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 transactions
Employer businesses
Account for 99% of all businesses
40% of all business income
Starting a small business
Three approaches
Starting from “scratch”
 Risk of failure is high
 Must understand market: location, product/service offered, how much will be sold
 Must understand competitors’ market
Buying an existing business
 Less risky
 Have current data on which to make decisions
Franchise
 The 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 name
Management skills
Training and materials
Method of doing business
Franchisee:
Investment
Labor and capital
Operations
Agrees 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 business
Successful business model already developed
Control of risks in External and Internal Business Environment
Already have brand recognition and a fully developed product/service
Access to business experts and management training
Can purchase advertising and supplies through co-op with other franchisees
Franchisor
Ability 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 characteristics
 Protect product quality
 Tendency to “micromanage” franchisee.
Franchisee:
 Start up costs are high
 Must pay a percentage of sales (royalty) back to Franchisor
 Dependent upon other Franchisees upholding reputation
 Franchisor may compete with franchisee
Evaluating Franchise Opportunities
Name recognition and reputation
Quality products?
Franchisor’s experience
How long has the company been franchising?
Growth
Steady growth or growth too fast?
How many franchisees, especially in location
Your investment
Affordability? Can you afford to lose the start up cash?
Do you need to borrow?
Annual expected (realistically) income
Your Knowledge, Skills, and Experience
Training?
Do you have previous experience in this area?
Be wary of franchise brokers
Broker represents franchisors, who are paying a commission
Written documentation of expected earnings.
Hire an accountant and/or lawyer to review documents
Study the disclosure document
After 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 franchisees
Most reliable way to verify franchisor’s claims
Seek professional help
Contact franchise associations
The importance of a Business Plan
Business Plan: formal written plan that clearly explains every aspect
of your business.
Missions/Goals
Strengths/Weaknesses
Market Analysis
Break Even Analysis
Components of a Business Plan
Executive Summary
Concise 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 business
Contact information
Analysis of industry
Form of business ownership
Who are your “ideal” customers?
What is your competitive advantage?
Ethical issues and social responsibility
Management and Operation Plan
SWOT analysis
 Strengths
 Weaknesses
 Opportunities
 Threats
Mission Statement
Business goals
Management team
Organization structure
Physical layout
Operational scenarios
Etc.
Human Resource Plan
Personnel
Job descriptions and specifications
Compensation and incentives
Corporate culture
Leadership
Training and prof. dev.
Marketing plan
Who is your ideal customer?
Analysis of competition
• Financial Plan
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Revenue
Expenses
Financing the business
Balance Sheet/Income Statement
Break Even Analysis
• Appendix
Key to Success?
Market Demand
Business failure is often due to a lack of understanding of the marketplace.
 Location
 Need 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 potential
Angel 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 small
More satisfying relationships with employees, clients, vendors, etc.
Becomes an integral part of the community where it resides
Ability to adapt quickly to changing business environment
Disadvantage: 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 innovation
Have a wide vision of where they want to go
A strong desire to be successful and make money
Love to idea of creating employment opportunities
Willing to accept a higher level of risk.
Skills Entrepreneurs need:
Need to be alert to changes in their everyday environment
Have a wild enough imagination to see how the changes can alert
them to other possibilities
Deep belief in their ideas and believe in the importance of their ideas
Research 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 cost
However:
Must follow federal privacy laws enacted by the Federal Trade Commission
Must 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 operates
Easy to establish
Simple structure
Owner maintains a high degree of control
Tax implications
Income from business goes on owner’s personal tax return. Taxed only once
Disadvantage:
Lack of access to capital
Owner is exposed to risk
 Personal assets may be seized to pay business debt. May cause personal bankruptcy
Business succession if owner dies.
General and Limited Partnerships
General partnerships
Each partner contributes financially, increasing the amount of capital
available.
Financial losses are shared in proportion to the investment
Share in work and managerial duties
Tax implications
Income is included on personal tax returns of partners. Taxed only once.
Liability—unlimited
Personal assets can be seized to cover business losses. May cause personal
bankruptchy
Limited Partnership
Partners 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 debts
 Paid a salary
 Participates 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-Profit
Public/Private Ownership
Advantages
Limited liability
Ease of raising capital through the sale of stock
Continuity of the business. Lives beyond the lifetimes of the owners
Disadvantages
Legal: Charter, filing fees, additional expenses
Tax 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 Code
Conditions to meet:
Have no more than 100 stockholders
Shareholders must be individuals (not companies) who are citizens or permanent
residents of the United States
Offer 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 interest
Disadvantages:
Subject to IRS Code, which changes frequently
May have a state corporation tax to pay
Limited Liability Corporation
Liability of each owner is limited to the amount that each invests
Option of being taxed like a partnership or corporation
Not limited on membership
Must have an operating agreement
Disadvantages
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 services
Elect Board of Directors
Surplus 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 profit
Any capital left after operating expenses are paid is funneled back
into the non-profit.
Exempted from income taxes
Must apply to state for incorporation; must file with IRS to become a
501( c )3.
Must be charitable, educational, scientific, religious, or literary
Must meet other criteria as established by the IRS code.
Merger/Acquisitions
Merger: two or more companies become a single company
Vertical: companies at different phases of the production process become one. Ex:
Steel Dynamics buying scrap metal recycler
Horizontal: 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
Business Plan Workbook
• Well Functioning teams
• Characteristics
• Shared set of values and mutual respect for the perspectives and skills of each
team member.
• “group” vs “team”
• Methods of communication
• Face to face; virtual; email
• When
• What to cover
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Collaborative vs cooperative
Team contract?
Agenda/minutes/assignments
Project schedule