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Small Business, Entrepreneurship, and Franchises

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Small Business, Entrepreneurship, and Franchises

The Small Business

  • Independently Owned and Operated
  • Not Dominant In Its Field
  • Relatively Small Annual Sales
  • Fewer Than 500 Employees

One reliable source of information for small businesses is the Small Business Administration (SBA). This government agency serves as a resource and advocate for small firms, providing them with financial assistance, training, and a variety of helpful programs that are discussed later in this chapter. The SBA defines a small business as a firm that is (a) independently owned and operated, (b) is not dominant in its field, (c) relatively small in terms of annual sales, and (d) has fewer than 500 employees. The SBA reports that 80 percent of all U.S. companies have annual sales of less than $1 million and that about 60 percent of the nation’s employers have fewer than five workers .

Economic Roles of Small Business

·         Provide New Jobs

·         Introduce New Products

·         Service Large Corporations

·         Engage in Specialization

Here are just some of the important roles small businesses play in the economy:

 

They provide jobs. Small businesses create about 67 to 75 percent of new jobs. Moreover, some 22 million small businesses employ more than 51 percent of the private non-farm U.S. workforce and generate more than half of the private U.S. gross domestic product.

They introduce new products. The National Science Foundation estimates that small businesses produce 55 percent of U.S. product innovations, a high percentage given the fact that small companies spend considerably less on research and development than large companies do.

They supply the needs of large corporations. Small businesses provide new workers (those entering the labor force for the first time) with basic job training. Additionally, many small businesses are distributors, servicing agents, and suppliers who service the needs of larger corporations.

They provide specialized goods and services. Michelle Donahue-Arpas launched GeniusBabies.com to sell a specialized good—gift baskets for parents of newborns.

Types of Small Business

Small businesses are of two distinct types: lifestyle businesses and high-growth ventures. Roughly 80 to 90 percent are modest operations with little growth potential (although some have attractive income potential for the solo businessperson). The self-employed consultant working part-time from a home office, the corner florist, and the neighborhood pizza parlor fall into the category of lifestyle businesses--firms built around the personal and financial needs of an individual or a family. Lifestyle businesses aren’t designed to grow into large enterprises.

In contrast to lifestyle businesses, some firms are small simply because they are new. Many companies--such as FedEx, Microsoft, and Papa John’s--start out as small entrepreneurial firms but quickly outgrow their small-business status. These high-growth ventures are usually run by a team rather than by one individual, and they expand rapidly by obtaining a sizable supply of investment capital and by introducing new products or services to a large market. But expanding from a small firm into a large enterprise is no easy task; there’s a world of difference between the two.

The typical small business has few products or services, focuses on a narrow group of customers, and remains in close contact with its markets. In addition, most small-business owners work with limited resources and tend to be more innovative.

How Entrepreneurs Spend Their Time

The men and women who start their own businesses are jacks-of-all-trades. However, they devote the lion’s share of their time to selling and producing the product.

Traits of Entrepreneurs

Besides the ability to see things differently, commonly know as vision, entrepreneurs tend to have these qualities in common:

         They are highly disciplined.

         They like to control their destiny.

         They listen to their intuitive sense.

         They relate well to others.

         They are eager to learn whatever skills are necessary to reach their goal.

         They learn from their mistakes.

Traits of Entrepreneurs

  • Stay abreast of market changes
  • Willing to exploit new opportunities
  • Seldom follow trends (rather, they spot and interpret trends)
  • Driven by ambition
  • Think positively
  • Prefer risk taking over security

Factors Contributing to Small Business Growth

  • Technology and the Internet
  • Women and Minorities
  • Downsizing and Outsourcing

Three other factors are contributing to the increase in the number of small businesses today: technological advances, an increase in the number of minorities and women starting businesses, and corporate downsizing.

Personal computers, laptops, fax machines, copiers, printers, answering machines, e-mail. and the Internet have made it easier and more affordable for people to start and operate small businesses. Technology and the Internet also make it easier for people to run their businesses from home. Accountants, writers, lawyers, and consultants can use technologies to set up shop at home—or on the web. In fact, according to the Small Business Administration, about 53 percent of all small businesses are home based.

An increase in the number minority and women entrepreneurs is also fueling small business growth. Data from the U.S. Small Business Administration show that between 1987 and 1997, the number of minority-owned firms grew 168 percent—more than triple the 47 percent growth rate of U.S. businesses overall. Minority-owned firms now make up 18.6 percent of all small businesses. The number of women starting small businesses has also increased sharply over the past three decades—from 5 percent of all small businesses to over 39 percent.

Contrary to popular wisdom, business start-ups soar when the economy sours. During hard times, many companies downsize or lay off talented employees, who then have little to lose by pursuing self-employment. Armed with years of experience, a working knowledge of their industries, and a network of connections, these former employees set out to establish companies of their own.

Women Starting Businesses

More than half of all women business owners started their own businesses because they had an entrepreneurial idea or wished to advance their careers.

Starting a Small Business

  • New Business
  • Existing Business
  • Franchise

No matter how fast you learn and how much investigating you do, you’re likely to find that the challenges of running a business are far greater than you anticipated. If you decide to take the risk, you can get into business for yourself in three ways: Start from scratch, buy an existing business, or obtain a franchise.

Starting a New Business

If you start a new business, you have the potential for controlling your destiny, reaching your full potential, unlimited profits, recognition for your efforts, and doing what you joy. Disadvantages of starting your own business include uncertainty of income, risk of losing your entire investment, long hours and hard work, complete responsibility, and high stress levels.

Buying an Existing Business

Another way to go into business for yourself is to buy an existing business. This approach tends to reduce the risks--provided, of course, that you check out the company carefully. When you buy a business, you generally purchase an established customer base, functioning business systems, a proven product or service, and a known location. You don’t have to go through the painful period of building a reputation, establishing a clientele, finding suppliers, and hiring and training employees. In addition, financing an existing business is often much easier than financing a new one; lenders are reassured by the company’s history and existing assets and customer base. With these major details already settled, you can concentrate on making improvements.

Still, buying an existing business is not without disadvantages. For one thing, the business may be overpriced. For another, inventories and equipment may be obsolete. Furthermore, the location may no longer be satisfactory, the previous owner may have created ill will, your personality may clash with those of existing managers and employees, and outstanding bills owed by customers may be difficult to collect. Keep in mind that no matter how fast you learn and how much investigating you do, you’re likely to find that the challenges of running an existing business are far greater than you anticipated.

The Franchise Alternative

An alternative to buying an existing business is to buy a franchise in somebody else’s business. This approach enables the buyer to use a larger company’s trade name and sell its products or services in a specific territory. In exchange for this right, the franchisee (the small-business owner who contracts to sell the goods or services) pays the franchisor (the supplier) an initial fee (which can range from $1,000 to $10 million) and monthly royalties.

Franchises are of three basic types. A product franchise gives you the right to sell trademarked goods, which are purchased from the franchisor and resold. Car dealers and gasoline stations fall into this category. A manufacturing franchise, such as a soft-drink bottling plant, gives you the right to produce and distribute the manufacturer’s products, using supplies purchased from the franchisor. A business-format franchise gives you the right to open a business using a franchisor’s name and format for doing business.

The Pros and Cons of Franchising

For one thing, when you invest in a franchise, you know you are getting a viable business, one that has “worked” many times before. If the franchise is well established, you get the added benefit of instant name recognition, national advertising programs, standardized quality of goods and services, and a proven formula for success. In addition to a ready-made blueprint for success, for an initial investment (from a few thousand dollars to upward of a million, depending on the franchise), franchisees generally get these services: site-location studies, market research, training, a support network, technical assistance, and assistance with building or leasing your structure, decorating the building, purchasing supplies, and operating the business. Because few franchisees are able to write a check for the amount of the total investment, some franchisors also provide financial assistance.



Although franchising offers many advantages, it is not the ideal vehicle for everyone. First, owning a franchise is no guarantee of wealth. Even though it may be a relatively easy way to get into business, not all franchises are hugely profitable. Another disadvantage of franchising is the monthly payment, or royalty, that must be turned over to the franchisor. Royalties are not necessarily bad as long as the franchisee gets ongoing assistance in return. An additional drawback of owning a franchise is loss of independence.

How to Evaluate a Franchise

Ø      What does the initial franchise fee cover?

Ø      How are periodic royalties calculated and when are they paid?

Ø      Are all trademarks and names legally protected?

Ø      Who provides and pays for advertising and promotion?

Ø      Who selects the location of the business?

A franchise agreement is a legally binding contract that defines the relationship between the franchisee and the franchisor. Because the agreement is drawn up by the franchisor, the terms and conditions usually favor the franchisor. Before signing the franchise agreement, be sure to consult an attorney.

Ø      Is the franchise assigned an exclusive territory?

Ø      Who has the right of first refusal on additional nearby franchises?

Ø      Is the franchisee required to purchase equipment and supplies from the franchisor?

Ø      How can the franchise agreement be terminated?

Ø      Can the franchise be assigned to heirs?

Nevertheless, some people find out too late that franchising isn’t the best choice for them. They make a mistake common among prospective franchisees—buying without really understanding the day-to-day business. Often, prospects simply don’t get beyond the allure of the successful name or concept—or the mistaken notion that a franchise brings instant success.

One of the best ways to evaluate a prospective franchisor is by talking to other franchisees. At a minimum, you should find out what other franchisees think of the opportunity. Market saturation is another important issue to consider when evaluating a franchise opportunity.

Importance of a Business Plan

  • Guide Company Operations
  • Outline Strategy
  • Attract Lenders and Investors

One of the first steps you should take toward starting a new business is to develop a business plan, a written document that summarizes an entrepreneur’s proposed business venture, communicates the company’s goals, highlights how management intends to achieve those goals, explains its marketing opportunities and strategy, and shows how consumers will benefit from the company’s products or services.

Preparing a business plan serves two important functions: First, it guides the company operations and outlines a strategy for turning an idea into reality. Writing a plan requires you to gain an in-depth understanding of the industry in which you plan to compete, and it subjects your ideas to the test of reality. It forces you to make important decisions about personnel, marketing, facilities, suppliers, and distributors and to develop programs that will help you succeed. Second, a business plan serves as a vehicle to attract lenders and investors. In fact, if you don’t have a business plan, many investors won’t even grant you an interview. A solid business plan is written proof to potential investors that an entrepreneur has performed the necessary research and has studied the business opportunity adequately. It demonstrates that the entrepreneur has considered both the positive and negative aspects of the new venture. It may even deliver the hard truth—that the concept just won’t work. Discovering this fact on paper can save considerable time and money.

Business Plan Elements

A formal plan, suitable for use with banks or investors, should cover these points:

         Summary. In one or two pages, summarize your business concept. Describe your product or service and its market potential. Highlight some things about your company and its owners that will distinguish your firm from competition. Summarize your financial projections and the amount of money investors can expect to make on their investment. Be sure to indicate how much money you will need and for what purpose.

         Mission and objectives. Explain the purpose of your business and what you hope to accomplish.

         Company and industry. Give full background information on the origins and structure of your venture and the characteristics of its industry.

         Products or services. Give a complete but concise description of your product or service, focusing on its unique attributes. Explain how customers will benefit from using your product or service instead of those of your competitors.

         Market and competition. Provide data that will persuade the investor that you understand your target market and can achieve your sales goals. Be sure to identify the strengths and weaknesses of your competitors in addition to the features and benefits of your product or service.

         Management. Summarize the background and qualifications of the principals, directors, and key management personnel in your company. Include résumés in the appendix.

         Marketing strategy. Provide projections of sales and market share, and outline a strategy for identifying and contacting customers, setting prices, providing customer services, advertising, and so forth. Whenever possible, include evidence of customer acceptance, such as advance product orders.

         Design and development plans. If your product requires design or development, describe the nature and extent of what needs to be done, including costs and possible problems.

         Operations plan. Provide information on the facilities, equipment, and labor needed.

         Overall schedule. Forecast development of the company in terms of completion dates for major aspects of the business plan.

         Critical risks and problems. Identify all negative factors and discuss them honestly.

         Financial forecasts and requirements. Include a detailed budget of start-up and operating costs, as well as projections for income, expenses, and cash flow for the first three years of business. Identify the company’s financing needs and potential sources.

         Exit strategy. Explain how investors will be able to cash out or sell their investment, such as through a public stock offering, sale of the company, or a buyback of the investors’ interest. When covering these points, keep in mind that your audience wants short, concise information—not lengthy volumes—and realistic projections for growth.

Why New Businesses Fail

Most new businesses fail for a number of reasons :

  1. Management incompetence.
  2. Lack of industry experience.
  3. Inadequate financing.
  4. Poor business planning.
  5. Unclear or unrealistic goals.
  6. Failure to attract and keep target customers.
  7. Uncontrolled growth.
  8. Inappropriate location.
  9. Poor inventory and financial controls.
  10. Inability to make the entrepreneurial transition.

Sources of Assistance

  • SCORE
  • Incubators
  • The Internet
  • Small Business Administration (SBA)

Many local business professionals are willing to serve as mentors and can help you avoid the pitfalls of business. As a small-business owner, you may turn to small-business resources such as the Service Corps of Retired Executives (SCORE), incubators, the Internet, and the Small Business Administration. These resources can help you evaluate your business idea, develop a business plan, locate start-up funding sources, and show you how to package your business image professionally.

Private Sources of Financing

Most new businesses turn to private financing sources, such as family, friends, and loans from banks, finance companies, or other commercial lenders to finance their needs.

One good source of private financing is big business. Companies such as Coca-Cola and Procter & Gamble fund young companies in exchange for stock or exclusive rights to future products.

Bank loans are another source of private financing, but obtaining such financing can be difficult for most start-ups.

Venture capitalists are investment specialists who raise pools of capital from large private and institutional sources (such as pension funds) to fund ventures that have a high, rapid growth potential and a need for large amounts of capital.

Comfortable with risks that scare off many banks, angel investors put their own money into start-ups with the goal of eventually selling their interest for a large profit.

According to a recent study by the Federal Reserve, approximately one-third of small businesses use credit cards to finance their new business ventures.

Going Public

Public financing is achieved by selling shares of a company's stock. Whenever a corporation offers its shares of ownership, or stock, to the public for the first time, the company is said to be going public. The initial shares offered for sale are the company’s initial public offering (IPO). Going public is an effective method of raising needed capital, but it can be an expensive and time-consuming process filled with regulatory nightmares. Public companies must file a variety of statements with the SEC, pay costly fees, and prepare audited financial statements.

KEY TERMS

         

business plan - A written document that provides an orderly statement of a company's goals and how it intends to achieve those goals

franchise - Business arrangement in which a small business obtains rights to sell the goods or services of the supplier (franchisor)

franchisee - Small-business owner who contracts for the right to sell goods or services of the supplier (franchisor) in exchange for some payment

franchisor - Supplier that grants a franchise to an individual or group (franchisee) in exchange for payments

incubators - Facilities that house small businesses during their early growth phase

initial public offering UPO) - Corporation's first offering of stock to the public

small business - Company that is independently owned and operated, is not dominant in its field, and meets certain criteria for the number of employees and annual sales revenue

start-up companies - New ventures

stock - Shares of ownership in a corporation

venture capitalists - Investment specialists who provide money to finance new businesses or turnarounds in exchange for a portion of the ownership, with the objective of making a considerable profit on the investment; also called VCs

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