Should
You
Build or Buy?
There are three primary options
for entering into a business for the first time.
- Start a business from scratch
- Franchise a proven business
concept
- Purchase an existing business
Each of these options has its advantages
and its disadvantages. Let's evaluate each of them briefly.
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Starting a Business from Scratch
Building a business from the ground
up has a certain emotional appeal to it. It requires vision
and persistence, has a relatively high failure rate, and generally
requires more time to get off the ground than the other two
alternatives. Nevertheless, it is often the best choice for
cash strapped entrepreneurs.
A traditional business start-up
affords a degree of control and flexibility that is unmatched
in other start-up options. As the owner of the business, you
are in complete control of every facet of the company. You
alone determine how quickly or slowly to expand. If you are
conservative in your expenditures and do not allow yourself
to be overtaken by debt, you will find this option to be an
attractive one - particularly if you have a limited amount
of capital.
Advantages:
|
Disadvantages:
|
Lower Cost |
Higher risk of failure |
Flexibility |
Lack of support and training |
Work at Own Pace |
Motivational Challenge |
Less Financial Risk |
Access to Start-up Capital |
Total Control |
Isolation |
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Purchasing a Franchise
Franchises offer entrepreneurs an
opportunity to buy into a proven business concept. The idea
behind a franchise is to avoid the school of hard knocks and
hit the ground running. In truth, there seems to be some advantage
to following a franchised business plan. By most estimates,
franchisees have a significantly higher success ratio than
their traditional start-up counterparts.
The popularity of franchises has
grown considerably in recent years. Many businesses have discovered
that franchising a successful business idea is the fastest
way to expand nationally. Over the past few decades the selection
of franchised business opportunities has expanded to include
virtually every retail and service concept imaginable. Maid
Services, Muffler Shops, Pest Control Services, Hair Care
Centers, Travel Agencies, and Mortgage Companies have all
joined the ranks of the fast food companies and convenience
stores that pioneered and perfected the franchise concept.
The right franchise can provide
national brand recognition, a finely tuned business plan,
initial and ongoing training and support, market research,
and even assistance with financing. But franchising is not
for everyone. For starters, most franchisors require that
a prospective franchisee show evidence of significant financial
capability. The most successful retail and fast food concepts
will require a minimum net worth approaching or exceeding
$250,000 before they will enter into serious discussions with
you.
There are of course a growing number
of service franchises which cater to individuals with more
limited financial capability. Janitorial Services, Maid Services,
Painting Services, Travel Agencies, Home Repair Services and
many other businesses offer opportunities at much lower levels
of investment. Be aware, however, that these companies will
have varying degrees of name recognition. Be wary of franchisers
that you have never heard of promising "unlimited" income
potential for a "modest" fee.
Most franchisers require that their
franchisees adhere very strictly to a prescribed business
plan. This is of course for your best good. It is one of the
principal ways the franchiser maximizes your chances of success.
The proven business concept is replicated in meticulous detail
at every new location.
Unfortunately, many entrepreneurs
are uncomfortable with the idea of being so tightly regulated.
A franchise can begin to feel very quickly like the job you
just left behind. While the financial rewards of a well-chosen
franchise can be substantial, you will have to determine for
yourself if the potential rewards justify the loss of control
and flexibility.
If you choose to consider the franchised
business option, be sure that you do a lot of research. Request
information from as diverse a group of franchisers as possible.
Ask a lot of questions and thoroughly evaluate all of your
options. As you carefully study the various alternatives you
will begin to formulate in your mind a picture of what constitutes
a worthy investment.
As you narrow your search, take
the time to call existing franchisees. Generally the franchiser
will provide you with a list of franchisees once you fill
out and submit an initial application. When you call the franchisees
be courteous and be mindful of the fact that they have a business
to run. Explain to them that you are evaluating a potential
investment in the company and that you would appreciate getting
the benefit of their perspective. Be prepared to ask the franchisee
a series of candid questions such as:
If you had it to do over again
would you purchase a franchise from this same company?
What is your biggest challenge?
What do you like most about
the business?
What do you dislike most
about the business?
Do you feel you are treated
fairly by the Franchisor?
Do you feel you receive the
support you need?
How long did it take you
to become profitable?
Do you feel the value you
receive exceeds your ongoing franchise fees?
Are you planning to expand
with this company? Why or why not?
Advantages: |
Disadvantages |
Proven
System |
High Average Up-Front Costs |
Name Recognition |
Monthly Franchise Fees |
National or Regional Advertising |
Lack of Flexibility |
Marketing, Financial & Operational Support |
Limited Geographic Territory |
Ongoing Training |
Restrictions on Expansion |
More Immediate Cash Flow |
Lack of Creativity & Control |
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Purchasing an Existing Business
Purchasing an existing business
can be both lucrative and risky. The stock of small businesses
is generally not publicly traded. Ownership of the enterprise
is typically closely held by one or more individuals. This
private ownership feature creates both additional risk and
additional opportunity.
Risk arises from the fact that financial
and operational information is not always available for a
small operation. If it is available, it may not be readily
accessible to you as a prospective buyer.
Opportunity derives from the fact
that valuation of small businesses in the private arena is
an inexact science. While there are rules of thumb when it
comes to ascribing value to a small business, they are generally
just that - rules of thumb. In the end, there will be a lot
of tire kicking and hand waving as a satisfactory price is
agreed upon.
There are two ways to create immediate
value by purchasing an existing enterprise.
1. Purchase a solid company with
a stable cash flow for a below market price.
2. Purchase a company with a large untapped potential for
a fair market price and then exploit its untapped potential.
The leveraged-buyout artists have
made billions of dollars over the years using these two techniques.
Warren Buffet, the legendary investor has made a good part
of his fortune by purchasing and holding large blocks of publicly
traded stock in companies such as Coca-Cola and Gillette.
What many people don't know is that Warren Buffet has also
quietly invested in a great many privately held companies.
He understands that true value can be created for his company
by capitalizing on the inherent inefficiencies of the private
market.
Of course, the thing that these
professional investors have that the average entrepreneur
does not have is access to expertise and information. This
should not discourage you from taking advantage of purchasing
opportunities. If you are smart and aggressive, you will be
able to gather as much information on a small private company
as a team of seasoned MBA's.
You will have to assertive as you
investigate the business. Plan to ask a lot of questions and
request as much documentation regarding the state of the business
as possible. At a minimum you will want to see financial statements
for the past 3-5 years. You should also request copies of
tax returns - which are often more revealing and truthful
than internal financial reports.
Ultimately you will be relying on
the good word of the present owners of the business to make
valuation assessments.
As you gather information try to
formulate credible answers to the following questions:
- Why is the company for sale?
- Is it a desirable business and
industry for you?
- Is it a business you understand?
- Is the company profitable?
- What kind of salary is the owner
paying himself? Can you live on that salary?
- Do the tax returns match up
with what the owner is showing and telling you? If not,
why not?
- Does the business have growth
potential?
- Has the current owner been able
to post year-over year revenue and profit growth? If not,
why not?
- What has been the trend over
the past few years?
- Is there some reason to believe
that you will be more successful in growing and managing
the business than the previous owner?
- Are the existing employees willing
to stay on under new ownership?
- Are there outstanding liabilities
which you will be assuming? If so, how much? Are the payments
factored into the current cash flow assumptions?
- Is it possible that there are
liabilities - financial, environmental, etc. that the owner
is not disclosing to you? What is the legal structure of
the business?
- Is the owner willing to finance
part or all of the purchase price? If so, can you afford
to make the payment and still meet the other obligations
of the business (including your own salary)?
- What method did the owner or
his agent use to develop the sales price? Does it seem reasonable?
- Does the owner seem willing
to negotiate the price?
- Is the business seasonal or
cyclical? If so, is the price based on "peak season" revenue
and profits or does it reflect an annual average?
- Who are the businesses primary
competitors?
- Does the company enjoy any competitive
advantages? If so, are those advantages sustainable for
the next few years?
- What share of the market does
this business currently enjoy?
- What is the current strategy
to increase market share?
- Who are the businesses primary
customers?
- Does the business rely on a
few large customers for the bulk of its revenue? If so,
how stable are those customer relationships? Are there contracts
in place to ensure that those relationships continue on
into the future?
- How does the company market
its products or services?
- Is the business easily expandable?
If it is a manufacturing business, does it have ample capacity
to increase production? If it is a service business, can
additional workers be hired and trained quickly to meet
an increase in demand?
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Ultimately you will want to get
the objective opinions of a qualified attorney and a CPA.
Negotiating and structuring a business purchase is a complex
task and one fraught with legal risks. The liability implications
of a poorly structured transaction can be enormous relative
to the cost of professional assistance.
Advantages: |
Disadvantages |
Immediate
Cash Flow |
Higher
Risk |
Opportunity
to Negotiate Price |
Lack
of Information |
Potential
for Owner Financing |
Legal
Complexities |
Existing
Employee Base |
Immediate
Overhead |
Existing
Operational Infrastructure |
Potential
for Hidden Liabilities |
Proven
Business Concept |
Steep
learning curve |
|