This Document Contains Chapters 5 to 8 Chapter 5 Innovation: The Creative Pursuit of Ideas SUGGESTED ANSWERS FOR DISCUSSION QUESTIONS (END-OF-CHAPTER) 1. Describe opportunity identification for the entrepreneur. Opportunity identification is the central domain of entrepreneurship. The first step for any entrepreneur is the identification of a “good idea,” but the search for good ideas is never easy. At the core of entrepreneurship lies the questions of how, why, and when opportunities for the creation of goods and services arise in an economy. When the entrepreneur has discovered a good opportunity, they are well on their way to becoming more serious about starting a business. 2. How are prior knowledge and learning important to the recognition of opportunities? Searching for ideas can be difficult, but one of the best places to start is by referring to the knowledge we already grasp. The first phase of the creativity process is knowledge accumulation. If we work within domains we have prior knowledge on we will already have tremendous amounts of information to take into the incubation stage. If, however, we do not have that knowledge yet on a subject, we can perform practices to help with creative search. Reading in a variety of fields, joining professional groups and associations, and traveling to new places, for example, can help us to learn new information that may help us to recognize opportunities. 3. What are the major sources of innovative ideas? Explain and give an example of each. (1) Trends—Trends signal shifts in the current paradigms (or thinking) of the major population. Example: (2) Unexpected occurrencesUnexpected successes or failures which prove to be a major surprise to the firm. (3) IncongruitiesThese exist whenever there is a gap or difference between expectations and reality. (4) Process needsThese exist whenever there is a demand for the entrepreneur to innovate and answer a particular need. (5) Industry and market changesContinual shifts in the market caused by technology, industry growth, etc. (6) Demographic changesTrend changes in population, age, education, occupations, geographic locations, etc. (7) Changes in perceptionThese changes occur in people’s interpretation of facts and concepts. (8) Knowledge-based conceptsInventions are knowledge-based; they are the product of new thinking, new methods, and/or new knowledge. 4. What is the difference between an adaptor and an innovator? An adaptor is one who takes the ideas of another and tries to make them profitable. There is no creativity involved because the person is not trying to profit from his own idea, but from that of another. An innovator is one who looks for an opportunity on which to capitalize. The innovator researches the need for the idea by finding out the thoughts of the potential customers. An innovator also thinks very carefully about what exactly the innovation has to be in order to appeal to the public. 5. What are four major components in the creative process? The four major components are: (1) Background or knowledge accumulation: The individual explores the different aspects of a given situation. The individual needs to develop different perspectives to better deal with situations that may arise. By reading, scanning magazines and newspapers, traveling, etc., the individual can accumulate some background knowledge. (2) The incubation process: The individual subconsciously “mulls over” the information that has been gathered. The individual can do this by engaging in “mindless” activities such as cutting the grass, exercising on a regular basis, and sitting back and relaxing on a regular basis. (3) The idea experience: Often the most exciting part of the process, this is when the idea or the solution the individual is seeking is found. (4) Evaluation and implementation: Successful entrepreneurs identify the ideas that are workable and that they have the skills to implement. Further, they do not give up when they run into obstacles. 6. What are the four steps involved in developing personal creativity? (1) Recognizing relationshipsMany inventions and innovations are the result of the innovator’s seeing new and different relationships among objects, processes, materials, technologies, and people. It helps to look for unorthodox relationships among the things and people around you. (2) Developing a functional perspectiveViewing things and people in terms of how they can be used to satisfy needs and to help complete a project. (3) Using your brainsThe right brain helps the person understand analogies, imagine things, and synthesize information. The left brain helps the person analyze, verbalize, and use rational approaches to problem solving. The functions of both brain hemispheres are important to the entrepreneur. (4) Eliminating muddling mind-setsThere are a number of mental habits that block or impede creative thinking. Some common mental blocks include: “either/or” thinking, security hunting, stereotyping, and probability thinking. 7. In your own words, state what is meant by the term innovation. Innovation means something new or something that has not been done before. It could be thought of as a new idea for a certain type of product or service. Innovation could also be described as an improvement of an existing idea, which makes the idea profitable. 8. What are the four major types of innovation? The four major types of innovation are: (1) InventionThe creation of a new product, service, or process that is often new and untried. Such concepts are “revolutionary.” (2) ExtensionThe expansion of a product, service, or process that is already in existence. This involves a different application of a current idea. (3) DuplicationThe replication of an already existing idea. The entrepreneur adds his own creative touches to enhance the idea and better the competition. (4) SynthesisThe combination of existing concepts and factors into a new formulation. This involves taking already existing ideas and putting them together to form a new application. 9. Briefly describe the five major misconceptions commonly associated with innovation. (1) Innovation is planned and predictable. Innovation should not be left to the research and development department only. Innovation is, in fact, unpredictable and may be introduced by anyone. (2) Technical specifications should be thoroughly prepared. Thorough preparation often takes too long. Quite often it is more important to use a try-test-revise approach. (3) Innovation relies on dreams and blue-sky ideas. Accomplished innovators are very practical people and create from the opportunities left by reality, not day dreams. (4) Big projects will develop better innovations than smaller ones. Larger firms are now encouraging their people to work in smaller groups, where it often is easier to generate creative ideas. (5) Technology is the driving force of innovation success. Technology is certainly one source for innovation, but it is not the only one. Market-driven or customer-based innovations have the highest probability of success. 10. Identify and describe five of the innovation principles. (1) Be action-oriented. Innovators must be active and searching for new ideas, opportunities, or sources of innovation. (2) Make the product, process, or service simple and understandable. People must readily understand how the innovation works. (3) Start small. Innovators should start small and then build and develop, allowing for planned growth and proper expansion in the right manner and at the right time. (4) Aim high. Innovators should aim high for success by seeking a niche in the marketplace. (5) Work, work, work. It takes work, not genius or mystery, to innovate successfully. ADDITIONAL ACTIVITIES DEVELOPING YOUR PERSONAL CREATIVITY This exercise is designed to help you develop your personal creativity. To enhance your creativity, you should make improvements in the following areas: 1. Personal development (self-discipline, self-awareness, self-confidence, improvement in energy level) 2. Problem-solving skills (problem recognition) 3. Mental fluency (quantity of thoughts/ideas) 4. Mental flexibility (switching gears/approaches) 5. Originality (unusual thoughts and ideas) It is best to start small and work on a few things at a time. Follow the step-by-step approach listed next. Use the accompanying worksheet to help you design a personal creativity program. 1. Choose one of the five areas for improvement listed (for example, mental fluency). 2. Establish a specific objective for this area (for example, to increase your ability to generate logical and intuitive solutions to problems at work). 3. Decide how much time you will give to this program (for example, three hours per week). 4. Decide how long you will work in this area (for example, one month, two months). 5. Decide what actions you will take and what exercises you will perform to improve in this area (for example, sentence-creation exercises, usage ideas, meditation, suspension of initial judgments). 6. Set up an outline of your program (that is, day of week, time of day, place, and what you will do during this time). 7. Review your program after completion, and write a similar program for another one of the five areas for improvement. PERSONAL CREATIVITY PROGRAM WORKSHEET Area of improvement ___ Specific objective ___ ___ ___ Number of hours per week ___ Duration of program ___ Actions/exercises ___ ___ ___ ___ ___ OUTLINE OF PROGRAM Short Cases POST-IT NOTES One way new products are developed is to take a current product and modify it in some form. Another way is to determine how a previously developed product can be marketed or used by a particular group of customers. The 3M Company is famous for many products, among them adhesives and abrasives. In one of 3M’s most famous innovative stories from the 1980s, a 3M manager, who was a member of a church choir, wanted to mark the pages of his hymnal so he could quickly find them. A bookmark would not do, because the piece of paper could easily fall out. The manager needed something that would adhere to the page but not tear it. Back at work, the manager asked one of the members of the research and development department if an adhesive existed that would do this. One did, but it never had been marketed because the company found that the adhesive was not strong enough for industrial use. At the manager’s request, a batch of the glue was prepared and applied to small pieces of paper that could be used as bookmarks. As the manager who had requested the product began to think about the new product, he concluded it had uses other than as a bookmark. Secretaries could use it to attach messages to files, and managers could use it to send notes along with letters and memos. In an effort to spur interest in the product, the manager had a large batch of these “attachable” notes—now called Post-it notes—made, and he began distributing them to secretaries throughout the company. Before long, more people began to ask for them. The manager then ordered the supply cut off and told everyone who wanted them that they would have to contact the marketing department. When that department became inundated with calls for Post-it notes, it concluded that a strong demand existed throughout the industry for these notes, and full production began. Today, Post-it notes are one of the largest and most successful product lines at the 3M Company. QUESTIONS 1. How did the creative thinking process work in the development of this product? Describe what took place in each of the four steps. The creative thinking process typically involves four key steps: preparation, incubation, insight, and evaluation. Here’s how these steps were applied in the development of Post-it notes: • Preparation: The manager, who sang in a church choir, encountered a problem: he needed a way to mark pages in his hymnal that would not damage or fall out. This stage involved identifying the problem and exploring potential solutions. He knew a typical bookmark wouldn’t suffice and wondered if there was a better alternative. • Incubation: The manager began reflecting on the idea of a reusable adhesive that could stick to paper but not damage it. During this phase, he sought help from a colleague in 3M’s research and development department, who recalled a previously developed but underused adhesive. • Insight: The breakthrough moment came when the manager connected the existing weak adhesive with his need for a removable bookmark. This was the critical "aha" moment when he realized that the product could serve a new purpose. He had the adhesive applied to small pieces of paper, creating what would eventually become Post-it notes. • Evaluation: After using the notes for their original purpose, the manager recognized that they had potential for broader uses, like attaching messages to files. By distributing samples to secretaries, he tested the product in a real-world setting and saw the growing demand, confirming its value and utility. 2. Why did the manager have the Post-it notes sent to secretaries throughout the company? What was his objective in doing this? The manager sent the Post-it notes to secretaries to test the product’s practicality and to generate interest within the company. His objective was twofold: • Testing the market: By giving the notes to secretaries, he could observe how useful they found the product in everyday tasks. Secretaries, who often handle paperwork and communication, were a key demographic for the product’s intended use. • Creating demand: The manager also wanted to create a sense of demand within the company. By allowing the secretaries to experience the usefulness of Post-it notes, he ensured that word of mouth would spread, leading to more requests for the product. When he cut off the supply and directed people to the marketing department, he effectively validated the potential market demand for the product. 3. What type of innovation was this—invention, extension, duplication, or synthesis? Defend your answer. This innovation is best classified as synthesis. Synthesis involves combining existing ideas or products in a new way to create something innovative. In this case, the adhesive already existed but had never been used in this context. The manager didn’t invent a new adhesive, nor did he extend or duplicate a current product. Instead, he took an underutilized adhesive and combined it with a simple idea—a piece of paper that can stick temporarily to surfaces, resulting in a new product that filled a previously unrecognized need. 4. Which of the sources of innovative ideas discussed in the chapter help account for this product’s success? Explain in detail. Several sources of innovative ideas contributed to the success of Post-it notes: • Unexpected occurrences: The weak adhesive was originally seen as a failure for industrial use because it wasn’t strong enough. However, this "failure" became an opportunity when the manager identified a different, non-industrial application for the adhesive. • Process needs: The manager identified a clear need in his personal life—the need for a bookmark that wouldn’t damage pages or fall out. This process-oriented need sparked the initial idea for Post-it notes. • Perception shifts: The manager’s ability to shift his perception of the adhesive’s utility from a weakness to a strength was crucial. He recognized that the same adhesive that was unsuitable for heavy-duty use was perfect for creating temporary notes that could be easily removed. • Market demand: The success of the product was further validated by testing it in a real-world environment (distributing the notes to secretaries), which generated significant internal demand. This internal test provided insight into a much larger potential market, leading to full-scale production. By leveraging these sources of innovation, 3M was able to transform a seemingly insignificant adhesive into one of its most successful products. Reflection Exercise: OPPORTUNITY TRENDS Examine the following categories of predicted opportunities that promise to be strong in the 21st Century. Do you believe any of these trends are or have been opportunities for entrepreneurs to capitalize upon? If so, select one present a venture that has capitalized on this trend. She doesn’t use a crystal ball, but futurist Faith Popcorn can see some of the major trends that sway consumer buying decisions. Popcorn believes that those who understand the future make fewer mistakes and become more successful. By spotting the trends that shape marketplaces, she hopes to help entrepreneurs start and grow businesses. She reaches entrepreneurs through her marketing consulting firm, Brain-Reserve. How well does Popcorn predict the trends of tomorrow? According to her, she hasn’t been wrong about a trend yet. Popcorn states that, as a marketer, she finds trend knowledge invaluable. In her book Clicking, she identified some of the most influential trends driving the marketplace. These are not fads—they are big, sweeping consumer movements that savvy entrepreneurs see as opportunities for big profits. Since Clicking was published, she has provided a yearly set of predictions regarding consumer trends. The following are her predicted trends for the twenty-first century. •Cocooning—The desire to shelter ourselves from the harsh realities of the outside world. •Fantasy Adventure—The need for the new and unconventional. We seek out ways to escape from our problems and experiment with our desires. •Skin Deeper—According to Popcorn, our material focus has left us emotionally starving. Due to increasing work hours and more emphasis on virtual relationships, we increasingly desire physical contact. •BrainFitness—According to Popcorn, a mental fitness boom is on the horizon. The focus on mental agility will parallel the need to prolong physical fitness and youthful appearance. •Secondhand Nostalgia—Due to the stresses and concerns of life, we will seek out safe places that allow for a retreat. We will also trend toward activities that were popular during safe times, such as the 1950s. •America’s Next Top Surgery—The rage for reality surgery shows and the advancement of medicine will cause an obsession with risky surgeries. Also, playing to the Fantasy Adventure trend, people will be motivated to try new surgeries to cure illnesses and improve appearance. •No Olds Barred—The enormous baby boomer market is aging into its 60s and 70s. These boomers view themselves as young and will demand products to meet their needs but not be labeled as products for the elderly. Popcorn suggests that one such outcome could be larger, easier-to-read dials in luxury automobiles (such as BMW or Infinity). •ExpertEASE—Given the availability of information on the Internet, expertise takes on a new meaning. According to Popcorn, “Expertise is no longer earned through years of training; all it takes is a little research.” She claims that we have lost the preferred taste for actual experience and have replaced it with virtual experiences. •DeBug-ReBug—In the past, we have focused on removing bad organisms from the environment. Recently, biologists have identified that some organisms can be beneficial and improve health. Popcorn suggests that spas and health care entities will offer “designer” treatments of advantageous organisms. •Mood Tuning—According to Popcorn, we now expect that the things we buy will adjust our feelings. We will seek out biologically enhanced purchases that will cause us to feel more confident, sexy, or whatever the situation dictates. Source: Adapted from “Faith Popcorn’s Predictions for 2006,” Arizona Reporter, http://managecamp.typepad.com/brand_managecamp_weblog/files/faith_popcorn_2006_predictions.pdf (accessed October 10, 2006). Chapter 6 Assessment of Entrepreneurial Opportunities SUGGESTED ANSWERS FOR DISCUSSION QUESTIONS (END-OF-CHAPTER) 1. Explain the challenges involved in new-venture development. The main challenges involve the survival and growth of a new venture. These are accomplished through a complete understanding of the environment, the characteristics of the entrepreneur, and the venture itself. 2. Describe some of the key factors involved in new-venture performance (use Figure 6.1). The key factors, as illustrated in Figure 6.1, are the effect of the environment (narrow markets, scarce resources), the entrepreneur’s personal goals and founding processes, and the diversity of the venture itself. 3. Many entrepreneurs lack objectivity and have no real insight into the market. Why are these characteristics considered pitfalls of selecting new ventures? Engineers and technically trained people are particularly prone to falling in love with an idea for a product or service. They seem unaware of the need for the careful scrutiny they would give to a design or project in the ordinary course of their professional work. Some entrepreneurs show a managerial short-sightedness. Also, they do not understand the life cycle that must be considered in introducing a new product or service. 4. Many entrepreneurs have a poor understanding of the finances associated with their new venture and/or have a venture that lacks uniqueness. Why are these characteristics considered pitfalls of selecting new ventures? Sometimes entrepreneurs are ignorant of costs or are victims of inadequate research and planning. Quite often they tend to underestimate development costs by wide margins. A new venture should be unique. It ought to have special characteristics and/or design concepts that draw the customer to it, and it should provide performance or service that is superior to competitive offerings. 5. Describe each of the five critical factors involved in the prestart-up and start-up phases of a new venture. (1) UniquenessThe range of uniqueness in a new venture can be considerable, extending from fairly routine to highly nonroutine. What separates the routine from the nonroutine venture is the amount of innovation required during prestart-up. Venture uniqueness is further characterized by the length of time a nonroutine venture will remain nonroutine. (2) InvestmentThe capital investment required to start a new venture can vary considerably. Another critical issue is the extent and timing of funds needed to move through the venture process. (3) Growth of salesThe growth pattern needs to be anticipated for new-venture sales and profits. Key questions to answer: Are sales and profits expected to grow slowly or level off shortly after start-up? Are large profits expected at some point with only small or moderate sales growth? Or are both high-sales growth and high-profit growth likely? It is important to remember that most ventures can be classified as: life-style ventures, smaller profitable ventures, or high-growth ventures. (4) Product availabilityEssential to the success of any venture is the availability of a salable good or service at the time the venture opens its doors. Lack of product availability in finished form can affect the company’s image and its bottom line. (5) Customer availabilityIf the product is available before the venture is started, the likelihood of venture success is considerably better than otherwise. Venture risk is affected by the availability of customers for start-up. A critical consideration is how long it will take to determine who the customers are and what their buying habits are. 6. Identify and discuss three examples of product/market problems that can cause a venture to fail. (1) Poor timingPremature entry into the marketplace can result in failure. (2) Inappropriate distribution strategyDistribution should be aimed at the product and customer. (3) Unclear business definitionSome firms are uncertain about the “exact” business they are in and undergo constant change and lack stabilization. 7. Identify and discuss two examples of financial difficulties that can cause a venture to fail. (1) Assuming debt too earlyAssuming debt financing too soon and in too large amounts can result in debt service problems. (2) Venture capital relationship problemsEntrepreneurs may have different goals and motivations that cause the venture to fail. 8. Identify and discuss two examples of managerial problems that can cause a venture to fail. (1) Concept of a team approach: Hiring and promoting personnel because they are family or friends, not because they are qualified. Examples: incompetent support professionals, poor relationship with parent companies, and venture capitalists. (2) Human resource problems: An owner who can’t relate to employees or never fulfills promises can cause a venture to fail. Examples: kickbacks and subsequent firings, verbal agreements not honored, deceit by the venture capitalist or the president. 9. List four major types of problems new ventures confront. Marketing and sales, product development, internal financial management, external financing, and human resource management 10. How can asking the right questions help an entrepreneur evaluate a new venture? What types of questions are involved? Asking the right questions can help the entrepreneur by screening an idea before implementing it, taking into account the feasibility and possible profits to be had from the idea. The types of questions involved include these: Is it a new product/service idea? Has a prototype been tested by independent testers? Has it been taken to trade shows? Is the product or service easily understood? What is the overall market? Has market research been conducted? What distribution and sales methods will be used? How will the product be made? Will the business concept be developed and licensed to others, or developed and sold away? Can the company get or has it already lined up the necessary skills to operate the business venture? 11. Explain the traditional methods of new venture evaluation: profile analysis, feasibility criteria approach, and comprehensive feasibility method. The profile analysis is a tool that enables entrepreneurs to judge a business venture’s potential by sizing up the venture’s strengths and weaknesses along with a number of key dimensions or variables. This method helps entrepreneurs mitigate for possible weaknesses that may inhibit the growth of their ventures, avoiding many of the mistakes. The feasibility criteria approach is a criteria selection list, based on questions from which entrepreneurs can gain insights into the visibility of their venture. The comprehensive feasibility approach incorporates external factors in addition to those included in the criteria questions. The breakdown of the factors involved in a comprehensive feasibility study include: technical, market, financial, organizational, and competitive. 12. Describe the contemporary methods of new venture evaluation: design methodology and the lean start-up methodology. Mirroring the general design approach of companies like IDEO that tackle problems in industries ranging from medicine to consumer products, Stanford University has founded an Institute of Design (known as the d school) and the Rotman School of Management at the University of Toronto has built a curriculum based on the power of design. Design is a learning process that shapes and converts ideas into form, whether that is a plan of action, an experience, or a physical thing. Mistakes and failures along the way are to be seen as opportunities to learn and adapt. Design development utilizes skills we all possess but are generally ignored due to more conventional problem solving practices. This takes an initial concept idea and develops a proof of concept that elicits feedback from relevant stakeholders. Several criteria must be met: concept feasibility, concept desirability, and concept viability. ADDITIONAL ACTIVITIES INTERNAL PROFILE ANALYSIS Choose any emerging company with which you are familiar. If you are not familiar with any, consult magazines such as Entrepreneur, Fortune Small Business, and Business Week, and gather information on one firm. Then complete the following internal profile analysis by placing a check mark (√) in the appropriate column. Based on your analysis, what three recommendations would you make to the company’s management? Short Case NOTHING UNIQUE TO OFFER During the past four months, George Vazquez has been putting together his plan for a new venture. George wants to open a pizzeria near the local university. The area has three pizza enterprises, but George is convinced that demand is sufficient to support a fourth. The major competitor is a large national franchise unit that—in addition to its regular foodservice menu of pizzas, salads, soft drinks, and desserts—offers door-to-door delivery. This delivery service is very popular with the university students and has helped the franchise unit capture approximately 40 percent of the student market. The second competitor is a “pizza wagon” that carries precooked pizzas. The driver circles the university area and sells pizzas on a first-come, first-served basis. The pizza wagon starts the evening with 50 pizzas of all varieties and sizes and usually sells 45 of them at full price. The last 5 are sold for whatever they will bring. It generally takes the wagon all evening to sell the 50 pizzas, but the profit markup is much higher than that obtained from the typical pizza sales at the franchise unit. The other competitor offers only in-house services, but it is well known for the quality of its food. George does not believe that it is possible to offer anything unique. However, he does believe that a combination of door-to-door delivery and high-quality, in-house service can help him win 15 to 20 percent of the local market. “Once the customers begin to realize that ‘pizza is pizza,’” George told his partner, “we’ll begin to get more business. After all, if there is no difference between one pizza place and another, they might just as well eat at our place.” Before finalizing his plans, George would like to bring in one more partner. “You can never have too much initial capital,” he said. “You never know when you’ll have unexpected expenses.” But the individual whom George would like as a partner is reluctant to invest in the venture. “You really don’t have anything unique to offer the market,” he told George. “You’re just another ‘me too’ pizzeria, and you’re not going to survive.” George hopes he will be able to change the potential investor’s mind, but if he is not, George believes he can find someone else. “I have 90 days before I intend to open the business, and that’s more than enough time to line up the third partner and get the venture under way,” he told his wife yesterday. QUESTIONS 1. Is there any truth to the potential investor’s comment? Is the lack of uniqueness going to hurt George’s chances of success? Explain. Yes, there is truth to the potential investor's comment. In today's competitive market, having a unique selling proposition (USP) is crucial for differentiating a business from its competitors. The lack of uniqueness could hurt George’s chances of success because customers already have several choices, including a well-known national franchise, a convenient pizza wagon, and a competitor with high-quality food. If George cannot offer something distinctive, whether in terms of product, service, or customer experience, it will be difficult to attract and retain customers who already have preferences. The comment suggests that George may just blend into the market without making a strong impact, making it harder for him to win over customers. 2. If George were going to make his business venture unique, what steps might he take? Be complete in your answer. To make his pizzeria unique, George could consider the following steps: • Enhanced Delivery Service: While the national franchise already offers door-to-door delivery, George could improve this service by offering quicker delivery, late-night delivery, or guaranteed delivery times. He could also introduce features like tracking orders via mobile apps or online platforms, which would appeal to tech-savvy university students. • Specialized Menu: George could create a menu with unique flavors, organic ingredients, or international pizza styles that competitors do not offer. For example, he could feature seasonal ingredients or pizzas inspired by different cuisines, like Mediterranean or vegan-friendly options, catering to health-conscious customers. • Loyalty Program: Implementing a student-focused loyalty program, offering discounts, rewards, or special promotions for frequent customers could set George’s pizzeria apart. This could include a "buy-one-get-one" deal after a certain number of orders or a discount on a student’s birthday. • In-House Experience: If George intends to combine delivery with an in-house service, he could create a cozy, student-friendly dining atmosphere with free Wi-Fi, entertainment like board games, or live music nights. This would make his place an appealing hangout spot beyond just being a restaurant. • Sustainability: Offering eco-friendly packaging, sourcing ingredients from local farmers, or using sustainable practices could be a unique angle, especially since environmentally conscious students may be drawn to these efforts. 3. In addition to the uniqueness feature, what other critical factors is George overlooking? Identify and describe three, and give your recommendations for what to do about them. 1. Financial Planning George’s comment about bringing in another partner just for extra capital without a detailed financial plan suggests he may be overlooking the importance of a solid financial foundation. He needs to conduct a thorough financial analysis, including projected startup costs, operating expenses, and expected revenue. A well-prepared business plan, including a break-even analysis and cash flow projections, is crucial to attract investors and ensure long-term viability. • Recommendation: George should develop a comprehensive financial plan, exploring different funding options, and budgeting for marketing, labor, rent, and unforeseen expenses. 2. Market Research George assumes that the local market can support another pizzeria without conducting thorough research. He should analyze the demand for pizza in the area, including university students’ preferences, eating habits, and price sensitivity. Relying on assumptions rather than hard data could lead to an overestimation of potential market share. • Recommendation: Conduct market research, including surveys or focus groups with local students and residents, to better understand what would draw them to a new pizza place. This will help tailor his offerings and marketing strategies to meet customer needs. 3. Marketing Strategy George has not mentioned how he plans to promote his pizzeria, and relying on word-of-mouth alone is risky in today’s competitive market. A strong marketing plan is essential, especially in attracting university students who might respond well to social media campaigns, student discounts, and special events. • Recommendation: George should develop a targeted marketing strategy using social media platforms like Instagram, Facebook, and TikTok, which are popular among university students. He could run limited-time promotions, offer discounts to student organizations, and even host events to create buzz before his opening. Reflection Exercise: ENTREPRENEURIAL BUSINESS ON E-BAY Examine the following points for conducting business on E-Bay. Based on our chapter material how would you analyse an E-Bay entrepreneurial opportunity? Would you consider pursuing E-Bay? Why or why not? Fledgling entrepreneurs are flocking to eBay because of the ease with which users can start a business. In 2015, more than 150 million active users conducted business on eBay, contributing to nearly $150 billion of commerce volume through eBay’s online platforms. Taking the following steps will get you well on your way to starting a successful eBay business. Research the market. Selling on eBay does not excuse anyone from the usual legwork involved in starting a business. In order to determine the right market, research should be conducted on how much items in a given category are selling for on eBay as well as elsewhere. Marketplace Research is a subscription based tool available through eBay that allows you to view historical pricing information for products. Develop a specialty. The more specialized your business becomes, the more confidence your customers will have in your offerings and the less time you will spend addressing questions about the random products you found in your basement. Most sellers start by selling used items, but eventually, the successful eBay seller will develop a niche to allow for greater economies of scale. Access assistance. You will certainly make mistakes as you build your eBay business, but many of your questions can be answered by accessing eBay’s help files or by reading the discussion boards, through which successful sellers provide feedback and advice. Invest in your business. If you plan to start your eBay business by selling off old items lying around your home, you will not need to invest much, if any, upfront capital; however, as your business grows, a few items will come in handy. First, designating a computer to be used solely for your eBay transactions will allow you to fully deduct it on your taxes. Second, a regulation postal scale will save you several hours waiting in line at the post office. Finally, a decent camera is a must. Posting poor-quality photos of your merchandise will lead your customers to wonder about the quality of the rest of your business. Develop a system. As with any business, policies and procedures become increasingly important the larger your business becomes. Standardizing your templates or buying some through eBay’s Seller Tools section will help to streamline the process. In addition, establishing a routine for corresponding with your customers regarding their questions and concerns will enable you to prevent any minor issues from escalating into major problems. Offer PayPal. As an accepted form of payment, approximately 95 percent of buyers prefer to pay online. Although less popular, some customers might prefer to pay with personal checks and money orders, so allowing these forms of payment can make those customers less familiar with online shopping more comfortable. Know your numbers. eBay charges listing and final value fees, which can add up if you have to post your merchandise multiple times; however, the cost of gaining access to eBay’s customer base is insignificant when compared to the cost of using traditional advertising channels. If you expect your product to take several auctions to sell, cover your costs by charging higher seller fees. Manage customer expectations. Make sure to under-promise and over-deliver to guarantee that your customers will not be disappointed when your product is described as “new” but arrives with a mild scratch. Be as forthright as possible. If you notice an imperfection, your customer surely will as well. Offering an unconditional guarantee puts the buyer at ease and avoids any complications due to damage during shipping or the customer claiming product misrepresentation. Source: Adapted from Marcia Layton Turner, “Get Sold on eBay,” Entrepreneur, March 2008, http://www.entrepreneur.com/magazine/entrepreneur/2008/march/190186.html(accessed March 16, 2008); and E-Bay’s 2011 Annual Report, http://www.shareholder.com/visitors/DynamicDoc/document.cfm?DocumentID=3008&CompanyID=ebay&zid=dce8ff6f(accessed April 10, 2012). Chapter 7 Pathways to Entrepreneurial Ventures SUGGESTED ANSWERS FOR DISCUSSION QUESTIONS (END OF CHAPTER) 1. Identify the three main pathways to entering business for a prospective entrepreneur. The three most common methods for entering business are to create a new venture, acquire an existing venture, or obtain a franchise. 2. What is the new-new approach to starting a new venture? How does this approach differ from a new-old approach? New-new is when you enter a market with a new product or service. Examples of recent new-new entries are plasma televisions, smartphones, and GPS devices. New-old is either improving a product or offering a service in an area where it is not currently available. While the new-new approach may receive more attention, it is more common to see companies started with new-old approaches. There are a lot of underserved markets around the world where a new-old approach can prove quite successful. 3. How can an individual who is thinking of going into business evaluate the financial picture of the enterprise? Use the methodology of Table 7.2 to prepare your answer. The entrepreneur must estimate how much it will cost to stay in a business for year, how much revenue will be generated during this period, and how long it will take the company to generate positive cash flow. An individual considering starting a business needs to consider the start-up and monthly expenses of the operation. Upside gain and downside losses must be estimated. What are the possible profits and losses of the company? Table 7.2 provides a helpful way of calculating these figures. 4. In addition to personal and financial issues, what other factors should the prospective owner be concerned with? Describe at least four. Factors to consider when going into business are many. Besides the personal and financial, if you’re considering starting a business you should review operational considerations such as the building, merchandise, and equipment needed for operations in record keeping, insurance, legal, marketing, and personal matters. If you’re buying an already existing business, you should also consider why the business is being sold, what the condition of the business is, what the condition of the inventory is, what the state of the company’s other assets are, how many of the employees will remain, and what the competition is. 5. What are the advantages of buying an ongoing business? Explain them. (1) Less fear about successful future operation—since the enterprise is already in operation, its successful future operation is likely. (2) Time and effort associated with starting a new enterprise are eliminated. The inventory, equipment, personnel, and facilities are already in place. (3) It sometimes is possible to buy an ongoing business at a bargain price. The owner may want to sell it quickly because of retirement, illness, to raise money for an emergence, or to pursue another opportunity soon. 6. What “right questions” need to be answered when deciding whether to buy a business? (1) Why is the business being sold? (2) What is the current physical condition of the business? (3) What is the condition of the inventory? (4) What is the state of the company’s other assets? (5). How many of the employees will remain? (6) What type of competition does the business face? (7) What does the firm’s financial picture look like? 7. How should a prospective buyer examine the assets of a company? Explain. The tangible (physical) and intangible (for example, reputation) assets of the company need to be assessed. These assets include inventory (age, quality, salability, and condition), furniture, equipment, fixtures (value, condition, lease or owned), accounts receivable (age of outstanding debts, past collection periods, credit standing of customers), trademarks, patents, copyrights, business name (value, role in the business’s success, degree of competitive advantage, and goodwill (reputation, established clientele, trusted name). 8. What is meant by the term franchise? A franchise is any arrangement in which the owner of a trademark, trade name, or copyright has licensed others to use it in selling goods or services. 9. In a franchising agreement, what is the franchisee often called on to do? What responsibility does the franchisor assume? The franchisee usually contracts for the following business package: (1) Make a financial investment in the operation (2) Obtain and maintain a standardized inventory and/or equipment package (3) Maintain a specified quality of performance (4) A franchise fee (5) Engage in a continuing business relationship The franchisor usually provides: (1) The company name (2) Symbols, logos, designs, and facilities (3) Professional management training (4) Sale of specific merchandise necessary for the unit’s operations at wholesale prices (5) Financial assistance (6) Continuing aid and guidance 10. What are some of the major advantages of franchising? Cite and explain three. The advantages of franchising include training and guidance from the franchisor, brand-name appeal, a proven track record, and some financial assistance. Professional training and guidance from an established franchise gives a franchisee a great advantage over the small business owner starting from scratch. The franchise also has already invested heavily to promote the name of the franchise, so the new business will have instant recognition and legitimacy in the market. Franchises will often offer help in getting the business started by offering loans and not requiring any repayment until the operation is running smoothly. 11. What are some of the major disadvantages of franchising? Cite and explain at least two. The disadvantages of franchising are the franchise feesboth initial fee and royalty payments each year, control exerted by the franchisor, and the sometimes unfulfilled promises made by franchisors to franchisees. There will the usual start-up costs of creating a business, as well as the franchise fees that must be paid. This may prove too large a burden for the entrepreneur. Many entrepreneurs enter business to be their own boss, but the franchise may be stifling to the owner. With less established franchises with less reliable reputations, franchisees may become frustrated if the franchisor is lax about holding up their end of the contract. 12. How can a prospective franchisee evaluate a franchise opportunity? Explain. The key to evaluating the value of a prospective franchise is a proper information search. It is important to examine the Uniform Franchise Offering Circular (UFOC), in order to learn more about the franchise. Typically, the age of a franchise, number of retail units, concentration in the state, and national representation are all reflected in the price. However, it is vital to do due diligence in learning all one can about a franchise from many sources, such as current and past owners of the franchise. 13. In evaluating whether or not to buy a franchise operation, the potential investor should ask a series of questions. What questions should the potential investor ask about the franchisor, the franchise, the market, and the potential investor (himself or herself)? There are a number of questions the potential investor should ask: (1) What are the contract provisions? Can the franchisor take away the franchise for minor infractions? (2) Is the franchise prospectus reasonable? Is the projected revenue too high for a new unit? Is the return on investment overly optimistic? Would the bank be prepared to advance a loan on this type of business undertaking? (3) Does the investment look promising? What might go wrong and jeopardize those investments? (4) Ultimately, am I willing to take the risk on this franchise? 14. What are the advantages and disadvantages of franchising? Advantages of franchising: (1) Training and guidance (2) Brand-name appeal (3) A proven track record (4) Financial assistance Disadvantages of franchising: (1) Franchise fees—it is not uncommon to be faced with a fee of $5000 to 100,000 (2) Franchisor control—the franchisor generally exercises a fair amount of control over the operation in order to maintain a degree of uniformity. (3) Unfulfilled promises—in some cases, especially among less-known franchisors, the franchisees have not received all they were promised. 15. Identify the Franchise Disclosure Document. Explain why it is important in franchising. The Franchise Disclosure Document was originally known as the Uniform Franchise Offering Circular (UFOC). It underlies the franchise agreement (the formal sales contract) between the parties at the time the contract is formally signed. It governs the long-term relationship and contains the only promises and obligations of the parties to each other that will remain in effect over the stated time term of the contracts. The FDD is essential for providing information as to the obligations of the franchisee and franchisor. Anyone considering buying a franchise should carefully read the FDD to ensure it is an arrangement they want to enter into in the long term. ADDITIONAL ACTIVITIES Short Cases AN IDEA FOR THE DOGS! Chris Wasserberg is a salesperson for a Fortune 100 firm. He has a bachelor’s degree in marketing and is one of the firm’s best salesperson. It is likely that Chris will one day become a sales manager is he stays with the firm. However, this is doubtful, because he hopes to start his own business. Since he was hired seven years ago, Chris has managed to build a nest egg of $160,000. He now is looking for a business that would require no more than $60,000 to $70,000 to get started. The rest would be used for operating capital and to keep him going until the company turns profitable. In the past, Chris has gathered ideas by reading magazines such as Entrepreneur and Inc., which report new types of businesses. Last week Chris read a story that intrigued him. A man on the West Coast has been building custom doghouses out of expensive materials and selling them for $5,000 to $15,000 each. Chris realizes few people can afford to pay this much for a doghouse. Yet most doghouses are not distinctive, and owners simply pay $50 to $150 for basic doghouses. Chris believes a market may exist for doghouses between these two extremes, in the range of $250 to $500. Chris has done the research and believes it would not be too difficult to differentiate his product from the standard doghouse. In particular, he is considering building a house that is slightly larger than the typical one, well insulated, and floored with washable vinyl; he would put the dog’s name above the door and shingle the roof. Additionally, he believes that if the house has the same basic design as the owner’s, it would be more appealing. The two biggest obstacles will be marketing and production—that is, getting people to order houses for their dogs and then building the houses. Chris believes that, with his background, he can handle the marketing, and it should not be too difficult to find someone to handle the construction. Moreover, until the business takes off, he believes he can continue with his sales job. 1. Is anything unique about Chris’s idea? Explain. Yes, Chris’s idea has unique elements. While custom doghouses already exist at the high end of the market, he is targeting a middle-tier market between the low-cost basic doghouses ($50 to $150) and the highly expensive ones ($5,000 to $15,000). His plan to offer doghouses in the $250 to $500 range, with features such as larger size, insulation, washable vinyl flooring, personalized design with the dog's name, and shingles, sets his product apart. The idea of designing the doghouse to match the owner’s home also provides a novel and appealing touch, potentially making it more attractive to dog owners who value aesthetics and customization. This approach differentiates his product from the standard options in terms of both quality and personalization. 2. What is the first thing he should do to follow up on his idea? Explain. The first step Chris should take is to conduct market research to validate his idea. This research would involve gathering data on the target market, specifically dog owners who might be interested in premium doghouses. He should investigate the demand for higher-quality, customized doghouses in his price range and determine whether potential customers are willing to pay between $250 and $500 for these features. This could include conducting surveys, interviews with pet owners, visiting local pet stores, or attending dog shows and events to gather feedback on his concept. Additionally, he could analyze existing competitors in the doghouse market and explore any gaps his product could fill. 3. When this is done, what else should Chris do? Outline a general course of action of him. After completing market research and confirming the viability of his idea, Chris should follow these steps: 1. Develop a Business Plan Chris should create a detailed business plan that includes his market research findings, cost structure, revenue projections, and strategy for scaling the business. The plan should outline how he intends to finance the venture, where he will source materials, and how he will manage production and marketing. It’s important to include a break-even analysis to understand when the business might become profitable. 2. Find a Reliable Manufacturer Since Chris doesn’t plan to handle the construction himself, he should start by finding a reliable partner or contractor who can produce the doghouses according to his specifications. He needs to ensure that the materials used (insulation, vinyl flooring, shingles) are of high quality, but also cost-effective to maintain the price range he’s targeting. Building a few prototypes would help to test the quality and appeal of his product. 3. Build a Marketing Strategy As a marketing expert, Chris should focus on crafting an effective marketing strategy. This could include creating an online presence through a website and social media platforms, partnering with local pet stores or veterinarians, attending pet expos, or targeting affluent dog owners through ads on specialized pet websites and magazines. Personalization features and high-quality materials should be highlighted in the marketing campaigns to distinguish his product. 4. Test the Market Chris should consider running a small pilot test to gauge demand before fully committing. He could sell a limited number of doghouses locally or online to see how well the product is received. Feedback from early customers would help refine the product and the production process. 5. Scale the Business Once the product and the business model are validated through initial sales, Chris can then focus on scaling the business. This could involve expanding his marketing reach, increasing production capacity, and exploring partnerships with larger pet retailers or even online platforms like Amazon for wider distribution. By following these steps, Chris can carefully evaluate the potential of his business idea while minimizing risks. CHECKING IT OUT When Arlene Ryan inherited $250,000 from her grandfather, she decided to use the money to start her own business. Arlene has been a legal secretary for 14 years and feels she knows quite a lot about business. “Every day I take depositions and type legal memoranda,” she noted to a friend. “And I’ve seen lots of businesses fail because they didn’t have adequate capital or proper management. Believe me, when you work for a law firm, you see—and learn—plenty. Almost six months passed before Arlene decided on a business to pursue. A franchise ad in a business magazine caught her attention; Arlene called and found out that the franchisor was selling fast-food franchises in her area. “We are in the process of moving into your section of the country,” the spokesperson told her. “We have 111 franchisees throughout the nation and want to sell 26 in your state.” Arlene went to a meeting that the franchisor held at a local hotel and, along with a large number of other potential investors, listened to the sales pitch. It all sounded very good. The cost of the franchise was $150,000 plus 5 percent of gross revenues. The franchisor promised assistance with site location and personnel training and encourages the prospective franchisees to ask questions and investigate the organization. “If you don’t feel this is a good deal for you, it’s not a good deal for us either; good business is a two-way street,” the spokesperson pointed out. “We are going to be looking very carefully at all franchise applications, and you ought to be giving us the same degree of scrutiny.” Arlene liked what she heard but felt it would be prudent to do some checking on her own. Before leaving the meeting, she asked the spokesperson for the names and addresses of some current franchisees. “I don’t have a list with me,” he said, “but I can write down some that I know of, and you can get their numbers from the operator.” He then scribbled four names and locations on a piece of paper and handed it to her. Arlene called information and was able to get telephone numbers for only two of the franchises. The other addresses apparently were wrong. She then placed calls to the two franchisees. The first person said she has owned her franchise for one year and felt it was too early to judge the success of the operation. When she found out Arlene was thinking about buying a franchise, she asked if Arlene would consider buying hers. The price the woman quoted was $10,000 less than what the company currently was quoting. The second person told Arlene he simply did not give out information over the phone. He seemed somewhat edgy about talking to her and continually sidestepped Arlene’s requests for specific financial information. Finally, he told her, “Look, if you really want this information, I think you should talk to my attorney. If he says it’s okay to tell you, I will.” He then gave Arlene the attorney’s number. Before, she could call the lawyer, Arlene left for lunch. When she returned, one of the partners of her firm was standing beside her desk. “Hey, Arlene, what are you doing calling this guy? He asked, holding up the telephone number of the franchisee’s attorney. “Are you planning to sue someone? That’s his specialty, you know.” Arlene smiled. “As a matter of fact, I am. I’m thinking of suing you guys for back wages.” The attorney laughed along with her and then walked back into his office. 1. What is your appraisal of the situation? Does it look good or bad? The situation raises several red flags for Arlene. The franchisor's sales pitch seemed polished, and the company encouraged prospective franchisees to investigate the opportunity, which is a good sign. However, several aspects are concerning: • The franchisor did not have a complete list of franchisees on hand, and the addresses of some franchisees were incorrect. This suggests a lack of transparency or poor organization. • One franchisee offered to sell her franchise at a discounted price after owning it for only a year, which could indicate that the business is not performing as well as expected. • The second franchisee was hesitant to provide information and directed Arlene to his attorney. His discomfort in sharing financial details could indicate that the franchise has legal or financial issues. Overall, the situation does not look good based on these observations. The reluctance of the current franchisees to share positive experiences and the inaccurate contact information are concerning and warrant further investigation. 2. Would you recommend that Arlene buy the franchise from the woman who has offered to sell? Why or why not? No, I would not recommend that Arlene buy the franchise from the woman. Several reasons support this decision: • Limited track record: The woman has only owned the franchise for a year, which is typically not long enough to determine its success or long-term profitability. • Offer to sell at a discount: The fact that the woman is willing to sell at $10,000 below the franchise’s current price suggests she may not be satisfied with the business's performance and is eager to exit. • No verified success: The woman didn’t provide any compelling reasons why her franchise might be a good investment for Arlene, and there is no guarantee that Arlene would fare any better. Until more information is available regarding the franchise's financial health and market potential, buying an existing unit, especially one up for sale so soon, seems risky. 3. What would you recommend Arlene do now? Be complete in your answer. To make an informed decision, Arlene should follow these steps: 1. Research the Franchise Thoroughly Arlene should conduct extensive due diligence before proceeding further. She can start by: • Requesting the franchisor’s Franchise Disclosure Document (FDD), which provides essential financial and legal information about the franchise, including the performance of other franchisees, fees, and obligations. • Investigating the franchisor’s reputation by searching for reviews, complaints, or lawsuits involving the company. • Contacting other franchisees (beyond the two she initially called) to get a broader perspective on the franchise's success, profitability, and the level of support provided by the franchisor. 2. Speak with an Attorney and an Accountant Arlene should consult a franchise attorney to review the legal aspects of the FDD and franchise agreement. Additionally, she should work with an accountant to analyze the financial viability of the business. If the franchise seems profitable after a thorough review, these experts can help her assess the risks and benefits. 3. Consider Alternatives Arlene should explore alternative business opportunities, including: • Investigating other franchise opportunities with more established track records and better transparency. • Considering starting an independent business in a sector she understands well, such as the legal services field, where she has significant experience. 4. Evaluate the Woman’s Offer Carefully If Arlene remains interested in buying the franchise from the woman offering a discount, she should: • Request detailed financial records from the seller, including sales, expenses, and profit margins. • Have an attorney and accountant evaluate these financials to ensure that the business is viable. • Ask why the seller is willing to part with the franchise so soon. A hasty exit could be a sign of underlying problems. By taking these steps, Arlene can make a well-informed decision and avoid any potential pitfalls associated with the franchise opportunity. Reflection Exercise: THE “REAL” OPPORTUNITIES IN VIRTUAL WORLDS Examine the following story of entrepreneurial opportunities in the “virtual world” that promise to be strong in the coming years. Would you consider pursuing this space? Why or why not? Use the text material as a basis for any analysis you make on his opportunity. As the online gaming population continues to grow, opportunities for entrepreneurs will grow as well. Approximately 34 percent of adult Internet users play online games on a weekly basis, which is more than the percentage of adults who use social networking sites and watch videos, according to a report from Parks Associates. As casual and hard-core gamers continue to move to the Internet, virtual economies have begun to develop, allowing them to buy virtual goods with virtual currency converted from real money; herein lies the business opportunity. Historically, gamers have informally traded, bought, and sold their virtual wares, but companies like Sparter are changing the landscape. The company provides a formalized market in which players of games like Everquest and World of Warcraft can exchange virtual currencies from virtual worlds and online games. The web site was officially launched in February 2007, with $250,000 in expected sales for the first year. The company’s founders, Dan Kelly and Boris Putanec, attribute their success to conducting significant market research. They discovered that people already were actively buying and selling virtual goods. By taking a commission from each seller’s transaction, the company can afford to offer the service to buyers at no charge. The founders decided to offer the service for multiple online games and to provide service for international transactions, which has allowed the company to diversify and hedge against flagging interest in any one game or from a given country. Sparter chose to focus on virtual currency exchange; however, this is just one business need that gamers will have as their communities continue to grow. Kelly suggests that micropayments and cyber-currency fraud will present new challenges and, in turn, new opportunities. Another opportunity that Kelly believes will always exist is providing informational services for games, such as forums and guides. For those entrepreneurs interested in starting a business serving online gamers, the following steps will help to ensure success in the industry: 1. Keep the international nature of the industry in mind. One of the benefits of virtual worlds is the complete anonymity that is provided to gamers, which allows not only for greater freedom in social interactions but also for the disappearance of all territorial boundaries. Companies that hope to address the needs of these customers must be aware of the global community. 2. Be prepared for a rapidly changing marketplace. Another benefit of virtual worlds is their almost complete flexibility. After all, they are digital representations of real-world items, but the only engineering limitations are those imposed utility makes for a better gaming experience, but it complicates the process of tracking the market for businesses that hope to have gamers as customers. Putanec suggests building a scalable business to take advantage of the currently fragmented market and to allow for better positioning when trends present themselves. by the companies hosting the games. This versa- 3. Be willing to speak with the online game developers. The gods of these virtual worlds are the developers who create the environments and artifacts available to gamers. It is in the best interest of these developers to encourage new service providers to enter the scene, given that such services will enhance the game play. By getting their feedback regarding your business concept, you will not only get an expert’s opinion, which is useful in honing your offerings, but you might even get an endorsement from an industry insider. (Source: Adapted from: Amanda C. Kooser, “Out of This World,” Entrepreneur (February 2008): 124.) Chapter 8 Sources of Capital For Entrepreneurs SUGGESTED ANSWERS FOR DISCUSSION QUESTIONS (END-OF-CHAPTER) 1. Using Figure 8.1 describe some of the sources of capital available to entrepreneurs, and discuss how they correlate to the varying levels of risk involved with each stage of the venture. Entrepreneurs have various forms of capital available to them, and most are more appropriate at different stages of the business. In the earliest stages of the business, the owner’s own money is often used. This is because the business is often unproven and thus entails a lot of risk. They may not be able to receive any other funds until they have some type of track record. Once the owners have demonstrated they are serious about the business, family and friends may provide money to support the entrepreneur. Angel investors who are looking for a good idea and the excitement of the entrepreneurial journey may come on board to provide funding. Angels are often looking for investment returns as well as contributing to the development of their communities and entrepreneurial ecosystems. Seed capital may come in to help take the business closer to larger market presence. Once a company has a track record and shows evidence that it can scale, venture capitalists will often choose to get involved. They’re interested in high growth opportunities. There is still a lot of risk involved, but the company has demonstrated that it has evidence that it can be successful. Once the company is more secure in the market, it will have access to banks and government programs. Banks tend to look for low risk companies to lend to, and government programs are looking for the most impactful programs for public dollars. When the company is established, it can begin to seek capital infusions from private placements of securities. The firm can sell stock through direct public offerings. When the company has demonstrated sufficient success in the market, it can seek out significant capital through an initial public offering. Millions, and even billions, of dollars can be generated for the company through an IPO. All these forms of capital are risky, but risk changes at different stages of the company life cycle. Thus, different instruments that respond in various ways to risk are used. 2. What are the benefits and drawbacks of equity and of debt financing? Briefly discuss both. One major benefit of equity is that there is no legal obligation to repay the principal amount or pay interest on it. There are two types of equity financing: public offerings and private placements. By going public you can raise large sums of capital in a short time. Other advantages include liquidity, value on stock, and image. Along with advantages there are disadvantages, which include cost, disclosure requirements, and shareholder pressure. Private placements allow selling stock to private parties. Debt financing involves a payback of the funds plus a fee for the use of the money. Advantages are: no relinquishment of ownership, greater return on equity; and low interest rates. Disadvantages include: regular interest payments, possible cash flow problems because of payback responsibility, and heavy use of debt which can inhibit growth and development. 3. If a new venture has its choice between long-term debt and equity financing, which would you recommend? Why? I would recommend equity financing because it would give the entrepreneur the chance to start off the small business without a big debt. Long-term debt matures in five years, which isn’t adequate time for the business to show a large profit. Also, long-term debt is used mainly to finance the purchase of property or equipment. 4. Why would a venture capitalist be more interested in buying a convertible debenture for $500,000 than in lending the new business $500,000 at a 4 percent interest rate? With a convertible debenture, the venture capitalist would have an opportunity to own stock in the company whereas the loan would not offer that opportunity. 5. What are some of the advantages of going public? What are some of the disadvantages? 6. What is the objective of Regulation D? Regulation D eases the regulations for reports and statements required for selling stock to private parties. 7. If a person inherited $100,000 and decided to buy stock in a new venture through a private placement, how would Regulation D affect this investor? There are no special disclosure/information requirements and no limits on the kind or type of purchasers. 8. Is it easier or more difficult to get new-venture financing today? Why? Although there are many new forms of funds available, such as crowdsourcing, many entrepreneurs are finding it more difficult than a decade ago to get financing. There are not as many banks making loans, and those that do are being more restrictive on who they loan to. Still, if a business has strong potential for success, investors will always be looking to finance companies that ensure good returns on investment. Entrepreneurs need to make stronger cases that they are worthy of such an investment. 9. Some entrepreneurs do not like to seek new-venture financing because they feel that venture capitalists are greedy. In your opinion, is this true? Do these capitalists want too much? No, when venture capitalists invest in a business they are taking a very high risk and they should be compensated for the risk. 10. Identify and describe three objectives of venture capitalists. Security and payback: VCs want to invest in sound companies and expect the companies to be successful; Return on investment: they expect a large ROI; Management team: VCs usually want to work with a team with good credentials and experience. 11. How would a venture capitalist use Figure 8.2 to evaluate an investment? Use an illustration in your answer. Figure 8.2 illustrates an evaluation system for measuring the status of a product/service and the status of management—on four levels (scoring 1 to 4 on each). It demonstrates that ideas as well as entrepreneurs are evaluated when the viability of a venture is proposal is determined. Let’s say a student approached their entrepreneurship professor asking whether a venture capitalist would be interested in investing in their business. The professor might ask what stage the idea is at. If the student said it’s only an idea at this point and it’s only the student doing it, the professor would explain that no venture capitalist would be interested until the idea was more fully developed and a more experienced team was built. However, if the student had a fully developed product that they had tested with customers and an experienced entrepreneur was willing to help with the business, the professor might recommend they approach a venture capitalist. There’s no guarantee a venture capitalist would be interested, but it is much more likely than the first scenario. 12. Identify and describe four of the most common criteria venture capitalists use to evaluate a proposal. (1) Capable of sustained intense effortWill the entrepreneur be able to cope with bad times of the business? (2) Thoroughly familiar with the marketDoes the entrepreneur know enough about the market to operate in it? (3) At least ten times return in 5-10 yearsWill the business profits show a return 10 times the amount it started showing? (4) Demonstrated leadership in pastHas the owner held any leadership roles? 13. In a new-venture evaluation, what are the four stages through which a proposal typically goes? Describe each in detail. (1) Initial screeningThis is a quick review of the basic venture to see if it meets the venture capitalist’s particular interest. (2) Evaluation of the business planThis is a detailed reading of the plan done in order to evaluate the factors mentioned earlier. (3) Oral presentationThe entrepreneur will verbally present the plan to the venture capitalist. (4) Final evaluationAfter analyzing the plan and visiting with suppliers, customers, consultants, and others, the venture capitalist will make a final decision. 14. An entrepreneur is in the process of contacting three different venture capitalists and asking each to evaluate her new business proposal. What questions should she be able to answer about each of the three? (1) Does the venture capital firm in fact invest in your industry? (2) What is it like to work with this venture capital firm? (3) What experience does the partner doing your deal have, and what is his/her clout within the firm? (4) How much time will the partner spend with your company if you run into trouble? (5) How healthy is the venture capital fund and how much has been invested? (6) Are the investment goals of the venture capitalist consistent with your own? (7) Have the venture firm and the partner championing your deal been through any economic downturns? 15. An entrepreneur of a new venture has had no success in getting financing from formal venture capitalists. He now has decided to turn to the informal risk capital market. Who is in this market? How would you recommend the entrepreneur contact these individuals? This type of investor is someone who has already made his/her money and now seeks out promising young entrepreneurs to support financially. They contact these individuals through a network of friends. Also, many states are formulating venture capital networks, which attempt to link informal investors with entrepreneurs and their new or growing ventures. ADDITIONAL ACTIVITIES Short Cases LOOKING FOR CAPITAL When Joyce and Phil Abrams opened their bookstore one year ago, they estimated it would take them six months to break even. Because they had gone into the venture with enough capital to keep them afloat for nine months, they were sure they would need no outside financing. However, sales have been slower than anticipated, and most of their funds now have been used to purchase inventory or meet monthly expenses. On the other hand, the store is doing better each month, and the Abramses are convinced they will be able to turn a profit within six months. At present, Joyce and Phil want to secure additional financing. Specifically, they would like to raise $100,000 to expand their product line. The store currently focuses most heavily on how-to-do-it books and is developing a loyal customer following. However, this market is not large enough to carry the business. The Abramses feel that, if they expand into an additional market such as cookbooks, they can develop two market segments that—when combined— would prove profitable. Joyce is convinced that cookbooks are an important niche, and she has saved a number of clippings from national newspapers and magazines reporting that people who buy cookbooks tend to spend more money per month on these purchases than does the average book buyer. Additionally, customer loyalty among this group tends to be very high. The Abramses own their entire inventory, which has a retail market value of $280,000. The merchandise cost them $140,000. They also have at a local bank a line of credit of $10,000, of which they have used $4,000. Most of their monthly expenses are covered out of the initial capital with which they started the business ($180,000 in all). However, they will be out of money in three months if they are not able to get additional funding. The owners have considered investigating a number of sources. The two primary ones are a loan from their bank and a private stock offering to investors. They know nothing about how to raise money, and these are only general ideas they have been discussing with each other. However, they do have a meeting scheduled with their accountant, a friend, who they hope can advise them on how to raise more capital. For the moment, the Abramses are focusing on writing a business plan that spells out their short business history and objectives and explains how much money they would like to raise and where it would be invested. They hope to have the plan completed before the end of the week and take it with them to the accountant. The biggest problem they are having in writing the plan is that they are unsure of how to direct their presentation. Should they aim it at a banker or a venture capitalist? After their meeting with the accountant, they plan to refine the plan and direct it toward the appropriate source. QUESTIONS 1. Would a commercial banker be willing to lend money to the Abramses? How much? On what do you base your answer? A commercial banker might be willing to lend money to the Abramses, but the amount and terms of the loan would depend on several factors, such as the strength of their business plan, their financial situation, and the bank’s lending criteria. • Assets as collateral: The Abramses own their inventory, which has a retail market value of $280,000 and cost them $140,000. Banks are more likely to lend money if there is collateral, and this inventory could be used as security for a loan. However, banks would likely lend based on the lower cost value ($140,000), not the retail value. • Track record: Although the bookstore is not yet profitable, it is improving monthly, which shows progress. The Abramses may need to demonstrate that they have a clear path to profitability and provide cash flow projections showing they can repay the loan. • Existing line of credit: The Abramses already have a small line of credit ($10,000, with $4,000 used). Their ability to secure and responsibly manage this credit would be taken into account. However, the fact that they need additional funding after only a year could raise concerns about whether the business is sustainable without continued external financing. If the bank is confident in the business’s ability to turn a profit within the next six months, they might offer a loan, but it is unlikely to be the full $100,000 requested. More realistically, the loan might be in the range of $50,000 to $75,000, possibly structured as a term loan, and it would come with specific terms for repayment and a lien on inventory or other assets as collateral. 2. Would this venture have any appeal for a venture capitalist? Why or why not? This venture is unlikely to appeal to a venture capitalist (VC) for several reasons: • Small scale: Venture capitalists typically look for businesses that have the potential for high growth and large returns on investment, often aiming for a 10x return or more. A small, local bookstore does not fit this profile because the growth potential is limited, even if they expand into new markets such as cookbooks. • Lack of scalability: Bookstores, particularly niche ones, have a limited ability to scale quickly. The bookstore is focusing on specific markets (how-to books and cookbooks), but it is not a tech-driven or highly scalable business that could appeal to venture capitalists. • Profitability timeline: VCs generally look for businesses that can demonstrate rapid growth and profitability. While the Abramses believe they will be profitable in six months, this timeline might be too slow for a VC, who would prefer to invest in a business that can demonstrate faster and more exponential growth. • Ownership dilution: Venture capitalists often seek significant ownership stakes in exchange for funding, which could dilute the Abramses’ control over the business. This might not align with their long-term goals, as they seem to prefer maintaining ownership and growing the business organically. 3. If you were advising the Abramses, how would you recommend they seek additional capital? Be complete in your answer. I would recommend a multifaceted approach to raise the capital they need, focusing on sources that align with the size and nature of their business: a. Commercial Loan or Line of Credit The Abramses should approach their bank for a small business loan or an increased line of credit. A loan or extended credit line would provide them with the $50,000 to $100,000 they need for expansion. • They should use their inventory as collateral to secure the loan. Since they already have a line of credit, they can ask to extend it or consolidate their debt into a larger loan, which may be easier to manage. • They should ensure that their business plan includes detailed financial projections, expected cash flow, and a clear plan for how the funds will be used to generate profit (e.g., the cookbooks market expansion). b. Small Business Administration (SBA) Loan If the commercial bank is reluctant to lend directly, the Abramses should consider applying for an SBA loan. SBA loans are government-backed and designed to support small businesses, often with more flexible terms and lower interest rates than traditional bank loans. • An SBA loan would offer better terms and longer repayment periods, helping them cover their short-term cash needs without excessive financial strain. c. Friends and Family Investment If the bank loan or SBA loan doesn’t cover the full $100,000, the Abramses could approach friends and family for additional funding. This type of investment can be structured as a private loan or a small equity stake in the business. • They should treat it professionally by presenting their business plan and offering repayment terms or equity shares that are mutually agreeable. d. Angel Investors Although venture capital may not be an option, the Abramses could explore angel investors, who typically invest in smaller ventures than VCs and may be more interested in niche businesses with potential for modest but steady growth. • Angel investors often offer smaller amounts of capital in exchange for equity, but their expectations might be more in line with the Abramses' growth trajectory. e. Inventory Financing If the main cash drain is inventory purchases, the Abramses might consider inventory financing. This is a type of short-term loan specifically used to buy more inventory, using the purchased inventory as collateral. • This would allow them to expand their cookbook selection without putting additional strain on their existing cash flow. f. Refining the Business Plan Before approaching any lenders or investors, the Abramses should refine their business plan to emphasize: • Market research showing the profitability of the cookbook market and projected sales growth. • Detailed financials, including current cash flow, profit margins, and how the new funds will be used to generate profit within the next six months. • A clear plan for repayment or return on investment. This approach would give them the best chance of securing the funding they need without taking on too much risk or diluting their ownership. THE $3 MILLION VENTURE The Friendly Market is a large supermarket located in a city in the Southwest. “Friendly’s,” as it is popularly known, has more sales per square foot than any of its competitors because it lives up to its name. The personnel go out of their way to be friendly and helpful. If someone asks for a particular brand-name item and the store does not carry it, the product will be ordered. If enough customers want a particular product, it is added to the regular line. Additionally, the store provides free delivery of groceries for senior citizens, check-cashing privileges for its regular customers, and credit for those who have filled out the necessary application and have been accepted into the “Friendly Credit” group. The owner, Charles Beavent, believes that his marketing-oriented approach can be successfully used in any area of the country. He therefore is thinking about expanding and opening two new stores, one in the northern part of the city and the other in a city located 50 miles east. Locations have been scouted, and a detailed business plan has been drawn up. However, Charles has not approached anyone about providing the necessary capital. He estimates he will need about $3 million to get both stores up and going. Any additional funding can come from the current operation, which throws off a cash flow of about $100,000 monthly. Charles feels that two avenues are available to him: debt and equity. His local banker has told him the bank would be willing to look over any business plan he submits and would give him an answer within five working days. Charles is convinced he can get the bank to lend him $3 million. However, he does not like the idea of owing that much money. He believes he would be better off selling stock to raise the needed capital. Doing so would require him to give up some ownership, but this is more agreeable to him than the alternative. The big question now is, How can the company raise $3 million through a stock offering? Charles intends to check into this over the next four weeks and make a decision within eight weeks. A number of customers have approached him during the past year and have asked him if he would consider making a private stock offering. Charles is convinced he can get many of his customers to buy into the venture, although he is not sure he can raise the full $3 million this way. The other approach he sees as feasible is to raise the funds through a venture capital company. This might be the best way to get such a large sum, but Charles wonders how difficult it would be to work with these people on a long-term basis. In any event, as he said to his wife yesterday, “If we’re going to expand, we have to start looking into how we can raise more capital. I think the first step is to identify the best source. Then we can focus on the specifics of the deal.” QUESTIONS 1. What would be the benefits of raising the $3 million through a private placement? What would be the benefits of raising the money through a venture capitalist? Benefits of Raising $3 Million through a Private Placement: • Maintaining Control: Private placement allows Charles to sell shares to a select group of individuals, such as loyal customers or personal connections, without giving up significant control over the company. Investors in a private placement typically demand less involvement in the company's day-to-day management compared to venture capitalists. • Loyal Investor Base: Many of the potential investors are likely to be his customers who believe in the business and its values. They may invest not only for financial returns but also because they trust Charles and his business philosophy, potentially fostering a loyal and supportive investor base. • Lower Costs of Raising Capital: Private placements typically have lower legal and regulatory costs compared to a public stock offering or venture capital funding, as they are exempt from some of the registration and disclosure requirements of public offerings. • Fewer Strings Attached: In a private placement, investors may not demand high rates of return or insist on control rights like venture capitalists. This can make it easier to maintain Charles' vision and business strategy without outside interference. Benefits of Raising $3 Million through a Venture Capitalist: • Access to Larger Sums of Capital: Venture capitalists (VCs) are used to investing large sums of money, so Charles may be able to secure the full $3 million in one transaction, which would be more difficult through a private placement of smaller individual investments. • Expertise and Mentorship: VCs often bring valuable expertise, industry connections, and guidance. They can help with strategy, growth plans, and possibly even expand the business faster and more efficiently than Charles could on his own. Their networks might also help with identifying additional opportunities for the Friendly Market. • Professionalized Operations: Venture capitalists often push for professionalizing company operations, bringing in experienced executives or streamlining processes, which could help Friendly’s transition from a local chain to a regional or national player. • Potential for Future Funding: VCs often fund multiple rounds of financing. If the business continues to grow, a VC could provide additional funding for future expansion phases. 2. Of these two approaches, which would be best for Charles? Why? The private placement would likely be the best approach for Charles, for several reasons: • Ownership and Control: Charles values retaining control over the business, and private placements typically allow founders to maintain more control compared to venture capital deals, which often come with conditions on decision-making and company direction. • Loyal Customer Investors: Given that many customers have expressed interest in buying shares, Charles could tap into a pool of investors who already have a vested interest in the success of the business. This group may be more forgiving of slower growth, less profit-driven, and willing to support Charles’ management style. • Fewer Obligations: Venture capital funding often comes with strings attached, such as performance benchmarks, high return expectations, and possibly the imposition of new management. If Charles prefers to run his business without external pressures or significant changes in operations, private placement is a more favorable option. • Smaller Investment Needs: While the $3 million target is substantial, Charles already has positive cash flow from his current operations ($100,000 monthly), so he may not need additional VC capital for future rounds. A private placement might generate sufficient capital with fewer obligations. However, if Charles cannot raise enough money through private placement alone, he could explore venture capital as a secondary option. But starting with private placement aligns better with his desire for control and maintaining the company’s current culture. 3. What would you recommend Charles do now? Briefly outline a plan of action he can use to get the financing process started. Plan of Action for Raising $3 Million: 1. Refine the Business Plan: • Ensure that the business plan clearly explains the current success of Friendly’s, its strong customer base, and how expansion will benefit the business. Include detailed financial projections, cash flow estimates, and how the $3 million will be used. • Specifically address the two new locations, expected sales growth, profit margins, and a timeline for the return on investment. 2. Evaluate the Private Placement Option: • Start by contacting those loyal customers who have expressed interest in a private stock offering. Gauge how much interest there is and how much capital can realistically be raised from this group. • Engage with a financial advisor or lawyer to ensure the private placement complies with legal regulations. This includes preparing offering documents, disclosures, and a subscription agreement. • Set an initial fundraising target (e.g., $1.5 million) through this channel to reduce dependence on loans or venture capital. 3. Engage Professional Help: • Work with an accountant or financial advisor to determine the best way to structure the offering, whether in the form of equity shares or other types of securities (convertible debt, for example). • Reach out to a lawyer with experience in securities law to ensure the private placement is legally sound. 4. Assess Debt Options with the Bank: • While Charles prefers equity over debt, he should still submit his business plan to the bank to explore the loan option as a backup or complement to the private placement. • Request a combination of debt and private equity, which might involve securing a loan for part of the $3 million and raising the rest through the private placement. 5. Prepare for Venture Capital as a Last Resort: • If the private placement and loan options do not generate enough capital, Charles should explore venture capital. • Begin researching VC firms that focus on retail or food sectors, and network to find potential partners who might be aligned with Charles' business vision. • If pursuing this route, he should be ready to negotiate control, ownership, and long-term vision, as VCs will likely want a say in the company’s strategic direction. 6. Finalize the Funding Mix: • After evaluating the responses from private investors and the bank, finalize the combination of private equity, bank loans, or VC funding needed to cover the $3 million. 7. Close the Deals: • Complete the private placement offering, secure any debt financing, and prepare for expansion. By following this plan, Charles can secure the capital he needs while maintaining control over his business and positioning Friendly Market for successful expansion. Solution Manual for Entrepreneurship: Theory, Process, and Practice Donald F. Kuratko 9781305576247
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