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The Five Paths to Business Ownership

There may be “50 ways to leave your lover,”2 as the song states, but there are only five ways to get into small business management:

?          You may start a new business. ? You may buy an existing business. ?        You may franchise a business. ?    You may inherit a business. ?            You may be hired to be the professional manager of a small business.

Although everyone gets into business by one of these five paths, the specific details of going into business are unique to each person.3 Start-ups may be deliberate, well planned, and financed. On the other hand, many start-up businesses “just happen.” Often a compelling hobby slowly morphs into a profitable business, or a chance occurrence leads to a new busi- ness venture. Purchases of existing businesses may occur in any number of ways, from cash purchases to “earn-outs” in which the business is bought over a period of time with money earned from the business. Franchises may range from “turnkey,” in which every part of setting up the business is handled by professionals, to those in which the only thing that is franchised is the right to use the business name. Some business managers work their way to the top from a beginning part-time employee position. Other professional managers are recruited to become the chief executive. It is common for hired management to use leveraged buyouts or employee stock option plans to purchase the firms for which they work. This chapter examines the details of these paths of entry into small business: start-ups, purchasing, franchising, inheritance, and professional management.

Starting a New Business

Starting a new business is at once the most risky path into business and the path that promises the greatest rewards for success. The success rate of start-up businesses is a matter of some controversy. As we note in Chapter 1, while the Small Business Administration (SBA) reports that 66% of new employers survive two years or more, 50% survive at least four years, and 40% survive more than six years,4 those businesses that get help last much longer. Eighty-seven percent of start-ups that begin in business incubators are still in operation five years later,5 and the survival rates for students from entrepreneurship programs and entrepreneurs seeking help from Small Business Development Centers are about twice that of businesses in general.6 Even for those who get help in starting their business, one must admire the courage and optimism of a person who chooses to start a new business (see Figure 6.1). Despite the rather high failure rate, creating a start-up is not, as some maintain, a triumph of hope over reality. Many businesses that end do so not because they failed, but because the owner took advantage of a better opportunity.7 The rewards, both financial and personal, of starting a successful new business can be most impressive.

Advantages of Start-Ups

There are many reasons that people choose to start a new business rather than purchasing an existing business, franchising, or being an employee:

start-up

A new business that is started from scratch.

buyout

The purchase of substantially all of an existing business.

LO2

Compare the rewards with the pitfalls of starting a new business.

?

A start-up begins with a “clean slate.” There are no existing employee problems, debts, law- suits, contracts, or other legal commitments that must be satisfied.

?          A start-up provides the owner with the opportunity to use the most up-to-date technologies. There are no “legacy” locations, buildings, equipment, or software that can hamper productivity. ?    A start-up can provide new, unique products or services that are not available from existing businesses or franchises. Existing businesses and franchises exist because of their success in

providing proven products and services. ? A start-up can be kept small deliberately to limit the magnitude of possible losses. A

purchased business or franchise requires immediate and constant cash flows to meet ongoing obligations.

Disadvantages of Start-Ups

Offsetting the advantages of starting a new business are several disadvantages:

?          A start-up business has no initial name recognition. An existing business or franchise has in- vested in developing its market. The brand rights can guarantee immediate acceptance of the business.

? A start-up will require significant time to become established and provide positive cash flows. An established business or franchise has built-in customers to provide immediate cash inflows.

?          A start-up can be very difficult to finance. Established businesses and franchises provide im- mediate assets, sales, and cash inflows that can be used to obtain financing for the business. ? A start-up usually cannot easily gain revolving credit from suppliers and financial institu- tions. An existing business or franchise often has lines of credit that transfer with the business. ?        A start-up may not have experienced managers and workers. Established businesses and fran-

chises provide experienced workforces, training, and management support.

Creating a New Business

The vast majority of start-up businesses are “me-too” enterprises. The business idea is simply to create another occurrence of a common business: a beauty shop, a restaurant, a bar or lounge, a rock band, a sign company, plumbing service, yard care, and so on. Starting a copycat business provides some protection from business failure. It is not necessary to define the business to the market be- cause everyone knows what a beauty shop, restaurant, or lounge provides.

On the other hand, this type of start-up can be very difficult to differentiate from other similar businesses. Often, the only competitive advantage may be the location of the start-up. This is why owners of common businesses go to so much effort to try to make a difference between their busi- ness and other, essentially identical, firms. An example is how Morton’s of Chicago and the Ruth’s Chris steak houses operate. Careful sampling of each firm’s steaks reveals no significant difference in price, quality, tenderness, size, or taste. The restaurants have similar menus and wine lists. Each, however, has distinctive interior decorating and presentation of their meals. Morton’s brings a selec- tion of huge uncooked steaks to each table for patrons to make their choices. The cooked steaks are served on oversized china plates. Ruth’s Chris provides equally large steaks, selected from a printed menu, served on plates that are heated to a high temperature to create the trademark “sizzle.”

Amy Conti, of San Antonio, provides an example of an accidental business start-up. She initially did babysitting for a few friends. When demand for her services exceeded her available time, she began having some of her friends, whom she knew to be competent, sub contract for her. She re- quired her “subs” to have advanced Red Cross first-aid certification and she closely supervised their sitting engagements. Her strict standards and ability to pay for standby sitters has made her service unique. The high reliability of her service and the confidence that parents have in the abilities of her sitters have made a business that is usually considered to be a part-time thing for the girl next door into a professional and profitable business for its founder.

The specific concept that leads to a start-up business usually comes from the experience of the person starting the business. Two-thirds of all start-ups are based on ideas from prior work experience, hobbies, and family businesses.12 These businesses are generally more likely to succeed than are businesses based on ideas from other sources. Research into the indicators of successful start-ups shows that one of the best predictors of success is the level of experience of the founders. Random events, suggestions from friends and associates, and specific education courses are the sources of only a relatively few start-up ideas.

Increasing the Odds of Start-Up Success

The probability of creating a successful start-up is increased greatly when the founder has certain attributes and when the founder takes certain actions. Doing the following things has been shown to be the most effective route to success (see Exhibit 6.1).

?          Start the business in a business incubator: A business incubator is an organization that pro- vides financial, technical, and managerial help to start-up businesses. Most incubators are asso- ciated with economic development agencies and are integrated into the community. Incubators provide access to angel investors, public grants for seed money, and technology support.

Business incubators are created to strengthen the local economy by helping create jobs through the establishment of successful small businesses. But incubators do much more than just create new jobs. They aid in the commercialization of new technologies, the revitaliza- tion of distressed neighborhoods, and the creation of wealth. The best incubators provide inexpensive office space with full-time on-site managers who can assist the entrepreneur in many ways. Incubator participants share common office services, such as telephone answer- ing, and production and copying of documents. Perhaps most important, incubators pro- vide legitimacy by furnishing the business with a location and with established business processes.

?          Take part in a mentoring program: Successful business owners and corporate executives do well by doing good. They can, by helping others, in a way repay the many people who helped them achieve success. Executive volunteers contribute their time and energy to assist- ing start-up and struggling small businesses as a public service. Because of their experience, mentors can help you avoid mistakes and make good business decisions.

?          Have a detailed start-up budget: The start-up phase is usually the most difficult time you will have in business. You are required to make myriad decisions concerning location, prod- uct, target market, promotion, sales, and all the facets of starting and operating a business. And you must juggle all these demands while simultaneously seeing that you have enough cash. A detailed start-up budget provides a road map for necessary spending during the start- up phase, when cash inflows are likely to be small or nonexistent. Companies that carefully plan their start-up activities and avoid any unnecessary spending are much more likely to succeed.

?          Produce a product or service for which there is a proven demand: It is an unfortunate fact that most new products and services fail to gain acceptance. NewProductWorks of Ann Arbor, Michigan, maintains a “failed product museum” that contains samples of over 73,000 items, all of which were commercial failures. During the dot-com bubble of 1998–2001, many busi- nesses started with novel and completely untested products and services. Examples are Beenz .com, which was started to facilitate Internet transactions; webvan.com and yourgrocer.com, both of which sold groceries online for home delivery; and estamp.com, which offered online purchasing of U.S. postage, to be printed on the user’s printer. All four of these businesses failed to gain success with their products. None of these businesses survived the “dot-com” bust of 2001, although the domain and patents of e-stamp.com were purchased by the cur- rently operating company, stamps.com.

Large corporations, such as Procter & Gamble or Sony, spend millions of dollars annu- ally testing the market acceptance of new products. Despite their huge resources and years of experience, they regularly introduce products that fail. (Are you old enough to remember “New Coke”?) Your start-up business will not have either the experience or the resources to absorb the loss from product failure. By producing a product or service for which there is a proven demand, the risk of product failure can be reduced or eliminated.

?          Secure outside investment: Securing outside investment accomplishes two things: First, the process of obtaining investment funds means that your business will be critically examined by outsiders who have no vested interest in your idea, product, or service. Second, the fact that you were able to convince outsiders to invest in your business indicates a level of belief in the business and you that provides legitimacy.

? Start with more than one founder: Starting with more than one founder provides the business with more experience, skills, and resources than can be furnished by a single indi- vidual. Having more founders in the business also provides an opportunity for synergy, in which the business results are greater than the sum of the input. Multiple founders can also provide a forum for examining ideas, evaluating information, and making good business decisions.

?          Have experience managing small firms: Managing a small business requires attention very much like that displayed by a person spinning plates on sticks. As a performer must move quickly from plate to plate, many demands of small business management require that you have the ability to quickly move from task to task, without allowing any task to ultimately go uncompleted.

The process can be overwhelming for inexperienced managers. Those entrepreneurs who have experience in small business management are more likely to be able to meet the many simultaneous demands of guiding a successful start-up than would a person new to small business.

?          Have industry experience: Each industry has its own peculiarities. Only through experience can you learn the methods, sources, and markets for any specific one. Even simple tasks, such as buying necessary material, can be nearly impossible without industry knowledge.

For example, suppose that you plan to start a quality steak house, similar to Ruth’s Chris or Morton’s of Chicago. Where do you buy prime beef of the required cut and quality? How do you cook the meat? Or, consider making high-tech, lightweight bicycles. Where can you buy titanium tubing? What does it cost? What do you need to cut, shape, and weld it? How will you sell the bikes? Are bicycles sold through wholesalers? Are they sold directly to bicycle shops? Or maybe you want to start a sign company to make sand-blasted signs. Where will you buy the resist material to protect the wood you don’t want blasted away?

The less you know about something, the easier it appears to be. A true expert makes a task seem effortless. Watching Tiger Woods play golf might lead you to believe that it is an incredibly easy game. Just stand up, hit the ball, and watch it fly to the green. Sure it’s easy: So why do fewer than 2 percent of golfers ever make a course par? The same is true of busi- ness. Businesspeople, such as Michael Dell, Scott McNealy, and Warren Buffet, make the process of succeeding in business seem effortless. But if you have been in the business, you know better. Being experienced won’t make your start-up easy, but at least you have firsthand knowledge of how your industry works that will make your task easier.

? Have previous experience in creating a start-up business: “Nothing succeeds like suc- cess.” In the 150 years since Dumas made this famous statement, it has come to be an un- questioned part of our language. It is just succinct enough, just truthful enough, to seem like a universal truth. For entrepreneurs, it is fortunate that the statement is also not completely true. Although one may learn from successes, most learners acquire expertise through a process of repetition, which only occasionally results in successes. One study of entrepreneurs who had successfully created a start-up business found that on average an entrepreneur suffered three start-up failures before achieving success. Thus it is more nearly correct to state that no entrepreneur succeeds without having prior experience in failing.

? Choose a business that produces high margins: High margins, the amount by which sales prices exceed product costs, provide a buffer for lots of mistakes. The single greatest hurdle to a successful start-up is obtaining and maintaining sufficient cash to support both operations and growth. When margins are low, loss of any one sale or customer has an

immediate effect. However, the problem of replacing the lost margin is much easier if you have to make only one or two sales or get one or two new customers to make up for the lost business.

?          Start the business with established customers: When you start with established customers, you know that you will immediately have cash inflows. There are basically three ways that you can go about obtaining committed customers prior to start-up: (1) You can start your new business as a spin-off from your current employer’s business. (2) You can start a business to specifically go into competition with your employer. (3) Or, you can start a business to sub- contract services to your employer or to other established businesses.

(1) Creating a spin-off is a regular business practice that is done by businesses of all sizes and at all stages of development. Some spin-offs are created to get rid of “noncore” activities. By disposing of the noncore activity, the parent firm reduces capital requirements and pro- vides a tighter focus for management on the remaining businesses. Other spin-offs are created when the parent lacks either the interest or the resources to pursue the opportunity. By being spun off, the start-up can gain access to resources other than those of the parent.

(2) Going into competition with your current employer is also a common practice. Of course, this almost always results in resentments and often ends in lawsuits over issues of trade secrets, rights to intellectual property, and abridgment of contractual provisions. You will have to make difficult ethical decisions. From a legal point of view, the contract be- tween employer and employee is satisfied when all wages and other benefits have been paid in return for you accomplishing the tasks for which you were hired. Absent a specific con- tract providing otherwise, neither party, employer nor employee, is obligated beyond this exchange. However, not so easily answered are the questions: (1) Is it ethical to use your employment to build relationships with customers that subsequently can be used to start a new business? and (2) Is it ethical for you to use knowledge and skill received through training and education furnished by your employer to go into business competing with your employer?

(3) Subcontracting services to an existing business is somewhere between doing a spin-off and starting a competing business. Services that are often contracted include sales, janitorial services, accounting, research, and product development. It is a common, accepted practice for the contractual relationship to be created prior to starting a business.

? Build trust in your “story”: Building trust is essential to the success of all start-ups. You must be able to convince suppliers, employees, and, most importantly, customers that the business is now successful and will be in the future. Not only is there an understandable reluctance for people to be associated with a potential “loser,” but customers, vendors, and employees all take risks by doing business with an unknown and unproven start-up.

Suppliers are often reluctant to deal with start-ups, even if you make your purchases in cash. Most new businesses are small compared to established businesses in the same industry. There is a good reason why you, as the owner of a new business, would prefer to make numer- ous orders of small quantities of the goods and services you need. Doing so reduces cash flow requirements and reduces the risk of your being stuck with old or obsolete inventory. For the vendor, however, accepting your frequent small orders greatly increases the cost of providing goods and services to you. Most vendors, especially wholesalers, work on very small margins. The cost of accepting and filling numerous orders for a new customer may well make such business unprofitable. It is, therefore, essential that the vendor believes in your eventual suc- cess and that you will become a valuable customer in the future.

Employees take on significant risks when they go to work for a start-up business. Not only may the start-up fail, but frequently the cash flow problems of start-ups cause payments for wages to be late or missed entirely. This is one reason why so many start-ups offer stock options and stock bonuses to employees. The start-up doesn’t have enough cash to pay high wages right now, but if it’s successful, employees will share the rewards in the future.

Customers can similarly be at risk when purchasing from a start-up business. In the event that the start-up fails, there is no recourse for warranty problems, for maintenance, or for up- grades to the product. This risk is especially acute when the product or service of the start-up affects the core business of its customers. For example, the San Antonio Bed & Breakfast

immediate effect. However, the problem of replacing the lost margin is much easier if you have to make only one or two sales or get one or two new customers to make up for the lost business.

?          Start the business with established customers: When you start with established customers, you know that you will immediately have cash inflows. There are basically three ways that you can go about obtaining committed customers prior to start-up: (1) You can start your new business as a spin-off from your current employer’s business. (2) You can start a business to specifically go into competition with your employer. (3) Or, you can start a business to sub- contract services to your employer or to other established businesses.

(1) Creating a spin-off is a regular business practice that is done by businesses of all sizes and at all stages of development. Some spin-offs are created to get rid of “noncore” activities. By disposing of the noncore activity, the parent firm reduces capital requirements and pro- vides a tighter focus for management on the remaining businesses. Other spin-offs are created when the parent lacks either the interest or the resources to pursue the opportunity. By being spun off, the start-up can gain access to resources other than those of the parent.

(2) Going into competition with your current employer is also a common practice. Of course, this almost always results in resentments and often ends in lawsuits over issues of trade secrets, rights to intellectual property, and abridgment of contractual provisions. You will have to make difficult ethical decisions. From a legal point of view, the contract be- tween employer and employee is satisfied when all wages and other benefits have been paid in return for you accomplishing the tasks for which you were hired. Absent a specific con- tract providing otherwise, neither party, employer nor employee, is obligated beyond this exchange. However, not so easily answered are the questions: (1) Is it ethical to use your employment to build relationships with customers that subsequently can be used to start a new business? and (2) Is it ethical for you to use knowledge and skill received through training and education furnished by your employer to go into business competing with your employer?

(3) Subcontracting services to an existing business is somewhere between doing a spin-off and starting a competing business. Services that are often contracted include sales, janitorial services, accounting, research, and product development. It is a common, accepted practice for the contractual relationship to be created prior to starting a business.

? Build trust in your “story”: Building trust is essential to the success of all start-ups. You must be able to convince suppliers, employees, and, most importantly, customers that the business is now successful and will be in the future. Not only is there an understandable reluctance for people to be associated with a potential “loser,” but customers, vendors, and employees all take risks by doing business with an unknown and unproven start-up.

Suppliers are often reluctant to deal with start-ups, even if you make your purchases in cash. Most new businesses are small compared to established businesses in the same industry. There is a good reason why you, as the owner of a new business, would prefer to make numer- ous orders of small quantities of the goods and services you need. Doing so reduces cash flow requirements and reduces the risk of your being stuck with old or obsolete inventory. For the vendor, however, accepting your frequent small orders greatly increases the cost of providing goods and services to you. Most vendors, especially wholesalers, work on very small margins. The cost of accepting and filling numerous orders for a new customer may well make such business unprofitable. It is, therefore, essential that the vendor believes in your eventual suc- cess and that you will become a valuable customer in the future.

Employees take on significant risks when they go to work for a start-up business. Not only may the start-up fail, but frequently the cash flow problems of start-ups cause payments for wages to be late or missed entirely. This is one reason why so many start-ups offer stock options and stock bonuses to employees. The start-up doesn’t have enough cash to pay high wages right now, but if it’s successful, employees will share the rewards in the future.

Customers can similarly be at risk when purchasing from a start-up business. In the event that the start-up fails, there is no recourse for warranty problems, for maintenance, or for up- grades to the product. This risk is especially acute when the product or service of the start-up affects the core business of its customers. For example, the San Antonio Bed & Breakfast Association contracted with a start-up business to develop and maintain a web-based avail- ability and reservation service for the association’s members. The start-up failed during the dot-com bust of 2001. When problems with the system subsequently developed, there was no one to fix them. The system was complex and the source code incomprehensible. As a result, the association lost a core service that provided value to its members.

The issue of building trust in your story is a catch-22. If customers, vendors, and employees do not have trust in the entrepreneur and in the business, quite simply, there is no business. How- ever, there must be a business, or you don’t need customers, vendors, and employees. There are several ways for a start-up business to build trust and legitimacy, and these are detailed in Chap- ter 2. Specific examples for the kinds of businesses discussed in this chapter include obtaining a performance bond that will pay vendors and customers if your business fails. Restaurants, lodging establishments, barbers, beauty shops, and other businesses that deal with issues of cleanliness as a business requirement can obtain licenses and join industry groups that perform inspections. Displaying licenses and certificates of inspection provides assurance that you are at least meeting minimum standards. Manufacturing businesses and construction businesses may hire engineers to certify design and construction details. Warranty service can be contracted to an independent company that specializes in providing such services. Rigorously maintaining business procedures that ensure on-time delivery of products and services and on-time payment of bills, wages, and loan payments will, in time, result in the start-up being trusted.

Many businesses have been successfully created which lacked one or more of these indicators. It is also true that many start-up businesses have failed, despite having all these characteristics. No one knows what makes the difference between such successes and failures. Some have speculated that the one indispensable trait of people who create successful businesses is determination to make the business work.

“LEAN” Entrepreneurial Methods

You may have read or heard about the currently popular idea of the “lean start-up.” “Lean” is the lat- est name for a set of tried-and-true methods that can lessen the capital requirements and, as a result, reduce the financial risk of a start-up. We discussed the similar concept of bootstrapping in Chapter 5. You remember that bootstrapping includes methods for “finding ways to achieve desired business goals and objectives when start-up capital is limited.” Both lean operations and bootstrapping are based on and share three underlying ideas:

1.         Waste not, want not. That this thought appears in a 1576 book when Shakespeare was a mere 12-years-old tells you how old this latest fashion is. Avoiding waste is one obvious way to achieve this, but so is borrowing something rather than renting it, and renting rather than buy- ing. Making do with an older but free laptop would be another example, as would saving every penny you can.

2.         Create, standardize, repeat. About the same time as Shakespeare, shipbuilders in Venice created a ship made of standard parts. It made creating subsequent ships much faster and easier. You do this when you make a form letter to solicit customers, when you create a cell phone app that thousands of people can download, or when you buy in bulk to save money. Some firms standardize their most important characteristics so customers get the same result wher- ever they buy, for example, in franchise restaurants. If your most important characteristics are built uniquely, you can still benefit from standardizing by applying it to the supporting, repeti- tive aspects of your business.

3.         Keep in touch. Central to the lean start-up is being close to your customer. It helps you know if your product or service is doing its job. It alerts you to problems earlier so you can correct them, and it is just a good business practice in general. Customers and their needs change, and to keep up, you need to keep in touch. As you learn what is needed, adjust your product or service to op- timally fit needs. Most cell phone apps get updated every few weeks. This is because as the app makers find out about bugs or glitches, they can fix them and get the fixed version out to users.13

Today’s lean start-up and bootstrapping stress the need for creativity and innovation in all aspects of business start-ups and operations. Eric Reis, the modern father of the lean start-up writes that

start-ups should attempt to produce the “minimum viable product,” ship it to paying customers, measure its success, apply what is learned to improving the product. There is an older quality control model that checks for problems before the product leaves the firm, and where safety is an issue, that is the best way to go. But for many other types of products or services, the minimum viable product approach is a better one.

Thomas Caldbeck, whose story introduces this chapter, exemplifies many aspects of the lean approach. He did not start into business until after he had mastered the basic management skills needed for success. His garage, van truck, and a spare bedroom in his home became his business location. He expanded into additional areas of business only after a customer had been obtained for that service. This way Tom relied on revenues to provide funds for growth. He maintained close contact with customers to ensure that they were satisfied with the work he was doing. He used his own funds for the start-up and leveraged their value by using bank financing for his truck and equip- ment. Part-timers and subcontractors who are paid only for work actually completed, met the need for employees.

Your current employer may provide assistance if your new venture is not going to be a direct competitor. Often, a new product or service idea arises from the work being done in the current employment of the start-up founder, as in the case of UltimateKeychains.com. The employer may, however, have no interest in pursuing the opportunity. In such cases, the start-up may well proceed with the employer’s active support.

Buying an Existing Business

The second most common way to enter small business management is to purchase an existing busi- LO3 ness. Buying an existing business has important advantages over creating a start-up. However, pur- chasing a business has its own, unique set of risks.

Advantages of Purchasing an Existing Business

There are some advantages to buying an existing business:

? Established customers provide immediate sales and cash inflows. Because the business is already successful, it has proven that there is sufficient demand for its products and services to operate profitably.

?          Business processes are already in place in an existing, operating business. This eliminates the need to hire employees, find vendors, set up accounting systems, and establish production processes.

?          Purchasing a business often requires less cash outlay than does creating a start-up. The seller will often provide financing that makes it possible for you to buy the business.

Disadvantages of Purchasing an Existing Business

Disadvantages to buying an existing business include:

?          Finding a successful business for sale that is appropriate for your experience, skills, and edu- cation is difficult and time-consuming.

?          It is very difficult to determine what a small business is worth. The value of a small business can never be known with certainty. You must rely on analyses, comparisons, and estimates.

? Existing managers and employees may resist change. It can be very difficult to convince employees to adapt to new business methods, procedures, and processes that can provide increased profits.

?          The reputation of the business may be a hindrance to future success. Sellers are usually reluc- tant to tell you about problems that the business has. Business owners are especially sensitive about discussing past disputes and lawsuits with vendors and customers.

?          The business may be declining because of changes in technology. ?           The facilities and equipment may be obsolete or in need of major repair.

You will greatly increase your chances of finding the right business by using multiple sources. Make some calls: Contact business brokers and ply your own network. You should be actively read- ing advertising of businesses for sale in newspapers and magazines and on the Internet. You might consider asking your employer if his or her business is for sale. Keep in mind that every business is for sale at a high enough price. If you hear of a business that is interesting, contact the owners and ask what it would take to buy it.

Brokers advertise and facilitate the sale of businesses for a fee, most usually a percentage of the ultimate selling price. Most states have laws that require brokers to work solely for the interest of the seller and to obtain the highest selling price possible. This creates a conflict of interest between the broker and you. The broker is trying to get the highest price. You’re trying to get the lowest.

The quality of broker services ranges from excellent to outright rip-offs. Only a few states have any education or licensing requirements, although some, such as Illinois, do require business bro- kers to register by filing a simple form. Accusations of misrepresentation and fraud by brokers are common in the business press.

Networking is an excellent way to find businesses for sale. While most businesses are for sale at any time, for competitive reasons most owners do not want to say so explicitly. Because customers, vendors, and employees are likely to feel threatened, openly advertising a business for sale can lead to the loss of revenue, credit from vendors, and key employees. For these reasons, it is common for business owners to make their intention to sell known only to trusted confidants in the industry and in the community. Attorneys, bankers, accountants, and insurance agents all will provide you with information only if they know that they can trust your discretion. You can usually get solid leads just by telling other businesspeople that you’re interested in buying a business.

There is a trade journal for every industry that exists. People in the mortuary business bone up with Embalmer and American Funeral Director. The replacement window industry looks through Fenestration. The electric sign industry is energized by Signs of the Times. The folks who process dead and decomposing animals into useable products digest Render magazine. The construction industry digs Rock and Dirt. No matter what type of business you might be considering, there is a magazine for it. They all have advertisements of businesses for sale.

The Internet also has numerous sites that advertise businesses for sale. A search using Google with the keyword “business” and the phrase “for sale” resulted in over 38 million pages listed. None of the advertisements that were inspected during the research for this book provided the name or the exact location of the advertised business. Rather, the sites have various ways you can obtain ad- ditional information. Some provide a link by which you can request more information. A very few listed phone numbers you can call. Others require becoming a member and paying a fee for access.

Your current employer is probably a ready source of information about businesses for sale in your industry. Most managers of small businesses are members of formal and informal groups of businesspeople, for example, the Chamber of Commerce, Rotary, Kiwanis, and other groups that have meetings and provide resources. Also, your employer probably has information about competi- tors and vendors in the area. Don’t forget the example of UltimateKeychains.com—your employer just might be interested in selling his or her business, as well.

Investigating Entrepreneurial Opportunities:

Performing Due Diligence

Suppose you’ve actually found a business you’d like to buy. Your job has just begun. Finding an appropriate business is merely the first, and easiest, step in the process. Buying a business is a lot like getting married—it is easy to get into, but if it turns out bad, it’s very hard to get out. Now that you’ve found that “perfect” business, you must make an exhaustive investigation to tell if it is re- ally suitable. Unlike residential real estate, which is highly regulated in the United States, sellers of businesses are not legally required to make disclosures of impairments or deficiencies. If you are outside the United States, your laws may be different. For example, in Canada, sales of businesses for a price less than $200,000 are tightly regulated. Sales for amounts greater than $200,000 are not regulated at all. As in the United States, it is your responsibility to fully investigate the business and to come to your own independent evaluation of its value.

Due diligence is the process of investigating to determine the full and complete implications of buying a business. During the process of due diligence every aspect of the business is examined in exacting detail. Nothing is taken for granted. No statement is accepted without evidence. Evidence is, itself, substantiated with sources external to the company. Properly performing due diligence minimizes the risk of failure and maximizes the probability of success by identifying the strengths and weaknesses of the business.

When a business is acquired, there is a clear order of steps that should be followed:

1.         Conduct extensive interviews with the sellers of the business. 2.      Study the financial reports and other records of the business. 3.           Make a personal examination of the site (or sites) of the business. 4. Interview customers and suppliers of the business. 5.       Develop a detailed business plan for the acquisition. 6.            Negotiate an appropriate price for the business, based on the business plan projections. 7. Obtain sufficient capital to purchase and operate the business.

The first five steps together make up the process of due diligence.18 A basic tenet of business law is caveat emptor, or “let the buyer beware.” This does not mean

that a seller can freely lie to you about the business. Deliberate misrepresentations can lead to law- suits and may be prosecuted as fraud. However, except for specific representations by the seller, you are responsible for understanding the condition and the facts of the business. It’s kind of a “don’t ask—don’t tell.” If you don’t ask the right questions, the seller has no obligation to tell you the right answers. Thus, as the buyer, you must determine how the business is currently being operated, and you must substantiate (or disprove) representations made by the seller regarding the existence and value of assets, liabilities, financial performance, and the condition of the business.

Due diligence has two primary goals. First, you are attempting to find any wrongdoing: (1) fraud committed by the owners or managers; (2) misrepresentations of the sellers, such as improperly recognized revenues or expenses; and (3) missing information, including pending or threatened xes. Second, you are trying to find any inefficiencies, unnoticed opportunities, waste, and mis- management. The first goal is information that greatly affects the value of the business and the advisability of purchasing it. The second goal is how you, as a new owner, can make changes to increase its value. Both goals can give you a negotiating advantage.

The first information that you get is usually a set of financial statements. There are four reasons why this is so: (1) the seller usually has financial statements available and incurs little added cost in providing them, (2) you, as a business person, are most likely familiar with financial statements and can extract useful information from them, (3) financial statements are accepted as representative of the business by bankers and investors, and (4) financial statements are considered to be indicators of future business results.

Financial statements should include (1) a balance sheet, (2) an income statement, and (3) a state- ment of cash flows. You should also examine the federal and state tax returns for at least the last five years. Information forms for partnerships, corporations, or limited liability companies should be examined also. Any financial statement prepared by or for the seller must be treated with skepti- cism. Some financial statements that you see will have been subjected to rigorous examination by professionals outside the business; some will have been dashed off by the owner at midnight on April 15. To be believable, the statements must be substantiated by external sources.

When you examine the income statement, you should focus on corroborating the amount and timing of revenues and expenses. Be aware that the income statements of small businesses are com- monly misstated. To avoid taxes, owners often charge personal expenses to the business, such as cars, country club memberships, travel, and even home office expenses. On the other hand, when preparing to sell the business, owners are motivated to overstate revenues and understate expenses to show the highest profit.

Balance sheet items that are likely to be misstated are intangibles, that is, things that have no physical existence, but rather are legal rights and obligations. Intangibles include accounts receiv- able, patents, licenses, and liabilities. Assets claimed on the balance sheet must be examined to ensure that they exist and that the stated value is reasonable. Because liabilities are legal require- ments to give up economic value in the future, such as debts for borrowed money or merchandise purchased on account, your risk is that there will be liabilities that are not disclosed. Your problem is that you are attempting to prove the absence of something. Once the examination is complete, you should adjust the amounts, contents, and format of the statements to reflect what you have discov- ered through due diligence.

During due diligence you should also try to answer many nonfinancial questions. Why is the business for sale? Who are key employees? What is the extent of obsolescence of equipment and key technologies? What are the prospects for the firm’s products and services? What opportunities can the firm reasonably expect to have in the near future?

1. According to this chapter, what are the 5 ways to get into small business management?

2. According to this chapter, what are the 12 ways to increase the chance of business start-up success?

3. What is the predominant method by which entrepreneurs open new businesses?

4. What is the greatest advantage of a franchise?

5. According to this chapter, what magazine is a good source of franchisors eager to sell you a franchise?

6. Before you as a potential franchisee sign on the dotted line what two documents should you study carefully?

Answer 1

1. Ways to get into small businesses-

a). to start a new business.

b). to buy an existing business.

c). to franchise a business.   

d). can inherit a business.

e). to be hired as the professional manager of a small business.

2. Ways to increase the chance of business start-up success-

a). five paths to business ownership

b). five ways to get into small business management

c). a startup can be well planned or just happened

d). new starts up take time revive

e). students take entrepreneurship program to enter into new businesses.

f). an owner must be very keen before taking any decision

g). proper reward programs must be done.

h). business based on relevant ideas grew must faster.

3. The lean startup-

The Lean Startup gives a logical way to deal with making and overseeing new businesses and get a coveted item to clients' hands speedier. The Lean Startup technique shows you how to drive a startup-how to direct, when to turn, and when to endure and grow a business with most extreme speeding up. It is a principled way to deal with new item advancement.

An excessive number of new businesses start with a thought for an item that they think individuals need. They at that point put in months, in some cases years, culminating that item while never demonstrating the item, even in an extremely simple shape, to the imminent client. When they neglect to achieve expansive take-up from clients, it is regularly in light of the fact that they never addressed planned clients and decided if the item was fascinating. At the point when clients eventually impart, through their lack of concern, that they couldn't care less about the thought, the startup comes up short.

4. Advantage of a franchise-

Set up organizations and franchise give quick resources, deals, and money inflows that can be utilized to get financing for the business. You may think that its less demanding to secure back for an establishment. It might cost less to purchase an establishment than begin your own particular business of a similar kind.

5. Regardless of what kind of business you may consider, there is a magazine for it. They all have notices of organizations available to be purchased 6. A). The usual set of financial information or statement

B). Income statement.