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Growing and Managing a Small Business An Entrepreneurial Perspective Dr Clive Vlieland-Boddy
Learning Outcomes • List the reasons why entrepreneurs choose to purchase existing businesses • Discuss the criteria for finding the right business • Explain how to research a potential business acquisition • Compare and contrast franchising with buying an existing independent business • Discuss the various techniques for valuing a small business • Explain how to negotiate a small business acquisition
Outline • FRANCHISING • FINDING THE RIGHT BUSINESS • VALUING A SMALL BUSINESS • NEGOTIATING THE ACQUISITION Getty Images
Franchising • Franchising • A marketing system revolving around a two-party agreement, whereby the franchisee conducts business according to the terms specified by the franchisor • Franchisee • An entrepreneur whose power is limited by a contractual agreement with a franchisor • Franchisor • The party in the franchise contract that specifies the methods to be followed and the terms to be met by the other party
What is a FRANCHISE? A form of business where the franchisor sells or provides to a franchisee: • the right to do business under a particular trade name or brand • the right to use/sell a proprietary product, process, or service • training and assistance in setting up the business • a business and marketing plan • economies of scale for purchasing and marketing • a financial (accounting) system • regular inspection and quality checks once the business is established
McDonald’s Subway Burger King 7-Eleven Domino’s Pizza Hardee’s The UPS Store KFC Most Successful Franchises
Advantages Probability of success Proven line of business Pre-qualification of franchisee Overall lower failure rates Training Franchisor-provided Financial assistance Loans & loan guarantees Operating benefits Location feasibility study Marketing assistance Quick start-up time Limitations Franchise costs Initial franchise fee Investment costs Royalty payments Advertising costs Restrictions on business operations Products sold Hours of operation Restrictions on expansion/growth Franchisor only source of supplies Loss of independence Lack of franchisor support Termination/renewal clauses The Pros and Cons of Franchising
Franchisor Controls on Franchisees • Restricting of sales territory • Requiring site approval and imposing requirement on the outlet’s appearance • Restricting the goods/services that can be sold • Requiring specific operating hours • Controlling advertising
An Attractive Franchise Opportunity Includes • Registered trademarks • Successful prototype stores with a track record of profitability and a positive reputation • A business that can be systematized so that it can be easily replicated. • A product or service that can be successful in many different geographic regions.
Franchise Disclosure Requirements • Rule 436 of the Federal Trade Commission • Uniform Franchise Offering Circular (UFOC) • A document accepted by the Federal Trade Commission as satisfying its franchise disclosure requirements • Litigation and bankruptcy history • Investment requirements • Conditions that would affect renewal, termination, or sale of the franchise
An Attractive Franchise Opportunity Includes – Contd… • An operations manual that specifies all the functions of the business and their associated policies • A training and support system • Site selection criteria and architectural standards • A detailed prospectus that spells out the franchisee’s rights, responsibilities, and risks.
Three Types of Franchise Opportunities and their Associated Risks and Benefits
Franchising Arrangements • Product and Trade Name Franchise • Grants the right to use a widely recognized product or name • Business Format Franchise • Provides an entire marketing system and ongoing guidance from the franchisor • Master Licensee • An independent firm or individual acting as a sales agent with the responsibility for finding new franchises within a specified territory • Multiple-Unit Ownership • The holding by a single franchisee of more than one franchise from the same company • Area Developers • Individuals or firms that obtain the legal right to open several franchised outlets in a given area • Piggyback Franchising • A retail franchise operation within the physical facilities of a host store
Before Buying a Franchise ASK QUESTIONS
Questions to Ask BeforeBuying a Franchise • Does the franchisor have an excellent reputation in the industry? • Is the franchisor in partnership or any other legal relationship with another franchisor? If so, how will the franchisee be protected should that relationship fail? • Is the franchisee required to do anything that appears questionable from a legal or ethical perspective? • Under what circumstances can the franchisee or franchisor terminate the franchise agreement and what are the consequences to either party? • Will the franchisor grant an exclusive territory? Is that area subject to reduction or modification? If so, under what conditions?
More Questions to Ask Before Buying a Franchise • Will the franchisor reveal the certified financial figures for one of its franchises and can those figures be verified with the franchisee? • Will the franchisor provide a management training program, an employee training program, public relations and advertising support, or credit? • Does the franchisor assist in finding a suitable location? • What is the financial health of the franchisor? Can financial statements be verified?
Even More Questions to Ask Before Buying a Franchise • What is the track record of the franchise? • Has the franchisor conducted an in-depth investigation of the franchisee to assure that he or she has the necessary skills and financial requirements to operate the business successfully? • How much capital will be required to start and operate the business to a positive cash flow? Does the initial fee include an opening inventory of products and supplies? What do royalties pay for and how are they calculated?
Where to Find out about Franchises • www.franchise1.com • www.franchising.com • www.en.wikipedia.org/wiki/franchising • www.franchising.org • www.franchiseinfosite.com Getty Images
Buying an Existing Business? Acquisition of Ongoing Operations and Relationships Reduction of Uncertainties A Quick Start A Bargain Price
Good Reasons to Purchase an Existing Business • It is less risky than starting from scratch, because facilities, employees, and customers are likely to be in place. • To acquire a business with ongoing operations and established relationships with loyal customers and reliable suppliers • The business has established trade credit, which is crucial because relationships with suppliers and others take a long time to develop. • It is an easier route to owning a business if the entrepreneur has limited business experience, especially if the owner stays on for a time to help with the transition. • To begin a businessmore quickly than starting from scratch. • To obtain an established business at a price below what a new business or franchise would cost
Pros Higher chance of success Less planning Existing customers/ suppliers Necessary equipment Bargain price Experienced employees Existing business records Cons Existing problems Poor quality of current employees Poor business image Modernization required Purchase price based on inaccurate data Poor business location Pros and Cons of Buying an Existing Business
What to Look For in a Business • A business that had a broad scope that would insulate it from market downturns. • A business with existing customers and vendors. • A low-tech business but with high growth. • A market that was not so large so as to encourage major players but not so small that the company couldn’t grow. • Available float from suppliers; in other words, leeway in having to pay vendors. • Manageable seasonality. • Cost cutting potential
Investigating and EvaluatingAvailable Businesses • Due Diligence • The exercise of prudence, such as would be expected of a reasonable person, in the careful evaluation of a business opportunity • Relying on Professionals • Accountants • Attorneys • Other experienced business owners
Find Out Why the Business Is For Sale • Owner’s stated reasons for selling the business • Poor health or illness in the family • Wants to retire while he can still enjoy life • Desires to relocate to a different section of the country • Has accepted a position working for another company • Wants to start a new business in a different industry • Has to sell the business to generate funds to settle a divorce, lawsuit, etc. Beware of sellers who may have priced the business at more than its worth, or who have “cooked the books” to make the business appear to be more attractive than it really is.
The REAL reason the Business Is For Sale • Larger companies are squeezing the firm out of the market • Key employees have been leaving • The industry is very mature and there aren’t any new ways or places to grow • Competitors’ products (or services) are superior • The business has developed a negative reputation in the community • The firm is facing a pending lawsuit • The business is just not profitable • The physical facilities are old or obsolete and in need of major renovation/repairs
Examining the Financial Data • Review financial statements and tax returns for the past five years. • Recognize that financial data can be misleading. • Assets overvalued • Expenses over-stated or under-stated • Income under-reported or over-reported • Unrecorded debts • Adjust asset valuations to reflect the true state of the business.
Valuing the Business • Asset-Based Valuation • Estimates the value of the firm’s assets; does not reflect the value of the firm as a going concern. • Market-Comparable Valuation • Considers the sale prices of comparable firms; difficulty is in finding comparable firms. • Cash-Flow-based Valuation • Compares the expected and required rates of return on the amount of capital to be invested in the business.
Non-quantitative Factors in Valuing a Business • Competition • Market • Future CommunityDevelopment • Legal Commitments • Union Contracts • Buildings • Product Prices
Placing a Value on a Service Business • The biggest asset of a service company is its employees, including senior management, followed by customers and the business system. • The value of a service company is found in the quality of the relationship between its management (staff) and customers. Without those relationships, there is no business. Getty Images
Negotiating and Closing the Deal • Negotiating the Terms of the Agreement • Continuation agreement • Non-competition clause • Seller financing • Earnouts and Indemnification agreements • The final price • Full payment vs installments • Closing the sale • Best handled by a third party • Bill of sale • Tax certifications • Payment agreements and guarantees
Do Your RESEARCH! • Develop a set of criteria for judging the business based on the entrepreneur’s needs and goals. • Understand the industry and the market niche in which the business will operate. • Examine the records of the business Getty Images
More Ways to RESEARCH! • Talk to employees, suppliers, and customers • Examine equipment and facilities to make certain they are current and in good working order • Examine all contracts • Verify the value of the business based on industry statistics and perhaps the advice of a professional business appraiser. Getty Images