4-1

1. Chapter 4 Startup and Buyout Opportunities In the Spotlight: FunZone www.choicemall.com/funzone • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-1

2. 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. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-2

3. Types of Ideas That Develop into Startups TYPE B TYPE A TYPE C New Technology New Market New Benefit Example:Developing a personal misting device to keep workers cool Example:Targeting the “New Age” beverage market by selling soft drinks with nutritional value Example:Using high-tech computers to develop a simulated helicopter ride 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. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-3

4. Sources of Startup Ideas Friends/Relatives5% Personal Interest/Hobby16% Family Business6% Suggestion7% Education/Courses6% Prior Work Experience45% Chance Happening11% Other4% • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-4

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

6. 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 Source: Adapted from Jeffery A. Timmons, New Venture Creation (Homewood, IL: Irwin, 1999), pp. 86-87. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-6

7. 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 • CONS • Existing problems • Poor quality of current employees • Poor business image • Modernization required • Purchase price based on inaccurate data • Poor business location • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-7

8. Income Statement as Adjusted by Prospective Buyer Original Required Adjusted Income Statement Adjustments Income Statement Estimated sales $172,000 $172,000 Cost of goods sold 84,240 84,240 Gross profit $87,760 $87,760 Operating expenses: Rent $20,000 Rental agreement will $24,000 expire in six months; rent is expected to increase 20%. Salaries 19,860 19,860 Telephone 990 990 Advertising 11,285 11,285 Utilities 2,580 2,580 Insurance 1,200 Property is underinsured; 2,400 adequate coverage will double present cost. Professional services 1,200 1,200 Credit card expense 1,860 Amount of credit card 460 expense is unreasonably large; approximately $1,400 of this amount should be classified as personal expense. Miscellaneous 1,250 $60,225 1,250 $64,025 Net income $27,535$23,735 • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-8

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

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

11. Nonquantitative Factors to Consider in Valuing a Business • Competition • Market • Future Community Developments • Legal Commitments • Union Contracts • Buildings • Product Prices • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-11

12. Suggested Risk Premium Categories CategoryDescriptionRisk Premium Source: James H. Schilt, “Selection of Capitalization Rates--Revisited,” Business Valuation Review, American Society of Appraisers, P.O. Box 17265, Washington, DC 20041 (June 1991), p. 51. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing 4-12