1. BUS827 Entrepreneurship and Business Strategy
Seminar 9 :
Modes of Entry into Business
Franchising – Ch 6
Buying an Existing Business – Ch7
BUS827 Modes of entry into business 1 1

2. Seminar 8: Franchising
L E A R N I N G O B J E C T I V E S
Describe the three types of franchising: trade name, product distribution and pure
Explain the benefits and the drawbacks of buying a franchise
Understand the laws covering franchise operation
Discuss the right way to buy a franchise
Outline the major trends shaping franchising
BUS Modes of entry into business 2 2

3. www.franchise.org.au/‎ for Australia
The Franchising Boom
More than 3,000 franchisors operate more than 825,000 outlets in the United States.
Franchises generate almost 17% of total annual sales in the United States.
Franchises employ one in every 8 workers in the U.S. in more than 300 major industries.
for Australia
BUS Modes of entry into business

4. What do we mean by Franchising?
A system in which semi-independent business owners (franchisees) pay fees and royalties to a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often to use its business format and system.
BUS Modes of entry into business

5. What are the aspects of the Franchising Relationship?
BUS Modes of entry into business

6. What are the Types of Franchising?
Tradename
The right to use the franchisor’s trade name without distributing particular products
Product distribution
Sell specific products e.g. motor vehicles
Pure (Business format)
Providing franchisor with complete business system - 85% of US franchises
BUS Modes of entry into business

7. What are the Franchising Basics?
Franchisee gets the right to use all of the elements of a fully integrated business operation.
Essence of what franchisees purchase from the franchisors: Experience.
Key Question: “What can a franchise do for me that I cannot do for myself?”
BUS Modes of entry into business

8. What are the Benefits of Franchising?
A business system
Management training and support
Start-up
Ongoing
Brand name appeal
“Cloning”
Standardized quality of goods and services
BUS Modes of entry into business

9. What are the Benefits of Franchising
National advertising programs
Franchisees contribute 1% to 5% of sales.
Financial assistance
About 20% of franchisors offer direct financial assistance to franchisees.
SBA – Franchise Registry
Proven products and business formats
BUS Modes of entry into business

10. What are the Benefits of Franchising?
Centralized buying power
Site selection and territorial protection
Important issue: Territorial encroachment
Greater chance for success
BUS Modes of entry into business

11. What are the Drawbacks of Franchising?
Franchise fees and ongoing royalties
Average upfront franchise fee = $25,147
Royalties range from 1% to 11% of franchisees’ sales
Average royalty = 6.7% of sales
Strict adherence to standardized operations
Restrictions on purchasing
Approved suppliers only
BUS Modes of entry into business

12. What are the Drawbacks of Franchising?
(continued)
What are the Drawbacks of Franchising?
Limited product line
Contract terms and renewal
Average term = 10.3 years
Unsatisfactory training programs
Market saturation
Less freedom –
“No independence”
“Happy prisoners”
BUS Modes of entry into business

13. What are the Ten Myths of Franchising?
1. Franchising is the safest way to go into business because franchises never fail.
2. I’ll be able to open my franchise for less money than the franchiser estimates.
3. The bigger the franchise organization, the more successful I’ll be.
4. I’ll use 80 percent of the franchiser’s business system, but I’ll improve upon by substituting my experience and know-how.
BUS Modes of entry into business

14. Ten Myths of Franchising
(continued)
Ten Myths of Franchising
5. All franchises are the same.
6. I don’t have to be a hands-on manager. I can be an absentee owner and still be very successful.
7. Anyone can be a satisfied, successful franchise owner.
BUS Modes of entry into business

15. What are the Ten Myths of Franchising?
(continued)
What are the Ten Myths of Franchising?
8. Franchising is the cheapest way to get into business for yourself.
9. The franchiser will solve my business problems for me; after all, that’s why I pay an ongoing royalty fee.
10. Once I open my franchise, I’ll be able to run things the way I want to.
BUS Modes of entry into business

16. What about Franchising and the Law- Australia?
Trade Practices (Industry Codes - Franchising) Regulations F2010C00457
Objective: To give franchisees the information they need to protect themselves from dishonest franchisees and to make good investment decisions
BUS Modes of entry into business

17. How do you Detect Dishonest Franchisers?
In addition to the text
How do you Detect Dishonest Franchisers?
Claims that the contract is “standard; no need to read it.”
Failure to provide a copy of the required disclosure documents.
Marginally successful prototype or no prototype.
Poorly prepared operations manual.
Promises of future earnings with no documentation.
High franchisee turnover or termination rate.
Unusual amount of litigation by franchisees.
BUS Modes of entry into business

18. How do you Detect Dishonest Franchisers?
In addition to the text
How do you Detect Dishonest Franchisers?
Attempts to discourage your attorney from evaluating the contract before signing it.
No written documentation.
A high pressure sale.
Claims to be exempt from federal disclosure laws.
“Get rich quick” schemes, promising huge profits with minimal effort.
Reluctance to provide a list of existing franchisees.
Evasive, vague answers to your questions.
BUS Modes of entry into business

19. What is the Right Way to Buy a Franchise?
Evaluate yourself - What do you like and dislike?
Research your market.
Consider your franchise options.
Get a copy of the Franchisor’s FDD – and read it!
Talk to existing franchisees.
Ask the franchiser some tough questions.
Make your choice.
BUS Modes of entry into business

20. What Factors Make a Franchise Appealing?
Unique concept or marketing approach
Profitability
Registered trademark
Business system that works
Solid training program
Affordability
Positive relationship with franchisees
BUS Modes of entry into business

21. What Trends re Shaping Franchising?
Changing face of franchisees
Better educated with more business acumen
Multiple-unit franchising
52% of franchisees operate multiple outlets (and growing)
Multiple-unit franchising-a method of franchising in which a franchisee opens more than one unit in a broad territory within a specified time period
International opportunities
IFA Survey: 52% of U.S. franchisors have an international presence
Master franchising
Franchising-a franchise that gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees
BUS Modes of entry into business

22. What Trends are Shaping Franchising?
Smaller, nontraditional locations
Intercept marketing.. the principle of putting a franchisee’s products or services directly in the paths of potential customers, wherever they may be. eg. Dunkin Donuts
Conversion franchising
72% of North American franchisors use as a growth strategy
Franchising-a franchising trend in which owners of independent businesses become franchisees to gain the advantage of name recognition e.g. Century 21
Cobranding - e.g. Woolworths/Caltex
Serving dual-career couples and baby boomers
BUS Modes of entry into business

23. Franchising: Is a key part of the small business sector
Conclusion
Franchising:
Is a key part of the small business sector
Increases the chance of business success for the entrepreneur
Growth continues
Ch. 6: Franchising and the Entrepreneur
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24. Buying an Existing Business
L E A R N I N G O B J E C T I V E S
Understand the advantages and disadvantages of buying an existing business
Define the steps involved in buying a business
Describe the three types of franchising: trade name, product distribution and pure
Explain the benefits and the drawbacks of buying a franchise
Understand the laws covering franchise operation
Discuss the right way to buy a franchise
Outline the major trends shaping franchising
BUS Modes of entry into business 24 24

25. What are the Key Questions to Consider Before Buying a Business?
Is the right type of business for sale in the market in which you want to operate?
What experience do you have in this particular business and the industry in which it operates? How critical is experience in the business to your ultimate success?
What is the company’s potential for success?
What changes will you have to make – and how extensive will they have to be – to realize the business’s full potential?
BUS Modes of entry into business

26. What are the Key Questions to Consider Before Buying a Business?
What price and payment method are reasonable for you and acceptable to the seller?
Is the seller willing to finance part of the purchase price?
Will the company generate sufficient cash to pay for itself and leave you with a suitable rate of return on your investment?
Should you be starting a business and building it from the ground up rather than buying an existing one?
BUS Modes of entry into business

27. Who are the Types of Business Buyers?
BUS Modes of entry into business

28. What are the Advantages of Buying a Business?
It may continue to be successful
It may already have the best location
Employees and suppliers are established
Equipment is already installed
Inventory is in place and trade credit is established
BUS Modes of entry into business

29. What are the Advantages of Buying a Business?
It’s turnkey
New owners can “hit the ground running”
New owners can use the previous owner’s experience
Financing is easier to obtain
It’s a bargain!
BUS Modes of entry into business

30. What are the Disadvantages of Buying a Business?
The financial costs are high
It’s a “loser”
Previous owner may have created ill will
“Inherited” employees may be unsuitable
The location may have become unsatisfactory
Equipment and facilities may be obsolete or inefficient
BUS Modes of entry into business

31. What are the Disadvantages of Buying a Business?
Change and innovation can be difficult to implement
Inventory may be outdated or obsolete
Accounts receivable may be worth less than face value
BUS Modes of entry into business

32. How do you Value Accounts Receivable?
Age of Accounts (days)
Amount
Collection Probability
Value
0-30
31-60
61-90
91-120
151+
Total
$40,000
$25,000
$14,000
$10,000
$7,000
$5,000
$101,000
.95%
88%
70%
40%
25%
10%
$38,000
$22,000
$9,800
$4,000
$1,750
$500
$76,050
BUS Modes of entry into business

33. What are the Disadvantages of Buying a Business?
Changes can be difficult to implement
Inventory may be stale
Accounts receivable may be worth less than face value
The business may be overpriced
BUS Modes of entry into business

34. What are key requirements for acquiring a Business?
Study: 50 to 75% of all business sales that are initiated fall through.
The right way:
Analyze your skills, abilities, and interests.
Develop a list of criteria
Prepare a list of potential candidates.
Investigate and evaluate candidate businesses and select the best one.
BUS Modes of entry into business

35. What are key requirements for acquiring a Business?
Explore financing options
Potential source: the seller
Negotiate a reasonable deal
Ensure a smooth transition
Communicate with employees
Be honest
Listen
Consider asking the seller to serve as a consultant through the transition
BUS Modes of entry into business

36. What are the Critical Areas for Analyzing an Existing Business?
Why does the owner want to sell ... what is the real reason?
What is the physical condition of the business?
Accounts receivable
Lease arrangements
Business records
Intangible assets
Location and appearance
BUS Modes of entry into business

37. What are the Critical Areas for Analyzing an Existing Business?
(continued)
What is the potential for the company's products or services?
Product line status
Potential for company’s products or services
Customer characteristics and composition
Competitor characteristics and composition
What legal aspects must I consider?
BUS Modes of entry into business

38. What are the Legal Aspects of Buying a Business?
Lien - creditors’ claims against an asset.
Bulk transfer - protects business buyer from the claims unpaid creditors might have against a company’s assets.
Contract Assignment - buyer’s ability to assume rights under seller’s existing contracts.
Due-on-sale clause
BUS Modes of entry into business

39. What are the Legal Aspects of Buying a Business?
(continued)
Covenant not to compete (restrictive covenant or non-compete agreement) contract in which a business seller agrees not to compete with the buyer within a specific time and geographic area.
Ongoing legal liabilities - physical premises, product liability lawsuits, and labor relations issues.
BUS Modes of entry into business

40. What are the Critical Areas for Analyzing an Existing Business?
(continued)
What is the potential for the company's products or services?
Product line status
Potential for company’s products or services
Customer characteristics and composition
Competitor characteristics and composition
What legal aspects must I consider?
Is the business financially sound?
Skimming
BUS Modes of entry into business

41. What are the key steps in the Acquisition Process?
BUS Modes of entry into business

42. How do you Determine the Value of a Business?
Business valuation is partly an art and partly a science.
A wide variety of factors influence the price of a business.
Valuing tangible assets is easy. It’s much harder to value intangible assets.
BUS Modes of entry into business

43. Median Sales Price of Private Companies in the US
BUS Modes of entry into business

44. How do you Determine the Value of a Business?
Goodwill
The difference in the value of an established business and one that has not yet built a solid reputation for itself.
BUS Modes of entry into business

45. How do you Determine the Value of a Business?
Balance Sheet Technique
Variation: Adjusted Balance Sheet Technique
Earnings Approach
Variation 1: Excess Earnings Approach
Variation 2: Capitalized Earnings Approach
Variation 3: Discounted Future Earnings Approach
Market Approach
BUS Modes of entry into business

46. What are the Balance Sheet Techniques?
“Book Value" of Net Worth = Total Assets - Total Liabilities
= $266, $114,325
= $151,766
Variation: Adjusted Balance Sheet Technique:
Adjusted Net Worth = $274, $114,325
= $160,313
BUS Modes of entry into business

47. What are the Earnings Based Approaches?
Variation 1: Excess Earnings Method
Step 1: Compute adjusted tangible net worth:
Adjusted Net Worth = $274, $114,325 = $160,313
Step 2: Calculate opportunity costs of investing:
Investment $160,313 x 22% = $35,269
Salary $35,000
Total $70,269
Step 3: Project earnings for next year: $75,000
BUS Modes of entry into business

48. What are the Earnings Based Approaches?
(continued)
Step 4: Compute extra earning power (EEP):
EEP = Projected Net Earnings - Total Opportunity Costs
= $75, ,269 = $4,731
Step 5: Estimate the value of the intangibles (“goodwill”):
Intangibles = Extra Earning Power x “Years of Profit” Figure*
= $4,731 x = $20,896
* Years of Profit Figure ranges from 1 to 7; for a normal risk business, the range is 3 to 4.
BUS Modes of entry into business

49. What are the Earnings Based Approaches?
Step 6: Determine the value of the business:
Value = Tangible Net Worth + Value of Intangibles
= $160, ,896 = $181,209
Estimated Value of the Business = $181,209
(continued)
BUS Modes of entry into business

50. What are the Earnings Based Approaches?
Variation 2: Capitalized Earnings Method
Value = Net Earnings (After Deducting Owner's Salary)
Rate of Return*
Value = $75,000 - $35, = $181,818
22%
* Rate of return reflects what buyer could earn on a similar-risk investment.
BUS Modes of entry into business

51. What are the Earnings Based Approaches?
(continued)
Variation 3: Discounted Future Earnings Method
Step 1: Project earnings five years into the future:
3 Forecasts:
Pessimistic
Most Likely
Optimistic
Compute a weighted average of the earnings:
Pessimistic + (4 x Most Likely) + Optimistic 6
BUS Modes of entry into business

52. How to calculate Discounted Future Earnings Method?
(continued)
Step 1: Project earnings five years into the future:
Year Pessimistic Most Likely Optimistic Weighted Average 1 2 3 4 5
$62,000
$68,000
$75,000
$82,000
$90,000
$74,000
$80,000
$88,000
$96,000
$105,000
$82,000
$88,000
$95,000
$102,000
$110,000
$73,333
$79,333
$87,000
$94,667
$103,333
BUS Modes of entry into business

53. How to calculate Discounted Future Earnings Method?
(continued)
Step 2: Discount weighted average of future earnings at the appropriate present value rate: 1
Present Value Factor =
(1 +k) t
Where:
k = Rate of return on a similar risk investment.
t = Time period (Year - 1, 2, 3...n).
BUS Modes of entry into business

54. How to calculate Discounted Future Earnings Method?
(continued)
Step 2: Discount weighted average of future earnings at the appropriate present value rate:
Year Weighted Average x PV Factor = Present Value 1 2 3 4 5
$73,333
$79,333
$87,000
$94,667
$103,333
.8197
.6719
.5507
.4514
.3700
$60,109
$53,301
$47,912
$42,732
$38,233
Total $242, 287
BUS Modes of entry into business

55. How to calculate Discounted Future Earnings Method?
(continued)
Step 3: Estimate the earnings stream beyond five years:
Weighted Average Earnings in Year 5 x Rate of Return
= $103,333 x %
Step 4: Discount this estimate using the present value factor for year 6:
$413,332 x = $125,363
The text book on p273 appears to be wrong
BUS Modes of entry into business

56. How to calculate Discounted Future Earnings Method?
(continued)
Step 5: Compute the value of the business:
Discounted earnings in years 1 through 5
Discounted earnings in years 6 through ?
Value = +
= $242, $125, = $367,650
Estimated Value of Business = $367, 650
BUS Modes of entry into business

57. What is the Market Based Approach?
Step 1: Compute the average Price-Earnings (P-E) Ratio for as many similar businesses as possible:
Company P-E Ratio
1 4.5
2 5.3 Average P-E Ratio = 4.90
x 40% (private company discount)
= 2.94
Step 2: Multiply the average P-E Ratio by next year's forecasted earnings:
Estimated Value of Business = 2.94 x $75,000 = $220,500
BUS Modes of entry into business

58. Understanding the Seller’s Side?
For entrepreneurs, few events are more anticipated – and more emotional – than selling their business.
Exit Strategies:
Straight business sale
Form a family limited partnership
Sell a controlling interest
Earn-out
Restructure the company
Sell to an international buyer
Use a two-step sale
Establish an ESOP
BUS Modes of entry into business

59. How to Restructure a Business for Sale?
You bring in an investor
Sell for $15m but still retain 50% ownership
BUS Modes of entry into business

60. How to Negotiate the Deal?
Go into negotiations with a list of objectives ranked in order of priority.
Try to understand what the seller’s priorities are.
Work to establish a cooperative relationship based on honesty and trust.
Avoid an “if you win, then I lose” mentality
Look for areas of mutual benefit
BUS Modes of entry into business

61. The Five Ps of Negotiating
In addition to the text
Poise - Remain calm during the
negotiation. Never raise your voice
or lose your temper, even if the situation gets difficult or emotional. It’s better to walk away and calm down than to blow up and blow the deal.
Preparation - Examine the needs
of both parties and all of the
relevant external factors affecting
the negotiation before you sit
down to talk.
Patience – Don’t be in such
a hurry to close the deal that
you end up giving up much of what
you hoped to get. Impatience is
a major weakness in
a negotiation.
Persistence - Don’t give in at the first sign of resistance to your position, especially if it is an issue that ranks high in your list of priorities.
Persuasiveness - Know what
your most important positions are, articulate them, and offer support for your position.
BUS Modes of entry into business

62. When buying an existing business:
Conclusion
When buying an existing business:
Assess the advantages and disadvantages
Follow the steps to improve your chances of success
Determine the value of the business
Appreciate the seller’s side
Negotiate wisely
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