Small Business and Business Ownership

Chapter 2

Small business and the US Economy

Independently owned and operated w/fewer that 500 employees.Non-employer are self-employed

Less than 4% of all income received from business transactionsEmployer businesses

Account for 99% of all businesses40% of all business income

Starting a small business

Three approachesStarting from “scratch”

Risk of failure is highMust understand market: location, product/service offered, how much will be soldMust understand competitors’ market

Buying an existing businessLess riskyHave current data on which to make decisions

FranchiseThe buyer (franchisee) purchases the right to sell the good or service of the seller

(franchisor).90% success rate.

Franchisor/Franchisee Relationship

Franchisor:Known and advertised brand nameManagement skillsTraining and materialsMethod of doing business

Franchisee:InvestmentLabor and capitalOperationsAgrees to follow the franchise contract.

Advantages of Franchising

The Explosive Growth of Franchising Worldwide (pg 13)Franchisee:

Start a new business while buying an existing businessSuccessful business model already developedControl of risks in External and Internal Business EnvironmentAlready have brand recognition and a fully developed product/serviceAccess to business experts and management trainingCan purchase advertising and supplies through co-op with other franchisees

FranchisorAbility to expand business without trouble of opening a new location.Able to delegate managerial and operational responsibility to franchisee

Disadvantages of Franchising

Operational control:Franchisor

preserve brand recognition and unique characteristicsProtect product qualityTendency to “micromanage” franchisee.

Franchisee:Start up costs are highMust pay a percentage of sales (royalty) back to FranchisorDependent upon other Franchisees upholding reputationFranchisor may compete with franchisee

Evaluating Franchise Opportunities

Name recognition and reputationQuality products?

Franchisor’s experienceHow long has the company been franchising?

GrowthSteady growth or growth too fast?How many franchisees, especially in location

Your investmentAffordability? Can you afford to lose the start up cash?Do you need to borrow?Annual expected (realistically) income

Your Knowledge, Skills, and ExperienceTraining?Do you have previous experience in this area?

Be wary of franchise brokersBroker represents franchisors, who are paying a commissionWritten documentation of expected earnings.Hire an accountant and/or lawyer to review documents

Study the disclosure documentAfter filing application for franchise, request and receive the franchisor’s disclosure

document at least 14 days before any contract is signed.Document will include key sections pertaining to financial and legal history of

franchise.

Seek input from current and previous franchiseesMost reliable way to verify franchisor’s claims

Seek professional helpContact franchise associations

The importance of a Business Plan

Business Plan: formal written plan that clearly explains every aspect of your business.

Missions/GoalsStrengths/WeaknessesMarket AnalysisBreak Even Analysis

Components of a Business Plan

Executive SummaryConcise overview of the nature and organization of the business, the rationale for

opening it, and why the business will be a success.Business Description

Business Purpose, goals, and how these will be achieved.Name of businessContact informationAnalysis of industryForm of business ownershipWho are your “ideal” customers?What is your competitive advantage?Ethical issues and social responsibility

Management and Operation PlanSWOT analysis

Strengths Weaknesses Opportunities Threats

Mission StatementBusiness goalsManagement teamOrganization structurePhysical layoutOperational scenariosEtc.

Human Resource PlanPersonnelJob descriptions and specificationsCompensation and incentivesCorporate cultureLeadershipTraining and prof. dev.

Marketing planWho is your ideal customer?Analysis of competition

• Financial Plan• Revenue• Expenses• Financing the business• Balance Sheet/Income Statement• Break Even Analysis

• Appendix

Key to Success?

Market DemandBusiness failure is often due to a lack of understanding of the marketplace.

LocationNeed to know the characteristics of customer and locate where they are!Zoning laws are crucial.

Lack of managerial experience Incompetence and managerial mistakes are often listed at top of lists of reasons why a

business fails.Insufficient capital to grow the business

Including poor control over cash flow and expenses. Cash flow: the net amount of cash and cash-equivalents moving into and out of a business.

Financing the Small Business

Venture Capital Company: group of investors that pool their capital to invest in companies with rapid growth potential in return for owning part of the company (equity position).

must have high profit potentialAngel Investor: Wealthy individual who will provide a business with

capital in exchange for equity in the company. “Shark Tank”.

Angel Investors

• You tube: Shark Tank Tree T Pee

Governmental Sources

Small Business Investment Company (SBIC): investment company that borrows money from the Small Business Administration solely for the purpose of investing or lending to small businesses.

Minority Enterprise Small Business Investment Company (MESBIC): finances business owned by minorities.

Microloans: makes small loans (under $35,000) to people such as single mother and public housing tenants

CDC/504 Loans: long-term, fixed rate financing for expansion or modernization. Private, non-profit that works through the SBA.

Assistance for Small Businesses

SCORE: Service Corps of Retired Executives: retired executives that work with small businesses. Website with wealth of info for small businesses.

ACE: Active Corps of Executives: ran by executives who are still working.

SBI: Small Business Institute: college and university students and instructors work with small businesses on specific problems.

SBDC: Small Business Development Center: consolidates information from various disciplines for small businesses.

Why start your own Business?

Want to be small and stay smallMore satisfying relationships with employees, clients, vendors, etc.Becomes an integral part of the community where it residesAbility to adapt quickly to changing business environmentDisadvantage: risk of failure due to lack of capital.

Small size usually equals limited financial resources and lack of access to capital market

By deciding to stay small, the owner limits the potential of the business.

The Role of the Entrepreneur

More of a mindset:Love innovationHave a wide vision of where they want to goA strong desire to be successful and make moneyLove to idea of creating employment opportunitiesWilling to accept a higher level of risk.

Skills Entrepreneurs need:

Need to be alert to changes in their everyday environmentHave a wild enough imagination to see how the changes can alert

them to other possibilitiesDeep belief in their ideas and believe in the importance of their ideasResearch everything they need to know about fulfilling their ideas,

their dreams. Self disciplined; task oriented; hard workers. Very demanding out of

themselves and others. Not for wimps!Women-owned business—pg 20

Internet Based Small Business

Appealing because it’s easy and has a low costHowever:

Must follow federal privacy laws enacted by the Federal Trade CommissionMust know how to properly collect and pay any applicable state sales and use tax

which are applicable in the state where the customer resides.Must understand rules and regulations that apply for exporting to foreign

countries.Become familiar with the federal laws regulating advertisement and marketing

online.Must follow Digital Millennium Copyright Act that protects the copyright of

intellectual property owners whose work is transmitted or used over the internet.May need to hire a consultant who specializes in online retailing.

Using Social Media

Affiliate Marketing: A common marketing strategy for increasing sales and customer loyalty is to reward customers for referrals.

Widget: a small piece of software from the retailer’s web page that is placed on the customer’s social media page. When a friend clicks on the widget and buys, the customer is rewarded.

Research: engage current and potential customers in a conversation about a product or service. Provides relevant information that assists a cutomer in making a purchase.

Types of Business Ownership

Sole Proprietorship:One person owns and operatesEasy to establishSimple structureOwner maintains a high degree of control

Tax implicationsIncome from business goes on owner’s personal tax return. Taxed only once

Disadvantage:Lack of access to capitalOwner is exposed to risk

Personal assets may be seized to pay business debt. May cause personal bankruptcyBusiness succession if owner dies.

General and Limited Partnerships

General partnershipsEach partner contributes financially, increasing the amount of capital

available.Financial losses are shared in proportion to the investmentShare in work and managerial duties

Tax implicationsIncome is included on personal tax returns of partners. Taxed only once.

Liability—unlimitedPersonal assets can be seized to cover business losses. May cause personal

bankruptchy

Limited PartnershipPartners have some limited liability in case of business failure.Are not allowed to manage the business.“General Partner” manages the business for all other partners.

Has unlimited liability—may be personally liable for debtsPaid a salaryParticipates in the profits and losses of the partnership

Page 23: Why General Partnerships are a Liability Nightmare

Corporation

Legal entity that can act and have liability separate from the individuals who set up the corporation.

Owners are “stockholders”. Only liable up to the amount of their personal investment.

Chartered by the state government. In Indiana—through the Secretary of State’s Office

Profit/Non-ProfitPublic/Private Ownership

AdvantagesLimited liabilityEase of raising capital through the sale of stockContinuity of the business. Lives beyond the lifetimes of the owners

DisadvantagesLegal: Charter, filing fees, additional expensesTax implications: Taxed twice—first as a corporation and then on each

individual stockholder’s income tax for the dividends received.May become inflexible; non-responsive to stockholders.Public corporations must publicly disclose financial information

The “S” Corp

Provides the protection of a corporation but taxed like a partnership.Under Subchapter S of Chapter 1 of the US Internal Revenue CodeConditions to meet:

Have no more than 100 stockholdersShareholders must be individuals (not companies) who are citizens or permanent

residents of the United StatesOffer only one class of stock (either common or preferred stock)Receive no more than 25% of corporate income from passive sources such as rent,

royalties, or interestDisadvantages:

Subject to IRS Code, which changes frequentlyMay have a state corporation tax to pay

Limited Liability Corporation

Liability of each owner is limited to the amount that each investsOption of being taxed like a partnership or corporationNot limited on membershipMust have an operating agreementDisadvantages

LLC must be dissolved after 30 years (some states)Death of a member dissolves the LLC

Flexible

Cooperatives

Same people who buy and use the products and services of the cooperative are the people who own and run it.

Combine resources for mutual benefits in order to provide servicesElect Board of DirectorsSurplus revenue is returned to the members in proportion to the

member’s use of it, not in proportion to investment.Farmers use them a lot.

Non-Profit Organizations

Exist to provide services to the public, not to make a profitAny capital left after operating expenses are paid is funneled back

into the non-profit.Exempted from income taxesMust apply to state for incorporation; must file with IRS to become a

501( c )3.Must be charitable, educational, scientific, religious, or literaryMust meet other criteria as established by the IRS code.

Merger/Acquisitions

Merger: two or more companies become a single companyVertical: companies at different phases of the production process become one. Ex: Steel

Dynamics buying scrap metal recyclerHorizontal: companies in the same industry or companies involved in the same phase of

a production process. Reduces competition and can reduce production costs by eliminating duplicate facilities and realizing economies of scale. Ex: Comcast and Frontier

Conglomerate: highly diversified company made up of two or more corporations in different industries. Ex: Berkshire Hathaway owns MedPro, Dairy Queen and Geico

Acquisitions: One company purchases the property and assumes the liabilities of another. The acquired company may keep its own identity.

Leveraged Buyout: Merger or acquisition is accomplished by using borrowed money