SMALL BUSINESS MANAGEMENTChapter 5: Buying a Business and
Franchising
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What advantages did this entrepreneur obtain as a result of buying an existing business?
How would he determine the price to buy this business?
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Advantages of Purchasing an Existing Business
Reduction of Risk Existing business records Less planning Experienced employees
Reduction of Time and Setup Expenses Reduction of Competition Capitalization of Business Strength Possible Assistance from Previous Owner Easier Planning Existing customers/ suppliers Necessary equipment Bargain price
Purchasing an Existing Business
Disadvantages of Purchasing Physical Facilities Personnel Inventory Accounts Receivable Financial Condition Market Deciding on the Price Poor business image Modernization required Purchase price based on inaccurate data Poor business location
Sources of Businesses For Sale
Internet Trade Journals Government Departments Real Estate Brokers Other Professionals
Matchmakers Accountants Lawyers Other experienced business owners
Word of Mouth
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Why is owner selling?
Owner’s reasons for selling the business Old age or illness Desire to relocate in a different section of the
country Opportunity to start another business 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
Evaluating a Business For Sale
Industry Analysis Sales and Profit Trends in the Industry
The Previous Owner Financial Condition of the Business
Validity of the Financial Statements Evaluation of the Financial Statements
Evaluating a Business For Sale
Condition of the Assets Liquid Assets (Cash and Investments) Accounts Receivable Inventory Building and Equipment Real Estate Goodwill
Evaluating a Business For Sale
Quality of Personnel External Relationships of the
Business Conditions of the Records
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Determining the Price or Value of a Business
Market Value Asset value
Book Value Replacement Value
Earnings Value Capitalization of Earnings Method
Average Earnings/Predetermined Interest Rate = Capitalized Value
Times Earnings Method Arbirtraily multiplies earnings by a factor of between 1-10 Small business usually between 4 or 5
Calculating average earnings for a business
Average earnings
Last year $5,000
Two years ago $4,000
Three years ago $7,000
Four years ago $10,000
Five years ago $14,000
total $40,000
Average earnings 40,000/5 = $8000 $8,000/10% =$80,000
Calculating weighted –average earnings for a business
Average earnings
Last year $5,000 X 5 = $25,000
Two years ago $4,000 X 4 = $16,000
Three years ago $7,000 X 3 = $21,000
Four years ago $10,000 X 2 = $20,000
Five years ago $14,000 X 1 = $14,000
total $96,000 = $6,600/10%
Weighted Average earnings
$96,000/15 = $6,600 = $66,000
Determining the Price or Value of a Business cont.
Combination Method Analytical Method
Adjusted net worth, past earning, future earnings
Historical Method – use historical experience to determine relative indicators of value of a business
Sally's Bar and Grill
Sally's Bar and Grill is available for purchase. Sally's earnings for the past five years were as follows: Last year $50,000Two years ago $60,000Three years ago $30,000Four years ago $40,000 Five years ago $25,000 Determine the value of the business using the following
methods (using interest rates of 11%) using both general and weighted average methods.
Capitalized earnings method Time interest method
The Purchase Transaction
Coverage purchase price, including principal and interest
amounts payment dates - when and to whom detailed list of assets included in the purchase conditions of the purchase - nonfinancial
requirements provisions for noncompliance with conditions and
penalties for breaches collateral or security pledged
Negotiating the Deal
History and Background of Franchising
Most rapid growth in North America since the 1950s.
48 cents of every retail dollar goes to franchise business
Franchise sector is Canada's largest employer
One franchise for every 12 Canadians Franchise revenue in $100 billion range
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What Is Franchising?
Manufacturer-Directed Franchise Ford Motor Company
Wholesaler-Retailer-Directed Franchise Home Hardware
Franchising Company Subway
Franchising Terms
Franchisee An entrepreneur whose power is limited
by a contractual agreement with a franchisor
Franchisor The party in the franchise contract that
specifies the methods to be followed and the terms to be met by the other party
Advantages of Franchising
Proven market for the product or service.
Services the Franchisor May Provide1. Selection of Location2. Purchase or Construction of Site,
Buildings, and Equipment3. Provision of Financing
Advantages of Franchising
Services the Franchisor May Provide (cont.)4. Standardized Methods of Operating5. Advertising6. Purchasing Advantages7. Training
Potential Disadvantages of Franchising
Lack of Independence Cost of the Franchise Unfulfilled Promises Restrictions of the Contract
Product or Service Offered Line Forcing Termination
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Potential Disadvantages of Franchising (cont)
Saturation of the Market Lack of Security Cost of Merchandise Effectiveness of Promotion Exaggeration of Financial Success
Evaluation of a Franchise Opportunity
1.Unproven versus Proven Franchise 2.Financial Stability of Franchise 3.Potential Market for the New Franchise 4.Profit Potential for a New Franchise 5.Territorial Protection 6.Training and Operations Assistance 7.Contract Length and Renewal and Termination
Terms 8.What current Owners are Saying About their
Franchise
The Entrepreneur as Franchisor
What businesses can be franchised? Bull Dog Fitness
Should franchise information provided by a franchisor be discounted? Why or why not?
What problems might arise in con consulting previous franchisees in the process of evaluating a franchise?
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The Entrepreneur as Franchisor
How does one become a franchisor?1. Establish a prototype.2. Prepare the necessary information.3. Investigate the legal requirements.
4. Develop a planned and standardized program of operations.
5. Obtain adequate financing.
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