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Chapter outline
• Issues to consider before going into business
• Starting a new business• Purchasing an existing business• Entering a franchise system• Comparison of options• Procedural steps when starting a
business venture.
Learning objectives
• Explain the 3 major issues that all prospective entrepreneurs and small-business owners must consider before going into business
• Compare and contrast the advantages and disadvantages of starting a new business.
Learning objectives
• Outline the factors to take into account when assessing a business for purchase
• Explain the different ways of calculating a business purchase price
Learning objectives
• Describe how a franchise operates• Use the ‘6 step’ process to organise your
strategy for going into business
Business commencement options
There are essentially 3 major options for going into business:
• Launch a new (start-up) business venture• Purchase an existing firm• Enter a franchise arrangement
Issues to consider before going into business
• Any business venture is driven by 3 forces:– Personal goals and abilities of the
owner/entrepreneur – What resources are available to the
business owner (money, staff, etc)?– The nature of the business opportunity
itself
Starting a new business — the advantages
Advantages• The owner can shape his or her own
vision• Flexibility — fewer constraints on owner• Cost minimisation — often cheaper to
start• New lifestyle goals — can ensure
business and personal goals are closely aligned from the outset
Starting a new business — the disadvantages
Disadvantages• Hard to raise capital• Lack of an established customer base• May suffer cash flow problems• Requires considerable effort to learn how
to operate the business effectively (‘learning curve expenses’)
Costs of a start-up venture
Some costs are common to all new enterprises, such as:
• Licenses and permits required to operate the business
• Working capital• Communications equipment (such as
telephones, computers, fax machines)• Operating plant and equipment
Costs of a new (start-up) business venture
• Staff recruitment expenses• Insurance• Raw materials (or trading stock)• Rental of premises (unless working from
the owner’s home)• Stationery
In addition, there will also be industry-specific expenses.
Purchasing an existing business
Advantages:• Can begin trading immediately• Easier to arrange finance for the venture• Established track record of the firm allows
a more objective evaluation of likely future performance
Purchasing an existing business
Disadvantages:• May ‘inherit’ existing liabilities• Less flexible than a start-up• Difficult to establish purchase price
Establishing a purchase price
Three major techniques used by sellers (vendors) and purchasers:
1. Market-based valuations
2. Asset-based valuations
3. Earnings-based (cash flow) valuations
Market-based valuations
The going market rate method• simply the ‘current market’ price for a
particular type of firm
• Selling price = Selling price of similar firms
Market-based valuations
Revenue multiplier method• common ‘industry multiple’ that is used to
estimate the most likely purchase price of the practice
• Selling price = Turnover × Standard industry multiple
Asset-based valuations
Involves setting a price after examining the assets and liabilities of the business:
Book value• asking price is set by first calculating the
worth of all the firm’s assets• Selling price = Tangible assets + Intangible
assets − Liabilities
Asset-based valuations
Adjusted book (net asset) value• simple book value method relying on the
books of account
Asset-based valuations
Liquidation value • value of the business if it was to be
broken up and sold as individual assets, rather than continuing to operate it as a going concern
Asset-based valuations
Replacement value• the cost of replacing all of the firm’s
tangible assets (at current market costs)
Earnings-based (cash flow) valuations
Return on investment • based on the assumption that the risk and
return of a business should be reflected in its selling price. It works on a formula which includes the estimated future profit earnings:
• Selling price = Net annual profit × (100/ROI)
Discounted cash flows• reduces (discounts) the future cash
income generated by the business back to its current value
• Value = + terminal value
Earnings-based (cash flow) valuations
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• Why is the business being sold?• Will existing staff remain if the business
is sold?• What debts/liabilities exist?• Can all licenses and permits to operate
be transferred?• How accurate are the financial
accounts?
Questions to ask
• What is the future state of the industry — is demand increasing or decreasing?
• Is the lease on the premises secure?• What is the condition of the physical
assets?• Will existing customers remain loyal if
business has new ownership?
Questions to ask
Entering a franchise system
• An increasingly common form of business operation.
• An arrangement whereby the originator of a business product or operating system permits another business owner to sell these goods, and/or to use the business operations system, on his or her behalf.
Entering a franchise system
• A licensing arrangement: a small firm receives permission to sell a particular product from an established parent organisation, but remains legally independent of that parent.
Entering a franchise system
• Typically has lower failure rates than new start-ups.
• Good for small business owners seeking security
• Less suitable for entrepreneurial types.
Entering a franchise system
• Franchisee: The business or individual who is given contractual permission to operate a particular business franchise system or sell a product by the original owner of the same.
• Franchisor: A business or individual who owns the right to a particular business franchise system or product.
Entering a franchise system
Product franchise: • gives the small business operator the
right to sell a particular commodity, or set of goods.
• Franchisee is a distribution mechanism for good or service; has a large measure of independence about how their business is operated.
Entering a franchise system
Product franchise (cont’d): • Franchisor’s role is limited to ensuring
that sufficient stock is made available, and that the franchisee is selling the product at a satisfactory price.
Entering a franchise system
Business system franchise: • A situation where the franchisor not only
supplies the product, but also gives comprehensive guidelines about how the business is run (e.g. McDonald’s).
• All aspects of organising and operating the business have already been investigated, pre-tested and successfully implemented by the franchisor.
Advantages of franchising
• The new business owner is spared the task of developing an operating system
• New business owner learns less ‘by mistakes’
• Customers are usually attracted by the presence of an established product.
Advantages of franchising
• Lower failure rate • Franchisors provide continuing training for
franchisees• Pre-organised access to raw materials
and supplies • Raising capital can also be easier
Disadvantages of franchising
• Access to these systems does not come cheaply
• Purchase price is often quite high• Franchisees have to pay a proportion of
their profits to the franchisor• Franchisees are restricted to serving a set
market
Disadvantages of franchising
• Franchisees subject to contractual arrangement, and as such have a limited lifespan
Summary
• There are 3 factors which influence all business ventures: – the personal goals, desires, experience
and abilities of the owner/entrepreneur– the financial, human and other
resources available – and the nature of the business
opportunity itself.
Summary
• There are 3 different ways of getting into business: – starting a new business – buying an existing operation – or entering into a franchise
arrangement.• Each has their own advantages and
disadvantages.
Summary
• There are 3 main ways of setting a price:– market-based valuations, – asset-based valuations – and earnings-based (cash flow)
valuations.
Summary
There are 6 steps involved in the process of evaluating business options. After these steps, the intending business owner must critically evaluate which business avenue is the best option.