CH-5-7 Franchising – Small Business Management: Entrepreneurship and Beyond : Book Guide

This Document Contains Chapters 5 to 7 Chapter 5 Franchising Teaching Tips • Entrepreneurs have three possible paths for getting into business for themselves—franchising, taking over an existing business, or starting from scratch. Approach this chapter as the first of three options. • The chapter is broken into three main sections: what franchises are, advantages and disadvantages from both the franchisee’s and franchisor’s perspectives, and how to choose the right franchise. • Send for a disclosure statement from a franchisor to show to your students. Most will be amazed at the size and comprehensive content. • This is a very good chapter during which to have a guest speaker come to your class to discuss his or her experience with franchises. • Use the case, What Would You Do? to bring out discussion regarding what it really takes to get into a franchise. The two businesses (Snip’N Clip and Yogen Fruz Worldwide) are there as thought starters, or you may choose to allow students to complete the exercise on any other franchise. Entrepreneur magazine’s annual Franchise 500 edition is a good starting point for students to choose a franchise. This end of chapter case is about Marc Shuman’ struggle to expand his franchised garage organization business. Read the case setup to your class from the beginning to “The Decision” (it is available at the end of this section). Then you can either begin class discussion with the whole group or break the class into groups of three or four and have them brainstorm strategies before opening discussion to all. After you hear students’ recommended strategies, read “The Decision” and “The Experts Weigh In” to share what really happened. Lecture Outline Opening Vignette: Fred DeLuca What’s the Point? The point of this chapter opener is the example of one entrepreneur who started his business making sandwiches while in college and became one of the most successful franchises in existence. Subway recently passed McDonalds in total number of outlets. Many students think of purchasing a franchise, but fewer consider the other side—developing an original idea into a franchised chain of businesses. Concept Module 5.1 About Franchising LO1 Explain what a franchise is and how it operates A. A franchise is the contractual agreement that binds a parent company (the franchisor) to an independent small business (the franchisee). B. Background Franchising began long before the current explosion of fast food restaurants. Cyrus McCormick and Isaac Singer started using contracts with independent representatives to sell the products they manufactured in the 1830s. This laid the foundation for franchising. C. Franchising Today Over 600,000 franchised businesses generate a total in excess of $1 trillion per year in the United States. (See Figure 5.1, Types of Franchises. It shows the changes in composition of Franchise 500 from 1980 to 1999. Food franchises make up a much larger percentage of total franchised businesses.) Reality Check: Just the Facts... This highlight box shows the huge contributions of franchised businesses. D. Franchising Systems 1. Product-Distribution Franchising Product franchising allows a franchisee to use the name, sell the products, and take advantage of promotion of a single manufacturer—the franchisor. 2. Business-Format Franchising Business-format franchising is more of a turnkey approach. Franchisees must adhere to much more stringent policies and procedures developed by a franchisor. Concept Check Questions 1. What is the difference between a franchise, a franchisee, and a franchisor? The difference between a franchise, a franchisee, and a franchisor is that a franchise is an agreement that binds a franchisor with a franchisee. A franchisor is a parent company of the product, service, or method. A franchisee is a small business that pays fees and royalties for exclusive rights to local distribution of the product or service. 2. How would you explain the difference between franchises and other forms of business ownership? The difference between franchises and other forms of business ownership is that franchises are expansions of a company, whereas other forms of business ownership are either new or existing. 3. Why would you prefer to buy a franchise rather than start a new business or buy an existing business? Answers will vary. One student responded, “I would prefer to buy a franchise rather than start a new business or buy an existing business because out of the two ‘musts’ in business ownership, know-how and money; the know-how is pretty much established in a franchise. For example, McDonald’s sends you to ‘Hamburger University’ to ensure success. Some advantages to franchising are a proven product/ service, market expertise, technical and managerial assistance, and ease of entry.” 4. Why is franchising important in today’s economy? Franchising is important in today’s economy because it accounts for 12 percent of all U.S. business, employing 8 billion people. Franchises make up 40 percent of total retail sales. Less quantitatively—they provide many people who do not have the skills to start a business from scratch with the opportunity to own their own business and control their own destiny. 5. What is the difference between product-distribution franchises and business-format franchises? Give an example for each that has not been cited in the text. The difference between product or trade-name franchises and business-format franchises is that product or trade-name franchises allow the franchisee to buy products from the franchisor or to license the use of its trade name. It regulates franchisee location to avoid excessive competition. Business-format franchising allows the franchisee to buy products from the franchisor as well, but in addition, it adopts an entire way of doing business. 6. After you have read about entrepreneurship in Chapter 2, would you consider someone who buys a franchise to be an entrepreneur? Does franchising stifle entrepreneurship? The question calls for some speculation and opinion. One student responds, “I would consider someone who buys a franchise an entrepreneur in most ways because an entrepreneur has an innovative idea whereas a franchisee does not have an innovative idea. However, he or she still must go through an ‘entrepreneurial event’ within the entrepreneurship process. A franchisee would experience two of the three events, a triggering event, and implementation.” Concept Module 5.2 Why Open a Franchise? LO2 Compare the advantages and disadvantages of franchising. A. For a segment of the self-employed, opening a franchise makes a lot of sense. Sometimes it does not pay to reinvent the wheel. Table 5.1, The Advantages and Disadvantages of Franchising illustrates the pros and cons for both the franchisor and franchisee. B. Advantages to the Franchisee 1. Proven Product—Customers know what to expect and recognize the product/business name. 2. Marketing Expertise—The pooled resources available through franchises provide advertising dollars to generate name recognition not available to independent businesses. 3. Financial Assistance—Some franchisors provide financial assistance to franchisees in the form of trade credit or overhead reduction. 4. Professional Guidance—A franchisee has a place to go with questions and receives suggestions, training, and guidance not available to independent business owners. 5. Opportunity to Learn—Some franchisors prefer that franchisees have no experience in their particular type of business (so they don’t have to unlearn bad habits). This can be a huge advantage for people making mid-career job changes. 6. Recognized Standards—A franchisor’s quality standards produce consistency between individual franchised locations. Customers know what to expect from one location to the next. 7. Efficiency—Franchisees can step into a business that has already determined appropriate inventory, equipment, and supplies in addition to the bulk purchasing available through franchising to lower unit costs. 8. Potential for Business Growth—If a franchisee is successful in one location, the opportunity to expand other franchises in other locations is often available. C. Disadvantages to the Franchisee 1. Cost of Franchise—The services, assistance, and assurance provided by franchisors come at a cost. Franchise fees and royalty fees can be expensive. (See Table 5.2, Getting In showing initial fees, startup costs, and royalty percentages.) 2. Restrictions on Freedom or Creativity—Franchisees have significantly less freedom of operation than independent business owners. 3. Overdependence or Unsatisfied Expectations—The franchisee must be willing and able to apply his or her own managerial decisions in running a business in the best way for the local market. 4. Risk of Fraud or Misunderstanding—Less than scrupulous franchisors have been known to mislead potential franchisees. Franchisees must read and understand every section of the franchise agreement before they sign it. 5. Problems of Termination or Transfer—Contractual agreements (like franchises) can be very difficult to get out of or to sell to someone else. 6. Poor Performance of Other Franchisees—Since customers patronize franchises because they know what to expect, a location that provides substandard products or services can have an ill effect on all other franchisees. D. Advantages to the Franchisor 1. Expansion with Smaller Capital Investment—Franchise fees provide expansion capital for franchisors. 2. Multiple Sources of Revenue—Franchisors have several sources of revenue built into franchise agreements. 3. Controlled Expansion—Franchisors have more capacity to control where and how fast the business expands than corporate chains. 4. Motivated Franchisees—Since franchisees are independent business owners, they are very motivated to succeed. The more the franchisees succeed, the better business is for franchisors. 5. Bulk Purchasing—Centralized purchasing provides lower unit costs of products, equipment, and supplies through economies of scale. E. Disadvantages to the Franchisor 1. Loss of Control—While franchisees face constraints when entering franchise agreements, so do franchisors. Franchisors need to get an agreement from franchisees to change, add, or eliminate products or services. 2. Profit Sharing—Franchisors do have to share profit with franchisees and investors rather than pocketing it all. 3. Franchisee Disputes—While the contractual agreement that binds both parties is written with the intent of solving as many problems in advance as possible, disputes always arise and must be dealt with. What Would You Do? Two potential franchises: Snip ’N Clip and Smoothie King 1. Of the two franchises presented, draft a business plan outline for the one that you would be interested in. Cover Page Table of Contents Executive Summary Company and Industry Products or Services Marketing Research and Evaluation (1) Sales forecasts (2) Target Markets and Market Segmentation (3) Market Trends (4) Competition (5) Market Share (6) Marketing Plan (7) Pricing as part of Marketing Plan (8) Promotion as part of Marketing Plan (9) Place as part of Marketing Plan (10) Service Polices as part of Marketing Plan Manufacturing and Operations Plan (1) Geographic Location (2) Facilities (3) Make-or-Buy Policy (4) Control Systems (5) Labor Force Management Team Timeline Critical Risks and Assumptions Benefits to the Community Exit Strategy Financial Plan (1) Sources and Uses of Funds (2) Cash Flow Statement (3) Balance Sheet (4) Profit-and-Loss Statement (5) Breakeven Analysis Appendix 2. Divide the class into teams to discuss the merits and potential drawbacks of each of these franchises. Snip ’N Clip – Advantages include widespread demand for hair cuts and styling. Franchised salons enjoy the benefit of standardized practices and wider name recognition than individual shops. Disadvantages include royalty fees and intense competition. Smoothie King – Advantages include current high demand for high-profit smoothies and no dominant leader in the market. Disadvantages include the question of whether smoothies are just a fad for which demand will fade. Concept Check Questions 1. What are the biggest advantage and the biggest disadvantage of franchising? Justify your answer. An advantage of franchising is the technical and managerial assistance because it provides support and direction for a new-business person. A disadvantage of franchising (besides the franchise fee and royalties) is poor performance of other franchises, because the others could ruin your reputation. 2. What do you expect to get in return for paying a franchise fee? In return for a franchise fee, you should expect the franchisor to provide all the terms and conditions of the franchise contract—like advertising, exclusive territory, managerial or financial assistance, or anything else specified. 3. What is a royalty fee? Royalty fees are a percentage of gross sales, not profits, that you must pay to the franchisor. Concept Module 5.3 Selecting a Franchise LO3 Explain how to evaluate a potential franchise A. Choosing the right franchise is a serious decision and can be a huge commitment of time and money. B. Evaluate Your Needs Potential franchisees need to determine how much capital they need to come up with and where it will come from. They must be ready to give up a degree of independence. They must be convinced they have the “fit” needed to succeed with the chosen franchise. They must be ready to make a long-term commitment and be willing to stick to it. C. Do Your Research 1. Many sources of franchise information exist—including general business periodicals, specific franchise periodicals, trade associations, and web pages. Many questions to ask are included in this section. (See Table 5.3, Franchise Information showing examples of franchise information on seven franchises.) 2. Other Information Sources Reality Check: Go to the Source Here are some questions to ask franchisees before signing a franchise agreement. 3. Questions to Ask D. Analyze the Market Some of the most important questions a potential small business owner (using any format) should ask relate to the market—the people who will be buying the proposed products. E. Disclosure Statements Franchisors are required by the FTC to provide disclosure statements to prospective franchisees. The intent of these documents is to provide any information the franchisee would need to make an informed decision regarding entering into an agreement with the franchisor. Disclosure statements provide information on the 20 items that are listed and defined in this section. (See Figure 5.2, Franchise Disclosure Statement listing the Table of Contents from a franchise disclosure statement.) F. The Franchise Agreement 1. The franchise agreement is a document that spells out the rights and obligations of both parties in a franchise. A franchisee should remember that the franchisor wrote the contract and most of the terms are weighed in their favor. Franchisees should not sign it until they thoroughly understand the contract and have had it reviewed by their lawyers. 2. Franchise, Royalty, and Advertising Fees—A franchise fee is the one-time payment a franchisee pays in order to enter into the franchise agreement. Royalty fees are a percentage of revenue paid each month. 'Trep Connections: Denny's Social Media Life Students will probably be surprised that a company as 'old school' as Denny's is active in promoting the business. 3. Termination of the Franchise Agreement—The franchise agreement spells out how the franchisee may lose franchise rights. 4. Terms and Renewal of Agreement—How long the agreement is in effect and how and if it can be renewed are included. 5. Exclusive Territory—The issue of exclusive territory is one of the most controversial topics in franchising. Franchisees need to know the geographic areas that they will have protected. 6. Due diligence is needed before entering into a franchise agreement. G. Get Professional Advice A franchisee should consult a lawyer and a CPA before signing a franchise agreement. Concept Check Questions 1. Is the disclosure statement the only source of information you need to check out a potential franchise? Why or why not? While it is a valuable source of information, the disclosure statement is not the only source of information you need to check out a potential franchise. The franchise agreement also needs to be looked at because it spells out your rights and obligations. You should talk with current and past franchisees. You should check with your lawyer, accountant, banker, and other professionals. 2. After reading about the topics included in a franchise agreement, who do you think controls most of the power in a franchise: the franchisee or the franchisor? Explain. In reading topics included in a franchise agreement—the franchisor controls most of the power in a franchise, which is why the FTC requires full disclosure by franchisors. 3. What are the potential sources of conflict between franchisees and franchisors? The potential sources of conflict between franchisees and franchisors include hours of operation, expansion, payment of fees, exclusive territories, and enforcement of standards. 4 You are worried that someone else will buy a specific franchise in your area before you do. Would it be all right to sign the franchise agreement before talking to your lawyer or accountant if you intend to meet with them later? Explain. No—do not sign any contract (including the franchise agreement) before talking to your lawyer or accountant, even if you intend to meet with them later. Your lawyer would inform you of all your rights and obligations. Also, different states have different laws which may affect your franchise. A disclosure statement doesn’t disclose everything. 5. If you are the franchisee of a bookstore and you are offered twice the business’s book value to sell it to a third party, should you or the franchisor collect the additional money? Take a position and justify it. A legal case could be made either way. The answer is whatever is spelled out in the franchise agreement, which is the legally binding contract between the two parties. 6. Explain how a franchise could be considered a partnership. What makes a franchise agreement simpler than a partnership that you would start with another individual? A franchise is a partnership because you are contractually bound to another business. Even if you are both incorporated, you are still partners (with most of the problems typical in partnerships). A franchise may be simpler because the franchise agreement spells out the rights, duties, and obligations of both parties better than most partnership agreements. Concept Module 5.4 International Franchising LO4 Explore franchising in the international marketplace Many franchises are experiencing significant growth through international markets rather than domestic U.S. markets. Some highlights of franchise legislation in several countries are included. Concept Check Questions 1. What do you think will be the growth areas (in products, services, and geographic areas) for franchises in the near future? Student answers will vary. One student stated, “I believe growth areas for franchises in the near future will be home goods which are delivered or mail ordered. People are busy and don’t have time to waste shopping, and they will always need the necessities. I believe this service will be extremely important.” Experience This…bonus student exercise Contact a local franchise owner and set up an appointment to visit. Ask if you can see a copy of the franchise agreement or, at least, discuss the terms and conditions of the agreement with the franchisor. Student responses will vary depending on what franchise they visited. Chapter Closing Case Extreme Garage Makeover Questions 1. What problems such as lawsuits, reputation, and public image would GarageTek face if they closed failing franchises? Students can discuss potential lawsuits that franchisees could bring against Shuman such as breach of contract for insufficient training. They should also be concerned about controlling public relations and problems of recruiting new franchisees should they close failing ones. 2. Was shuttering the failed franchises the right move for Shuman? What are his other options? Students may make a case for giving struggling franchisees more chances, but they need to realize that too many resources going to the least productive businesses could put the entire system at risk. Shuman wisely took a progressive approach toward helping those franchises that were struggling rather than shutting their doors immediately. The Decision www.inc.com/magazine/20060301/handson-casestudy.html One afternoon in November 2003, Shuman strode into the conference room at GarageTek’s headquarters for the company’s annual meeting. The eight members of GarageTek’s franchise advisory council sat at a large table, unaware of the major shakeup that was about to happen. Shuman ran through a PowerPoint presentation that explained why certain franchises were failing. He also outlined how corporate profit would improve if they were shut down. “We sold the idea of folding the failing locations to the council as a matter of courtesy,” he says. As Shuman clicked through slide after slide, some members of the council began to realize that their days were numbered. There were no arguments or heated exchanges, but the room was tense. “We were all kind of stunned,” recalls one franchisee from California, who asked not to be named. The successful franchise owners, not surprisingly, were more at ease. “People who were successful were comfortable with [Shuman’s plan],” says Peter Belman, who now runs GarageTek locations in Washington, D.C., and Atlanta. “I think people who were less successful were probably mixed.” Rather than shutting down the failing locations immediately, Shuman gave 15 owners about six months to turn things around, calling low performers regularly to quiz them about their financial problems and suggest improvements. During 2004, Shuman’s watch list increased to 19 owners. Three franchisees bounced back, but 16 others continued to struggle. Shuman and his team turned up the heat on the failing franchises that summer. In early 2005, he began to call business brokers to quietly line up buyers for locations in the most promising of those markets. By late 2005, 14 of the owners on Shuman’s target list had left. Two others sold their franchises. “Some guys were left with some pretty hard feelings,” Shuman says. He and his team moved quickly to correct their mistakes. The first step was to create more stringent criteria for new franchisees. To pass the initial screening, candidates now need a net worth of $1 million, with at least $250,000 in liquid assets; their proposed territories must boast at least 250,000 single-family homes, occupied by owners. They’re also required to run the franchises themselves. GarageTek also decided to administer a 350-question personality test, looking for candidates with traits similar to GarageTek’s top performers, who tend to be enterprising and not overly accommodating—a sign of independence. Finally, all candidates fly to New York to meet with Shuman and his corporate team. To identify problems early on, he installed software that enables him to track each franchise’s financial performance. In addition, all new franchisees attend a two-week sales and accounting session at GarageTek’s headquarters. Sales, marketing, and operations experts then visit each new location, troubleshooting and offering pointers. GarageTek also arms new owners with a seven-volume training manual, a marketing kit filled with sample advertisements, access to GarageTek’s intranet, which has more marketing material, and a database of prospective buyers. Newcomers are required to participate in monthly conference calls and regional and national franchisee meetings. Shuman is also teaching by example. He recently bought GarageTek’s Atlanta franchise, which will be run by co-owners and serve as a flagship store. So far, the strategy seems to be working. In 2005, GarageTek’s sales jumped 33 percent, to $20 million, even though the company had 21 fewer franchises than in 2004. Now that he has a streamlined system in place, Shuman plans to add 55 new franchises during the next few years, for a total of 100. But he admits that he has more to learn. “We’re not, by any stretch, done,” he says. SOURCE: Stephanie Clifford, “Case Study: Hooked On Expansion,” Inc., March 2006, 44–50 Chapter 6 Taking Over an Existing Business Teaching Tips • This second option for entering business—taking over an existing business—contains a lot of information and much for students to absorb. Set the stage for discussion for this chapter by emphasizing the importance of a business buyer remaining objective throughout the process and not letting emotions cloud judgment. • Discuss the importance of “due diligence” and detective work needed to find out what you are really buying in a business. • Chances are good that at least one of your students has been involved with a family business. Have him or her discuss the differences with family businesses—especially succession planning. • You may wish to consider having a business broker speak to your class. • Use the chapter closing case, two partners struggle with the decision of whether to sell their business or not. Read the case setup to your class from the beginning to “The Decision” (it is available at the end of this section). Then you can either begin class discussion with the whole group or break the class into groups of three or four and have them brainstorm strategies before opening discussion to all. After you hear students’ recommended strategies, read “The Decision” and “The Experts Weigh In” to share what really happened. Lecture Outline Opening Vignette: Jan Koum and Brian Acton, founders of WhatsApp What’s the Point? Students can use the story as inspiration because of the sheer magnitude of the numbers and also analyze the pros and cons of purchasing a business for sale. Concept Module 6.1 The Business Buyout Alternative LO1 Compare the advantages and disadvantages of buying an existing business. A. The second alternative for business ownership covered in this chapter is purchasing an existing business. An offshoot of this option is taking over a family business. B. Advantages of Buying a Business (See Table 6.1, The Advantages and Disadvantages of Buying a Business.) 1. Established customer base at present location 2. Customers familiar with location 3. Planning can be based on known, historical data 4. Supplier relationship already in place 5. Inventory and equipment in place 6. Experienced employees 7. Possible owner financing C. Disadvantages of Buying a Business (See Table 6.1, The Advantages and Disadvantages of Buying a Business.) 1. Image difficult to change 2. Employees may be ones whom you would not choose 3. Business may not have operated the way you like and could be difficult to change 4. Possibly obsolete inventory and equipment 5. Financing costs could drain your cash flow and threaten the business’s survival 6. The business’s location may be undesirable, or a good location may be about to become not so good 7. Potential liability for past business contracts Reality Check: Stay In the Box - Negotiating Strategies The purchase of any business involves negotiation. No matter what method buyers and sellers use for business valuation, the final outcome will be determined by negotiating. This box contains negotiating tips and tactics. Concept Check Questions 1. What are some arguments for buying an established business rather than starting one yourself? Students should verbalize in their own words such advantages as established customers, established location, reputation of business, trained employees, and supplies and equipment in place. 2. Should one ever consider purchasing a presently unsuccessful business (that is, a business with relatively low or no profits)? Explain. Yes, purchasing an unprofitable business can be a good strategy if the buyer has some skill or talent that can turn the business around. Go in understanding the kinds of investments you have to put into it: money, time, effort, and mental. Concept Module 6.2 How Do You Find a Business for Sale? LO2 Propose ways of locating a suitable business for sale. Newspaper classified advertising and local business professionals (bankers, lawyers, accountants, and SBA reps) are preliminary sources for businesses for sale. Business brokers list and represent businesses for sale. Websites, even eBay, list businesses. Concept Check Questions 1. Discuss the advantages of dealing through a business broker. What precautions should one take when dealing with a business broker? A business broker knows the ropes and understands the buying and selling process, but he or she may only have the seller’s interests at heart. He or she may be more concerned about generating commission than satisfying the customer’s needs. 2. What are the positives and negatives of searching for a business for sale via an online site? Online sites show a wide range and variety of businesses in one concentrated search, but not the breadth needed to complete a transaction. Online sites are the beginning of due diligence, not the end. Concept Module 6.3 What Do You Look For in a Business? LO3 Explain how to measure the condition of a business and determine why it might be offered for sale. A. An important point to be made here is to not let emotions cloud a business purchase decision. Some key questions to be answered include: 1. How long has the business existed? 2. What is the profit record? 3. What is the condition of the inventory? 4. Is the equipment in good condition? 5. How long does the lease run? 6. Are there dependable sources of supply? 7. What about present and future competition? 8. What is the condition of the area around the business? 9. Does the present owner have family, religious, social, or political connections that have been important to the success of the business? 10. Why does the present owner want to sell? 11. Are personnel satisfactory? 12. How does this business, in its present condition, compare with one that you could start and develop in a reasonable amount of time? B. Due Diligence Due diligence is the entire process involved in analyzing a business to purchase. Analysis begins with financial statements and ratios and continues through every facet of the business. C. General Considerations If purchasing a business, put earnest money in escrow to show that you are a serious buyer, but have protection if the deal falls through. Become familiar with the bulk sales provision of the Uniform Commercial Code for the state in which the business is located. D. Why Is the Business Being Sold? Some detective work may need to be done during due diligence to try to assess the reason the business is being sold. A buyer should have a healthy skepticism for reasons provided up front. Entre-perspectives - Watch Out This box provides an example of some things to watch for in analyzing a business. E. Financial Condition 1. Financial analysis begins with the company’s financial statements, but it does not end there. Bank deposits and tax returns should be evaluated. Many things can be done to make financial statements less than a true reflection of financial condition—deferred maintenance, inventory or labor shortages, and insufficient write-off of bad debts are examples. 2. A business buyer should not take previous year financial statements as the whole picture. Financials are harder to distort over a longer period of time, so look at three to five years at least. 3. Independent Audit 4. The Profit Trend Reality Check: Show and Don't Tell - Letter of Confidentiality This box provides an example of a letter that a prospective business buyer would send to assure that all confidential information disclosed about the business will stay confidential. 5. The Expense Ratios 6. Other Measures of Financial Health Concept Check Questions 1. When buying an established business, what questions should you ask about it? From whom might you seek information about the business? Questions could include: What has the profit record of the business been? In what condition is the inventory? What are the terms and conditions of the lease? Are there adequate sources for supplies? What about competition? Talk to bankers, creditors, suppliers, and competitors. 2. What factors warrant special attention in appraising a firm’s (a) inventory? (b) equipment? (c) accounts receivable? Answers could include: (a) Is the inventory fresh, dated, or dead? (b) Is the equipment new, usable, dated, or useless? (c) The older the age of A/R, the lower their value. 3. What should a prospective buyer know about the seller’s inventory sources and other resource contacts? How is this information obtained? What type of relations with suppliers have they had? Does the business being purchased owe money on accounts? Are they past due? Will the suppliers continue to work with you in a similar fashion? Talk to suppliers, and find their sources. 4. You are analyzing the financial records of the business you have been thinking about buying. You discover that, although the firm has excellent current and quick asset ratios by industry standards (current assets are higher than current liabilities), its cash is low and it hasn’t paid its bills on time. What might have caused this? Would this influence your decision to buy the business? Your due diligence would probably lead you to believe that the owner may be attempting to manipulate the business financials to look better than they really are—keep looking deeper for evidence. Concept Module 6.4 What Are You Buying? LO Differentiate between tangible and intangible assets, and assess the value of each. A. The value of a business comes from what it owns, what it owes, how much cash it generates, and the risks involved. (See Figure 6.1, What Should You Pay? which shows how tangible assets, intangible assets, and profitability add up to the purchase price.) B. Tangible Assets 1. Tangible assets cast a shadow and are typically easier to attach a value to than intangibles ones. 2. The Inventory—The biggest concern about inventory is the amount of “dead stock.” 3. The Equipment—In valuing equipment, use the analogy of dog years. Every year of a dog’s life is comparable to about seven human years. The same holds true for technology. A one-year-old computer is worth much less than a one-year-old desk. Reality Check: What's it Really Worth? This box illustrates the fact that the older accounts become, the less valuable they are because of the decreased likelihood of collection. C. Intangible Assets 1. Intangible assets have value to a business, but may be more difficult to put a dollar amount on because they are not visible. 2. Goodwill—Goodwill is an intangible asset that enables a business to earn a higher return than a comparable business with the same tangible assets. While most business sellers will ask for goodwill in the price, not all businesses justify it. 3. Leases and Other Contracts 4. Patents, Copyrights, and Trademarks D. Personnel When purchasing a business, the people working there must be considered just as important as profits and production. Retention of certain key people will keep a successful business going. E. The Seller’s Personal Plans Reduce risk of the previous business owner becoming new competition by writing a protective clause into the contract of sale called a noncompete clause. Concept Check Questions 1. Does every business for sale have an intangible asset of goodwill? Explain. Every business has NOT build the intangible asset of goodwill, but most small business sellers will believe that they have. This is the point that no matter which valuation method is applied to a business, buyers and sellers will set the floor and the ceiling price - then the process is based upon negotiation. 2. Which type of asset would be more difficult to value - tangible or intangible? Why? The point of the question is not as much the difficulty in valuing either type of asset, but more the different processes used. Tangible assets may have a slight edge in ease in finding a comparable price for the same item. As with the previous question, the true value really comes down to negotiation. Concept Module 6.5 How Much Should You Pay? LO Calculate the price to pay for a business. A. Determining the purchase price of a business involves several important factors: 1. Valuation of the firm’s tangible net assets 2. Valuation of the firm’s intangible assets, especially any goodwill 3. Expected future earnings 4. The market demand for the particular type of business 5. The general condition of the business B. A balance sheet method of valuation determines the price of a business based on the worth of its assets. An income statement method of valuation determines the price of a business based on its profit potential. C. What Are the Tangible Assets Worth? 1. Book value—the value of an asset based on what it originally cost or the amount shown in accounting records. 2. Replacement value—what it would cost to buy the same materials, merchandise, or machinery today. 3. Liquidation value—how much an item would bring if sold immediately, for example, at an auction. D. What Are the Intangible Assets Worth? 1. Goodwill can be regarded as 1) compensation to the owner for his or her losses on beginner’s mistakes you might have made if you had started from scratch, and 2) payment for the privilege of carrying on an established and profitable business. 2. Valuing goodwill is a highly subjective process. The value of intangible assets comes down to what you think they are worth and what you are willing to pay. You will need to negotiate with the seller to establish the “actual” price. (See Table 6.2, Calculating the Purchase Price of an Existing Business.) Concept Check Questions 1. Which is more important in appraising a business—profitability or return on investment? Discuss. A case could be made for either, depending on the personal desires of the buyer. If return on investment is most important, then the buyer is interested in investing money to generate the greatest return. If profitability is most important, then the buyer is interested in maximizing short-term profits. 2. Does competition help or hurt the valuation of a business? Explain. This question should generate significant discussion. Competition is good for customers and economies because competition raises standards and provides incentive for continuous improvement of goods, services, and processes. Businesses with new ideas change markets. Can competition hurt individual businesses? Absolutely, if they do not have a competitive advantage. 3 Discuss the ways in which the tangible assets of a business may be valued. What is the most realistic approach to determining a business’s true value? Why? Inventory can be valued by the replacement cost of buying those same goods again; by the purchase price of the existing goods; or by liquidation value—what those goods could be sold for at auction. Inventory needs to be timely, fresh, and well balanced. Be wary of dead stock. Equipment should be new or usable. Electronic equipment becomes dated quickly. Be wary of old or useless equipment. If you are the buyer of a business, you will want to purchase at liquidation price. If you are selling a business, you would prefer to sell at book value. Thus begins the negotiation process. 4. What is goodwill, and how may its value be determined? Goodwill is an intangible asset that gives a company an edge in revenues and profitability over similar businesses with the same tangible assets. It is difficult to determine the value of goodwill. It is a perceived value—what the buyer sees compared to what the seller sees. Goodwill can be seen as the price a business buyer pays for not making the same mistakes the seller has already made. 5. How can a buyer determine the rate of return to use in evaluating the worth of a business? The purchaser of a business can view buying a business from an investment perspective—the rate of return the business generates should be compared with investing that same amount of money in some other investment. Concept Module 6.6 Buying Your Business LO6 Understand factors that are important when finalizing the purchase of a business A. The Terms of Sale 1. Rather than making one cash payment (which most purchasers can’t come up with anyway), terms need to be negotiated. Installment payments can help the purchaser’s cash flow and the seller’s tax payments. 2. A tactic called “thinning the assets” can make a business more affordable. B. Closing the Deal Closing can be handled by using either a settlement attorney or an escrow settlement. A settlement attorney acts as a neutral party to draw up the necessary documents and represents both the buyer and the seller. With an escrow settlement, the buyer deposits the money, and the seller provides the bill of sale and other documents to an escrow agent. Concept Check Questions 1. What is meant by “thinning the assets”? Cite examples. Thinning the assets is a means of making the business more affordable for the buyer. It can be accomplished by separating real estate ownership from ownership of the business, by leasing equipment rather that outright purchase, and by selling off excess inventories. Concept Module 6.7 Taking Over a Family Business LO Describe what makes a family business different from other types of business. A. Taking over a family business is actually a fourth alternative for entering the world of business ownership—an alternative that has unique opportunities and challenges. B. What Is Different About Family Businesses? Two factors make family businesses different: 1) the complex interrelationships of family members interacting with each other and interacting with the business, and 2) the intricate succession planning needed. Entre-perspectives: Zildjian Cymbal Company, Their Family Business is a Sequoia The point of this box is to illustrate a successful family business that started in 1623. Ask your class what would be required in terms of commitment and sacrifice for a family business to survive 380 years and 14 generations and continue to grow C. Complex Interrelationships Three overlapping perspectives affect family businesses—the perspective of the family, the perspective of the business owners, and the perspective of the business managers. Situations become complex when people must maintain a balance between all three. (See Figure 6.2, Family Business Perspectives.) D. Planning Succession Less than one-third of all family businesses survive through the second generation. The major cause of family business failure is lack of a succession plan. Why don’t more families create a succession plan? (See Figure 6.3, Succession Model of Family Business.) 1. It means admitting the mortality of a senior generation. 2. Many senior members are not confident in the next generation’s ability to run the business. 3. Transfer of control is put off too long, often because the senior members are concerned about their own financial security. 4. Seniors are too personally tied to the business to let go. E. General Family Business Policies 1. When hiring, family members must meet the same criteria as nonfamily employees. 2. In performance reviews, family members must meet the same standards as nonfamily employees. 3. Family members should be supervised by nonfamily employees when possible. 4. If family members are under age 30, they are only eligible for “temporary” employment (less than one year). 5. No family member may stay in an entry-level position permanently. 6. All positions will be compensated at fair market value. 7. For family members to seek permanent employment, they must have at least five years’ experience outside the company. Family members must prove their worth to another employer to be useful here. What Would You Do? 1. What should the mother do for her family (and her business) to operate more normally? Members of family businesses must realize that they play different roles at different times. There is a time to do what needs to be done to run a business, and there is a time to be a functional family. It sounds like this mother may have to put on her “President’s hat,” and tell her sons something to the effect of, “Shape up, quit bickering, and do what needs to be done for us to run this business.” Not easy for a mother, but it’s what presidents do. 2. Would bringing in a nonfamily manager with direct line control ever each brother help or cause more problems? How can they ever decide who will eventually take over control of the business? Bringing in a nonfamily manager is a drastic step, because it would almost certainly mean that the mother would have to remove herself from the business. A business cannot have two at the top of its organization chart. All the family members involved in the business MUST eventually come to some agreement on succession planning. Failure to do so (and the accompanying disagreements) has caused the end of many family businesses. Concept Check Questions 1. A mother believes that all the family’s children should have equal ownership of the family business regardless of their participation in the business. The father sees the situation completely differently. He believes that the children who are actively involved should receive more ownership. How can this dispute be resolved? This situation illustrates a serious problem for family businesses. The bottom line is that there is no one correct answer. A lot of open, frank discussion needs to take place as the family attempts to find a middle ground that is acceptable to everyone with a minimum of resentment and deterioration of family harmony. Experience This…bonus student exercise Look for the name of a business broker in your community. Call the broker and ask about the process of buying an existing business. What terms and considerations are common? What businesses does the broker currently represent? Student answers will vary based on what brokers they contact. Chapter Closing Case Is Buying Two Businesses Better than One? Questions - 1. The CEOs lived on different continents and barely knew each other. Could they make a deal work? Yes, despite being on different continents and barely knowing each other, they made the deal work by finding common ground in management styles, passion, and spending time collaborating. 2. What do you believe the biggest barriers to this two-way business purchase would be? Two teams on two different continents are, of course, a huge concern – Biggest barriers to the two-way business purchase: The biggest barriers would include differences in business practices, labor laws, high employee benefit costs in Singapore, and managing teams across continents. 3. What would you recommend to overcome those barriers? Recommendations to overcome barriers: To overcome these barriers, I would recommend clear communication, flexibility in adjusting compensation packages, and regular collaboration through technology like conference calls to bridge the distance and cultural differences. The Decision Four weeks later, Schwarzer got a call from Bio*One, SingVax's largest shareholder: The deal was on. It was ready to give Santangelo one more chance. "If this didn't come off, SingVax was likely to be wound up," Santangelo says. "We only had limited cash. We had to make it work." Over the next nine months, Stinchcomb and Santangelo spent hours working together in person, on the phone, and by e-mail to unite their two ventures. The pair hit it off, discovering that they shared management styles as well as a passion for public health. But their discussions weren't without the occasional debate. Stinchcomb was surprised at the high costs of SingVax's employee benefits. But Santangelo insisted that they were unavoidable, in part because of Singapore's income tax structures as well as local labor laws (on top of salaries, employers have to contribute up to 14.5 percent of wages to the Central Provident Fund, a social security savings plan). "It certainly required a learning curve on my part," says Stinchcomb. Eventually the pair were able to work out a way to adjust compensation packages in each country so that they were fair across the company. The new company soon had a business plan and fundraising target: at least $11 million. The merged entity, the two agreed, would inherit the Inviragen name and focus first on developing the dengue fever vaccine, the most advanced product in the companies' combined portfolio. Coming up with a new budget was probably the most laborious process for the two CEOs, who spent three months e-mailing back and forth with line-by-line adjustments on everything from manufacturing costs to air conditioning (the second largest expense for SingVax's offices in Singapore, where temperatures are 85 degrees to 90 degrees year round). Then there was the nerve-racking due diligence process, which kicked off in the spring and wasn't over until the late summer. Next, the two had to decide who would lead the merged entity. Santangelo suggested that Stinchcomb become CEO. After all, the company would be headquartered in the United States, where most biotech investors are. And Santangelo, who took the title of COO, would remain in Singapore, close to many of the new company's target markets. (Osorio became chief scientific officer.) The 26-employee company has its main offices in Fort Collins. Osorio runs a laboratory in Madison for preclinical animal trials of all the company's vaccines. And the former SingVax facility in Singapore manages Southeast Asia -- based trials and coordinates with the company's manufacturer in India. Last September, Inviragen and SingVax announced their merger and a $15 million Series A equity investment from Bio*One, Charter, Madison-based Venture Investors, and Phillip Private Equity of Singapore. Human trials for Inviragen's dengue fever vaccine will be under way in the U.S. by May and in Colombia by September, with trials for the HFMD vaccine planned for later in the year. Success is far from certain. Pharmaceutical giant Sanofi-Aventis, for example, is developing its own dengue fever vaccine. But Stinchcomb is confident that his company will be a strong competitor. Meanwhile, the three executives -- who coordinate from their disparate locations by conference call three times a week -- are growing accustomed to one another. "Sometimes you wonder whether people will be more difficult than you think," says Osorio. "But right now, we're making a great team." SOURCE: www.inc.com/magazine/20100501/case-study-attempting-a-global-merger.html Chapter 7 Starting a New Business TeAching Tips • Use the Opening Vignette to illustrate an example of college students who has started a very successful small business before graduating . • Chances are good that some of your students have started businesses in the past. Ask them to share the biggest challenge they faced. Compare their stories with information in the text. • The section on Types of New Businesses covers only three types: home-based, on-the-side, and fast-growth. Have students discuss other types such as slow-growth, mom-and-pop-type businesses, and others. • Lead a brainstorming exercise relating to the Business Ideas section to come up with ideas for new businesses. • Make the point in the How Will You Compete? section that a small business cannot be everything to everyone. • Use the case, What Would You Do to get students into small groups to analyze a startup possibility. • The chapter closing case is on generating buzz and revenue for a new business. Lecture Outline Opening Vignette: Megan Cox and Miguel Salinas, Wink Natural Cosmetics What’s the Point? The point of this chapter opener is to illustrate visionary entrepreneurs who created technologies to stimulate growth in eye lashes and brows. Concept Module 7.1 About Startups LO1 Discuss the advantages and disadvantages of starting a business from scratch. A. Starting a business from scratch is more difficult than buying an existing one or purchasing a franchise—but it has its rewards. B. Advantages of Starting from Scratch 1. Freedom to shape business 2. Ability to create own competitive advantage 3. Pride and satisfaction of creation 4. Challenge 5. No carryover of other business—start with clean slate C. Disadvantages of Starting from Scratch 1. Higher risk of failure 2. Problem identifying local market needs 3. Difficulty getting attention and communicating with potential markets 4. Multitude and variety of decisions that must be made Concept Check Questions 1. Compare and contrast the advantages and disadvantages of starting a business from the ground up. Be sure to include the different types of businesses in your analysis. Advantages—molding a new business, distinct competitive edge, and the challenge of starting a new business. Disadvantages—higher risk of failure, trouble identifying market needs, informing people of business’s existence, and the stress of starting a new business. Students should cite examples. Concept Module 7.2 Types of New Businesses LO2 Describe types of new businesses and discuss the characteristics commonly shared by fast-growth companies. A. A typical goal of starting a small business is to create a stable organization that provides the owner with a comfortable living. (A majority of small business owners do not aim for the Inc 500, which is measured by rapid growth.) Many approaches are available and possible; this section views but a few—e-business, home-based business, starting a business on the side, and fast-growth startups. B. E-Businesses The Internet is a powerful tool for conducting business. Online businesses can potentially reach many more people than ever before. But keep in mind that the Internet does not make all other business metrics obsolete. A small business owner must still make a profit, keep employees happy, provide customer service, and sell a product that people want. Some characteristics that a successful web business must possess: 1. Have a sound business strategy 2. Have a clear market analysis and create traffic coverage 3. Logistics are huge 4. Use the Internet to increase efficiencies C. Home Based Businesses 1. Advantages of a Home-Based Business—The fastest-growing segment of business startups comprises those operated out of one’s home. a) Control over work hours b) Convenience c) Ability to care for domestic responsibilities d) Low overhead expenses e) Lack of workplace distractions f) Decreased commute time g) Tax advantages 2. Disadvantages of a Home-Based Business a) Difficulty setting aside long blocks of work time b) Domestic interruptions c) Informal, cramped, insufficient workspace at home d) Demands on family members to cooperate e) Lack of respect f) Lack of workplace camaraderie g) Zoning issues D. Starting a Business on the Side While this route may be fraught with difficulties, many people “keep their regular job” while starting a business on the side. E. Fast Growth Startups Inc. magazine publishes an annual edition in which it identifies its Inc. 500. These are the fastest-growing businesses around. The fastest growing company for 2013 averaged 43,148% growth per year! (See Figure 7.1, Inc. 500 by the Numbers for additional information about these companies.) Characteristics of these fast-growth companies include: 1. They rely on team effort. 2. They’re headed by people who know their line of work. 3. They’re headed by people who have started other businesses. 4. They’re making big bucks. 5. They’re high tech. 6. They’re better financed—but not by much. 7. Their markets aren’t just local. Concept Check Questions 1. Define “hypergrowth” companies, and evaluate the reasons for their phenomenal rate of growth. What are the most valid explanations for the rate of success found in these companies? Hypergrowth is a term used for a company expanding much more rapidly than normal. They can be seen as “overnight successes.” Students should review and discuss characteristics cited beginning. 2. Many entrepreneurs test the waters of a market by starting a sideline business. What are the advantages and disadvantages of selling items on Internet auctions like eBay? Is a person who regularly has 20 or 25 items for sale at any given time an entrepreneur? What types of products would be most appropriately sold in this manner? Advantages of testing a market by selling on eBay include low overhead and the ease of getting started. There are several new product categories that customers do not go to eBay to find – food and edible products, for example. Entrepreneurs are not defined by the number of products that they sell at any given moment. Relatively small (for easy shipping) electronic gadgets are always popular eBay sellers. Concept Module 7.3 Evaluating Potential Startups LO3 Evaluate potential start-ups and suggest sources of business ideas. A. The first thing needed to start a business is an idea—but not every idea is a viable business opportunity. B. Business Ideas 1. Point out the difference between ideas and opportunities. A business opportunity is attractive, durable, and timely, and is anchored in a product or service that creates or adds value for its buyer. 2. Windows of opportunity open and close as products move through their product life cycle. (See Figure 7.2, Windows of Opportunity at Stages of the Product Life Cycle.) Optimally, you want to get through while the window is still opening—if the opportunity is right for you. Potential entrepreneurs should ask the following questions: a) Does the idea solve a consumer want or need? b) If there is a demand, are there enough people who will buy the product to support a business? c) Can this idea be turned into a profitable business? d) Do you have the skills needed to take advantage of this opportunity? e) Why hasn’t anyone else done it? If others have tried, what happened? Reality Check: Quotable Quotes • Opportunity is missed by most because it is dressed in overalls and looks like work. • For every failure, there’s an alternative course of action You just have to find it. When you come to a roadblock, take a detour…. C. Where Business Ideas Come From See Figure 7.3, Sources of New Business Ideas Among Men and Women for pie charts that show common sources for business ideas. 1. Prior Work Experience—Working for someone else is a great way to learn “the ropes to skip and the ropes to know” to avoid future errors and build competitive advantage. The corridor principle is a great way to visualize the consequences of taking advantage of some opportunities and passing on others. 2. Hobbies and Avocations—If running a business is a chance to do what you love, turning a hobby into a business can be a good path. 3. Chance Happening or Serendipity—Some ideas or opportunities come out of nowhere, so it pays to keep one’s eyes open all the time. Several stories illustrate this point in the chapter. What Would You Do? 1. Carrie Ann is concerned about the timing of releasing her product. She is not sure the window of opportunity is open wide enough at this time for her business to succeed, but she worries that, if she waits for the opportunity to develop, another product will beat her as first to the market. How would you advise her in her opportunity analysis? This is the situation almost every entrepreneur faces with a new-to-the-world product. She needs to conduct marketing research and analyze market trends, but a time will come when she will have to make a “go-no-go” decision. With a product of this type, she could introduce slowly and in stages while the market develops. The problem with this strategy is the attention a successful product attracts from competitors who could enter before she is firmly established. 2. Carrie Ann’s business could become a fast-growth player as described in this chapter. What would she need to do to become a fast-growth company? Students can look at the list of fast-growth characteristics to compare how many would apply to Carrie Ann’s business. Entre-perspectives Creativitve Release This box entails the stimulation of creativity - This is a good point at which to integrate creativity exercises in class (like the Experience This… at the end of the section). Concept Check Questions 1. Explain the concept “window of opportunity” as it relates to new startups from idea conception through the final decision about whether or not to turn the idea into a reality. The window of opportunity is the time frame where your idea could take off, the market can handle your idea, and consumers have a need for your product. You need to get your idea off the ground while the need still exists—windows of opportunity close as time passes. 2. Entrepreneurs get their ideas for business startups from various sources. Elaborate on these sources, and analyze which ones are the most reliable indicators for the new business owner with regard to future success. Prior work experience: new ideas, new concepts, and better ways of doing things. Hobbies and pastimes: something you enjoy doing. Either can work well, but already having experience can help avoid problems you have faced in the past. Comment on the differences in sources of business ideas between men and women. 3. What are some examples of consumer preferences and values? What are some examples of things the new business owner can do to ensure capturing some of the market for the good or service being produced? Some customers want a product for the least amount of money. Others want the best quality product they can find. Another area is customer service that establishes a long-term relationship. As an owner, you can put out a low price leader, be the first in quality, or maintain excellent customer service. 4. What criteria do you see as most critical when differentiating an idea from an opportunity? The difference between an idea and an opportunity largely comes down to the financial feasibility involved. If you can create a sustainable business that will be profitable, you have an opportunity. Concept Module 7.4 Getting Started LO4 Explain the most important points to consider when starting a new business. A. Most of the topics of starting a business are covered in detail throughout the text, but some specifics are covered here. B. What Do You Do First? As previously discussed, decisions to be made early are whether a person wants to work alone or for someone else, and testing of idea feasibility. C. The Importance of Planning to a Startup This is a point that is difficult to overemphasize. Chapters 3 and 4 discussed planning fairly thoroughly, but repetition is a good educational tool. (See Figure 7.4, How Much Money Will You Need?, which discusses initial capitalization.) Entre-perspectives This box highlights Jorge Odon, an auto mechanic who created a device that could save the lives of mothers and babies in developing countries. D. How Will You Compete? Everyone knows that a business can’t be all things to all people. This section illustrates the primary choices that a small business can compete on and become known for. (See Figure 7.5, On Which Mountain Will You Compete?) 1. Operational excellence (price)—Businesses that pursue this area to compete focus all their activities on improving efficiencies in order to offer the lowest prices possible. 2. Product leaders (quality)—These businesses constantly innovate to make the best products available even better. 3. Customer intimacy (service)—These businesses concentrate on building long-term relationships with their customers. E. Customer Service Customer service is crucial in running a small business. It is often the single most important reason customers choose to purchase products at a small business. F. Licenses, Permits, and Regulations The first stop for potential small business owners is their local city hall and county clerk offices. There they can find what local licenses and zoning ordinances apply. Certain types of businesses need special permits—health department inspections for handling processed food, for example. G. Taxes 1. Taxes are no small matter for a small business owner. Quarterly payments of federal (and possibly state) income taxes are required. The forms used to file income and taxes depend on the form of ownership chosen. 2. Once employees are added, a small business needs a federal Employer Identification Number. For Social Security purposes, an employer must withhold 7.51 percent of an employee’s wages and pay a matching 7.51 percent. The self-employed must pay both halves for themselves. 3. Whether a person is classified as an employee or an independent contractor has some serious tax and benefit implications—follow IRS classification guidelines. 4. A small business must deposit a percentage of each employee’s earnings for federal and state unemployment taxes. The federal unemployment tax rate is 6.2 percent of the first $7,000 per employee, but a credit percent of up to 5.4 percent is allowed for state unemployment tax. The state rate you pay depends on the amount of claims filed by former employees. The more claims, the higher your unemployment tax, within certain limits. Entre-perspectives Uber Inventor-Old School Students may be surprised to find that Thomas Edison had over 1,000 patents to his credit. He was not just an inventor, but also a true entrepreneur who only pursued new products that had commercial application. Many of his products (like the light bulb) required the invention of many supporting products/processes to operate. Use the web page http://inventors.about.com/library/inventors to show your class a complete list of Edison’s patents. Concept Check Question 1. Give some examples of things the new entrepreneur should immediately investigate in order to ensure to the maximum extent possible that the business will “get off the ground.” Discuss market analysis, competitive analysis, and bases for competitive advantage. Review cost analysis for the startup, and discuss legal forms of ownership and location analysis. New entrepreneurs should immediately investigate the following to help their business "get off the ground": 1. Market Demand: Research the target market to ensure there’s sufficient demand for your product or service. 2. Competitor Analysis: Identify competitors and study their strengths, weaknesses, pricing, and customer base. 3. Regulations and Licenses: Check for any legal requirements, licenses, permits, or zoning regulations specific to your industry. 4. Initial Costs and Funding: Estimate startup costs and explore funding options such as loans, investors, or grants. 5. Customer Preferences: Understand the needs, preferences, and pain points of potential customers. 6. Supplier and Vendor Availability: Identify reliable suppliers and partners to secure inventory, materials, or services. 7. Location: If applicable, research the best location for your business in terms of foot traffic, customer access, and costs. 2. Is a business plan really necessary even for a very small startup business? How much market analysis and competitive analysis should the new entrepreneur conduct prior to startup? In classroom discussion, students should be able to make a case for the importance of a business plan to any business. It helps to give a picture of what could happen, to find hidden costs, and to anticipate fluctuation in the business cycle. Yes, a business plan is necessary even for a small startup as it provides a clear roadmap, helps secure funding, and guides decision-making. In terms of market and competitive analysis, the new entrepreneur should conduct sufficient research to understand customer demand, pricing, competitors’ strengths and weaknesses, and potential market gaps. This analysis doesn’t need to be exhaustive, but enough to validate the business idea and ensure there’s a clear opportunity for success in the market. 3. What are some of the tangible resources that the new entrepreneur might need in order to go into business initially? What are some options for obtaining capital for a business that is brand new and therefore has no financial history? Answers will vary depending on the type of business the student is interested in starting. The intent of the question is to prompt students to think about the equipment, supplies, inventory, and facilities that will be needed. Small business owners must start with their own capital. Banks are often hesitant to loan money to startup businesses since no historical data is available—a business plan is a must! Investors might be found. Friends and family may also help. 4. Discuss the legal ramifications of starting your own business. Where should the new entrepreneur go to get information and advice regarding laws that govern the type of business that is being promoted? Taxes and compliance with regulations are big issues when starting a business. When you have employees, you have to worry about more taxes and workers’ compensation insurance. The IRS will provide information, as will your attorney, accountant, SBDC, and incubators. 5. After startup, what is the single most important tool the small business owner has at his or her disposal for ensuring the success of the business? Why is it so crucial? Discussion should center on the importance of keeping a business updated as an ongoing, useful management tool. After startup, customer feedback is the most important tool for ensuring success. It’s crucial because it allows the business owner to understand customer needs, identify areas for improvement, and adapt products or services to better meet market demands, fostering customer loyalty and driving growth. Experience This…bonus student exercise A good idea is nothing more than a tool in the hands of an entrepreneur. Take a class session to conduct a brainstorming exercise to stimulate creativity. Brainstorming begins by defining a purpose. In this case, we want to generate ideas for a business that undergraduate business students can start before they graduate. Choose a student to serve as the facilitator, who will record every idea on the board—with no criticism or negatives. Encourage brainstorming to occur spontaneously and abundantly (although you may wish to set a parameter that the idea be legal in nature). Students should strive to fill a known or perceived void. Don’t spend time getting committed to one idea. Once a sizable list has been generated (about 50 ideas, or when the exercise runs out of gas), identify the most promising ideas. Refine and prioritize the ideas. Have the group choose five or six ideas and discuss their opportunity potential. Could they stand on their own as viable opportunities—or better yet, could two, three, or all six be combined into a feasible venture? Students’ feedback will vary. Chapter Closing Case The Price of Admission 1. What are the advantages and disadvantages of giving content away? The upside of giving content away online is the ability to generate much more attention quickly. Consumers are conditioned to expect things of all type to be free online. The downside is obviously that free does not generate money. 2. What if the new strategy didn’t work and the content was now free? If Skurman decides to give away the content for College Prowler, then he will have to find a new way to generate revenue. A possibility could be to charge the colleges for leads rather than charging students for college information. 3. What would you advise Skurman to do and still have a viable company? Since students are very close to the target market for this product, it should be interesting to hear their responses for how College Prowler could make money. Paying for college leads may be the most viable alternative. The Decision Last October, Skurman changed College Prowler's business model. The company, which now has a staff of 11, hired new student editors to update the site's content, and Skurman began meeting with admissions staffs at colleges and universities. "Our pitch to them is that they don't want just a random list of students," Skurman says. "They want to make sure the student understands their school, that the fit will be great, and that they'll be reaching the student early in the process." That rang true to Michael Steidel, director of admissions at Carnegie Mellon. "We've got to think about more innovative ways to communicate with kids before they shoot an application out," Steidel says. But Steidel has been reluctant to pull the trigger. "Of the names I buy from College Board, only 8 percent translate into a bona fide inquiry, and that's pretty low," he says. College Prowler's leads are different, Skurman says, because the company sells only the names of users who opt to receive information about specific colleges. But Skurman has yet to close a deal with a single school. Fortunately, he has had better luck with corporate clients looking to market to college-age consumers. Wachovia is buying leads, and Skurman recently inked a deal with the Army ROTC. The company, he says, now gets half its revenue from lead generation. The rest comes from ad and book sales. On July 16, all of College Prowler's online information was made available for free. Page views, Skurman says, jumped 60 percent the first week and are increasing every day. The average amount of time users spend on the site has doubled. By opening up the site, Skurman hopes to fulfill his second goal: helping as many families as possible choose the right college. His third goal -- financial success -- may be more difficult. "It's going to take time to prove to colleges that we're finding great applicants who they haven't already found and that we're doing it at a competitive price," he says. "We're still figuring it out." SOURCE: www.inc.com/magazine/20091001/finding-the-right-price-for-a-hot-product.html Solution Manual for Small Business Management: Entrepreneurship and Beyond Timothy S. Hatten 9781285866383