Start-ups and Buyouts, Family Business and Franchising Opportunities

1. Start-ups and Buyouts, Family Business and Franchising Opportunities January 22, 2004

2. “Wherever you see a successful business, someone once made a courageous decision.”--Peter F. Drucker

3. Agenda • Startup and Buyout Opportunities • Family Business Opportunities • Franchising Opportunities

4. Part 1: Startup and Buyout Opportunities • Why Startups? • Types of startups and sources of ideas • Evaluating investment opportunities • Why Buy an Existing Business? • How to evaluate how much a business is worth?

5. The Startup: creating a new business • What are the typical reasons for pursuing a startup rather than other alternatives?

6. Why Startups? Developing a commercial market for a recently invented or newly developed product or service. Taking advantage of available resources, ideal location, advances in equipment, employees, suppliers, and bankers Avoiding precedents, policies, procedures, and legal commitments of existing firms

7. Types of Startups

8. Friends/Relatives5% Personal Interest/Hobby16% Family Business6% Suggestion7% Education/Courses6% Prior Work Experience45% Chance Happening11% Other4% Sources of Startup Ideas

9. Evaluating Ideas & Opportunities • Is there a clearly defined market need for the product or service, and is the timing right? • Can the proposed business achieve a durable or sustainable competitive advantage? • Is the venture financially rewarding, and does it have significant profit and growth potential? • Is there a good fit between the entrepreneur and the opportunity? • Is there a fatal flaw in the venture that could make the business unsuccessful?

10. Pros and Cons of Starting from Scratch Lower costs Flexibility New markets Creativity Higher Risk No track record No clients Many decisions Extensive planning

11. Why Buy an Existing Business? • To reduce some of the uncertainties and unknowns that must be faced in starting a business from the ground up. • To acquire a business with ongoing operations and established relationships with customers and suppliers. • To obtain an established business at a price below what it would cost to start a new business.

12. Pros and Cons of Buyouts Higher chance of success Less planning Existing customers/ suppliers Necessary equipment Bargain price Experienced employees Existing business records Existing problems Poor quality of current employees Poor business image Modernization required Purchase price based on inaccurate data Poor business location Hidden financial aspects, liabilities Customers tied to current owner

13. Why is the business for Sale? • Old age or illness • Desire to relocate in a different section of the country • Decision to accept a position with another company • Unprofitability of the business • Discontinuance of an exclusive sales franchise • Maturation of the industry and lack of growth potential

14. How much is it worth? • Asset-Based Valuation • Estimates the value of the firm’s assets • Modified book value • Replacement value • Liquidation value • Does not reflect the value of the firm as a going concern. • Market-Based Valuation • Considers the sale prices of comparable firms • Difficulty is in finding comparable firms

15. How much is it worth? • Earnings-based Valuation • Determines the value of the business based on its potential future earnings • Divide normalized earnings by an appropriate capitalization rate • Function of risk and projected growth • Cash-Flow-based Valuation • Compares the expected rate of return on investment to a required rate • Required rate = Risk free rate of return + risk premium

16. Nonquantitative Factors • Competition • Market • Future community development • Legal commitments • Union contracts • Buildings • Product prices

17. The Ideal Business • Requires no investment • Has a recognized, measurable market • A perceived need for the product or service • A dependable source of supply for required inputs • No government regulation • Requires no labour force • Provides 100% gross margin • Buyers purchase frequently • Receives favorable tax treatment

18. Part 2: Family Business Opportunities • The family business: a unique opportunity • Advantages and special features of a family-run businesses • The process of leadership succession • Transfer of ownership

19. The Family Business: a unique institution • What is a family business • A company in whose ownership and/or functioning two or more members of the same family are directly involved. • A firm whose ownership passes from one generation of a family to another • Decisions affecting both business and family

20. The Overlap of Family and Business Concerns

22. Advantages of a Family Business • Strength of family relationships during challenging periods of business change • Financial sacrifices that family members make for the good of the firm • Operation as a family business distinguishes the firm from its competitors. • Higher levels of concern for its community and non-family employees • Capability to plan and prepare for the long haul • Emphasis on quality and value

23. Special Features of Family-Run Businesses • The founder’s imprint on the culture • The need for good management • Parent-child / couple relationships • Sibling rivalry • In-laws and Nonfamily employees • Family retreats and councils

24. The Process of Leadership Succession • Assessment of available family talent • Allowing only qualified competent family members to assume leadership roles in the firm increases the value of the firm for all who have an ownership interest in it • Mentoring • Reluctant parents and ambitious children

25. A Model of Succession in a Family Business Stage IIIIntroductoryFunctional Stage IPre-Business Stage IIIntroductory Child becomes aware of facets of firm and/or industry. Orientation of child by family member is informal. Child is exposed to business jargon, employees, and the business environment. Child works as part-time employee. Work becomes more difficult. Includes education and work for other firms. Entry of Successor Stage IVFunctional Stage VAdvanced Functional Potential successor begins work as full-time employee. Includes all nonmanagerial positions. Potential successor assumes managerial position. Includes all management positions prior to becoming president. . . Transfer of Leadership Stage VI Early Succession Stage VIIMature Succession Successor assumes presidency. Includes period in which the successor becomes dejure head of company. Successor becomes defacto head of company. Source: Adapted from Justin G. Longenecker and John E. Schoen, “Management Succession in the Family Business,” Journal of Small Business Management, Vol. 16 (July 1978), pp. 1–6.

26. Transfer of Ownership • Preserve a sound business entity • Assure equity among heirs • Minimize taxes

27. Part 3: Franchising Opportunities • Understanding the franchise option • Types of franchising • Pros and cons • Evaluating Franchise Opportunities • Selling a franchise • Understanding the franchisor/franchisee relationship

28. Understanding Franchising • Franchising is a marketing system revolving around a two-party legal agreement, whereby the franchisee is granted the privilege (the franchise) to conduct business as an individual owner but according to the methods and terms specified by the franchisor ina contract

29. Types of Franchising • Product and Trade Name Franchise • Grants the right to use a widely recognized product or name • Business Format Franchise • Provides an entire marketing system and ongoing guidance from the franchisor • Piggyback Franchising • The operation of a retail franchise within the physical facilities of a host store

30. Types of Franchising • Master Licensee • An independent firm or individual acting as a sales agent with the responsibility for finding new franchises within a specified territory • Multiple-Unit Ownership • Holding by a single franchisee of more than one franchise from the same company • Area Developers • Individuals or firms that obtain the legal right to open several franchised outlets in a given area

31. Structure of Franchising FranchiseParties FranchiseFacilitators Franchisor Industry Associations(example: IFA) Master Licensee/Area Developers Federal/Provincial Agencies Business/ConsultingFirms (example:Franchise Connections) Franchisee-OwnedOperating Units Company-OwnedStores

32. Pros and Cons Probability of success Proven line of business and marketing methods Established brand Quicker start-up time Training Financial assistance Operational and management support • Franchise costs • Initial franchise fee • Royalty payments • Advertising costs • Restrictions on business operations and growth • Loss of independence and conformity to corporate policies • Exclusive supplier relationships

33. Franchisor Assistance • Financing • Payment schemes • Site selection • Bulk purchasing of equipment and inventory

34. Franchising Restrictions on Business Operations • Restricting of sales territory • Requiring site approval and imposing requirement on the outlet’s appearance • Restricting the goods/services that can be sold • Restricting the resale of the franchise without their permission • Restricting advertising and hours of operation

35. Evaluating Franchising Opportunities • Locating a potential franchise • Global franchising opportunities • Investigating the franchise • Franchisors themselves • Existing and previous franchisees • Independent, third-party sources

36. Understanding the franchisor/franchisee relationship • Contract • Legal advice • Franchising Scams • The Rented Rolls Royce Syndrome • The Hustle • The Cash-Only Transaction • The Boast • The Big-Money Claim • The Couch Potato’s Dream • Location, Location, Location • The Disclosure Dance

37. The Franchisor’s perspective Benefits Reduction of capital requirements Increase in management motivation Speed of expansion • Drawbacks • Reduction in control • Sharing of profits • Increase in operational support costs

38. Franchisability of product/service • Innovative and differentiated • Standard characteristics for control and purchasing • High gross margin • Wide geographic appeal • Capable of 20% annual market growth • Transferable formula • Reasonable initial franchise fee • Easily promoted idea

39. Summary: Startup and Buyout Opportunities • Discussed reasons for starting new business rather than busing from an existing firm or acquiring a franchise • Distinguished the different types and sources of startup ideas • Identified factors that determine whether an ideas is a good investment opportunity • Discussed reasons for buying an existing business • Summarized four basic approaches for determining a fair value for a business

40. Summary: Family Businesses • Described the basic concept of family businesses and its major advantages • Discussed some special features of family-run firms • Described a model of succession

41. Summary: Franchising Opportunities • Described basic concept of franchising and some of the important approaches • Identified the major advantages and disadvantages of franchising • Discussed process for evaluating a franchise • Discussed benefits derived from becoming a franchisor • Discussed the critical franchisor/franchisee relationship

42. Next Steps • Read: • textbook chapter 4 • Bill Sahlman article on B-plans • Form teams to discuss business ideas and prepare 2 minute pitch • Next week’s guest speaker: • Sean O’Dea, founder of Second Cup and Proshred Security