1. © 2007 John Wiley & Sons Australia, Ltd

2. Options for going into business
Chapter 5
Options for going into business

3. Chapter outline Issues to consider before going into business
Starting a new business
Purchasing an existing business
Entering a franchise system
Comparison of options
Procedural steps when starting a business venture.

4. Learning objectives
Explain the 3 major issues that all prospective entrepreneurs and small-business owners must consider before going into business
Compare and contrast the advantages and disadvantages of starting a new business.

5. Learning objectives
Outline the factors to take into account when assessing a business for purchase
Explain the different ways of calculating a business purchase price

6. Learning objectives Describe how a franchise operates
Use the ‘6 step’ process to organise your strategy for going into business

7. Business commencement options
There are essentially 3 major options for going into business:
Launch a new (start-up) business venture
Purchase an existing firm
Enter a franchise arrangement

8. Issues to consider before going into business
Any business venture is driven by 3 forces:
Personal goals and abilities of the owner/entrepreneur
What resources are available to the business owner (money, staff, etc)?
The nature of the business opportunity itself

9. Starting a new business — the advantages
The owner can shape his or her own vision
Flexibility — fewer constraints on owner
Cost minimisation — often cheaper to start
New lifestyle goals — can ensure business and personal goals are closely aligned from the outset

10. Starting a new business — the disadvantages
Hard to raise capital
Lack of an established customer base
May suffer cash flow problems
Requires considerable effort to learn how to operate the business effectively (‘learning curve expenses’)

11. Costs of a start-up venture
Some costs are common to all new enterprises, such as:
Licenses and permits required to operate the business
Working capital
Communications equipment (such as telephones, computers, fax machines)
Operating plant and equipment

12. Costs of a new (start-up) business venture
Staff recruitment expenses
Insurance
Raw materials (or trading stock)
Rental of premises (unless working from the owner’s home)
Stationery
In addition, there will also be industry-specific expenses.

13. Purchasing an existing business
Advantages:
Can begin trading immediately
Easier to arrange finance for the venture
Established track record of the firm allows a more objective evaluation of likely future performance

14. Purchasing an existing business
Disadvantages:
May ‘inherit’ existing liabilities
Less flexible than a start-up
Difficult to establish purchase price

15. Establishing a purchase price
Three major techniques used by sellers (vendors) and purchasers:
1. Market-based valuations
2. Asset-based valuations
3. Earnings-based (cash flow) valuations

16. Market-based valuations
The going market rate method
simply the ‘current market’ price for a particular type of firm
Selling price = Selling price of similar firms

17. Market-based valuations
Revenue multiplier method
common ‘industry multiple’ that is used to estimate the most likely purchase price of the practice
Selling price = Turnover × Standard industry multiple

18. Asset-based valuations
Involves setting a price after examining the assets and liabilities of the business:
Book value
asking price is set by first calculating the worth of all the firm’s assets
Selling price = Tangible assets + Intangible assets − Liabilities

19. Asset-based valuations
Adjusted book (net asset) value
simple book value method relying on the books of account

20. Asset-based valuations
Liquidation value
value of the business if it was to be broken up and sold as individual assets, rather than continuing to operate it as a going concern

21. Asset-based valuations
Replacement value
the cost of replacing all of the firm’s tangible assets (at current market costs)

22. Earnings-based (cash flow) valuations
Return on investment
based on the assumption that the risk and return of a business should be reflected in its selling price. It works on a formula which includes the estimated future profit earnings:
Selling price = Net annual profit × (100/ROI)

23. Earnings-based (cash flow) valuations
Discounted cash flows
reduces (discounts) the future cash income generated by the business back to its current value
Value = terminal value

24. Questions to ask Why is the business being sold?
Will existing staff remain if the business is sold?
What debts/liabilities exist?
Can all licenses and permits to operate be transferred?
How accurate are the financial accounts?

25. Questions to ask
What is the future state of the industry — is demand increasing or decreasing?
Is the lease on the premises secure?
What is the condition of the physical assets?
Will existing customers remain loyal if business has new ownership?

26. Entering a franchise system
An increasingly common form of business operation.
An arrangement whereby the originator of a business product or operating system permits another business owner to sell these goods, and/or to use the business operations system, on his or her behalf.

27. Entering a franchise system
A licensing arrangement: a small firm receives permission to sell a particular product from an established parent organisation, but remains legally independent of that parent.

28. Entering a franchise system
Typically has lower failure rates than new start-ups.
Good for small business owners seeking security
Less suitable for entrepreneurial types.

29. Entering a franchise system
Franchisee: The business or individual who is given contractual permission to operate a particular business franchise system or sell a product by the original owner of the same.
Franchisor: A business or individual who owns the right to a particular business franchise system or product.

30. Entering a franchise system
Product franchise:
gives the small business operator the right to sell a particular commodity, or set of goods.
Franchisee is a distribution mechanism for good or service; has a large measure of independence about how their business is operated.

31. Entering a franchise system
Product franchise (cont’d):
Franchisor’s role is limited to ensuring that sufficient stock is made available, and that the franchisee is selling the product at a satisfactory price.

32. Entering a franchise system
Business system franchise:
A situation where the franchisor not only supplies the product, but also gives comprehensive guidelines about how the business is run (e.g. McDonald’s).
All aspects of organising and operating the business have already been investigated, pre-tested and successfully implemented by the franchisor.

33. Advantages of franchising
The new business owner is spared the task of developing an operating system
New business owner learns less ‘by mistakes’
Customers are usually attracted by the presence of an established product.

34. Advantages of franchising
Lower failure rate
Franchisors provide continuing training for franchisees
Pre-organised access to raw materials and supplies
Raising capital can also be easier

35. Disadvantages of franchising
Access to these systems does not come cheaply
Purchase price is often quite high
Franchisees have to pay a proportion of their profits to the franchisor
Franchisees are restricted to serving a set market

36. Disadvantages of franchising
Franchisees subject to contractual arrangement, and as such have a limited lifespan

37. Comparison of options

38. Procedural steps when starting a business venture
Figure 5.2: The process of going into business

39. Summary There are 3 factors which influence all business ventures:
the personal goals, desires, experience and abilities of the owner/entrepreneur
the financial, human and other resources available
and the nature of the business opportunity itself.

40. Summary There are 3 different ways of getting into business:
starting a new business
buying an existing operation
or entering into a franchise arrangement.
Each has their own advantages and disadvantages.

41. Summary There are 3 main ways of setting a price:
market-based valuations,
asset-based valuations
and earnings-based (cash flow) valuations.

42. Summary
There are 6 steps involved in the process of evaluating business options. After these steps, the intending business owner must critically evaluate which business avenue is the best option.