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Please read the article and answear about questions. Determining the Value of the Business After you...

Please read the article and answear about questions.

Determining the Value of the Business

After you have completed a thorough and exacting investigation, you need to analyze all the infor- mation you have gathered. This is the time to consult with your business, financial, and legal advis- ers to arrive at an estimate of the value of the business. Outside advisers are impartial and are more likely to see the bad things about the business than are you. You should make a decision to actually attempt to buy the business only after the evaluation process is complete.

It is very difficult to place a value on a small business. The most theoretically rigorous method of valuing an ongoing business, using discounted cash flows, is based upon estimates of future cash outflows and inflows, given the change in ownership. Making such estimates is highly problematic. Because of these difficulties, it is common to use other, less rigorous methods to place a value on a business, such as asset valuation, comparable sales, financial ratios, or industry heuristics.

Discounted Cash Flow Methodology

Discounted cash flow analysis is based on the concept that the longer you have to wait to receive money, the less valuable it is right now. The application of discounted cash flows to business valua- tion is similar to having an annuity. An annuity consists of some amount of money which is invested to earn interest. The interest that is earned and a portion of the capital invested is then paid back to the holder of the annuity in a series of equal cash payments. In a similar way, when one buys a business, an investment is made. The business then should provide a return sufficient to repay the investment and also provide a return on that investment.

A detailed explanation of the use and calculation of discounted cash flows is presented in the appendix to Chapter 14, beginning on page 450.

Asset Valuation Methodology

Asset valuation methods are based on the assumption that a business is worth the value of its assets minus the value of any liabilities. There are two major problems with using asset valuation meth- odologies. First, such estimates do not consider the value of an ongoing firm over the value of its identifiable assets; for example, the value of an established restaurant over the value of the build- ing, signage, equipment, and fixtures. Second, it is very difficult and time consuming to separately identify and estimate the values of all the assets of a business—imagine a hardware store with tens of thousands of items.

There are three methods commonly used to estimate the value of a firm’s assets, book value, net realizable value, and replacement value.

Book value is the the original acquisition cost of the asset, minus all depreciation expense rec- ognized to date. There are three major problems with using book value

1.         The original cost of an asset might bear no relation to its current value—for example, a com- puter bought five years ago may be worth next to nothing today.

2.         Depreciation is an arbitrary, although systematic, method of transferring asset value to expense. Depreciation makes no attempt to measure actual loss of value of an asset. For example, for income tax purposes, a new car is depreciated over a five-year period of time, where in fact it loses 40 percent of its value when you drive it off the lot, but may well have significant cash value at the end of the depreciation period.

3.         Internally developed assets, such as patents, trademarks, and trade secrets do not have book value. For an example, consider The Coca-Cola Company. Its single greatest asset is its rights to the names “Coca-Cola” and “Coke.” However, if you examine the annual statement of the company, you will discover that no value for this right is shown in the balance sheet. To address such problems, you must make adjustments to the value of assets that are obviously worth more or less than their book values.

Net realizable value is an estimate of the amount for which an asset would sell, less the costs of selling it. If you were selling a building, the cost of selling would be the money spent on the real estate agent, advertising, and preparing the building for display.

Replacement value is an estimate of what an identical asset would cost to be acquired and readied for service. Net realizable value is usually significantly less than the replacement value of any specific asset.

Comparable Sales

Comparable sales of other firms in the same industry are commonly used to estimate the value of a business. This method has two major problems. First, no two firms are exactly alike. Second, there are often no recent sales to use for comparison.

Financial Ratios

Financial ratios are often used to place a value on businesses, because industry ratios are indepen- dent of the size of the business. For example, the percentage food cost for the entire Pizza Hut chain is essentially the same as that of an independent pizza restaurant. Using financial ratios requires that you have an estimate of future income and tax flows. Businesses are never identical. At the mini- mum they occupy different locations. At the other extreme, they may be different in all measurable aspects: location, size, gross sales, profitability, condition of markets, and physical assets. The best source of industry financial ratios is from data collected by industry associations or industry statistic providers, such as BizMiner.

Some of the commonly used ratios are:

The earnings multiple ratio is simply firm value divided by actual or expected annual earnings. Multiplying forecast earnings by the earnings multiple provides a quick estimate of firm value.

Pre-tax return on assets (ROA) is calculated by dividing earnings before income tax by asset value. Multiplying forecast earnings by the pretax ROA gives an estimate of net asset value, or total asset value minus liabilities.

Net income to equity is determined by dividing income by the equity owners have in the busi- ness. To estimate firm value, you must multiply your estimate of future earnings by the ratio. This ratio, however, can seriously understate firm value because it does not include the value of borrowed capital.

Net income to (equity + debt) is an extension of net income to equity that explicitly includes the value of borrowed capital as a component of firm value.

Income capitalization is calculated by dividing projected net income excluding depreciation, interest, and owner draws, by the best return that you could expect to obtain in other invest- ments. For example, if you are forecasting that you will have a net income of $66,000 and your cost of capital is 11 percent then the estimated value of the business would be $600,000 ($66,000/0.11).

Industry Heuristics

Industry heuristics are simply rules of thumb that are commonly used to estimate firm value in relation to some easily observable characteristic of the business. Industry heuristics are similar to comparable sales in that they represent the combined experience of people active in the industry. For example, in the bed and breakfast and small inn industry, two heuristics are often used to esti- mate the value of an operating inn. The first is that an inn should sell for approximately $100,000 per rental room. The second is that an inn should sell for approximately four times its annual gross revenue.

Industry heuristics can be amazingly accurate. In a recent survey of 300 inns, the Professional Association of Innkeepers International found that the average selling prices of inns between 2000 and 2002 was $99,300 per guest room. The average gross revenue multiplier was 4.3.19 Similar heuristics exist for nearly all industries and are usually available from the group’s trade association. You’ll learn how to find associations in the next chapter.

Structuring the Deal

A buyer and seller get together to negotiate the final price for a business. The buyer should have performed the due diligence procedure and be confident about the assessment of the condition and value of the business. Along the way you, as the buyer, should have decided on the absolute highest price that you would be willing to pay. That highest price is called your point of indifference20 in the negotiation process. The term comes from the idea that once that price is reached, you should be indifferent as to whether or not a deal is made.

Of course, you’ll open negotiations with a price substantially lower than your point of indiffer- ence. The purpose of opening low is twofold: (1) you want to make the purchase at the lowest price possible, and (2) you recognize that the seller assumes that any opening offer is less than what you are actually willing to pay. A low opening bid allows both parties room to reach a compromise sat- isfactory to both.

In addition to negotiating for price, you also negotiate about the terms of the sale. When you are buying a business, everything is negotiable, not just the price. In fact, the terms of the acquisition, such as seller financing, payment periods, noncompete agreements, and the exact details of what is being acquired, all interact to affect the price that you are willing to pay and that the seller will accept. There are four basic ways that a business may be bought: (1) you may buy out the seller’s interest in the business, (2) you may buy in, by acquiring some, but not all of the ownership, (3) you may buy only the key assets of the business such as the inventory or equipment of the business, and not the business itself, and (4) you may take over a public business by buying a controlling interest of its stock.

Buyouts

Buyouts are restricted to businesses that have a formal legal form of organization, including corpo- rations, limited liability companies, and some partnerships. Legal business organizations are arti- ficial entities that exist separately from the owners. Buyouts are accomplished through purchasing the ownership interest in the entity. Technically, partnerships and sole proprietorships do not exist separately from the owners and thus cannot be purchased. Rather, the assets of the business must be purchased and the liabilities assumed in a process called key resource acquisition or bulk asset sale. The subsequent business is considered to be a new entity different from the selling entity. In practice, partnerships can continue in existence despite a change in ownership. Sole proprietorships cannot.

The primary advantage to a buyout is simplicity. The seller must only transfer his or her stock to the purchaser to complete the transaction. The business continues as an entity, owning its assets and maintaining responsibility for its liabilities. The primary disadvantage to a buyout is that all liabilities are transferred, including potential lawsuits that arise from actions and transactions that took place prior to the change in ownership. This has, as in the case of the widespread class-action suits concerning asbestos, led to bankruptcy for the purchaser.

A buyout may take place all at once, with all stock being transferred at a single point in time. Sometimes buyouts are made with ownership being transferred over some agreed upon time range. Buyouts made by employees are examples of changes of ownership over time. Employee buyouts were made legal in 1974 when employee stock ownership plan regulations were codified into law. An employee buyout occurs when the owners of a company sell a majority of stock to the employees through an employee stock option plan (ESOP) as was provided in the 1974 legislation. ESOPs are complicated transactions that require highly skilled professionals to implement them.

Buy-ins

A buy-in results when someone acquires only a part of the ownership of an existing business. Any amount of ownership may be considered a buy-in, as long as less than 100 percent of the ownership is transferred. Buy-ins can be made in any form of business. Technically, if one buys into a sole proprietorship, it becomes a partnership. Corporations and limited liability companies may continue without a change of the form of entity.

There are two advantages to making a buy-in: (1) a buy-in allows the purchaser to leverage inside knowledge, and (2) it aids in keeping key employees. The seller and the managers of a successful business, by definition, have experience in operating that business profitably. The buyer, no matter how expert, does not have the same depth of knowledge of the business being purchased. One great threat to the buyer of a business is that employees who are key to its operations will leave the busi- ness. Keeping the current owner as an active participant of the business reassures employees that large changes are not likely to occur.

The disadvantages of a buy-in are the same as the advantages: the prior owner and management remain with the business. This often causes friction when the new owner wishes to make changes, and the old owner and managers do not.

Key Resource Acquisitions

Key resource acquisitions, also called bulk asset purchases, are the only way a sole proprietorship may be purchased. This technique may also be used with any other form of business. As the name implies, key resource acquisitions comprise purchasing only the assets of the business. Most usu- ally, the seller will keep any cash and receivables and will retain responsibility for some short-term liabilities such as notes payable.

As we saw earlier, the most difficult issue in purchasing a business using this method is as- signing a value to the intangible assets, such as the value of the business name, the value of having an ongoing business, the value of established relationships, and so forth. The value of the

business in excess of the value of the identifiable assets is called goodwill. You should attempt to recognize a minimum amount of goodwill. One advantage of business ownership is the ability to shelter income by using noncash deductions to reduce income taxes. Prior to 2002, a business could reduce income taxes by deducting goodwill over a period of years. However, businesses purchased after December 15, 2002, are now prohibited from deducting for goodwill.21 Thus the more of the business’s value that is recognized as goodwill, the less income can be sheltered from income tax.

Key resource allocation provides one important advantage. Because only the assets are acquired, the subsequent business, regardless of its legal form, is not responsible for any of the acts or transac- tions made prior to purchasing the business. Although this does not completely relieve the successor business from all prior liabilities, it does protect it from action concerning any noncollateralized liabilities, such as a line of credit or a personal loan of the seller.

Takeovers

Takeovers are possible only of businesses that have stock which is freely transferable without the permission of management or other owners. In other words, only corporations and certain partnerships can, under any circumstance, be acquired in a takeover process. A takeover com- prises purchasing enough of the target business’s stock to gain control of the board of directors of the business. In a takeover, the buyer (often called a raider) seizes control of the business without the permission of all owners. Sometimes, only a few owners are involved, as takeovers can often be accomplished by purchasing or even borrowing a relatively small percentage of outstanding stock.

Takeovers are hostile events. There is the threat that current management will be replaced. Oc- casionally, the raider will explicitly state that the intention of the takeover is to sell off portions of the business, or even to liquidate it completely. In these circumstances, current management is likely to make strenuous efforts to prevent the takeover from occurring.

Because of the requirement that stock be freely transferable, only a few small businesses are vulnerable to hostile takeovers. Accomplishing a takeover of a small business is likely to result in the loss of key employees and the resentment and resistance of those employees who remain. As a result of these limitations and problems, takeovers are usually done on medium to large businesses. Only very rarely does anyone acquire a small business through a hostile takeover.

Franchising a Business

What Is Franchising?

Franchising is a legal agreement that allows one business to be operated using the name and busi- ness procedures of another. The most ubiquitous franchise, worldwide, is McDonald’s, which has over 30,000 restaurants in more than 100 countries. Approximately 85 percent of McDonald’s res- taurants are owned by independent businesspeople who operate them in a franchise relationship. The remainder are company stores, that is, stores that are owned and operated by the McDonald’s Corporation.22 Most franchisors are large businesses, most franchisees small: McDonald’s Corpora- tion is a large business; McDonald’s franchisees are small businesses.

Franchises are agreements between two entities, (1) the franchisor who sets conditions and stan- dards and who grants operating permissions, and (2) the franchisee, who pays a fee for the rights, and who agrees to abide by the conditions and standards.

Four elements are essential for an agreement to constitute a franchise:

1.         The agreement provides the franchisee with a legal right to engage in the business of offering, selling, or distributing goods or services.

2.         The agreement provides that the franchisee may engage in business using a marketing plan or system provided by the franchisor.

3.         The agreement grants the franchisee use of a brand name, trademark, service mark, logo, or other commercial symbol which designates the franchisee as an affiliate of the franchisor.

4.         The agreement requires the franchisee to pay a fee for the right to enter into the business.

The value of a franchise is determined by (1) the rights granted and (2) the cash flow potential to the franchisee. Each of these factors can be highly variable from one franchise to another. There are four basic forms of franchising:

1.         Trade name franchising is an agreement that provides only the rights to use the franchisor’s trade name and/or trademarks. Two examples of this are True Value Hardware and Associated Grocers, Inc.

2.         Product distribution franchising provides the franchisee with specific brand named prod- ucts, which are resold by the franchisee in a specified territory. Two examples of this type of franchising are Snap-On Tools and auto dealerships.

3.         Conversion franchising provides an organization through which independent businesses may combine resources. An example is Century 21 Real Estate. Individual real estate businesses combine to create a nationwide brand name and enhanced advertising effectiveness.

4.         Business format franchising is exemplified by the McDonald’s Corporation. A McDonald’s franchise includes the right to use McDonald’s many trade names, specifications of the product to be sold, operating methods, marketing plan, and national advertising. Franchisees pay to the franchisor both an up-front fee to obtain the franchise rights and a percentage of gross sales.

In addition to the above, some franchisors, such as Subway (sandwich shops), sell master fran- chises that require opening multiple stores within a specified area. Subway describes these franchi- sees as being “development agents.” Master franchisees are required to open a minimum number of stores within a specified time period, which they may do by selling subfranchises within the development area.

Franchising has become the predominant method by which entrepreneurs open new businesses. Depending upon who is doing the counting, somewhere between 1 in 10 and 1 in 8 businesses currently operating in the United States are franchised operations. Today, in addition to fast food, nearly every product or service from accounting to zoology is available from franchised businesses.

The most important reason that franchising has become such a successful way of doing business is that a well-run franchise offers a “win–win” situation for both the franchiser and the franchisee. Fran- chisers have the opportunity to experience high growth and rapid market penetration without having the requirement to raise capital in huge amounts and to obtain skilled, experienced managers in large numbers. Franchisees are able to partner with an established business that has proven success.

Franchising provides an entrepreneur with the opportunity to own a small business quickly while avoiding the high risks of a start-up. As we have discussed, starting a new business from zero is very expensive in terms of demands on the entrepreneur. Most start-ups have limited capital resources, and very little room to make business mistakes while learning what is needed to make the business succeed. Franchisers have survived their own start-up phase of business, and have determined the “recipe” for success. For this reason, franchises (on average) have lower failure rates and shorter times to achieve positive cash flows and business profits.

Advantages of Franchising

Let’s take a look at the specific characteristics of franchises that offer such advantages to would-be entrepreneurs.

Having a Fully Developed System of Doing Business

Perhaps the single greatest advantage of a franchise is that it comes with a complete business sys- tem. Many franchises are actually “turnkey.” That is, the franchiser oversees (or even manages) the selection of location, the construction of facilities, the acquisition and installation of necessary equipment, and the initial inventory with which to open business. Many franchises come complete with computer software for budgeting inventory control, ordering, point-of-sale computerized cash register, and complete accounting application. So, what does the franchisee do? First, the franchisee must, in one manner or another, pay for all these services. Second, the franchisee will be required to complete training to become intimate with the details of the franchise business system. Third, the franchisee will be required to take an active part in opening and operating the franchise business.

Franchise Opportunities

There are more franchises available than you can count. Unlike finding a small business to buy, finding a franchise is easy. Every issue of Entrepreneur magazine contains the advertisements of dozens of franchisors eager to sell their franchises to you. Entrepreneur.com, the magazine’s web- site, lists 500 franchises. The franchises are listed in rank by the number of new locations opened in the last year. The list of franchises is also broken down into more categories, including:

?          Fastest-Growing Franchises ?            Top New Franchises ?           Best of the Best ? Top 10 Lists

?          Top Home-Based Franchises ?          Top Low-Cost Franchises ?   Top Global Franchises

It is interesting that 8 of the top 10 franchises overall are in the service industry. The other two, which happen to be numbers one and two on the Entrepreneur Franchise 500 list, are the fast-food restaurants Subway and Dunkin’ Donuts.

If you don’t find one you like in Entrepreneur, the Internet contains thousands of resources for identifying franchise opportunities. A Google search of the web using the terms “franchise opportunity” returned 788,000 pages. Several of the highest listed pages were the sites of services that offer informa- tion concerning franchises of all types. Some offer free services. Some charge a fee for information.

Among the 788,000 sites listed by Google are two U.S. government agencies, the Federal Trade Commission (FTC) and the Small Business Administration (SBA), a British government site, Business Link (www.businesslink.gov.uk), and an Australian site, Smallbusiness.gov.au, (www.smallbusiness.gov.au). Similar government sources are available around the world.

Franchising’s industry association, the International Franchise Association (IFA) (www .franchise.org) maintains a website that contains a database of over 800 franchises. The compa- nies listed range from old familiars such as 7–11 stores to the really obscure such as Jet-black and Pop-A-Lock.

Once you’ve identified a potential franchise, you should perform due diligence, just as if you were buying an operating business. What you are most interested in with franchises is the stability, integrity, and financial performance of the franchisor. You really should interview current franchi- sees, and you should talk to competing franchisors and their franchisees. If you buy a franchise, you will invest thousands of hours and thousands of dollars. Be sure that it is really an opportunity for you and not just for the franchisor.

Legal Considerations

Before you sign on the dotted line, you should personally study two key documents you always receive from a franchisor—the uniform franchise offering circular (UFOC) and the franchise agree- ment. The UFOC is a standard document franchises use to explain their operations, requirements, and costs to potential franchisees. You can get a guide to help interpret the UFOC at the Federal Trade Commission site. The franchise agreement is the specific contract signed, often incorporating the information included in the UFOC. Both documents are complex. To make sure you have all your bases covered, it is important to get the opinion of an experienced franchise lawyer. You want to know several things, including (1) if and how you can transfer the franchise license to someone else, (2) how you may terminate the contract, (3) how the franchisor may terminate the contract, and (4) what disclosures you are required to make.

If the contract restricts or prohibits you from transferring the franchise to another or if it requires that you achieve unrealistic results to be able to renew, an unscrupulous franchisor has an oppor- tunity to take over your successful business at a bargain price. Your blood, sweat, tears, and life savings will have gone for naught.

The contract must specify the conditions under which it may be terminated. There have been lawsuits and allegations of fraud against some franchisors because of contract provisions that pro- hibit the franchisee from terminating the contract, but give the franchisor permission to cancel with specifying cause or giving advance notice. If you can’t terminate the contract in the case that the franchisor goes bankrupt, most likely you will also be forced out of business.

Franchising has a long history of unscrupulous and fraudulent operations. Because of the many abuses, the U.S. government and the governments of all 50 states have passed regulatory legislation for franchisors. The minimum disclosure standards that a franchisor must meet are specified by Rule 436 of the Federal Trade Commission. Despite this law, however, abuses and frauds are still being perpetrated. In fact, the third item listed on the SBA’s Hot List site is a document that details how to avoid being victimized by scam artists. In college terms, do your homework—know what the oppor- tunity is and who the franchisors are. As is true of purchasing an operating business, caveat emptor.

Inheriting a Business

Unless your parents or grandparents are small business owners, you might think that this section does not apply to you. However, the fact that you are taking this course indicates that you have at some interest in becoming a business owner yourself. Thus, someday you may well find yourself on the other end of the inheritance process: You may be the founder who wishes to pass your business to your heirs. Whether you are inheriting a business or bequeathing a business, you face the same problems of passing ownership. Only your point of view changes.

In Chapter 2, we introduced the topic of family businesses. As we point out there, family-owned businesses make up a huge percentage of all businesses in the United States. In fact, this pattern holds throughout the world. Ownership of all of these millions of businesses can potentially be passed through family succession, for example, by being inherited in one form or another.

Family Businesses Succession

Inheritance is not restricted to parent-child or grandparent-grandchild. Family businesses can be, and often are, passed from the current owner-manager to nieces, nephews, cousins, or in-laws.

One of the most difficult things that you will ever have to do is make a successful ownership tran- sition. Turning over management authority is not easy for most founders, nor is it easy for the heir of the founder to assume the authority. However, if the firm is to prosper, you’ve got to find a way to do it. Research shows that family-owned businesses usually fail after the death or retirement of the founder. Fewer than 30 percent are successfully transferred to a second generation. Fewer than 13 percent succeed long enough to be inherited by the third.24 Family businesses that successfully make the transition do so by taking specific actions to organize the business and ensure that it can run profitably when the founder is gone.

Developing a Formal Management Structure

To make the transition, you will have to establish a formal management structure. You will have to develop a comprehensive business plan that states clear goals and objectives. Most difficult, you must be able to clearly see the strengths and weaknesses of family members who will remain in the business.25 You must then hire professional managers to run those functions that family members cannot. Once successors have been selected, they must be educated in all parts of the family busi- ness to develop experience and skills.

Whether you are the founder or the successor, you face an overwhelming task. The founder must impart his or her unique knowledge, skill, and experience that has made the business successful. The successor must learn all these things. While this is happening the founder and successor will have to work closely together.26 Always there will be issues of who is in charge. No matter the skills and experience of the successor, as long as the founder is active in the business, many people will automatically turn to him or her for decisions. Succession Issues for the Founder

To ensure that your business survives after you’re gone, you must be proactive in bringing selected family members into the business as soon as you can.27 The issue that must be faced in this process is selecting the appropriate family members. All members of the family business, whether being active in management roles or simply being silent owners, should have an open and ongoing dialog about the strategy, goals, and operations of the business. If you, as the founder-manager, take part in family dialogs about the business, you will gain insight into their values, ideas, and goals. Although family members usually share a set of basic values, there is inevitably some diversity in motivations and personal goals. This diversity can be a positive advantage when it brings new thinking to the manage- ment of your business. On the other hand, it can be a source of divisiveness which can lead to a failure to cooperate or even to angry confrontations to the point of mutual lawsuits among family members.

To avoid having the diversity of values, goals, and motivators from becoming the source of such intrafamily strife, you and the other family business members should respect one another’s differ- ences by:

?          Being certain that all family members know and accept that they are not forced to enter the management of the business if they don’t want to.

?          Providing each member of the family business with the opportunity to obtain education and experience outside the business. Working in other businesses will provide knowledge and skills that cannot be provided solely from within the family business.

?          Allowing each family member who does wish to enter the business to find out and do those functions and activities that he or she does best.

?          Not assuming that the leadership of the business must come from within the family. Being part of the family does not guarantee business leadership skills. After all, almost all of us have at least one “black sheep” in our family.

Once you have brought a family member into the firm, you must provide opportunities for learn- ing and growth. This is achieved by deliberately and methodically sharing both responsibility and authority. Often, the founder of a small business finds it very difficult to give up decision-making authority to family members, especially to children and grandchildren. Regardless, you have to “let go” and allow family members that you bring into the business to use their knowledge, skills, and experience to make decisions in the areas where they have special competence. It is only by doing that you and your heirs can develop stronger management skills necessary to ensure the future suc- cess of the business.

Successfully bringing family members into the firm, allowing them to find their areas of special abilities, and sharing both responsibility and authority for management decision making is an es- sential first step. Next, you need to set up specific avenues of access among family members to be able to share their ideas and challenges. One way to achieve this goal is to set up regular “family board” meetings—meetings where each family member listens carefully to the others, and each has a chance to express specific concerns. Openness and regularity in intrafamily communications ensure that you will develop your family managers into a learning community that will benefit from each other’s mistakes and successes.

You should write out your specific decisions and desires concerning who inherits what. You should then personally inform everyone who is affected by your decisions. You must also explicitly state the reasons for selecting any one family member over another when there is competition for a specific job in the business. All too commonly the heir not selected challenges the succession after the founder dies. When this happens, the business often fails, and only the lawyers win.28

Succession Issues for the Successor

To ensure that the business thrives after you’ve taken over, you must be able to gain the loyalty of other family members, professional managers, and employees. You will be treading a fine line between acceding to the wishes of the founder, and making changes as all dynamic businesses re- quire. When changes are necessary, you should take the time to involve as many of those affected as possible in the decision process. It is important that you neither allow the business to become fossilized—a monument to the founder—nor present yourself in such way that you are perceived as an “upstart”—determined to erase all signs of the founder.

In the best of all possible worlds, you will have started working in the family business while you were quite young. As you aged and matured, you would have been given increasingly more difficult and important tasks to complete. You would have worked in all parts of the company, from the most menial to the most demanding. As you learned these tasks, you would have been provided the same performance evaluations, training, and mentoring as would be provided to any employee being groomed for greater responsibilities.

Such a gradual and growing role in the business goes a long way toward reducing suspicion and resentment of workers that the “boss’s kid” is being given the position despite any lack of compe- tency. (Assuming, of course, that you are actually competent.) As you, the successor-to-be, gain greater responsibility and authority you will also gain experience and skills in the multiple activities and functions of the firm. Although the responsibility for teaching and grooming the successor lies with the founder, you, the successor, have a responsibility to know and to master the areas that are essential to the success of the business.

These essential skills include (but are not limited to):

?          Technical knowledge—You must understand the science, technology, and methodology of the industry of which the business is part.

?          Financial knowledge—You must understand the financial needs and resources of the business and industry, and be competent to negotiate with lenders, investors, vendors, and customers.

?          People skills—You must be able to effectively deal with people, with other family members in the business, with employees, suppliers, regulators, and, most importantly, with customers.

?          Leadership skills—You must be able to communicate your vision for the company to family members and to employees, getting them to “buy in” and make the business goals their goals.

? Knowledge of your own limitations—Nobody can know and be expert at everything. You must know your weaknesses, and be quick to obtain assistance in those areas.

Finally, you must determine just how final authority will be passed to you. Business succession is not always the result of the death of the founder. Often the founder simply realizes that it is time to “pass the torch” to the next generation. Your problem, as the successor, is to understand and to be comfortable with the role, if any, that the founder is to play in the business once you take over. Often, the founder takes an executive position, such as chairman of the board, while the successor becomes chief executive officer. Sometimes, however, strong-willed founders just can’t keep from meddling. When this is the situation it is probably best that the founder leave the business altogether and allow the successor space to create his or her own management style in the business.

Ownership Transfer

Whether you are the founder or the successor, you certainly do not want to wait until the founder dies to transfer ownership. If you are the founder, once you’re dead, your desires become irrelevant. If you are the successor, once the founder is dead, there is no authority figure who can help with issues of control and strategy. Rather than waiting for the founder to die, you should assist in com- pleting a comprehensive estate-planning process while the founder is still healthy and in charge.29 In most cases, a gradual transfer of ownership is preferable to a single inheritance.30 This strategy may not be appropriate, however, if there are multiple heirs. Of greatest importance is determining who gets voting stock. If the heirs who are not involved in management receive voting stock, issues of who is in control can arise because of jealousy and intrafamily rivalries.

There is no easy answer to these issues. In fact, the transfer of ownership is highly complex and is unique to each family business. The larger and more successful your business is, the more com- plex and difficult the problem becomes. Using experts in law, accounting, and business can help identify the potential problems and help organize solutions. For family business succession plans, using specialists is essential. For family business experts, the major professional association is the Family Firm Institute. There are several organizations for business brokers; you can find them in the Google directory by entering “business broker association.” In any case, it always pays to ask other entrepreneurs and advisers such as lawyers and accountants if they have recommendations and personal experience with these experts. Involving specialists also sends a clear message to creditors and suppliers that both old and new owners are determined to make a success of the transition. Professional Management of Small Business

As small businesses grow, the requirements of managing them increase proportionately. If a busi- ness grows large enough, no matter how experienced or talented a business owner is, eventually the demands of managing will become too great to be handled alone. At this point, one of two things happens: (1) the business starts to decline, or (2) professional managers are hired to share the man- agement load.

In the terms of small business, professional management is not an issue of education, titles, or credentials. A professional manager of a small business is one who has the experience and skills to use a systematic approach to analyzing and solving business problems.

These kinds of people are not easy to find. You may have to look to other businesses in your industry for experienced managers who are seeking new challenges and opportunities. You may find such people working for your vendors or your customers. In an ideal world these people would already be working among your employees, people who, because of their individual drive, personal- ity, and skills, have learned your business quickly, and have taken on responsibility and authority.

An opportunity for you to get into small business while avoiding the many risks of start-ups or franchises, and at the same time avoid the difficulties of raising capital to buy an existing business, is to go to work for the business as a hired manager. If you have the skills and experience of a profes- sional manager that will allow you to be hired, taking the position will provide a unique perspective of the business from the inside. Should the business prove to be one that you want to own, you are in a position to understand the business’s worth and to negotiate terms that make it possible for you to acquire it.

Employee managers of small firms are often would-be entrepreneurs. The set of management skills needed to be an effective manager of small business is very similar, if not identical, to the set needed to be an effective business founder or owner. Because of this, it is common for a manager to become an owner—either of your business or of a competing business. Entry into ownership is accomplished through all the ways discussed in this chapter, including leaving employment to start up a new busi- ness, buying out or buying into an existing business, or contracting a franchise relationship.

There are only five paths of entry into small business management, although the details of how any one person gets started are unique. You may start a business, buy a business, franchise a busi- ness, inherit a business, or be employed as a manager in a business. Getting into business, for all its difficulties and problems, however, is the easiest part of small business management. Making the business successful and finding a graceful and appropriate way to get out is the true challenge, and that is what we look at in later chapters.

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?

Homework Answers

Answer #1

1- 5 ways to get into small business management are start a business, buy a business, franchise a busi-ness, inherit a business, or be employed as a manager in a business

2-Understanding the science, technology; methodology of the industry of which the business is part;understanding the financial needs and resources of the business and industry;competent to negotiate with lenders, investors, vendors, and customers; effectively deal with people,with employees, suppliers, regulators, and customers;effective leadership skill and knowing one self-boundary.

3-Franchising is the pre-dominant way

4- It offers a “win–win” situation for both the franchiser and the franchisee.

5-Entrepreneur.com

6-Uniform franchise offering circular (UFOC) and the franchise agreement

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