chapter 8 concept & development of entrepreneurship entrepreneurial decision process types of...

Chapter 8

Concept & Development of Entrepreneurship

Entrepreneurial Decision Process

Types of Start-up Ventures

Entrepreneurship & Economic Development

Ethics and Social Responsibility

Entrepreneurship 2nd Canadian Edition © 2009 McGraw-Hill Ryerson Ltd. 8-1

Franchising and AcquisitionsStarting a Business using Non-Traditional Methods

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Chapter Learning Objectives

1. To understand franchising from the perspective of both the entrepreneur looking to reduce the risk of new entry.

2. To understand how to evaluate a franchise that is for sale.

3. To be aware of the pros and cons of using acquisitions as a start-up strategy.

4. To become aware of the different methods of evaluating a business that is for sale.

5. To understand the tasks of negotiation and develop the skills to more effectively conduct these tasks.

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Chapter Opening Profile

Greg GuyGraduated university and wanted to be an

entrepreneur

•Purchased Buying in Bulk franchise for $100,000•Liked the idea of a franchise with training and assistance

•Did not practice due diligence to fully investigate the opportunity•Paid relatively high royalties and rent to franchisor as per the franchise agreement•Did not receive any marketing support for his area•Walked away when agreement up for renewal

•Purchased Play More Pool franchise•“The key is to do your homework in advance and buy the right franchise.”

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Franchising

• Franchising (definition): the right or licence granted by a company to an individual or group to market its products or services in a specific territory

• Franchisor: a person or corporation that offers a franchise

• Franchisee: an entrepreneur who purchases a franchise

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Advantages/Disadvantages to the Franchisee

Advantages• Less risk

• Product acceptance

• Management expertise

• Capital requirements

• Start-up assistance

• Knowledge of the market

• Operating and structural controls

• Ongoing marketing support

Disadvantages• Loss of independence

• Costs and determining price: royalties

• The franchise agreement

• Over-saturation

• Size/strength of network matters

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DisadvantagesThe franchise agreement:

•Control over the marketing mix•Franchisor can force franchisee to sell unprofitable products or set prices below the breakeven point

•Renewal and termination•Costs of supplies

•Some franchisors gouge franchisees and force them to pay high prices for pizza boxes and other supplies•Remodeling Clauses

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DisadvantagesOver-saturation

•Some franchisors have overly aggressive expansion strategies

•Right of first refusal handicaps new franchisees in existing markets

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• Franchising as an expansion strategy offers:

– Less risk due to using other peoples’ money– Fewer employees required– Cost advantages due to economies of scale: helps in

purchasing and marketing expenses– Potential for problems

between franchisees and franchisor

– Difficulty in finding quality franchisees

– Weak performance of franchisees reflects badly on the whole network


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Types of Franchises

• Dealership: act as retail stores for the manufacturer

• Branded business: name, image, and method of doing business; such as fast food, automotive repair, hotels

• Branded Services: established name, reputation, and method of doing business; real estate agencies

• Franchise Opportunities:– Good health– Time saving or

convenience– Environmental

consciousness– The second baby

boom

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Investing in a Franchise

Factors to be considered:– Unproven versus proven franchise

• Price is inversely related to risk– Financial stability of franchise

• Track record of existing franchisees– Is the franchisor making money by selling franchisees

or – operating a successful network of profitable

franchisees?– Potential market for the new franchise

– Profit potential for a new franchise

– Territorial protection

– Training & Operations assistance

– Contract Length

– Contract RenewalDo your research!

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Information Potential Franchisees Should Ask For

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Acquisition of an Existing Business

Advantages• Established business• Location• Established marketing

structure• Cost• Existing employees• More opportunity to be

creative• Reduce the number of

competitors• Reduction in start-up time

Disadvantages• Marginal success record

– Location– Facility– Management

• Overconfidence in ability• Key employee loss• Business is over-valued• Paying too much for

Goodwill– Means the “favourable

reputation”• Lack of financial disclosure

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Acquisition of an Existing Business

• Finding a business that is for sale• Current business contacts• Current personal contact• Commercial Real Estate Sales agents• Advisors

• Accountants• Bankers• Lawyers

• Websites• Newspapers• Trade magazines

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Investigating a Potential Acquisition

• Financial assessment:

– Validity of the statements and accounting methods used

– Financial condition of the business

• Industry and market analysis:

– Competitors

– Trends in the industry

– Economy

– Market condition

• Assets of the business:

– Condition

– Usage of assets

– Definition of assets

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• Human resources:

– Are there any key employees?

– What do they intend to do upon the sale of the business?

– What is the management like? Will changes have to be made?

• Other considerations:

– Owner’s motive(s) for selling?

– Pending laws or regulations

Investigating a Potential Acquisition

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People can have varying opinions looking at the same business:

This text focuses on

– Discuss factors entrepreneurs should look when evaluating buying a business

– Discuss some evaluation methods

– Introduce a “combination method” that draws on many other evaluation techniques

Evaluating a Potential Acquisition

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Investigating a Business for Sale

• Synergies between your existing business?• Opportunity to complement each other?• Can the business be integrated into existing

businesses?

• Market capitalization or multiple method:

– Price of business– Net income (weighted)

divided by the desired rate of return based as a decimal

– $200,000/.25– Equals $800,000

• What resources can be brought into the business?

• Management capabilities• Industry outlook

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Combination Method

• Based on the premise that an entrepreneur is only interested in how much cash can be earned and paying for tangible assets

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Combination Method (continued)

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Structuring the Deal

• Only make an offer after inspecting all financial records• The 2 most common means of acquisition are

– The entrepreneurs direct purchase of the firm’s entire stock or assets

• The entrepreneur obtains funds from a lender• Or the “bootstrap” purchase of these assets

– Acquire a small amount of the firm, eg 20% for cash– Then purchase the remainder with a long-term note

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• Leveraged buyout (definition): purchasing an existing venture by an entrepreneur or employee group– Use of borrowed funds to buy undervalued assets,

improve the business, and then re-sell or hold– Debt to equity usually

exceeds 5:1– Key success factor is the

new owner’s ability to cover the debt payments from the cash flow of the business

• Looking for:– Reasonable asking price

for the business– Debt capacity of the

business– An appropriate financial

package

Structuring the Deal

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Negotiating for More Resources

• Distribution task (definition): negotiating how the benefits of the relationship will be allocated between the parties

• Integration task (definition): exploring possible mutual benefits from the relationship so that the “size of the pie” can be increased

• Reservation price (definition): the price (the bundle of resources from the agreement) at which the entrepreneur is indifferent about whether to accept the agreement or choose the alternative

• Bargaining zone (definition): the range of outcomes between the entrepreneur’s reservation price and the reservation price of the other party

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Negotiating for More Resources (continued)

• Assessments:– What will you do if an agreement is not reached?– What will the other party to the negotiation do if an

agreement is not reached?

– What are the underlying issues of this negotiation? • How important is each issue to you?

• How important is each issue to the other party?

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Negotiating for More Resources (continued)

• Strategies:– Build trust and share information– Ask lots of questions– Make multiple offers simultaneously

– Use differences to create trade-offs that are a source of mutually beneficial outcomes

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Chapter Closing Comments

1. To understand franchising from the perspective of both the entrepreneur looking to reduce the risk of new entry and from the entrepreneur looking for a way to grow his or her business.

2. To understand how joint ventures can help an entrepreneur grow his or her business and acknowledge the challenges of finding, and maintaining an effective joint venture relationship.

3. To be aware of the pros and cons of using acquisitions as a start-up or growth strategy.

4. To understand the possibilities of achieving growth through mergers and leveraged buyouts and the challenges associated with each.

5. To understand the tasks of negotiation and develop the skills to more effectively conduct these tasks.

chapter 8 concept & development of entrepreneurship entrepreneurial decision process types of...

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