of the site (or sites) of the business. • Interview the business’ customers and suppliers. • Develop a detailed business plan for the acquisition. The first five steps make up the process of due diligence, after which: • Negotiate an appropriate price, based on business plan projections. • Obtain sufficient capital to purchase and operate the business.
  13. 13. © McGraw-Hill Education 13 Due Diligence A basic tenet of business law is caveat emptor, or “let the buyer beware.” Due diligence has two primary goals. • First, look for any wrongdoing – fraud, misrepresentations, or missing information. • Second, look for inefficiencies, waste, opportunities, or mismanagement. The first goal affects the value of the business and the second shows potential ways to increase the firm’s value. • This gives you a negotiating advantage. Financial statements should include: • A balance sheet. • An income statement. • A statement of cash flows. • Intangibles are likely to be misstated.
  14. 14. © McGraw-Hill Education 14 Determining the Value of the Business The most rigorous method uses discounted cash flows. • Based on estimates of future cash outflows and inflows, given the change in leadership – also highly problematic. • Due to these difficulties, it is common to use less rigorous methods. • Asset valuation. • Comparable sales. • Financial ratios. • Industry heuristics.
  15. 15. © McGraw-Hill Education 15 Determining the Value of the Business Asset Valuation Methodology Asset valuation assumes the firm’s value is assets minus liabilities, but there are two major problems with this methodology. • Such estimates do not consider the value of an ongoing firm over the value of its identifiable assets. • It is very difficult to separately identify and value all the assets. Three methods used to estimate value of a firm’s assets. • Book value is acquisition cost minus depreciation – unreliable as depreciation is arbitrary and some assets have no book value. • Net realizable value is the amount an asset would sell for, less the cost of selling it. • Replacement value estimates what an identical asset would cost to acquire and prepare for service.
  16. 16. © McGraw-Hill Education 16 Determining the Value of the Business: Comparable Sales and Financial Ratios There are two major problems with the comparable sales approach. • First, no two firms are exactly alike, and second, there are often no recent sales to use for comparison. Some of the commonly used ratios are: • The earnings multiple ratio is firm’s value divided by actual/expected annual earnings. • Pretax return on assets (ROA) divides earnings before tax by asset value. • Net income to equity is determined by dividing income by owner equity. • Net income to (equity + debt) is an extension of net income to equity that explicitly includes the value of borrowed capital. • Income capitalization divides projected net income less depreciation, interest, and owner draws, by the return you could expect elsewhere.
  17. 17. © McGraw-Hill Education 17 Determining the Value of the Business: Industry Heuristics Industry heuristics are rules of thumb used to estimate firm value in relation to some easily observable characteristics of the business. • For example, two heuristics in the small inn industry are that an inn should sell for approximately $100,000 per rental room. • The second is that an inn should sell for approximately four times its annual gross revenue. Industry heuristics can be amazingly accurate. • Industry heuristics exist for all industries and are usually available from the group’s trade association.
  18. 18. © McGraw-Hill Education 18 Buying an Existing Business: Structuring the Deal A buyer and seller get together to negotiate the final price. • The buyer should have performed due diligence and arrived at the highest price they would pay, the point of indifference. • You will open negotiations with a price below that point as you want keep the price low and the seller knows the first offer is low. • In addition to price, you also negotiate the terms of sale. • You may buy out the seller’s interest in the business. • You buy in by acquiring some, not all, of the ownership. • You may buy only the key assets and not the business itself. • You may take over a public business by controlling stock interest.
  19. 19. © McGraw-Hill Education 19 Structuring the Deal: Buyouts and Buy-Ins LLCs, corporations, and some partnerships are subject to buyouts. • Accomplished through purchasing ownership interest. • The subsequent business is considered a new entity. • Primary advantage is simplicity. • A buyout can take place all at once, in a single point of time. • An employee buyout occurs through an employee stock ownership plan (ESOP). A buy-in occurs when someone acquires part ownership. • One advantage is it allows the purchaser to leverage inside knowledge. • Another is it aids in keeping key employees. • On the other hand, key employees such as the owner or managers may be a disadvantage when they stay.
  20. 20. © McGraw-Hill Education 20 Structuring the Deal: Key Resource Acquisitions and Take Overs Key resource acquisitions, or bulk asset purchases, are the only way a sole proprietorship is purchased. • The seller keeps cash and receivables and retains short- term liabilities. • The most difficult aspect is valuing intangible assets. • One important advantage is the buyer is not responsible for any of the acts of a prior owner. Takeovers are possible only in firms with transferable stock. • The buyer purchases enough stock to gain control. • The raider gets control without permission of all owners. • Takeovers are hostile events. • The raider may liquidate all or parts of the business. • Only a few businesses are vulnerable – corporations and certain partnerships. • Rare in small businesses.
  21. 21. © McGraw-Hill Education 21 Inheriting a Business Whether inheriting or bequeathing, the problems are the same. • A successful transition needs specific actions to organize the business. • Develop a comprehensive business plan with goals and objectives. • The founder must pass knowledge to successor, who must learn. The founder must be proactive in bringing family member in. • There is no force used. • Offer experience/training. • Let them use their strengths. • Leadership does not have to be a family member. Write out your specific decisions and desires. As successor, you must gain loyalty and walk a fine line. The essential skills you need: • Technical knowledge. • Financial knowledge. • People skills. • Leadership skills. • Knowledge of your limitations.
  22. 22. © McGraw-Hill Education 22 Inheriting a Business: Ownership Transfer Do not wait until the founder’s death to transfer ownership. • If you are the founder, your desires become irrelevant. • If you are the successor, there is now no authority figure to help with issues of control and strategy. In most cases, a gradual transfer is preferable to a single inheritance. • May not work with multiple heirs. • Of greatest importance is who gets voting stock. The transfer of ownership is complex and unique to each family business. • For larger, successful firms, consider using experts and specialists.
  23. 23. © McGraw-Hill Education 23 Professional Management of Small Business If a business grows large enough, it becomes too much for one person and one of two things happens: • The business starts to decline. • Or, professional managers are hired to share the management load. Professional managers are not easy to find. • Ideally it would be a current employee. • If you have the skills and experience of a professional manager, taking a position provides a unique perspective on the business. • If you like the business, you may move to acquire it in the future. • Employee managers of small firms are often would-be entrepreneurs.
  24. 24. © McGraw-Hill Education 24 Getting Out of Your Business Succession transfers or terminates a firm. A token purchase price is a sell off, and no payment is a pass off. Closing with no debts is a walkaway. In a workout, the owner pays off debt by working another job. The worst case is bankruptcy. An entrepreneur may close one firm to start another – a serial entrepreneur. Access text alternative for this image.
  25. 25. Because learning changes everything.® www.mheducation.com End of main content. Copyright 2021 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

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