© 2007 John Wiley & Sons Australia, Ltd
Chapter 5
Options for going into business
Chapter outline
• Issues to consider before going into
business
• Starting a new business
• Purchasing an existing business
• Entering a franchise system
• Comparison of options
• Procedural steps when starting a
business venture.
Learning objectives
• Explain the 3 major issues that all
prospective entrepreneurs and smallbusiness owners must consider before
going into business
• Compare and contrast the advantages
and disadvantages of starting a new
business.
Learning objectives
• Outline the factors to take into account
when assessing a business for purchase
• Explain the different ways of calculating a
business purchase price
Learning objectives
• Describe how a franchise operates
• Use the ‘6 step’ process to organise your
strategy for going into business
Business commencement options
There are essentially 3 major options for
going into business:
• Launch a new (start-up) business venture
• Purchase an existing firm
• Enter a franchise arrangement
Issues to consider before going into
business
• Any business venture is driven by
3 forces:
– Personal goals and abilities of the
owner/entrepreneur
– What resources are available to the
business owner (money, staff, etc)?
– The nature of the business opportunity
itself
Starting a new business —
the advantages
Advantages
• The owner can shape his or her own
vision
• Flexibility — fewer constraints on owner
• Cost minimisation — often cheaper to
start
• New lifestyle goals — can ensure
business and personal goals are closely
aligned from the outset
Starting a new business —
the disadvantages
Disadvantages
• Hard to raise capital
• Lack of an established customer base
• May suffer cash flow problems
• Requires considerable effort to learn how
to operate the business effectively
(‘learning curve expenses’)
Costs of a start-up venture
Some costs are common to all new
enterprises, such as:
• Licenses and permits required to operate
the business
• Working capital
• Communications equipment (such as
telephones, computers, fax machines)
• Operating plant and equipment
Costs of a new (start-up)
business venture
•
•
•
•
Staff recruitment expenses
Insurance
Raw materials (or trading stock)
Rental of premises (unless working from
the owner’s home)
• Stationery
In addition, there will also be industryspecific expenses.
Purchasing an existing business
Advantages:
• Can begin trading immediately
• Easier to arrange finance for the venture
• Established track record of the firm allows
a more objective evaluation of likely future
performance
Purchasing an existing business
Disadvantages:
• May ‘inherit’ existing liabilities
• Less flexible than a start-up
• Difficult to establish purchase price
Establishing a purchase price
Three major techniques used by sellers
(vendors) and purchasers:
1. Market-based valuations
2. Asset-based valuations
3. Earnings-based (cash flow) valuations
Market-based valuations
The going market rate method
• simply the ‘current market’ price for a
particular type of firm
• Selling price = Selling price of similar firms
Market-based valuations
Revenue multiplier method
• common ‘industry multiple’ that is used to
estimate the most likely purchase price of
the practice
• Selling price = Turnover × Standard
industry multiple
Asset-based valuations
Involves setting a price after examining the
assets and liabilities of the business:
Book value
• asking price is set by first calculating the
worth of all the firm’s assets
• Selling price = Tangible assets + Intangible
assets − Liabilities
Asset-based valuations
Adjusted book (net asset) value
• simple book value method relying on the
books of account
Asset-based valuations
Liquidation value
• value of the business if it was to be
broken up and sold as individual assets,
rather than continuing to operate it as a
going concern
Asset-based valuations
Replacement value
• the cost of replacing all of the firm’s
tangible assets (at current market costs)
Earnings-based (cash flow)
valuations
Return on investment
• based on the assumption that the risk and
return of a business should be reflected in
its selling price. It works on a formula
which includes the estimated future profit
earnings:
• Selling price = Net annual profit
× (100/ROI)
Earnings-based (cash flow)
valuations
Discounted cash flows
• reduces (discounts) the future cash
income generated by the business back
to its current value
n
• Value =

t 1
CFt
+ terminal value
t
(1  r )
Questions to ask
•
•
•
•
•
Why is the business being sold?
Will existing staff remain if the business
is sold?
What debts/liabilities exist?
Can all licenses and permits to operate
be transferred?
How accurate are the financial
accounts?
Questions to ask
• What is the future state of the industry —
is demand increasing or decreasing?
• Is the lease on the premises secure?
• What is the condition of the physical
assets?
• Will existing customers remain loyal if
business has new ownership?
Entering a franchise system
• An increasingly common form of business
operation.
• An arrangement whereby the originator of
a business product or operating system
permits another business owner to sell
these goods, and/or to use the business
operations system, on his or her behalf.
Entering a franchise system
• A licensing arrangement: a small firm
receives permission to sell a particular
product from an established parent
organisation, but remains legally
independent of that parent.
Entering a franchise system
• Typically has lower failure rates than new
start-ups.
• Good for small business owners seeking
security
• Less suitable for entrepreneurial types.
Entering a franchise system
• Franchisee: The business or individual
who is given contractual permission to
operate a particular business franchise
system or sell a product by the original
owner of the same.
• Franchisor: A business or individual who
owns the right to a particular business
franchise system or product.
Entering a franchise system
Product franchise:
• gives the small business operator the
right to sell a particular commodity, or set
of goods.
• Franchisee is a distribution mechanism
for good or service; has a large measure
of independence about how their
business is operated.
Entering a franchise system
Product franchise (cont’d):
• Franchisor’s role is limited to ensuring
that sufficient stock is made available,
and that the franchisee is selling the
product at a satisfactory price.
Entering a franchise system
Business system franchise:
• A situation where the franchisor not only
supplies the product, but also gives
comprehensive guidelines about how the
business is run (e.g. McDonald’s).
• All aspects of organising and operating
the business have already been
investigated, pre-tested and successfully
implemented by the franchisor.
Advantages of franchising
• The new business owner is spared the
task of developing an operating system
• New business owner learns less
‘by mistakes’
• Customers are usually attracted by the
presence of an established product.
Advantages of franchising
• Lower failure rate
• Franchisors provide continuing training
for franchisees
• Pre-organised access to raw materials
and supplies
• Raising capital can also be easier
Disadvantages of franchising
• Access to these systems does not come
cheaply
• Purchase price is often quite high
• Franchisees have to pay a proportion of
their profits to the franchisor
• Franchisees are restricted to serving a set
market
Disadvantages of franchising
• Franchisees subject to contractual
arrangement, and as such have a limited
lifespan
Comparison of options
Procedural steps when starting a
business venture
Figure 5.2: The process of going
into business
Summary
• There are 3 factors which influence all
business ventures:
– the personal goals, desires, experience
and abilities of the owner/entrepreneur
– the financial, human and other
resources available
– and the nature of the business
opportunity itself.
Summary
• There are 3 different ways of getting into
business:
– starting a new business
– buying an existing operation
– or entering into a franchise
arrangement.
• Each has their own advantages and
disadvantages.
Summary
• There are 3 main ways of setting a price:
– market-based valuations,
– asset-based valuations
– and earnings-based (cash flow)
valuations.
Summary
There are 6 steps involved in the process
of evaluating business options. After
these steps, the intending business owner
must critically evaluate which business
avenue is the best option.