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Should You
Build or Buy?

There are three primary options for entering into a business for the first time.

  1. Start a business from scratch
  2. Franchise a proven business concept
  3. 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:

  1. Why is the company for sale?
  2. Is it a desirable business and industry for you?
  3. Is it a business you understand?
  4. Is the company profitable?
  5. What kind of salary is the owner paying himself? Can you live on that salary?
  6. Do the tax returns match up with what the owner is showing and telling you? If not, why not?
  7. Does the business have growth potential?
  8. Has the current owner been able to post year-over year revenue and profit growth? If not, why not?
  9. What has been the trend over the past few years?
  10. Is there some reason to believe that you will be more successful in growing and managing the business than the previous owner?
  11. Are the existing employees willing to stay on under new ownership?
  12. Are there outstanding liabilities which you will be assuming? If so, how much? Are the payments factored into the current cash flow assumptions?
  13. 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?
  14. 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)?
  15. What method did the owner or his agent use to develop the sales price? Does it seem reasonable?
  16. Does the owner seem willing to negotiate the price?
  17. 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?
  18. Who are the businesses primary competitors?
  19. Does the company enjoy any competitive advantages? If so, are those advantages sustainable for the next few years?
  20. What share of the market does this business currently enjoy?
  21. What is the current strategy to increase market share?
  22. Who are the businesses primary customers?
  23. 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?
  24. How does the company market its products or services?
  25. 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

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