Small Business Management: A Planning Approach

Small Business Management:A Planning Approach Joel Corman Suffolk University, Emeritus Robert Lussier Springfield College Lori Pennel Bunker Hill Community College

PART 1The Small Business CHAPTER 3Business Ownership Options

3-1Owning a Business • Owning one’s own business means working harder for less money, less freedom and leisure time. • When the business grows and prospers, the rewards of more money and leisure time may or may not develop. • Small business should be owned by individuals who derive satisfaction from the enterprise. • Decisions such as starting a new venture or buying an ongoing small business is crucial. • One must define the specific business to avoid costly and time-consuming mistakes.

3-2 The New Venture • New ventures develop from a variety of sources. • Systematic innovation defines pure entrepreneurship • A well-defined strategy for exposing new opportunities that occur from changes in industry or in social or economic environments

3-2aExternal Causes • New products or services introduced create more business opportunities than any other source of new ventures. • Cumbersome licensing and patent procedures and the threat of imitation by large companies often hold inventors’ back. • Changes in perception is part of the social environment. • Economic changes involve opportunities that arise from necessity.

3-2bVoluntary Self-Employment • Usually arises from a variety of dissatisfactions with present employment • Starting a new venture based on perceived ways to modify a product or improve a service often uses knowledge acquired from a former workplace. • Starting a new venture in an unrestricted area or by waiting out time restrictions can avoid legal risks. • The right to manufacture a product can be obtained based on a patent.

3-2cHobbies • Awareness of a market for a product that originates from a hobby may provide an opportunity for starting a new small business, research the success potential for such a project • Ask realistic questions about the marketplace: • Is this a long-term opportunity or a short-term fad that can be exploited? • Is this a genuine business opportunity, and how to enter the market? • Select the location and employees • The business plan is the most crucial element in organizing the new venture.

3-3Buying an Established Business • Purchasing an established business is less hectic than compared to a start-up process • To buy an existing business, one could either search actively for an acquisition or acquire a targeted business. • Steps to take to acquire a company: • Find out what companies are for sale. • Formulate specific criteria for acquiring one of the companies.

3-3Buying an Established Business (contd.) • Evaluating a business for acquisition involves performing a background investigation: • Personal observation • Talking to knowledgeable parties • Talking to outside experts • Relevant thoughts to consider before buying: • Can I manage this business? Will I enjoy it? Can I afford it? • Why is the owner selling the business? • What is the competition in the area? • What are the customer and neighbors attitudes towards it? • What kind of reputation does the present owner have? • What are the profit-line trend during the past five years? This year? Are the profits consistent with the sales?

3-3 Buying an EstablishedBusiness (contd.) • What is the true value of the fixed assets and what condition are they in? • Is the area growing for business and what are the area’s nationality and politics? • What is the condition of the current assets? • Will key employees remain with the business? • Advantages • The business is in an established location. • The business already has established suppliers and customers. • Profits may be earned quickly as start-up time is less. • The owner will groom the buyer. • The odds of a continuing profit are high. • The business has built up goodwill with its customers.

3-3Buying an Established Business (contd.) • Disadvantages: • The purchase price cannot be justified. • The buyer will inherit ill will created by the previous owner. • The building and layout need modernization. • The current inventory is slow-moving or obsolete. • The business is illegally located. • The seller’s credit practices are poor, resulting in diminished cash flow and/or uncollectible accounts. • Unwanted or unnecessary employees may come with the business.

3-4 Worth of a Small Business • The large number of businesses changing hands during the 1980s and 1990s gave rise to the profession of business valuation. • Business valuation is based on information on personal, financial and legal relations. • Choosing a business valuation expert: • Check with a network of people, both within and outside the geographical area. • Should have experience of at least 15 years in the field, along with being a CPA or possessing a MBA degree.

3-4aBook Value • Used to determine a business’s value • Book value equals the value of assets minus the value of liabilities. • The difficulty with a selling price determined by book value method is: • Book value of assets is purchase price minus accumulated depreciation, and depending on the method of depreciation the book value of assets could vary. • An adjustment to the financial reports is required to estimate the business’s true value.

3-4bReplacement Cost • The replacement cost is the current valuation of assets in the business. • Intangible assets must also be examined and incorporated into the company’s replacement value.

3-4cComparable Market Analysis • The comparable market analysis method bases the value of one business on the value of other similar businesses for sale in the area by comparing: • Number of employees • Sales • Demographics • Location • Profit ratios • A price is identified from the business most closely resembling another so that one can determine a range of values,

3-4cComparable Market Analysis (contd.) • Using the method for arriving at the value • The buyer may be overpaying for a business. • The seller may be undervaluing his or her interests. • Used often in real estate transactions involving residential units • Purchasing franchise units uses this method because of a fair degree of uniformity.

3-4d Capitalized Earnings • Capitalized value is the value that would bring stated earnings at a specified rate of return. • The capitalized earnings method for determining business worth has its drawbacks: • After-tax profits can be calculated in various ways: • An income statement can be manipulated. • Adjustments to financial statements may have been made because of a change in ownership. • When using this method, it is wise to: • Check the average yearly profits for the past five years using weighted averages. • Consider the possible rate of return. • Consider the nature of future profits.

3-4e Auditing • The verification of a firm’s financial statements by an independent party • As figures on both income and balance statements can be manipulated, when auditing records determine what adjustments should be made to the seller’s statements • Beneficial to hire own accountant to perform an independent audit, to arrive at the true worth

3-5 Final Steps in Buying a Business • Negotiate to close • Two main factors: • Your top dollar price • Your target price • Keep in mind the intangible factors • Some good rules to follow • Be prepared • Identify your needs • Let your attorney be the middleman • Be ready to leave the deal

3-5Final Steps in Buying a Business (contd.) • The closing • Have your attorney ascertain that there are no legal implications or contingent liabilities • Claim on the business that may result from some action • Prepare a written purchase agreement to: • Handle the transfer of the title • All other stipulations agreed upon • Method of payment • Agreements concerning assets

3-6Acquiring a Franchise • To minimize risk of a buyout, purchasing a franchise is a good option. • A franchise is a relationship between the franchisor (seller) and the franchisee (buyer) wherein the franchisor grants the franchisee the rights and licenses to sell a product or service developed by the franchisor, which may include: • Assisting in starting or operating the business. • The right to use the corporate name or logo for which the franchisee pays a fee.

3-6 Acquiring a Franchise (contd.) • Franchises can be purchased in three major categories: • Purchase only a trade name. • Obtain a product franchise, right to resell specific products • Purchase a turnkey franchise, where the franchisor supplies a complete business format encompassing every aspect of the business. • Franchising succeeds because it enables someone to own and operate a small business using the systems and procedures of big business.

3-6aAdvantages for the Franchisor • Selling franchises lets the franchisor: • Expand in size and scope, using other people’s money. More cash is generated for the franchisor’s. • In addition to the original franchisee fee, a franchisor charges • A perpetual percentage of the gross income as royalties • Marketing and other expenses • The franchisor must maintain all service necessary to supply and supervise franchisees in order to ensure consistent quality and profitability.

3-6b Advantages for the Franchisee • For a relatively small fee, the franchiseeobtains expertise through the franchisor that otherwise would be too costly. • A franchisor may offer benefits in: • Financing • Training • Marketing • Management

3-6cDisadvantages of Franchising • Limitations the prospective franchisee must consider before signing up with the franchisor: • Costs • The better known and more profitable the franchise, the more capital required • Profits don’t start accumulating immediately, therefore enough money is required to cover expenses and shortages. • Restrictions and Limitations • As a franchise one must adhere to all policies and rules. • Exclusive territory rights which may limit growth • Franchisee is committed to paying all fees and costs associated with the agreement.

3-6dThe Trade Regulation Rule • To protect the franchisee against fraud and deception, the FTC enacted the Trade Regulation Rule, in October 1979: • Franchisors must disclose detailed information on their operations at the first personal meeting with a potential franchisee, at least 10 days before a franchise contract is signed. • To enable buyers to make intelligent decisions based on franchisors’ disclosure of information • Purchasing a franchisee requires signing a franchise contract. • Ensure that all terms are clear and agreeable.

3-7 Sources of Assistance for Small Business • Assistance to small businesses usually involves advise on: • Finance • Sales • Accounting • Merchandising • Advertising • Other business activities • Assistance can be obtained from: • Small Business Administration (SBA) • Financial assistance • Business development program • State and local SBA development companies

3-7 Sources of Assistance for Small Business (contd.) • Disaster loans • Procurement assistance • Management assistance • Service corps of retired executives • Minority enterprise agencies and associations • Small business investment companies (SBICs) • Incubator programs • Small business development centers • Venture capital firms • Trade associations • Colleges and universities • Small business institutes (SBI) • Consulting firms • Suppliers and equipment manufacturers

Small Business Management: A Planning Approach