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Slide 1 Small Business and Entrepreneurship Chapter 6 6-1 ©2007 Prentice Hall Chapter 6: Small Business and Entrepreneurship Slide 2 Chapter 6 Objectives After studying this chapter, you will be able to: • Highlight the major contributions small businesses make to the U.S. economy • Identify the key characteristics that differentiate small businesses from larger ones • Discuss three factors contributing to the increase in the number of small businesses • Cite the key characteristics common to most entrepreneurs 6-2 ©2007 Prentice Hall Chapter 6 Objectives After studying this chapter, you will be able to: Highlight the major contributions small businesses make to the U.S. economy Identify the key characteristics that differentiate small businesses from larger ones Discuss three factors contributing to the increase in the number of small businesses Cite the key characteristics common to most entrepreneurs Slide 3 Chapter 6 Objectives, cont. • List three ways of going into business yourself • Identify six sources of small-business assistance • Discuss the principle sources of small-business private financing 6-3 ©2007 Prentice Hall Chapter 6 Objectives, cont. List three ways of going into business yourself. Identify six sources of small-business assistance Discuss the principle sources of small-business private financing Slide 4 The World of Small Business • An entrepreneur • An idea • A Drive to succeed 6-4 ©2007 Prentice Hall Most businesses start out like GeniusBabies.com: with an entrepreneur, an idea, and a drive to succeed. Since the founding of the United States, small businesses have been a vital part of the national economy. They play a role in virtually every sector of the economy, from e-commerce companies such as GeniusBabies.com to the independent contractors who drive routes for FedEx Ground, the freight arm of FedEx. Many well-known entertainers, from singer Ani DiFranco to comedian/actor Bernie Mac, became small-business owners as a way to take control of their careers. The opportunities for small business ownership are as diverse as the U.S. economy. Irwin Speizer, “Going to Ground,” Workforce Management, December 2004, 39– 44. . Alan Hughes, “Funny Money,” Black Enterprise, December 2004, 130–144; Bo Burlingham, “Don’t Call Her an Entrepreneur,” Inc., September 2004, 97–102. This slide includes an image of an older gentleman who is shaking hands with what appears to be a banker. They appear to be standing inside of a bank near the bankers desk. Slide 5 Roles of Small Business • Provide new jobs • Introduce new products • Service large corporations 6-5 ©2007 Prentice Hall Here are just some of the important roles small businesses play in the economy: They provide jobs. Small businesses employ about half of the private-sector workforce in this country, and create 75 percent of new jobs. They introduce new products. The National Science Foundation estimates that 98 percent of the nation’s “radical” new-product developments spring from small firms. They supply the needs of large corporations. Many small businesses act as distributors, servicing agents, and suppliers to large corporations. This slide includes an image on the right side of the slide. There is a large dollar sign and a bar chart in the background. There is man standing on top of the dollar sign attempting to point to one of the bars on the chart. There are four business people at the bottom of the slide facing to the left. Slide 6 Roles of Small Business • Inject money into the economy • Take business risks • Provide specialty goods and services 6-6 ©2007 Prentice Hall Here are just some of the important roles small businesses play in the economy: They inject a considerable amount of money into the economy. Small businesses spend $2.2 trillion annually, just a bit less than the $2.6 trillion spent by big companies. They take risks that larger companies sometimes avoid. Entrepreneurs play a significant role in the economy as risk takers, the people willing to try new and unproven ideas. They provide specialized goods and services. When Mike Woods tried to teach his son how to read, he couldn’t find any toys on the market that helped teach phonics. So he left his job as a partner in a big law firm and started LeapFrog. The company’s initial product was the Phonics Disk, a toy that teaches children shapes, sounds, and pronunciation of letters and words. This slide includes an image on the right side of the slide. There is a large dollar sign and a bar chart in the background. There is man standing on top of the dollar sign attempting to point to one of the bars on the chart. There are four business people at the bottom of the slide facing to the left. Slide 7 Characteristics of Small Businesses Lifestyle High-Growth Run by Individuals Run by Teams Limited Products/Services Multiple Products/Services Limited Resources Investment Capital Limited Marketplace Large Marketplace 6-7 ©2007 Prentice Hall 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. Slide 8 Factors Contributing to an Increase in Small Business • E-Commerce • Technology • Diversity • Corporate downsizing • Outsourcing 6-8 ©2007 Prentice Hall Three factors are contributing to the increase in the number of small businesses today: e-commerce and other technological advances, the growing diversity in entrepreneurship, and corporate downsizing and outsourcing. This slide includes an image of two computers with a globe in the background. The right computer has a red line that is pointing to the left computer. Slide 9 E-Commerce and Technology • New business • E-tailing opportunities • Resources 6-9 ©2007 Prentice Hall E-commerce and other technologies have spawned thousands of new business ventures in recent years—both firms that create the technology and firms that use it. GeniusBabies.com is a perfect example of a small business enabled by the Internet (see Exhibit 6.1). Consider the difference it has made in Michelle Donahue-Arpas’s life. As you’ll see at the end of the chapter, she opted to launch her company as an online-only retail operation. Without the Internet, she would have to either sacrifice family time and run her business out of a traditional retail store or find a considerable source of money to finance the catalog operations of a traditional mail-order company. This slide includes an image of a computer that has several letters and envelopes coming out of the computer monitor. Slide 10 Diversity • Growing women/minority ownership • Immigrant start-ups • Young professionals 6-10 ©2007 Prentice Hall Minority business ownership is also on the rise across the United States. Minorities now own 15 percent of all U.S. businesses. Part of this growth is attributed to firms that do a better job of marketing to specific segments of the population. For example, Hispanicowned businesses have been doing better than the economy as a whole in recent years, thanks in large part to their success at marketing to the growing Hispanic American population. The tradition of immigrants starting small companies stretches back to the first days of the United States and continues strong today. With help from programs such as StartSmart, run by Coastal Enterprises in Wicasset, Maine, immigrants and political refugees get coaching and assistance on achieving financial independence through business ownership. Finally, young people are one of the strongest forces in entrepreneurship today and launch the majority of all new businesses. It’s never too early to start; Google, Microsoft, Dell, and plenty of other high-flying companies were started by college students. “Advocacy Small Business Statistics and Research,” U.S. Small Business Administration [accessed 3 July 2007] www.sba.gov. . Jim Hopkins, “Hispanic-Owned Companies See Strong Growth Spurt,” USA Today, 2 July 2003, B1. . Coastal Enterprises website [accessed 3 July 2007] www.ceimaine.org; David J. Dent, “Coming to America,” Inc., November 2004, 100–107. . Scarborough and Zimmerer, Effective Small Business Management, 16. This slide includes an image of a globe with North America showing and several diversified hands that appear to be holding up the globe. Slide 11 Downsizing and Outsourcing • Recession start-ups • Value web • Opportunity generation 6-11 ©2007 Prentice Hall Contrary to popular wisdom, business start-ups often 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. In fact, several well-known companies were started during recessions. The outsourcing and value web phenomena discussed in Chapter 4 (page 87) create numerous opportunities for small businesses and entrepreneurs. Some companies subcontract special projects and secondary business functions to experts outside the organization. Others turn to outsourcing as a way to permanently eliminate entire departments. This slide includes an image of a very large hand removing a chair from what appears to be a game of musical chairs. There are two people sitting in chairs, and two people trying to share the chair that is remaining. Slide 12 Characteristics of Entrepreneurs • Highly disciplined • Like to control their destiny • Listen to their intuition • Relate well with others • Eager to acquire new skills • Learn from their mistakes 6-12 ©2007 Prentice Hall Contrary to what you might expect, most entrepreneurs are not glamorous adventurers; instead, they are often ordinary people. Most entrepreneurs 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. Slide 13 Characteristics of Entrepreneurs • Stay abreast of market changes • Exploit new opportunities • Seldom follow trends • Driven by ambition • Think positively • Prefer risk taking over security 6-13 ©2007 Prentice Hall They stay abreast of market changes. They are willing to exploit new opportunities. They seldom follow trends (rather, they spot and interpret trends). They are driven by ambition. They think positively. They prefer the excitement and potential rewards of risk taking over security. While most entrepreneurs are anxious to become their own boss, most cite making money as a secondary reason for starting their own business, not the primary reason. Slide 14 Importance of a Business Plan Guide Operations Outline Strategy Attract Lenders and Investors 6-14 ©2007 Prentice Hall Preparing a business plan serves two important functions: First, it guides the company operations and outlines a strategy for turning an idea into reality; second, it helps persuade lenders and investors to finance your business. In fact, without a business plan, many investors won’t even grant you an interview. Keep in mind that sometimes the greatest service a business plan can provide an entrepreneur is the realization that “the concept just won’t work.” Discovering this on paper can save you considerable time and money. This slide includes a blurred image of three business people standing over a table discussing some sort of plan. Slide 15 The Business Plan Purpose • Summarize business venture • Communicate goals • Highlight strategies • Strategic advantages 6-15 ©2007 Prentice Hall Getting started in a new business requires a lot of work, not the least of which is planning. Planning forces you to think ahead. Before you rush in to supply a product, you need to be sure that a market exists. You must also try to foresee some of the problems that might arise and figure out how you will cope with them. 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, and shows how consumers will benefit from the company’s products or services. This slide includes an image of several business people that appear to be in a huddle strategically planning. Slide 16 The Business Plan Blueprint • • • • • • • • Summary Mission and objectives Company and industry Products or services Market and competition Management Marketing strategy Design and development plans 6-16 ©2007 Prentice Hall Summary. In one or two pages, summarize your business concept. Clearly articulate your business model and strategy for success—astute investors know what makes a business work, and they want to know that you do, too. Describe your products and their market potential. Highlight some things about your company and its owners that will distinguish your firm from the 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— and before you take another step, make sure that this is a mission you can pursue with passion, through thick and thin, with every ounce of commitment and energy you can muster. 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. 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. This slide includes an image of a construction worker with a hard hat. He is carrying several blueprints. Slide 17 The Business Plan Blueprint • • • • Operation plans Overall schedule Critical risks and problems Financial projections and requirements • Exit strategy 6-17 ©2007 Prentice Hall 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 projections 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. This slide includes an image of a construction worker with a hard hat. He is carrying several blueprints. Slide 18 Small Business Ownership • Start-up • Buy a business • Franchise 6-18 ©2007 Prentice Hall Once you’ve done your research and planning, 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. Roughly two-thirds of business founders begin start-up companies; that is, they start from scratch rather than buying an existing operation or inheriting a family business. Starting a business from scratch has many advantages and disadvantages. This slide includes an image of a business man holding a briefcase in his left hand and a very large light bulb in his right hand. Slide 19 Starting a New Business Advantages Disadvantages + Control your destiny – Uncertainty of income + Reach your potential – Risk of loss + Unlimited profits – Long hours & hard work + Recognition – Complete responsibility + Doing what you enjoy – High stress levels 6-19 ©2007 Prentice Hall Some advantages of starting a new business include: Control your destiny Reach your potential Unlimited profits Recognition Doing what you enjoy Some disadvantages include: Uncertainty of income Risk of loss Long hours & hard work Complete responsibility High stress levels Slide 20 Buying an Existing Business Advantages Disadvantages + Customer base – Alienated customers + Business systems – Obsolescence + Product or service – Location + Location – Personality clashes + Financing – Outstanding receivables 6-20 ©2007 Prentice Hall 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 also has 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. Slide 21 The Franchising Alternative • Product franchise • Manufacturing franchise • Business-format franchise 6-21 ©2007 Prentice Hall 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. This format including many well-known chains, including Taco Bell, Pizza Hut, UPS Stores, and Curves fitness centers. This slide includes an image of a large scale with two packages on that scale being weighed for shipment. Slide 22 Evaluating a Franchise • Initial franchise • Exclusive territory • Periodic royalties • Right of first refusal • Trademarks and names • Equipment and supplies • Agreement termination • Advertising and • Franchise agreement promotion • Business location 6-22 ©2007 Prentice Hall How do you protect yourself from a poor franchise investment? The best way is to study the opportunity carefully before you commit. This slide and the next suggest some points to consider as you study the package of information on the franchise. What is covered by the original franchise fee? Does it cover a starting inventory of products and supplies? How are the periodic royalties calculated and when are they paid? Are all trademarks and names legally protected? Who provides and pays for advertising and promotion? Who selects the location of the business? Is the franchise assigned an exclusive territory? If the territory is not exclusive, does the franchisee have the right of first refusal on additional franchises established in nearby locations? Is the franchisee required to purchase equipment and supplies from the franchisor or other suppliers? Under what conditions can the franchisor and/or the franchisee terminate the franchise agreement? Can the franchise be assigned to heirs? Slide 23 Pros and Cons of Franchising Advantages Disadvantages Get a viable business No guarantee of wealth Name recognition High monthly royalties Network of support Limited independence Blueprint for success Limited flexibility 6-23 ©2007 Prentice Hall Why is franchising so popular? 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. Buying a franchise also gives you instant access to a support network, and in many cases a readymade blueprint for building a business. 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. One of the biggest disadvantages of franchising is the monthly payment, or royalty, that must be turned over to the franchisor. Another drawback of franchises is that many allow individual operators little independence. Franchisors can prescribe virtually every aspect of the business, down to the details of employee uniforms and the color of the walls. Furthermore, when a chain loses its cutting edge in the marketplace, being stuck with a franchise can be painful. In addition, if independent retailers run into trouble with their product lines, they can change suppliers or perhaps switch rapidly to a whole new line of business. Franchisees can’t. Slide 24 Why Small Businesses Fail •Management Incompetence •Diminished Customer Base •Lack of Experience •Uncontrolled Growth •Insufficient Financing •Inappropriate Location •Poor Business Planning •Inadequate Controls •Unworkable Goals •Poor Entrepreneurial Skills 6-24 ©2007 Prentice Hall Businesses can fail for any number of reasons, as the table above suggests. Lack of management skills, experience, and proper financing are among the top 10 reasons for failure. So is uncontrolled growth. Growth forces changes throughout the organization that affect every aspect of the business operation. When growth is too rapid, it can force so much change that things spin out of control. And nothing can kill a successful business faster than chaos. Besides growing too rapidly, another mistake entrepreneurs make is to stray too far from the original product or market. Even when signs of failure begin to surface, some entrepreneurs don’t pull the plug fast enough. Slide 25 Sources of Small Business Assistance • Government agencies • Advisory boards • Nonprofit • Media organizations • Business partners • Mentors • Networks • Business incubators and accelerators 6-25 ©2007 Prentice Hall A number of city, state, and federal government agencies offer business owners advice, assistance, and even financing in some cases. For instance, many cities and states have an office of economic development (or similarly named agency) chartered with helping companies prosper so that they might contribute to the local or regional economy. At the federal level, small businesses can apply for loans backed by the Small Business Administration (www.sba.gov) and learn more about selling to the federal government—including bidding on the many contracts reserved for small or minority-owned companies—at www.business.gov. Many government agencies also have special offices (check their websites) to help small firms compete. The companies you do business with can also be a source of advice and support. For example, Bank of America’s (www.bankofamerica.com) Small Business Resource Center offers a variety of articles, online tutorials, and financial calculators. Similarly, Microsoft (www.microsoft.com/smallbusiness) offers free seminars, podcasts, and webcasts with information of interest to small business owners. Mentors and Advisory Boards Many entrepreneurs and business owners take advantage of individual mentors and advisory boards. Your local library and the Internet offer enough information to help any small business owner face just about every challenge imaginable. For instance, blogs written by business owners, investors, and functional specialists such as marketing consultants can offer valuable insights. No matter what industry you’re in or what stage your business is in, you can probably find a local or line network of people with similar interests. For instance, some entrepreneurs meet regularly in small groups to analyze each other’s progress month by month. A business incubator is a center that provides “newborn” businesses with just about everything a company needs to get started, from office space to information technology to management coaching, usually at sharply reduced costs. A business accelerator is similar to an incubator, and the terms are often used interchangeably. Generally speaking, accelerators focus more on providing advice and financing (in some cases) and less on providing office space and other infrastructure. To find an incubator or accelerator in your area, search online or contact your city or state economic development office. Slide 26 Financing a New Business Private Financing Banks and MicroMicro-lenders Venture Capitalists Angel Investors 6-26 ©2007 Prentice Hall Once you’ve decided to go into business for yourself, you will probably need some money to get started. Where can firms obtain the money they need to launch and operate a new business? Most new businesses turn to private financing sources, such as family, friends, and loans from banks, finance companies, or other commercial lenders. As the start-up grows, owners can raise additional funds by selling shares of stock to the public. As you can imagine, financing an enterprise is a complex undertaking. The process begins by assessing the firm’s financing needs and determining whether funds are needed for the short or the long term. You must also assess the cost of obtaining financing, and you must weigh the advantages and disadvantages of financing through debt or equity, taking into consideration the firm’s special needs and circumstances. In short, choosing the right sources of financing can be just as important as choosing the right location. Your decision will affect your company’s capital structure—the mix of debt and equity—forever. Private financing covers every source of funding except selling stock to the public via a stock market. Bank loans are one of the most important sources of financing for small business—but there’s an important catch: In most cases, banks won’t lend money to a start-up that hasn’t established a successful track record. Venture capitalists (VCs) are investment specialists who raise pools of capital from large private and institutional sources (such as pension funds) to fund ventures that have high growth potential and a need for large amounts of capital. Start-up companies that can’t attract VC investment often look for angel investors, private individuals who put their own money into start-ups with the goal of eventually selling their interest for a large profit. This slide includes an image of what appears to be a bank. Surrounding the bank are pictures of a dollar sign and a percentage sign. Slide 27 The Cost of Capital • Risk factors • Interest rates • Funding vehicles 6-27 ©2007 Prentice Hall In general, a company wants to obtain money at the lowest cost and least amount of risk. However, lenders and investors want to receive the highest possible return on their investment, also at the lowest risk. A company’s cost of capital, the average rate of interest it must pay on its financing, depends on three main factors: the risk associated with the company, the prevailing level of interest rates, and management’s selection of funding vehicles. Obviously, the more financially solid a company is, the less risk investors face. However, time also plays a vital role. Because a dollar will be worth less tomorrow than it is today, lenders need to be compensated for waiting to be repaid. As a result, long-term financing generally costs a company more than short-term financing. This slide includes an image on the right side of the slide. There is a large dollar sign and a bar chart in the background. There is man standing on top of the dollar sign attempting to point to one of the bars on the chart. There are four business people at the bottom of the slide facing to the left. Slide 28 Obtaining Capital Debt Financing Equity Financing Secured SecuredLoans Loans Stock StockSales Sales Unsecured UnsecuredLoans Loans Initial InitialPublic Public Offering Offering 6-28 ©2007 Prentice Hall Debt financing refers to what people normally think of as a loan. A creditor agrees to lend money to a debtor in exchange for repayment, with accumulated interest, at some future date. Loans can be secured or unsecured. Secured loans are those backed by something of value, known as collateral, which may be seized by the lender if the borrower fails to repay the loan. The most common types of collateral are accounts receivable, inventories, and property such as marketable securities, buildings, and other assets. Unsecured loans are ones that require no collateral. Equity 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 with no guarantee you'll get the amount of money you need. Slide 29 Debt Versus Equity Characteristic Debt Equity Maturity Specific Nonspecific Claim on Income Fixed Cost Variable Cost Claim on Assets Priority Residual Influence on Management Little Varies 6-29 ©2007 Prentice Hall When choosing between debt and equity financing, you should weigh the advantages and disadvantages of each. In addition to considering whether the financing is for the short or the long term and assessing the cost of the financing, such as interest, fees, and other charges, you must also evaluate your desire for ownership control. Two of the biggest benefits of debt financing are (1) the lender does not gain an ownership interest in the business, and (2) a firm’s obligations are limited to repaying the loan. By contrast, equity financing involves an exchange of money for a share of business ownership: It allows firms to obtain funds without pledging to repay a specific amount of money at a particular time, but in exchange for this benefit the firm must give up some ownership control.