ENTREPRENEURSHIP

BUYING A BUSINESS

By

Rajeev RoyAssociate Professor & NEN Faculty Leader

XIMB

© Rajeev Roy, XIMBEntrepreneurship

Oxford University Press, 2008

CHAPTER 7ENTREPRENEURSHIP

By

RAJEEV ROYOXFORD UNIVERSITY PRESS 2008

BUYING A BUSINESS



Chapter objectives• To list the benefits of buying an existing business• To list the disadvantages of buying an existing business• To discuss the possible sources of information about a business for

sale• To describe a step by step process of buying a business• To tabulate the factors to be investigated before a purchase• To understand various methods of valuing a business• To discuss the major mistakes made in buying a business• To understand the concept of franchising• To list the benefits of being a franchisee• To discuss the factors important in evaluating a franchise

opportunity• To describe the elements of a franchise agreement



Advantages of Buying a Business

• Buying an existing business will enable you to go around a lot of problems likely to crop up in opening a business.

• The existing business would have already got some licenses and government approvals which would be otherwise difficult to get.

• Land is scarce and it is difficult to find an appropriate location. An existing business is likely to come bundled with the land.

• The plant and machinery have already been bought and have been installed and tested.

• Employees are experienced. • A supplier base has already been established.



Advantages of Buying a Business

• There is a readymade market. • A distribution network has been set up and money and

effort has already been invested in establishing a rapport with retailers and wholesalers.

• Goodwill and reputation would have been built up. • Cash flow is going to start immediately. • Banks may be more willing to lend to a business with

running operations, an established customer base and a steady cash flow.

• It might be cheaper than setting up new operations. • The former owner may be persuaded to guide you in

the early days. This free advice may prove to be invaluable.



Disadvantages

• The industry as a whole is not doing well and the situation is not likely to improve in the near future.

• The owner may not have been truthful about the business.

• The equipment could be old and outdated. • The location is bad or is likely to become bad. • Employees may be unproductive or incapable

of meeting the standards required of them.



Disadvantages

• Any bad reputation that the business had acquired amongst suppliers, distributors and other people in the industry is likely to pass on to you.

• The previous owner may have got into some unfavourable long term contractual obligations

• The inventory lying in stores could be obsolete or unfit for use.

• If the company’s products have not been received well by the market it will be harder to gain market share than it would have been for a new product.



Buying a Business

• Preliminary information collection• Site visit• Scrutiny• Additional information collection• Negotiation• Transition



Getting Information

• The industry• Accountants, lawyers• Bankers• Advertisements• Others



Scrutiny

• Financial statements• Other statutory documentation• Valuation of capital equipment• Inventory• Licenses and permits• Contracts with customers and suppliers• Debt and accounts payable• Accounts receivable• Reputation of the firm



Valuation

• Value of assets– Book value– Replacement value– Market value

• Return on investment• Payback period• Discounted cash flow



Negotiations

Elements other than cash:• Combination of stock and cash• Accounts receivable• Lease; with option to buy• Non-compete clause



Common Mistakes While Buying

• Scrutunise claims• Risk vs returns• Valuation of receivables• Antagonising the seller



McDonalds

• Arguably the most successful franchise chain

• Operates 30,000 outlets in over 100 countries

• Became a success after Ray Croc bought it from the McDonald Brothers

Franchising



Advantages of a Franchise

• By taking a franchise, you get a proven system of operation.

• The franchisor allows you the use of an established brand name.

• The franchisees can also use professionally designed point of sale advertising materials, packaging material, posters and print and TV ads.

• This brand recognition is driven by national and regional advertising programmes.

• The franchisor will often train the franchisee and the franchisee’s employees before letting a new franchisee start the business.



Advantages of a Franchise• Ongoing product development and research is another

advantage of being with a franchise chain. • Large companies can gain from economies of scale

but that would not be possible for individual entrepreneurs.

• The cost of starting up the franchise operations and the ongoing operating costs are very well documented by the franchisor and the details are shared with all prospective franchisees.

• A franchisor can add value by putting a quality program in place.

• The franchisor often does market research to find out if the market is big enough to support an outlet.



Choosing a Franchisor

• It is good to get into an industry that is growing and shows signs of sustaining a rate of high growth over the next few years.

• It is also important to take into account, the performance of the franchisor’s products in the market.

• It is better to choose a franchisor, which has been in this business for a long time.

• It is disadvantageous to become one of the initial franchisees in a chain.

• The reputation of the franchisor counts for a lot.



Choosing a Franchisor

• The franchisor’s relationship with other franchisees is also a very important factor to consider.

• Take a close look at the profitability indicated in the figures shared by the franchisor. Some of the assumptions made while arriving at those figures may need to be changed.

• It might need a good amount of investigation to come up with accurate estimates of the success rate of franchisees.



The Franchise Agreement

• The size and location of space needed • The franchise fee including down

payment and continuing royalties• Refundable deposits • A franchisee’s allotted territory• The range of products and services

which are offered by the franchisor



The Franchise Agreement

• Training and who pays for it• Advertising and who pays for it• Any other assistance• No-compete clauses• Dispute resolution and legal recourse

Documents

ENTREPRENEURSHIP