MBA management

Entering a Business Topics:

Introduction


Entrepreneurship is about managing risk, and buying an existing business is one way of reducing risk. It does not eliminate risk but does provide a less risky alternative. Buying a business is not an easy exercise; it is in fact, a complicated process and one needs to do it carefully.

Buying an existing business, which comes with readymade infrastructure- and may be even human resource- enables a faster start to a potential entrepreneur.

Some entrepreneurs are comfortable in running a business or building it up but are particularly hassled about many issues in the beginning. If done carefully, buying a business can reduce start-up hassles.

Buying a franchise is yet another way of decreasing thee uncertainties and hassles of starting a business from scratch. Buying up an existing business seems to be an easy way of getting into business on your own. But, before taking the plunge, the benefits and possible disadvantages of buying a business should be examined.

Search of New Business


It is not easy to come across a business owner willing to sell business. Business owners do not go around telling everyone that they want to sell-off their business.

It is difficult to come across news of a business for sale. Some of the sources that can be tapped are:

1) Industry: Assuming that one want to buy a business related to the work he is engaged in, it is likely that he will hear talk of people wanting to sell. Usually, businesses in distress are the ones who want to sell-off quickly. There are many pointers that indicate likelihood of distress in a business.

2) Accountants and Lawyers: these are thee professionals who are in touch with a number of businesses across industries and are likely to come across information regarding a potential sale. Many of them may even offer to act as brokers.

3) Bankers: Distressed businesses are more likely to be sold. Banks and financial institutions are the first to smell trouble. Sometimes, they encourage the owner to sell in the hope of recovering at least a part of their investment and also in the hope of passing on the business to more capable hands.

4) Advertisements: There are very few advertisements that advertise a business up for sale. Usually, these ads are put up by banks and financial institutions who want to sell the businesses to recover amounts owed by defaulting borrowers. Some ads are also put up by individual business owners wishing to sell their business or some assets attached to a business, usually, some high- priced equipment such as a rotary kiln or an off-set printing press.

5) Others: Information pertaining to the potential sale of a business can originate in the most unlikely places. It pays to keep ears and eyes open to catch useful scraps of information. On the other hand, it is not advisable to scour industrial estates knocking on each gate, enquiring if the business is for sale or not.

Options for Entering in Business


There are many options for entering in a business, the major ones include:

1) Franchise
2) Buying a Franchise
3) Developing a Franchise
4) Starting a Business
5) Partnering
6) Buying a Business

Buying a Franchise
Franchising is a strategy for entering in a business. Franchising is a means of marketing goods and services in which the franchiser grants the legal right to use branding, trademarks and products and the method of operation is transferred to third party—the franchisee—in return for a franchise fee. The franchiser provides assistance, training and help with sourcing components and exercises significant control over the franchisee’s method of operation. It is considered to be relatively less risky business start-up for the franchisee but still harnesses the motivation, time and energy of the people who are investing their own capital in the business, For the franchiser it has a number of advantages, including the opportunity to build greater market coverage and obtain a steady, predictable stream of income without requiring excessive investment.

Generally, there are two types of franchises:

1) Business Format Franchise: Business format franchise is when a franchiser licenses the rights to sell a product or service and provides proprietary methods for operating a business, including logos, systems, and training. Fast food, mailing outlets, convenience stores, and gas stations fall into this category of franchising.

2) Product or Trade Name Franchise: Product or trade name franchise is where a franchiser sells the rights to use a trademark or brand name as part of existing business. For example, beverage distribution.

Buying a franchise can be the easiest way to enter into business with a proven model of success developed by the franchiser, starting a new business is risky. The franchiser has taken much of that risk and has made running that particular business more or less formulaic. This does not mean that there are no risks; there are risks but the magnitude of those more or less formulaic. This does not mean that there are no risks; there are risks but the magnitude of those risks are greatly diminished and the uncertainty of the product or service success is already established in the general market. This does not always and necessarily mean that the specific demographics in which franchise will be operating is a proven concept yet. That aspect of it has to be vetted. And that could be biggest risk.

While taking –out the risk of testing, if a particular format or service sells in a particular market, the risk mitigation through entry fees is paid. Most franchises are priced so that the startup costs exceed the cost of setting-up a similar business. Since the set-up is formulaic, through, it is a proven approach to success, all other things being equal.

Developing a Franchise
Many dream of this idea that involves creating a new business model, testing it, and then developing a replicating process so that a franchise can be developed from this replication concept. Each franchise is identical and is typically run by entrepreneurs. The franchiser can benefit can benefit from the initial headwork by both getting initial franchising fees from each franchiser can benefit from the initial hard work by both getting initial franchising fees each franchise and then annuity payments as each franchise continues to flourish. The name and the model are owned so it is hard to copy. The following checklist suggests what to look for in order to develop the business;

1) Know What Business is Getting Into: Start small prove the concept at the pilot level and then develop a more robust business model that is replicable.

2) Talk to Franchise Consultants: This small, prove the concept at the pilot level and then the concept is new of it is scalable.

3) Reach- out to Thought Leaders: The people who understand, support and can stand behind the venture with some clout are good to find. Hook-up with incubator programs and alliances that allow the business to leverage resources and time. These leaders are now potential board. Hook-up with the local Chamber of Commerce and venture capital firms.

4) Understand the Law: Different status have laws that vary. The business may need help in making sure that both business and the franchisee are protected.

5) Know Business’s Professional Limitations: Hire the best leaders. Business may be good at new concept and taking them to the pilot stage. Once business has a scalable model, stakes are different. Make sure that business have a professional management team to run the operations.

Starting a Business
For many, starting a business can be an exciting venture, especially if the offering is something that is novel, or trendy. This can be gratifying undertaking and in some respects, much like raising a child and nurturing it to success. Those starting-out in a new business underestimate the effort that goes into making the business a going concern. The investment is usually more than most estimate, the time it takes to break-even is longer than expected and there are surprise along the way that require contingency planning and resources, not apparent in a conventional planning methodology . Fewer than half of new business survive past the first two years of operation and fewer than 20 per cent survive the first five! The most notorious of these is the restaurant business. The failure rate for restaurants in the first two years is 90 per cent.

Before entering a new business, careful study of demand, business model, competition, capital availability and management of its operations are critical to launching it. Evaluate all options before entering into a business venture, especially when the economics conditions are challenging.

Partnering
Going into a business with a partner can be a fun venture. If businessman can pool his resources including his capital, management talent and expertise, this can be a profitable and productive venture. This can be done in any of the formats discussed above. Good understanding of partnerships and good relationship with the partner(s) are critical to the success of such an arrangement. A contact is also critical to a successful partnership.

If businessman spouse already has a business or an idea for a venture, it is tempting to be partners. As long as an agreement of roles, responsibilities and monitoring of ongoing operations to the satisfaction of both can be worked-out, this can be made to work. Keeping the household relationship separate from the business is difficult, but can be made to work with some ground rules set-up before starting the arrangement.

Buying a Business
Buying an established business is an attractive option for those who are not good at estimating what it takes to get a business going; businessman does not know if it ever will reach year hundreds of thousands of businesses in this country are bought and sold.

Buying a business offers some flexibility. Businessman can run the business himself or find someone who can run it for him and compensate that person for doing so. A running business can be evaluated by going through its history, talking to its customers and suppliers and checking-out reputation in the community. Buying a business and instincts and what would differentiate the acquired business from what it is. This requires a vision and leadership expertise. Before closing a deal, make sure that all liabilities are researched of due diligence have been done as businessman take the business on as his own.

Factors Considered while Buying a Business


Buying an existing business can be a much less risky and more quickly venture than starting our own business from scratch. But it is not entirely risk free and our success will depend heavily on how wisely we choose and evaluate the business that we buy.

Here are the “tries to kick” as we begin investigating a prospective business purchase. These items are not meant to substitute for an in-depth evaluation—which we will want to conduct once you have gone through this first step.

Various factors to be considered while buying a business are:

1) Financial Statements: Look at both financial statements and tax returns from the past 3-5 years to judge both the current fiscal health and financial trends. Make sure we see figures that are accompanied by an audit the current fiscal health and financial trends. Make sure we see figures that are accompanied by an audit letter from a reputable CPA firm. Do not accept a simple financial review or a compilation, because these are based on figures supplied by the company. Is the business in sound financial condition? Do financial statements match tax returns? Are sales and operating ratios in line with the industry average? Our accountant can help us to analyze these figures to determine the net worth of our company.

2) Payables and Receivables: Check the dates on invoices to see the business is keeping –up with its bills. Normal payment times vary from industry to industry, but generally thirty to sixty days are standard. If bills are being paid ninety or more days past the invoice date, the owner may be struggling with cash flow. Also find out whether or not any liens have been placed against the business because of unpaid bills.

Inspect the accounts receivable with a skeptical eye; often their stated value is somewhat inflated. Take a close look at the dates on them to determine how many are delinquent and by how long. This is important because the older the receivable, the lower its value and the greater the chance that it will never be paid. While you are it, make a list of the business’s top ten accounts and run a credit check on them, if the majority of customers or clients are creditworthy but late to pay, we may be able to solve the problem with a more rigorous collection policy. If the clientele is financially unstable, start looking for another business.

3) Employees: Key personnel are an important asset to many businesses. We need to determine how critical the employees are, to the success of the business. We also need to look at their work habits to determine if these are people whom we can work with. How long have these key employees been with the company? Will these people remain with the company after a change of ownership? What are their relationships with customers and would customers follow any of these employees if they were to leave? Also look at the role the current owner plays in the company. Is this a role we want to play? Are there any current employees who can take over those responsibilities if necessary?

4) Customers: These are the most important asset we may be buying with thee business. Make sure they are as solid as the other tangible assets, we will be acquiring. Does the clientele have a special relationship with the current owner (long-time friends or relatives) How long have these accounts been with the business and what percentage of the income do thy represent? Will they leave or stay when the business passes to new hands? Does the current owner or manager seem to have good relationships with the customers? Is there a written policy for handling customer complaints, returns, disputes, etc.? Has the owner supported the local community or the industry?

5) Location: This is especially important if we are buying a retail business. How important is location to the success of the business? How good is the location of this particular business? Is there sufficient parking to make it easy for customers to visit? How dependent is the business on walk-in trade? What does the future hold for the area? Is it in the process of rapid change from new residential or business complexes on the way? Will the location become more or less desirable because of contemplated changes in the neighborhood?

6) Appearance of Facilities: The environment in which a company operates can tell us a lot about it. Take some time to eyeball the company’s physical location. How does this place look to us? Did we have a good first impression when we entered? How well is it maintained? Is there any outstanding maintenance work to be done- leaky roof, peeling paint, poor signage? Is the place well organized out front and in the back where inventory is kept?

7) Competitors: When we are buying a business, we need to understand the competitive environment in which it operates. Pay attention to industry trends and how they might affect the company that we are considering. How competitive is this industry? Who are our competitors and what are their tactics? Are price wars common in this business? How has the competitive environment changed recently? Have any competitors gone out of business? Why? We can track this information by contacting an industry association or reading trade publications.

8) Registrations, Licenses, Zoning: Make sure that key business licenses and other legal documents can be easily transferred. Determine, what the process for transfer would be and what it would cost, by contracting the proper state and local authorities. If a company is a corporation, what state is it incorporated in? Is it operating as a foreign corporation in its home state?

9) Image: How a company is perceived can be a serious asset or a liability that cannot be judged from a balanced sheet. There are a wide range of intangibles that we need to consider when we are evaluating a company- everything from the why it services its customers to how it answers the phones to whether or not it supports the community or the industry. This category is often referred to as “goodwill.” Talk to customer suppliers, competitors, banks, and owners of other businesses in the area to learn more about this firm’s reputation. Remember that it is very difficult to change a negative perception.

Process of Buying


Once a potential target for purchase has been identified, the next logical step is to thoroughly investigate the business. This has to be done in a systematic manner.

1) Preliminary Information Collection: Talk to the business owner to find out more about the business. One of the most important question to be asked is--- Why is the owner selling the business? Usually, people off-load a business in case it is losing money, but there may be a variety of other reasons prompting the business owner to sell. He/She may have simply lost interest in the business. There may be some other reasons such as the old age of the owner and his/her willingness to retire, his propensity to explore a new opportunity and so on.

2) Site Visit: Nothing like visiting the business to get a feel for the business one is planning to buy. In case it is a business open to the public such as a shop or a restaurant, one can walk in anytime convenient to him. It is a good practice to visit repeatedly mixing in both announced and unannounced visits.

3) Assessment: It is the stage to ask the business owner to hand over documents to help the successor assess the business. Audited financial documents for past years, sales data, purchase records for capital equipment and raw material, employee records, bank statements, etc., can be of help in the assessment. Not all documents are taken at once. Usually, after the first lot of documents is scrutinized, some questions remain documents are taken at once. Usually, after the first lot of documents is scrutinized, some questions remain unanswered or further questions are raised. That calls for more documents to be presented for scrutiny. It is not a question of trusting or mistrusting the seller but of making sure that the business measure up to the parameters.

4) Additional Information collection: It is useful to cross-check the information on the company documents with some significant other sources. This can be done by interviewing customers, employees, competitors, etc. This may also need accessing other documents from government files, public records, etc. It is useful to talk to industry to get a view of the overall scenario in the industry.

5) Negotiation: The negotiation is not just about agreeing on a piece. There are a lot of factors which will be discussed and negotiated upon. One important thing to remember is that anytime during the deal, each party is free to walk away from it. There is no compulsion to come to an agreement and finalize the deal.

6) Transition: The process does not come to an end with a change in ownership. What follows is a very critical transition period. During this time, it is important to get the support of key people. It could be in the form of passionate involvement of key senior employees or a statement from a major customer expressing confidence in the new owner’s abilities. At this stage, it is invaluable to get some guidance from the former owner. It will help a lot to handle apprehension of employees and business associates alike. This is also the time to introduce in the new handle apprehension of employees and business was incurring a loss, there is also the time to introduce important changes in the style of functioning. If thee business was incurring a loss, there must have been a reason for that and resolving that would need a change in the way things were getting done previously.

Valuation of Business


Many different methodologies can be used to value a firm being acquired. There is no best way to do it. A lot depends on the circumstances.

The various methodologies used can be put in the following categories:

1) Value of Assets: The value of a firm is taken as the value of the sum of its assets. For current assets and current liabilities, the starting point is the value as shown in the balance sheet and other books of account, and then some adjustments are made, the inventory may be valued at a discount to account for stray wastages and some obsolescence. Accounts receivable will be valued at a significant discount after taking into consideration, the age and quality of the receivables.

Land is obviously valued at current market rates, but there may be significant disagreements on what is the current market price.

The main issue is the valuation plant and machinery. Different types of value approaches are:

i) Book Value: Book value is the value carried in the financial statements. Usually, it is the acquisition cost minus the accumulated depreciation. Some adjustments may be made to reflect subsequent up-gradation and changes in the market value. The problem with using this value is that it may have no correlation with the current worth of the machinery.

ii) Replacement Value: Replacement value represents the cost of replacing existing machinery at current market prices. The seller would want to use this figure.

iii) Recovery Value or Sale Value: Recovery value or sale value indicates the price thee equipment would fetch if sold in the open market. The buyer is likely to use a pessimistic estimate of the current sale value.

In addition to the value of tangible assets in the form of intellectual property and market reputation have also to be valued.

2) Return on Investment (ROI): Return on Investment (ROI) is used to gauge the profitability of an investment. It is calculated by dividing the profits by the amount invested. It is expressed in terms of a percentage. An investment of Rs 10,00,000 giving an annual return of 3,00,000 is said to have an ROI of 30 per cent.

It is a very popular tool because of its versatility and simplicity. It can be adjusted to account for taxes and interest payments.

The main criticism leveled against the use of ROI is that it fails to take into account different levels of risk. For example, an 8 percent return in government bonds cannot be compared to 30 per cent return in an entrepreneurial venture as they represent different levels of risk.

3) Payback Period: Payback period refers to the length of time required to recover an investment. It is calculated by dividing the investment by the annual profits or by estimating the time it would take to generate cumulative cash flows equal to the initial investment. If a business costs Rs. 6,00,000 to acquire and it gives an average annual cash flow of about Rs. 2,oo,ooo, the payback period is three years.

This is a very popular metric used by smaller businessmen to quickly evaluate new opportunities. All other things equal. An investment with a shorter payback period is preferred.

The main problems with this method are as follows:

i) It does not put a value on profits accruing beyond the payback period.
ii) The time value of money is not acknowledged. Information and depreciation are not taken into consideration.

Advantages of Buying a Business

1) Buying an existing business will enable the person to avoid a lot of problem likely to crop-up in opening a new business.

2) The existing business would have already got some licenses and government approvals, which would be otherwise difficult to get. A new business would require a lot of time and, in some cases, even a lot of ‘speed money’ to get those licenses and permits. Some existing units have certain permits or incentives than are no longer open to new units being set-up.

3) Land is scarce and it is difficult to find an appropriate location. An existing business is likely to bundle the purchaser with the land it operates form, Furthermore, the viability of its location has already been tested. There is no make separate efforts to deal with brokers and haggle with landowners to acquire land.

4) The plant and machinery have already been bought and have been installed and tested. They also have a history of performance, which might be logged in factory log books.

5) Employees are experienced. It might be possible to pick up experienced employees from other organizations too, but in this case, the employees have experience in that particular business set-up.

6) A supplier base has already been established. Processes have been established and a relationship has been built –up with the suppliers.

7) There is a readymade market. The firm has been selling its products and a customer base has been established.

8) A distribution network has been set-up and money and effort has already been invested in establishing a rapport with retailers and wholesalers.

9) Goodwill and reputation built up over the years by the existing business would not change to a large extent with the change in ownership.

10) Banks may be more willing to lend to a business with running operations, an established customer base, and a steady cash flow.

11) Cash flow is going to start immediately. A new operation takes some time in stocking up the goods, sending them to the market and getting a stable cash flow. In an existing business, cash flows have already been established.

12) It might be cheaper than setting up new operations. Assets may seem more valuable to a person getting into the business than to one getting out of the business.

13) The former owner may be persuaded to guide us in the early days. This free advice may prove to be invaluable. It happens more likely if the payments for the purchase of the business are phased over a period of time.

Disadvantages of Buying a Business

There may be some disadvantages of buying an existing business, which should be weighed against the benefits before making a decision.

1) There may be some disadvantages of buying an existing business, which should be weighed against the benefits before making a decision.

2) The owner may possibly be dishonest about the business. The fact that the business is not doing well might be hidden by false statements by the owner, employees, etc. The financial statements and other documents might have been carefully camouflaged or falsified.

3) The equipment is old and outdated. There may have been some recent technological changes that have rendered thee existing machinery useless.

4) The location may be bad or likely to become bad. For example, a talk with the town planners may reveal that the frontage of thee restaurant you were planning to buy is going to be ruined by the new fly-over coming up.

5) Employees may be unproductive or incapable of meeting the standards required of them. Also, it is possible that the employees have been at odds with the management and there has been a poor work culture.

6) Any bad reputation that the business had acquired amongst suppliers, distributors and other people in the industry is likely to pass on to next successor, notwithstanding the change in ownership.

7) The previous owner may have got into some unfavorable long-term contractual obligations, which threaten the viability of the business. For example, a commitment to produce and supply a fixed quantity of material at a prefixed rat would have worked will in situations of suppressed raw material prices but any rise in raw material prices would render such a contract unviable.

8) The inventory lying in stores could be obsolete or unfit for use.

9) If the company’s products have not been received well by the market, it will be difficult to gain market share for these products as compared to a new product.

Negotiation


Negotiation is thee process whereby interested parties resolve disputes, agree upon courses of action, bargain for individual or collective advantage, and/or attempt to craft outcomes which serve their mutual interests. It is usually regarded as a form of alternative dispute resolution.

Features of a Negotiation

1) There are minimum two parties present.
2) Both parties have predetermined goals.
3) Both participants do not share some of the predetermined goals.
4) There is an outcome.
5) Both parties believe the outcome of the negotiation may be satisfactory.
6) Both parties are willing to modify their position.
7) The parties’, incompatible positions make modification of position difficult.

Characteristics of Negotiation Situations

According to Lewicki and Littener, all negotiation situations like the ones cited above have the following well-defined characteristics:

1) There is a conflict of interest between two or more parties; that is, what one wants is not necessarily what the other one wants.

2) Either there is no fixed or established set of rules or procedures for resolving the conflicts or the parties prefer to work outside of a set of rules and procedures to invent their own solution to the conflict.

The parties at least for the moment, prefer to search for agreement rather than to fight openly, to have one side capitulate, to break off contact permanently, or to take their dispute to a higher authority for resolution. The parties understand the purpose of negotiation.

Conduct the Negotiation

Negotiations with a supplier should occur only when a buyer feels confident about the level of planning and preparation put forth. However, planning is not an open-ended process; buyers must usually meet deadlines that satisfy the needs of internal customers within the buyer’s organization. Thus, the buyer faces pressure to initiate, conduct and conclude the negotiation within a reasonable time. Effective planning also requires hard work on the following points:

1) Define the issues.
2) Assembling issues and defining the bargaining mix.
3) Defining Interests.
4) Defining one’s own objectives (targets) and opening bids (where to begin).
5) Assessing constituents and the social context in which the negotiation will occur.
6) Analyzing the other party.
7) Planning the issue presentation and defense.
8) Defining Protocols: Where and when the negotiation will occur, who will be there, what the agenda will be and so on.
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