This Document Contains Chapters 13 to 15 Chapter 13 Strategic Entrepreneurial Growth SUGGESTED ANSWERS FOR DISCUSSION QUESTIONS (END-OF-CHAPTER) 1. In what way does an entrepreneur’s vision affect the company’s strategic plan? To a large degree, venture planning is an extension of the entrepreneur’s ego. Planning is the process of transforming entrepreneurial vision and ideas into action. This is done through three basic steps: (1) Commitment to an open planning process (2) Accountability to a corporate conscience (3) Establishment of a pattern of subordinate participation in the development of the strategic plan 2. How is the strategic plan of an engineer/scientist entrepreneur likely to be different from that of an entrepreneur whose primary strength is in the manufacturing area? Be complete in your answer. In smaller companies, the owner’s personal objectives will influence company objectives. The engineer/scientist entrepreneur will tend to develop a strong technological edge, while the entrepreneur whose primary strength is in the manufacturing area will use these skills in determining the company’s objectives. Company objectives are chosen to exploit the strengths of the business and sidestep its weaknesses. Primary consideration is usually given to objectives such as return on investment, sales growth, productivity, cost containment, and personal acquisition and development. 3. Give three reasons why many entrepreneurs do not like to formulate strategic plans. (1) Time scarcity—Some feel they do not have the time to allocate to planning. (2) Lack of knowledge—This may be due to minimal exposure to and knowledge of the planning process. (3) Lack of expertise—Many of those who do have the knowledge of the planning process still lack the specialized expertise necessary in the planning process. 4. Does strategic planning really pay off for entrepreneurial ventures? Yes. Improved performance is often the result of planning. A recent study showed firms recognized cost savings, accurate forecasting, and faster decision making as a result of long-range planning. 5. Describe the entrepreneurial strategy matrix and explain why it is effective for entrepreneurs. Researchers Sonfield and Lussier developed an entrepreneurial strategy mix that measures risk and innovation. Innovation is the creation of something new and different. Risk is the probability of major financial loss. The model allows even the most inexperienced entrepreneur to characterize their new or existing venture situations and identify appropriate strategies. 6. Briefly identify and describe the stages of development for a new venture. New venture development—consists of activities associated with the initial formulation of the venture. Start-up activities—encompasses the foundation work needed for creating a formal business plan. Growth—this stage is a transition from the entrepreneurial one-person leadership to managerial team-oriented leadership Business stabilization—sales begin to stabilize and the entrepreneur must begin thinking about the enterprise will go over the next three to five years Innovation or decline—firms that fail to innovate will die 7. Firms that fail to innovate will die. What does this statement mean in the context of new ventures? If a firm is not looking to bring in new sources of revenues, its operations will stagnate as the market changes. Companies may acquire new firms or create new products or services to acquire new customers. A company must swing into high gear to gain more profitably or it will swing into decline and failure. 8. How can entrepreneurs build an entrepreneurial firm? Be complete in your answer. Entrepreneurs can build an entrepreneurial firm by: (1) Sharing the entrepreneur’s vision (2) Increasing the perception of opportunity (3) Institutionalizing the perception of the opportunity (4) Institutionalizing change as the venture’s goal (5) Instilling the desire to be innovative through a reward system, an environment that allows for failure, flexible operations, and the development of venture teams 9. Successful ventures balance entrepreneurial characteristics with managerial style. What does this statement mean? A successful venture requires both an entrepreneurial perspective and a managerial perspective. It is important that manager utilize both types of perspective when appropriate. The entrepreneurial perspective looks for new opportunities, while the managerial perspective tries to ensure the company has what it needs to succeed in meeting performance goals. 10. Comparing the entrepreneurial focus with the administrative focus involves five major areas of consideration. What are these areas? Strategic orientation, commitment to seize opportunities, commitment of resources, control of resources, and management structure. 11. Identify and describe the four key factors that need to be considered during the growth stage. (1) Control—a company must ensure trust, have a willingness to forgive for risk taking, and not be overbearing, in order to ensure the venture is moving forward. (2) Responsibility—it is important to create a sense of responsibility and insure innovation and shared responsibility is taking place throughout the company (3) Tolerance of failure—when a company is first started it will make mistakes as people learn what works. This mindset must continue through the growth stage as well. There are three distinct forms of failure that should be distinguished: moral failure, personal failure, and uncontrollable failure. (4) Change—Fast managerial responses are needed during ever changing environmental changes. 12. What is meant by managing paradox and contradiction? When a venture experiences surges in growth, a number of structural factors begin to present multiple challenges. Entrepreneurs constantly struggle over whether to organize these factors, such as cultural elements, staffing and development of personnel, and appraisal and rewards, in a rigid, bureaucratic design or a flexible, organic design. Research has shown that new-venture managers experiencing growth, particularly in emerging industries, need to adopt flexible, organic structures. Rigid, bureaucratic structures are best suited for mature, stabilized companies. Thus, the cultural elements need to follow a flexible design of autonomy, risk taking, and entrepreneurship. 13. Identify five unique managerial concerns of growing businesses. The distinctiveness of size—smallness gives emerging businesses certain disadvantages, such as a limited market and a smaller staff to do the work. The one-person-band syndrome—when an entrepreneur refuses to delegate responsibility to employees. Time management—entrepreneurs should learn to use time as a resource and not allow time to use them Community pressures—the community exerts pressure on the entrepreneur in regards to participation, leadership, and donations. Continuous learning—Staying abreast of industry changes is another way for entrepreneurs to maintain a competitive edge. 14. Define the one-person-band syndrome. The one-person-band syndrome—when an entrepreneur refuses to delegate responsibility to employees. This is common among entrepreneurs, since they built the business they are often nervous to give up their sense of control. However, if they refuse to let others gain responsibility the company may fail to grow. 15. Explain the concept of entrepreneurial leadership. Entrepreneurial leadership can be defined as the entrepreneur’s ability to anticipate, envision, maintain flexibility, think strategically, and work with others to initiate change. It may be the most critical element in the management of high growth ventures. ADDITIONAL ACTIVITIES Short Cases HENDRICK’S WAY When Hendrick Harding started his consumer products firm, he was convinced he had a winning product. His small, compact industrial drill was easier to use than any other on the market and cost 30 percent less than any of the competitors’ drills. The orders began to pour in, and within six months, Hendrick’s sales surpassed his first year’s estimate. At the end of the first 12 months of operation, his firm was grossing more than $100,000 a month, and he had a six-week backlog in filling orders. The rapid growth of the firm continued for two years. Beginning about four months ago, however, Hendrick began to notice a dip in sales. The major reason appeared to be a competitive product that cost 10 percent less than Hendrick’s drill and offered all the same benefits and features. Hendrick believes that, with a couple of minor adjustments, he can improve his product and continue to dominate the market. On the other hand, Hendrick is somewhat disturbed by the comments of one of his salespeople, George Simonds. George spends most of his time on the road and gets to talk to a great many customers. Here is what he had to say to Hendrick: “Your industrial drill has really set the market on its ear. And we should be able to sell a modified version of it for at least another 36 months before making any additional changes. However, you need to start thinking about adding other products to the line. Let’s face it; we are a one-product company. That’s not good. We have to expand our product line if we are to grow. Otherwise, I can’t see much future for us.” The problem with this advice is that Hendrick does not want to grow larger. He is happy selling just the industrial drill. He believes that, if he continues to modify and change the drill, he can maintain a large market share and the company will continue to be profitable. As he explained to George, “I see the future as more of the past. I really don’t think there will be a great many changes in this product. There will be modifications, sure, but nothing other than that. I think this firm can live off the industrial drill for at least the next 25 years. We’ve got a great thing going. I don’t see any reason for change. And I certainly don’t want to come out with a second product. There’s no need for it.” QUESTIONS 1. What is the danger in Hendrick’s thinking? Explain in detail. Hendrick’s thinking poses several dangers: • Market Complacency: Relying solely on one product can lead to complacency. The competitive landscape is dynamic, and competitors can easily introduce better or cheaper alternatives. Hendrick’s belief that his drill will remain relevant for 25 years is risky, as market demands and technologies evolve. • Lack of Innovation: By focusing only on modifications rather than new products, Hendrick risks missing out on opportunities for innovation. This can lead to stagnation, where the company fails to capture new market segments or address changing consumer needs. • Customer Expectations: Customers may start to expect a broader product line, and the lack of new offerings could drive them to competitors that provide more variety and innovation. • Vulnerability to Market Changes: If sales continue to decline due to competitors, Hendrick’s firm may face financial difficulties without a diversified product range to cushion against market shifts. 2. Could the concept of understanding the managerial versus entrepreneurial mind-set as described in the chapter be of any value to Hendrick? Why or why not? Yes, understanding the differences between managerial and entrepreneurial mindsets could be valuable for Hendrick. • Entrepreneurial Mindset: This approach emphasizes innovation, risk-taking, and exploring new opportunities. If Hendrick embraces this mindset, he may recognize the importance of diversifying his product line and adapting to market changes, potentially leading to greater growth. • Managerial Mindset: This approach focuses on efficiency, stability, and managing existing operations. Hendrick’s current mindset leans toward this perspective, which may prevent him from recognizing the need for change and innovation. By balancing both mindsets, Hendrick could retain operational efficiency while also fostering innovation and exploring new product development opportunities. 3. Using Table 13.2 as your point of reference, how would you describe Hendrick’s focus? Based on your evaluation, what recommendations would you make to him? Based on Table 13.2, Hendrick’s focus can be described as: • Narrow and Static: He is focused primarily on a single product without considering the broader market landscape or future opportunities. His emphasis is on maintaining the status quo rather than exploring new avenues for growth. Recommendations: 1. Market Research: Conduct thorough market research to understand evolving customer needs and preferences, and identify potential gaps that new products could fill. 2. Product Development: Consider developing complementary products that can enhance the existing product line, thereby attracting new customers and providing more options for current customers. 3. Adaptability: Foster a culture of innovation within the company to remain adaptable to market changes and encourage input from the sales team and other employees about new product ideas. 4. Long-Term Strategy: Develop a long-term strategic plan that includes not just modifications to the drill, but also the potential for diversification into new product categories that align with the company’s core competencies. By taking these steps, Hendrick could safeguard his business against future risks and capitalize on new growth opportunities. KEEPING THINGS GOING The Clayton Company has grown 115 percent in the past year and 600-plus percent in the past three years. A large portion of this growth is attributable to Jan Clayton’s philosophy of hiring the best possible computer systems people and giving them the freedom they need to do their jobs. Most of Jan’s personnel operate as part of work teams that analyze, design, and implement computer systems for clients. The process works as follows: First, the company will get a call from a potential client indicating that it needs to have a computer system installed or special software written for its operations. Jan will send over one of her people to talk to the client and analyze the situation. If it turns out that the Clayton Company has the expertise and personnel to handle the job, the client will be quoted a price. If this price is acceptable, a Clayton group will be assigned the project. An example of a typical project is the client who called three weeks ago and wanted to purchase five tablet computers for the firm’s engineering staff. The company wanted these engineers to have smartphones so they could work on the road easily and access all of their files. Additionally, the firm wanted its computer-aided design software to be modified so the engineers could see their computer-generated drawings in 3-D. The Clayton group provided the computers and smartphones, installed and updated the entire system, and modified the software in two working days. Jan realizes that the growth of her enterprise will be determined by two factors. One is the creativity and ingenuity of her workforce. The other is the ability to attract talented personnel. “This business is heavily labor intensive,” she explained. “If someone wants a complete computer system installation and customization, that may take 50 hours. If I don’t have the people to handle the project, I have to turn it down. My expansion is heavily dependent on hiring and training talented people. Additionally, I need more than just hard workers. I need creative people who can figure out new approaches to handling complex problems. If I can do these two things, I can stay a jump ahead of the competition. Otherwise, I won’t be able to survive.” To try to achieve these key factors for success, Jan has initiated three changes. First, she has instituted a bonus system tied to sales; these bonuses are shared by all of the personnel. Second, she gives quarterly salary increases, with the greatest percentages going to employees who are most active in developing new programs and procedures for handling client problems. Third, she has retreats every six months in which the entire staff goes for a long weekend to a mountain area, where they spend three days discussing current work-related problems and ways to deal with them. Time is also devoted to social events and to working on developing an esprit de corps among the personnel. QUESTIONS 1. In what phase of the venture life cycle is Jan’s firm currently operating? Defend your answer. Jan’s firm is currently operating in the growth phase of the venture life cycle. Defense: • Significant Growth: The firm has experienced substantial growth, with a 115% increase in the past year and over 600% in the past three years. This rapid growth indicates that the business has moved beyond the startup phase, where establishing a market presence and generating initial sales are primary focuses. • Market Expansion: The company is actively pursuing new projects and clients, demonstrating an ability to scale operations and take on more significant and complex jobs, which is characteristic of the growth phase. • Talent Development Focus: Jan's emphasis on hiring, training, and retaining talented personnel aligns with the growth phase's need for a robust workforce to support expanding operations and increasing demand. 2. How are Jan’s actions helping to build an adaptive firm? Give three specific examples. 1. Bonus System Tied to Sales: • By implementing a bonus system that rewards all personnel based on sales performance, Jan encourages collaboration and a shared commitment to the company's success. This incentivizes employees to adapt to changing market conditions and client needs, fostering a culture of teamwork and responsiveness. 2. Quarterly Salary Increases for Innovation: • Jan's practice of providing quarterly salary increases, particularly for those who contribute to developing new programs and procedures, motivates employees to innovate and think creatively. This approach not only rewards current contributions but also promotes a mindset focused on continuous improvement and adaptation. 3. Regular Team Retreats: • The six-month retreats serve as a platform for staff to discuss work-related challenges and brainstorm solutions in a relaxed environment. This open communication fosters a culture of collaboration and adaptability, enabling the team to respond effectively to client problems and shifting market demands. 3. If Jan’s firm continues to grow, what recommendations would you make for future action? What else should Jan be thinking about doing to keep things moving smoothly? Be specific in your answer. Recommendations for Future Action: 1. Scalable Training Programs: • As the firm grows, Jan should implement formalized training programs to quickly onboard new hires and ensure that all employees are equipped with the skills needed to meet client demands. This could include mentorship programs or workshops focused on the latest technologies and industry trends. 2. Expand Talent Acquisition Strategies: • To maintain a competitive edge, Jan should consider diversifying her recruitment strategies to attract talent from various backgrounds and experiences. Partnering with universities for internships or collaborating with tech boot camps can help bring in fresh talent and innovative ideas. 3. Enhance Project Management Processes: • As project complexity increases, Jan should implement robust project management tools and methodologies (such as Agile or Scrum) to streamline operations, improve communication, and ensure timely project delivery. This will help maintain quality and client satisfaction as the workload increases. Additional Considerations: • Fostering a Culture of Feedback: Jan should establish a structured feedback mechanism that allows employees to voice concerns and suggestions regularly. This will help her stay attuned to employee morale and operational issues. • Exploring New Markets: Jan should assess opportunities to expand into new market segments or geographical areas to diversify revenue sources. This strategic planning will ensure long-term sustainability and reduce reliance on current client bases. • Investing in Technology: Jan should consider investing in new technologies and tools that enhance productivity and efficiency, such as automation software or advanced data analytics, to keep the firm competitive in the rapidly evolving tech landscape. By implementing these recommendations, Jan can support sustained growth while ensuring that her company remains adaptive and responsive to both internal and external challenges. Reflection Exercise: The TOWS Matrix DIRECTIONS: Using the concept of the SWOT Analysis presented in Chapter 13, the TOWS Matrix allows an analysis of a new venture based on its combined Strengths, Weaknesses, Opportunities, and Threats. Find a new start-up venture and work with the CEO to establish the combinations of the following: Strengths, in light of Opportunities; Strengths, in light of Threats; Weaknesses, in light of Opportunities; and Weaknesses, in light of Threats. This combination of the SWOT Matrix will help you to understand the tactics a firm should develop based on its own recognized strengths and weaknesses within the framework of the external environment. Chapter 14 Valuation of Entrepreneurial Ventures SUGGESTED ANSWERS FOR DISCUSSION QUESTIONS (END-OF-CHAPTER) 1. Identify and discuss the three underlying issues in the evaluation of a business. Three underlying issues in the evaluation of a business are the differing goals of buyer and seller, the emotional bias of the seller, and the reasons for acquisition. (1) Goals of the buyer and seller—The buyer and the seller always assign different values to the enterprise because of their basic objectives. There is always a tendency for the seller to establish the highest possible value for the business regardless of the true market condition, the environment, or the economy. The buyer will always seek the lowest possible price to be paid. To the buyer, the enterprise is an investment and it is normal to assess the profit potential. (2) Emotional bias—The seller sees the enterprise as something that has matured and is ready to bring in profits, and as a result there is a tendency for the seller to see the venture worth more than outsiders believe it is really worth. (3) Reasons for the acquisition—Reasons might be: increasing market share, vertical integration, expansion of product line, using idle or excess plant capacity. 2. Define the term due diligence. How is it applied to the acquisition of an existing venture? Due diligence means a thorough analysis of every facet of an existing business. When applied to an acquisition of an existing venture, it involves several critical questions: Why is the business being sold?, What is the physical condition of the business?, How many key personnel will remain?, What is the degree of competition?, What are the conditions of the lease?, Do any liens against the business exist?, Will the owner sign a covenant not to compete?, Are any special licenses required?, What the future trends of the business?, and, finally, How much capital is needed to buy? 3. To analyze a business, what types of questions or concerns should the entrepreneur address in the following areas: history of the business, market and competition, sales and distribution, management, and finances? (1) History of the business: date company was founded, state in which company was incorporated, and company’s original line of business and any subsequent changes. (2) Market and compensation: company’s major business and market, description of major projects, and sales literature on projects. (3) Sales and distribution: compensation of salesmen, are any sales made on consignment, and details on branch office sales, if any. (4) Financial: Obtain details on franchise, lease, and royalty agreements, determine if company has subsidiaries (or divisions), review consolidating statements of profit and loss, and verify the cash balance and determine maximum and minimum cash balances needed throughout the year. (5) Management: Organization chart, what is management’s reputation in its industry, and does key management devote 100 percent of its time to the business? 4. One of the most popular methods of business valuation is the adjusted tangible book value method. Describe how this method works. Goodwill, patents, deferred financing costs, and other tangible assets are considered with the other assets and deducted from or added to the net worth. This upward or downward adjustment reflects the excess of the fair market value of each asset above or below the value reported on the balance sheet. 5. Explain how the P/E method of valuation works. Give an example. The valuation is determined by dividing the market price of the common stock by the earnings per share. If a company has 200,000 shares of common stock and a net income of $100,000, the earnings per share are $2. Since the company has 200,000 shares of common stock, the valuation of the enterprise would be $400,000. 6. What are the steps involved in using the discounted earnings method? Give an example. There are basically four steps to this method: (1) Expected cash flow is estimated. (2) An appropriate discount rate is determined. (3) A reasonable life expectancy of the business must be determined. (4) The firm’s value is determined by discounting the estimated cash flow over the expected life of the business. A good example would be Figure 14.2 or one that substitutes new figures. 7. How do the following methods of valuing a venture work: fixed price, multiple of earnings, return on investment, replacement value, liquidation value, excess earnings, and market value? In each case, give an example. 8. Explain why the following are important factors to consider when valuing a business: start-up costs, accuracy of projections, and degree of control. The following factors may intervene in the valuation process of a business. Start-up costs are extensive and a buyer may be willing to pay more for an on-going business in order to avoid these costs. Sales revenues, market potential, and earnings potential, should all be examined carefully for their accuracy because they are subject to economic data, fluctuating trends, and uncertain environments. The degree of control that the seller has in his or her business is equal to his or her actual interest. Therefore, the seller should control 51 percent of the company or the buyer will not be purchasing full control of the company. ADDITIONAL ACTIVITIES WHAT WOULD YOU RECOMMEND? Jane Winfield would like to buy Ted Garner’s company. She has conducted a detailed financial analysis of Ted’s firm and has determined the following: 1. Book value of the inventory: $250,000 2. Discount rate on future earnings: 24 percent 3. Book value of the plant and equipment: $150,000 4. Fair market value of the inventory: $400,000 5. Fair market value of other intangibles: $60,000 6. Number of shares of common stock: 100,000 7. Fair market value of the plant and equipment: $400,000 8. Price/earnings multiple: 9 9. Book market value of other intangibles: $30,000 10. Estimated earnings over the next five years: Based on this information, how much should Jane valuate the business according to each of the following methods: adjusted tangible assets, P/E, and discounted future earnings? Based on your findings, recommend the valuation method she should use. Finally, given all of your calculations, estimate what the final price will be. Give reasons for this estimate. Enter your answers here. a. Adjusted tangible assets valuation: ___ b. Price/earnings valuation: ___ c. Discounted future earnings valuation: ___ d. Final sales price: ___ Short Cases A VALUATION MATTER Charles Jackson has always been interested in determining the value of his small business. He started the operation five years ago with $1,500 of savings, and since then it has grown into a firm that has 15 employees and annual sales of $1.88 million. Charles has talked to his accountant regarding methods that can be used in valuing his business. His accountant has briefly explained two of these to Charles: adjusted tangible book value and discounted earnings. Charles has decided to use both methods in arriving at a valuation. Following is the information he has gathered to help him use both methods: Charles also believes that it is best to use a conservative discount rate. He has settled on 24 percent. QUESTIONS 1. Using the adjusted tangible book value method, what is Charles’s business worth? Show your calculations. Calculation: • Total Assets = Inventory + Plant and Equipment + Other Assets = 600,000 + 400,000 + 100,000 = 1,100,000 • Adjusted Tangible Book Value = Total Assets - Total Liabilities = 1,100,000 - 700,000 = 400,000 Value: $400,000 2. Using the discounted earnings method, what is Charles’s business worth? Show your calculations. Discounted Earnings Method Calculation: • Present Value of Earnings: • Year 1: $80,645.16 • Year 2: $81,406.95 • Year 3: $78,745.51 • Year 4: $84,663.88 • Year 5: $85,488.02 Total Present Value: = 80,645.16 + 81,406.95 + 78,745.51 + 84,663.88 + 85,488.02 = 411,949.52 Value: $411,949.52 3. Which of the two methods is more accurate? Why? More Accurate Method The discounted earnings method is more accurate because it accounts for future earning potential and the time value of money, providing a better reflection of the business's value compared to the adjusted tangible book value. WHICH WILL IT BE? Georgia Isaacson and her son Rubin have been thinking about buying a business. After talking to seven entrepreneurs, all of whom have expressed an interest in selling their operations, the Isaacsons have decided to make an offer for a retail clothing store. The store is very well located, and its earnings over the past five years have been excellent. The current owner has told the Isaacsons he will sell for $500,000. The owner arrived at this value by projecting the earnings of the operation for the next seven years and then using a discount factor of 15 percent. The Isaacsons are not sure the retail store is worth $500,000, but they do understand the method the owner used for arriving at this figure. Georgia feels that since the owner has been in business for only seven years, it is unrealistic to discount seven years of future earnings. A five-year estimate would be more realistic, in her opinion. Rubin feels that the discount factor is too low. He believes that 20 to 22 percent would be more realistic. In addition to these concerns, the Isaacsons feel they would like to make an evaluation of the business using other methods. In particular, they would like to see what the value of the company would be when the adjusted tangible book value method is employed. They also would like to look at the replacement value and liquidation value methods. “We know what the owner feels his business is worth,” Georgia noted to her son. “However, we have to decide for ourselves what we think the operation is worth. From there, we can negotiate a final price. For the moment, I think we have to look at this valuation process from a number of different angles.” QUESTIONS 1. If the owner reduces the earnings estimates from seven to five years, what effect will this have on the final valuation? If he increases the discount factor from 15 percent to 20 to 22 percent, what effect will this have on the final valuation? • Reducing Earnings Estimates from 7 to 5 Years: This will likely lower the final valuation because fewer years of projected earnings will be considered, thus reducing the total present value of expected cash flows. • Increasing Discount Factor from 15% to 20-22%: A higher discount rate will also decrease the present value of future earnings, leading to a lower valuation. 2. How do the replacement value and liquidation value methods work? Why would the Isaacsons want to examine these methods? • Replacement Value: This method estimates how much it would cost to replace the assets of the business with new ones. It helps gauge the value based on current market conditions and asset conditions. • Liquidation Value: This method assesses the total worth of a business if it were to be sold off quickly, usually at a discount. It provides a worst-case scenario for valuation. • Purpose of Examination: The Isaacsons may want to evaluate these methods to ensure they understand the intrinsic value of the business's assets and to negotiate effectively based on potential asset values. 3. If the Isaacsons conclude that the business is worth $410,000, what will be the final selling price, assuming a sale is made? Defend your answer. Final Selling Price If the Isaacsons conclude that the business is worth $410,000, the final selling price will likely be around this figure, as they can use this valuation as a basis for negotiation. The final price will depend on the seller's willingness to negotiate, market conditions, and perceived value by both parties. Application Exercise: A Rising Valuation for Africa and Brazil Two regions that were formally considered third world are now emerging so fast that their valuation is on the rise. Africa and Brazil have made huge strides into the economic mainstream with the potential of becoming world forces to be respected. Explain what this could mean for global ventures. Could valuations rise in these booming economies? How should entrepreneurs consider these markets? McKinsey’s Global Institute reported in 2010 that Africa’s economic pulse had quickened, infusing the continent with a new commercial vibrancy. Telecommunications, banking, retailing, and construction are all flourishing with private investment surging. A World Bank report in 2012 showed that over a third of the countries on the continent attained growth rates of at least 6 percent, with another 40 percent growing between 4–6 percent. Among fast-growing African were resource-rich countries such as Ghana, Mozambique, and Nigeria, as well as other economies such as Rwanda and Ethiopia, all posting growth rates of at least 7 percent in 2011. Many of Africa’s 50-plus individual economies still face serious challenges, including poverty, disease, and high infant mortality. Yet Africa’s collective GDP, at $1.6 trillion, is now roughly equal to Brazil’s or Russia’s, and the continent is among the world’s most rapidly growing economic regions. The key reasons behind this growth surge included government action to end armed conflicts, improve macroeconomic conditions, and undertake microeconomic reforms to create a better business climate. African governments increasingly adopted policies to energize markets such as privatizing state-owned enterprises, increasing the openness of trade, lowering corporate taxes, strengthening regulatory and legal systems, and providing critical physical and social infrastructure. If recent trends continue, Africa will play an increasingly important role in the global economy. By 2040, it will be home to one in five of the planet’s young people, and the size of its labor force will top China’s. Africa has almost 60 percent of the world’s uncultivated arable land and a large share of the natural resources. Its consumer-facing sectors are growing two to three times faster than those in the OECD countries. And the rate of return on foreign investment is higher in Africa than in any other developing region. Brazil is another nation on its way to growing out of its emerging market status and becoming one of the richest and most developed countries on earth. Several factors have facilitated this growth. A focus on the infrastructure has been a driving force. The “Growth Acceleration Plan” is an umbrella term for thousands of infrastructure projects across the country. The program started in 2007 with an initial $4.2 billion investment. The main goal is to improve the poor infrastructure that has created a pattern of social exclusion, and thereby expand economic potential in traditionally neglected areas. Reducing poverty and inequality has been another main goal of Brazil. From 2001 to 2008, the inequality gap shrank by 6 percent— the largest improvement in Latin America—and millions of people have been lifted out of poverty. Foreign investment has been important to Brazil as it has made several improvements in its capital markets. In 2008, the São Paulo Stock Exchange merged with the mercantile and futures exchange to form the largest exchange in Latin America and the fourth largest exchange in the world, with market capital of $1.167 trillion. Brazil’s human, mineral, and agricultural resources are on par with those of the United States and Canada, and it has a few great opportunities to take advantage of in order to continue such enormous growth. One is energy with oil and natural gas reserves are enough to make the country self-sufficient, with some left over for export; biofuels since Brazil has rich farmland will make it a leading ethanol producer; and solar and wind power opportunities with the winds that come off its large coastline. A second opportunity to consider is that Brazil has more fresh water than any other nation on earth. Climate change will make water even scarcer, which will make Brazil more attractive for residents and investors alike. A third opportunity are the world-class sporting events such as the 2014 World Cup and the 2016 Olympics being hosted in Brazil, which will create new infrastructure and attract international investors. So today Brazil is experiencing its greatest economic growth in history—averaging GDP growth of 4.5 percent per year since 2002. The country’s GDP expanded by an estimated 7.5 percent in 2010, which brought total GDP to almost $2.2 trillion—the highest in Latin America— and GDP per capita to over $11,000 (sixth-highest in Latin America). Furthermore, joblessness is at an all-time low, foreign exchange reserves have soared (sixth-highest in the world), and the country’s sovereign debt received an all-important investment-grade rating. Brazil is extremely capable of becoming an advanced economy, and certainly deserves its position among the BRIC (Brazil, Russia, India, China) countries. With over $3.4 billion of venture-capital deals now being done in emerging markets, it appears the valuation of Africa and Brazil are sure to experience continued improvement. Source: Adapted from Acha Leke, Susan Lund, Charles Roxburgh, and Arend van Wamelen, “What’s Driving Africa’s Growth,” McKinsey Global Institute (June 2010), http://www. mckinseyquarterly.com/Whats_driving_Africas_-growth_2601 (accessed June 2, 2012); Sean Williams, “Why Is Brazil an Emerging Market Economy?”, University of Iowa Center for International Finance & Development (April 2011), http://ebook.law.uiowa.edu/ebook/uicifd-ebook/why-brazilemerging-market-economy (accessed June 2, 2012); Ekow Quandzie, “World Bank Expects Faster Economic Growth for Africa in 2012 Despite Volatile Global Economy,” Ghana Business News (April 23, 2012), http://www.ghanabusinessnews.com/2012/04/23/world-bank-expects-faster-economicgrowth-for-africa-in-2012-despite-volatile-global-economy/(accessed June 1, 2012). Chapter 15 Harvesting the Entrepreneurial Venture SUGGESTED ANSWERS FOR DISCUSSION QUESTIONS (END-OF-CHAPTER) 1. What are the potential choices for an entrepreneur to examine as the venture matures? As a venture matures, there are choices to be made. It may be a decision regarding managerial control and succession for successful continued operations. It may be a desire to initiate a “liquidity event” where the venture is able to generate a significant amount of cash for the investors. It may be that the venture has grown to a stage where now the possibility of an IPO (Initial Public Offering) is a reality. Or, it may be the sale of the business. 2. A number of barriers to succession in privately held businesses exist. Using Table 15.1, identify some of the key barriers. One of the major ones is the owner. To a large degree, the owner is the business. Any attempts by the family to get the person to step aside are often viewed by the owner as efforts by greedy family members who want to plunder the operation for personal gain. More significantly, there may be anxiety over death, since raising the topic of death conjures up a negative image in everyone’s mind. Other barriers to succession may be sibling rivalry, family members’ fear of losing status, or a complete aversion to death for fear of loss or abandonment. 3. What pressures do entrepreneurs sometimes face from inside the family? (Use Figure 15.1 in your answer) The entrepreneur will face the pressure of a family member wanting to manage the business, the pressure of the family members wanting an heir to be declared, and also rivalry among the different branches of the family. Also, from family members outside the firm, the entrepreneur will face the pressure to inherit part of the operation, to become involved in the business, and the pressure to be hired. 4. What pressures do entrepreneurs sometimes face from outside the family? (Use Figure 15.1 in your answer) From outside the family and within a firm, an employee may pressure the entrepreneur to give the employee an opportunity to buy a stake in the business or be given a percentage of the business in the owner’s will. Also, from outside the firm the entrepreneur may feel pressure from competitors and customers along with technological pressure, new-product development, tax laws, regulatory agencies, and trends in management. 5. An entrepreneur can make a number of choices regarding a successor. Using Table 15.2 as a guide, discuss each of the choices. The entrepreneur can look for an entrepreneurial successor. This is someone who often provides critical ideas for new-product development and future ventures. This person has high ingenuity, creativity, and drive. The entrepreneur can look for a managerial successor. This person would be interested in efficiency, internal control, and the effective use of resources and often provides the stability and day-to-day direction needed to keep the enterprise going. The entrepreneur could also look inside or outside his family for a successor. Looking inside, he or she would look for a son or daughter, nephew or niece with whom he or she gets along well. Looking outside, the entrepreneur would look for a professional manager, a specialist, or a person with the right talents to be an assistant. The entrepreneur might also be training a team of both family and nonfamily members in hopes that a successor will arise from there. 6. How might the Oakland Scavenger case affect succession decisions in small business? The Oakland Scavenger case may affect succession decisions in small businesses in that a small business may be sued by an employee of a different ethnic origin than the owner, based upon not being accorded the same treatment as a son or daughter. This case has started a movement that is sure to result in more guidelines and limitations for family employment, and privately held businesses will have to be aware of this challenge when preparing succession plans. 7. What are three of the contextual aspects that must be considered in an effective succession plan? Three of the contextual aspects that must be considered in an effective succession plan are type of venture, capabilities of managers, and environmental factors. 8. In what way can forcing events cause the replacement of an owner/manager? Cite three examples. A forcing event will require the entrepreneur to step aside and let somebody else direct the operation. Three examples would be death, an abrupt departure with no advance warning, and illness or a nonterminal physical incapacitation. 9. What are five qualities or characteristics that successors should possess? Some of the most common of these successor qualities are sufficient knowledge of the business or a good position (especially marketing or finance) from which to acquire this knowledge within an acceptable time frame; fundamental honesty and capability; good health; energy, alertness, and perception; enthusiasm about the enterprise; personality compatible with the business; high degree of perseverance; stability and maturity; reasonable amount of aggressiveness; thoroughness and a proper respect for detail; problem-solving ability; resourcefulness; ability to plan and organize; talent to develop people; personality of a starter and a finisher; and appropriate agreement with the owner’s philosophy about the business 10. Why do entrepreneurs look forward to the day when they can take their company public? Many entrepreneurs seek capital through the public markets. They seek an exit from their firm in the form of what is referred to as a “liquidity event” which stands for the positioning of the venture for the realization of a cash return for the owners and the investors. This “event” is most often achieved through an initial public offering or complete sale of the venture. 11. What eight steps should be followed to harvest a business? Discuss each of these steps. Step 1: Prepare a Financial Analysis: The purpose of an analysis is to define priorities and to focus the next few years of business. Step 2: Segregate Assets: There are four points that tax accountants and lawyers may suggest to follow to reduce your taxes. Step 3: Value the Business: This part constitutes a most important step in its sale. Step 4: Identify the Appropriate Timing: Knowing when to sell your business is critical. Step 5: Publicize the Offer to Sell: This should consist of a short prospectus with enough information to interest investors. Step 6: Finalize the Prospective Buyers: You should assess characters and managerial reputation in order to find the best buyer. Step 7: Remain Involved through the Closing: Meet with the buyer to help eliminate misunderstandings and negotiate major requirements. Step 8: Communicate After the Sale: Problems between new managers and remaining employees need to be resolved for a smooth transition. ADDITIONAL ACTIVITIES PASSING IT ON Management succession and continuity are two critical concerns of most entrepreneurs. In your library or on the Internet (if accessible), look through the past-year issues of these magazines: Business Week, U.S. News & World Report, Inc., Fortune Small Business, Entrepreneur, and Fast Company. Focus on articles related to the management succession and continuity of specific firms. Then choose the two you find to be most interesting and informative and answer the following questions: 1. What business is this company in? 2. What difficulties did the owner have formulating a strategy regarding his or her succession? 3. What was the entrepreneur’s final decision on how to handle the succession? 4. What lessons can be learned from this individual’s experience? IN CONCLUSION Based on what you have learned from these two cases, what recommendations would you give to an entrepreneur who is in the process of developing a succession plan? Be as helpful as possible. Short Cases JUST AS GOOD AS EVER When Pablo Rodriguez was found in the storage area, no one knew for sure how long he had been unconscious. Within 30 minutes, he was in the emergency room of Mercy Hospital, and by early evening, the doctors had determined that Pablo had suffered a mild heart attack. During the first few days he was in the hospital, Pablo’s family was more concerned with his health than anything else. However, as it became clear that Pablo would be released within a week and allowed back at work within two weeks, family members talked about his stepping aside as president of the operation and allowing someone else to take over the reins. Pablo is president of a successful auto-parts supply house. Gross sales last year were $3.7 million. Working with him in the business are his son, daughter, and two nephews. Pablo started the business 22 years ago, when he was 33. After working for one of the large oil firms for 10 years as a sales representative to auto-parts supply houses, Pablo broke away and started his own company. At first, he hired outside help. During the past five years, however, he has been slowly bringing his family on board. It was Pablo’s hope that his son would one day take over the business, but he did not see this happening for at least another 10 to 15 years. Pablo’s wife, Rebecca, believes that although he should continue to work, he should begin to train his son to run the business. On the day before he left the hospital, she broached this idea with Pablo and asked him to think about it. He replied: “What is there to think about? I’m too young to retire, and José does not know the business well enough to take over. It will take at least five more years before he is ready to run the operation. Besides, all I have to do is slow down a bit. I don’t have to retire. What’s the hurry to run me out of the company? I’m as good as ever.” Rebecca and José believe that, during the next couple of months, they must continue working on Pablo to slow down and to start training José to take over the reins. QUESTIONS 1. Why is Pablo reluctant to turn over the reins to José? Include a discussion of Figure 15.1 in your answer. Pablo's Reluctance: Pablo is hesitant to turn over the reins to José primarily due to his belief in his own competence and youthfulness, as reflected in Figure 15.1, which illustrates the emotional and psychological barriers to succession. He perceives himself as still being effective and may fear losing control or relevance within the business. Additionally, he doubts José's readiness, thinking he lacks sufficient experience, which reinforces his reluctance. 2. Cite and discuss two reasons Pablo should begin thinking about succession planning. Reasons for Succession Planning: • Continuity of Business Operations: Succession planning ensures that there is a clear transition strategy in place, preventing disruptions in business operations if something unexpected happens to Pablo. • Skill Development: By starting the training process now, Pablo can equip José with the necessary skills and knowledge, ensuring a smoother transition when the time comes, rather than having to rush the process later. 3. What would you recommend Rebecca and José do to convince Pablo that they are right? Offer at least three operative recommendations. Recommendations for Rebecca and José: • Create a Structured Training Plan: Develop a formal plan that outlines the specific skills and knowledge José needs to acquire over the next few years, allowing Pablo to mentor him actively. • Involve Pablo in Discussions: Encourage open dialogues about succession planning that highlight Pablo’s strengths and how his mentorship can shape José into an effective leader, emphasizing that this is not about retirement but about legacy. • Set Clear Milestones: Establish short-term goals for José to achieve within the business that will build his confidence and demonstrate to Pablo that he is capable of taking on more responsibilities gradually. NEEDING SOME HELP ON THIS ONE In the past, most people who wanted to get their foreign sports cars fixed had to turn to the dealer from which they had purchased the car. In recent years, however, auto repair shops that specialize in foreign sports cars have become popular in some areas of the country. When Jack Schultz started his company ten years ago, he was lucky if he had two cars a day to work on. Today, Jack has 15 people working for him, and he usually has a backlog of about five days’ work. Some of this work is repairs caused by auto accidents; a lot of it is a result of improper maintenance by the owners. Jack is 64 years old and feels he will work for about six more years before retiring. The business is very profitable, and Jack and his wife do not need to worry about retirement income— they have saved more than enough. However, Jack is concerned about what to do with the business. He has two children who work with him, Bob (31 years old) and Tim (29 years old). Jack has not asked either of them if they would want to take over the operation. He assumes they will. He also has a nephew, Richard (35 years old), working for him. All three of these relatives have been with Jack for nine years. Jack believes that any one of the three could successfully head the venture. But he is concerned about in-fighting should he favor one over the others. On the other hand, if he turns the business over to all three of them collectively, will they be able to get along with one another? Jack has no reason to believe that the three cannot work things out amicably, but he is unsure. Jack has decided that he cannot wait much longer to groom an heir. The major stumbling block is identifying who that person will be. Additionally, Jack really does not know anything about picking a successor. What characteristics should the individual possess? What types of training should the person be given? What other steps should be followed? Jack feels that he needs to answer these questions as soon as possible. “I know how to plan business operations,” he told his wife last week, “but I don’t know how to go about planning for the succession of business operations. It’s a whole different idea. I need some help on this one.” QUESTIONS 1. Identify and briefly describe four characteristics you would expect to find in a successful manager of this type of venture. Characteristics of a Successful Manager: • Leadership Skills: A successful manager must inspire and motivate the team, fostering a collaborative environment to encourage high performance and morale among employees. • Technical Knowledge: Understanding the intricacies of foreign sports car repairs and maintenance is crucial. This includes staying updated on the latest technologies and repair techniques in the automotive industry. • Business Acumen: The manager should possess strong financial and operational knowledge to make informed decisions regarding budgeting, pricing, and inventory management to ensure profitability. • Conflict Resolution Skills: Given the potential for sibling rivalry and group dynamics among family members, the ability to mediate conflicts and build consensus will be essential for maintaining a harmonious work environment. 2. What steps does Jack need to follow to successfully identify and groom a successor? Be complete in your answer. Steps for Identifying and Grooming a Successor: • Self-Assessment and Reflection: Jack should evaluate his own leadership style and the specific needs of the business. This can help clarify what traits and skills he values in a successor. • Open Dialogue with Potential Candidates: Jack should initiate conversations with Bob, Tim, and Richard to gauge their interest in taking over the business and to understand their career aspirations and perspectives on management. • Evaluate Skills and Interests: Assess each candidate's strengths, weaknesses, and areas of interest through performance reviews and discussions. This evaluation can help Jack determine who aligns best with the business's vision. • Establish a Development Plan: Create a structured training program tailored to the chosen successor, focusing on areas like leadership, technical skills, business management, and customer service. • Mentorship: Jack should actively mentor the selected successor, providing them with insights into daily operations, decision-making processes, and key relationships within the industry. 3. If you were going to advise Jack, what would you recommend he do first? How should he get started with his succession plan? What should he do next? Offer him some general guidance on how to handle this problem. Recommended First Steps for Jack: • Start with Open Communication: Jack should have candid conversations with Bob, Tim, and Richard about his succession plans, encouraging them to express their thoughts and intentions regarding the future of the business. This will help alleviate concerns about favoritism and promote transparency. • Conduct a Skills Assessment: After gauging their interest, Jack should assess each candidate’s skills and interests, identifying who might be best suited for the role of manager. • Create a Training and Mentorship Program: Once a candidate is identified, Jack should develop a detailed plan for their professional growth, outlining specific training opportunities and mentorship sessions. This ensures the successor is well-prepared for their future responsibilities. • Monitor Progress and Adjust: Throughout this process, Jack should regularly check in with the successor, providing feedback and making adjustments to the training plan as needed. This ongoing support will help build confidence and competency in the chosen heir. By following these steps, Jack can effectively navigate the succession planning process and ensure a smooth transition of leadership in his business. Reflection Exercise: Oakland Scavenger Company In the text the Oakland Scavenger Company (a garbage collection firm) was discussed. Certain employees there complained of employment discrimination because they were overlooked for positions reserved for family members. The U.S. District Court of Northern California dismissed the suit on the basis that it had no relation to antidiscrimination laws. However, the U.S. Court of Appeals for the Ninth Circuit reviewed the decision and held that “nepotistic concerns cannot supersede the nation’s paramount goal of equal economic opportunity for all.” Reflect on this legal case. Can you find other cases that are more recent which relate to this topic? Are the decisions similar or have they been adjusted? What is your opinion on “blood line” being a discriminating factor? Solution Manual for Entrepreneurship: Theory, Process, and Practice Donald F. Kuratko 9781305576247
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