4-1 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Chapter 4 Startup and Buyout Opportunities In the Spotlight: FunZone In the Spotlight: FunZone

4-2 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Learning Objectives: Chapter 4 1. Give three reasons for starting a new business rather than buying an existing firm or acquiring a franchise. 2. Distinguish the different types and sources of startup ideas. 3. Identify five factors that determine whether an idea is a good investment opportunity. 4. List some reasons for buying an existing business. 5. Summarize four basic approaches for determining a fair value for a business. 6. Describe the characteristics of highly successful startups.

4-3 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Types of Ideas That Develop into Startups New Market Example: Targeting the “New Age” beverage market by selling soft drinks with nutritional value New Technology Example: Using high-tech computers to develop a simulated helicopter ride New Benefit Example: Developing a personal misting device to keep workers cool TYPE A TYPE B TYPE C TYPE A:Providing customers with a product or service that is not in their market but already exists elsewhere. TYPE B:Using new technology that provides the basis for new product or service ideas. TYPE C:Performing an old function for customers but in a new and improved way.

4-4 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Sources of Startup Ideas Prior Work Experience 45% Family Business 6% Other 4% Chance Happening 11% Education/Courses 6% Suggestion 7% Personal Interest/Hobby 16% Friends/Relatives 5%

4-5 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Examples of Startup Ideas Personal Experience Hobbies Accidental Discovery Deliberate Search Natalie Stiles OCS Consulting Services Consulting experience with GE Natalie Stiles OCS Consulting Services Consulting experience with GE Vickie Henry Feedback Plus Shopping ability Vickie Henry Feedback Plus Shopping ability J. P. Shyu Hang-It Clip Need to hang data on wall J. P. Shyu Hang-It Clip Need to hang data on wall Bill Waugh Taco Bueno, Burger Street Extensive research in the fast-food industry Bill Waugh Taco Bueno, Burger Street Extensive research in the fast-food industry

4-6 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Evaluation Criteria for a Startup Venture Marketing Factors Need for product Customers Value created by product for customer Life of product Market structure Market size Market growth Competitive Advantage Cost structure Degrees of control over price, costs, channels of supply Barriers to entry: regulatory protection, response/lead-time advantage, legal advantage, contacts and networks Economics Return on investment Investment requirements Break-even point Management Capability Fatal Flaw Marketing Factors Need for product Customers Value created by product for customer Life of product Market structure Market size Market growth Competitive Advantage Cost structure Degrees of control over price, costs, channels of supply Barriers to entry: regulatory protection, response/lead-time advantage, legal advantage, contacts and networks Economics Return on investment Investment requirements Break-even point Management Capability Fatal Flaw Source: Adapted from Jeffery A. Timmons, New Venture Creation (Homewood, IL: Irwin, 1999), pp

4-7 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing CONS Existing problems Poor quality of current employees Poor business image Modernization required Purchase price based on inaccurate data Poor business location Pros and Cons of Buying an Existing Business PROS High chance of success Less planning Existing customers/suppliers Necessary equipment Bargain price Experienced employees Existing business records +

4-8 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Income Statement as Adjusted by Prospective Buyer Original Required Adjusted Income StatementAdjustmentsIncome Statement Estimated sales$172,000$172,000 Cost of goods sold84,24084,240 Gross profit$87,760$87,760 Operating expenses: Rent$20,000Rental agreement will$24,000 expire in six months; rent is expected to increase 20%. Salaries19,86019,860 Telephone Advertising11,285 11,285 Utilities2,580 2,580 Insurance1,200Property is underinsured; 2,400 adequate coverage will double present cost. Professional services1,2001,200 Credit card expense1,860Amount of credit card 460 expense is unreasonably large; approximately $1,400 of this amount should be classified as personal expense. Miscellaneous1,250$60,2251,250$64,025 Net income$27,535$23,735

4-9 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Valuation of a Business Asset-Based Valuation Approach Market-Based Valuation Approach Earnings-Based Valuation Approach Cash Flow-Based Valuation Approach Examines the value of business assets taken separately Does not reflect the value of a going concern Examines the value of business assets taken separately Does not reflect the value of a going concern Looks at similar businesses sold recently Considers future earnings Is based on future cash flows Is the best theoretical method Requires a more complex procedure Is based on future cash flows Is the best theoretical method Requires a more complex procedure

4-10 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Determinants of a Firm’s Capitalization Rate Risk High Low High Capitalization Rate Low Capitalization Rate Low Firm Value High Firm Value Projected Growth High Low Capitalization Rate High Capitalization Rate High Firm Value Low Firm Value

4-11 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Nonquantitative Factors to Consider in Valuing a Business CompetitionCompetition MarketMarket Future Community DevelopmentsFuture Community Developments Legal CommitmentsLegal Commitments Union ContractsUnion Contracts BuildingsBuildings Product PricesProduct Prices

4-12 Small Business Management, 11th edition Longenecker, Moore, and Petty © 2000 South-Western College Publishing Suggested Risk Premium Categories Category Description Risk Premium Source: James H. Schilt, “Selection of Capitalization Rates--Revisited,” Business Valuation Review, American Society of Appraisers, P.O. Box 17265, Washington, DC (June 1991), p. 51.