Ronald J. Ebert & Ricky W. Griffin BUSINESS ESSENTIALS Fourth Edition PART 1 . . . . . . . . . . . . . . . . . . . . . . . . Understanding the Contemporary Business Environment Ronald J. Ebert & Ricky W. Griffin Copyright ©2003 Prentice Hall, Inc.

Entrepreneurship and Small Business Chapter 4 Entrepreneurship and Small Business

“Entrepreneurs are simply those who understand that there is little difference between obstacle and opportunity and are able to turn both to their advantage.” ~ Victor Kiam

Key Topics Small business and its importance in the economy Sole proprietorships, partnerships, and corporations Creating and managing corporations Corporate trends and issues Starting and funding a small business Pros and cons of franchising

Discussion What does the concept mean? Who are some successful entrepreneurs in Gaza? (Probe for local examples as well as better-known individuals.) Why have these people been successful? Point out that regardless of product or market, many experts agree that personal characteristics are key to successful entrepreneurship.

What Is “Small Business”? Independently owned and managed business that does not dominate its market

What Is “Small Business”? Developing a definition of “small business” is challenging. The U.S. Department of Commerce considers a business small if it has fewer than 500 employees, while the Small Business Administration defines small business according to both the total number of employees AND total annual sales relative to other players in the industry. For the purpose of this course, we have opted to define small businesses as those that are independently owned and managed, and do not dominate their markets.

Small business plays a critical role in the U.S. economy. Job Creation Innovation Importance to Big Businesses

How about in Palestine? 95% percent of all businesses are small, they employ 10 persons or less. Why the businesses in Palestine are dominated by small ones? Individualism trend. Family oriented. Lack of availability of fund. Lack of awareness of the process of establishing corporations. The skills needed to set and manage large companies are not there. The Israeli occupation’s policies. Lack of government support.

Small Bus. Role in the economy Small businesses play a critical role in the health of the U.S. economy. Job Creation: According to the SBA, seven of the ten industries that added the most new jobs in 1998 were in sectors dominated by small businesses. Furthermore, small businesses currently account for 38% of all jobs in the high-technology sectors of the economy. Innovation: According to the SBA, small businesses supply 55% of all “innovations” introduced into the American marketplace. Examples: personal computers, photocopying machines, jet engines. Discussion: Why are small businesses such prolific innovators? Wouldn’t you expect the opposite, given that most small businesses have limited resources? Importance to big business: Small businesses play a crucial role in the success of large businesses in terms of supply, distribution, and services.

The Labor Force Reflects the Importance of Small Business 86.09 11.00 2.00 0.20 0.10 Percentage of All U.S. Businesses Total Employees Under 20 20-99 100-499 500-1000 1000 or more 25.60 29.10 25.50 7.10 12.70 Percentage of All U.S. Workers Total Employees Under 20 20-99 100-499 500-1000 1000 or more

The Labor Force Reflects the Importance of Small Business Over 86% of U.S. businesses have no more than 20 employees. The total number of people employed by these small businesses is about one quarter of the entire U.S. workforce. Another 29% of the workforce is employed by businesses with fewer than 100 employees. Discussion: Many students probably either work in small businesses, or come from families who run small businesses. Ask for a show of hands regarding how many students fit this description. What types of businesses have they worked for? What are the pros and cons of working in a small business? Of owning a small business?

Popular Areas of Small Business Enterprise in US Services Retailing Construction Financial Insurance Wholesaling Transportation Manufacturing Manufacturing 5% Finance & Insurance 10% Other 1.7% Wholesale 8% Transportation 5% Construction 10% Services 37.6% Retailing 22.7%

Types of Business Organizations Type of Business 73% 7% 20% Sales Revenue 5% 6% 89% Sole Proprietorship Partnership Corporations

Types of Business Organizations Regardless of business type, all business owners must decide which form of legal organization best suits their goals: sole proprietorship, partnership, or corporation. The previous slide shows that while the vast majority of businesses are organized as sole proprietorships, corporations account for the overwhelming majority of aggregate sales revenue. Discussion: Why do corporations account for such a disproportionately large chunk of sales revenue? What are the implications for smaller businesses? For our economy as a whole?

Comparative Summary: Three Forms of Business Business Form Liability Continuity Management Investment Sources Proprietorship Ends with death or decision of owner Personal, unrestricted Personal Personal, unlimited General Partnership Personal, unlimited Ends with death or decision of any partner Unrestricted or depends on partnership agreement Personal by partner(s) Corporation Capital invested As stated in charter, perpetual or for specified period of years Under control of board of directors, which is selected by stockholders Purchase of stock Copyright ©2003 Prentice Hall, Inc. 4 - 16

Sole Proprietorships Advantages: Freedom Simple to form Low start up costs Tax benefits Disadvantages: Unlimited Liability Limited resources Limited fundraising capability Lack of continuity Unlimited Liability Legal principle holding owners responsible for paying off all debts of a business

Sole proprietorships\ traders Sole proprietorships are the most basic legal form of business organization. Advantages: Freedom: Sole proprietors answer to no one but themselves—this is a terrific fit for certain personalities (and we can probably all think of someone who fits the profile!). Simple to form: In some states, forming a business is as simple as hanging a sign on the door. Low start-up costs: Low costs go hand-in-hand with minimal legal requirements Tax benefits: Sole proprietors are taxed only on personal income, and can take advantage of certain tax deductions.

Sole proprietorships\ traders Sole proprietorships are the most basic legal form of business organization. Disadvantages: Unlimited liability: Sole proprietors are personally liable for all debts incurred by the company (including damages in lawsuits). This is the most significant drawback to this form of business. Limited resources: This can ultimately limit the size of the business. Limited fundraising capability: Sole proprietors often find it difficult to borrow money. Difficult to provide loan security. Lack of continuity: A sole proprietorship legally dissolves when the owner dies.

Partnerships Advantages: More talent and money More fundraising capability Relatively easy to form Tax benefits Disadvantages: Unlimited Liability Disagreements among partners Lack of continuity Unlimited Liability Legal principle holding owners responsible for paying off all debts of a business

Partnerships Advantages: The most common type of partnership, a general partnership, is simply a sole proprietorship multiplied by the number of partner-owners. Advantages: More talent and money: A partnership draws on the talent and money of more than one person. More fundraising capability: Partnerships are able to borrow money more easily from lending institutions, and also have the option of inviting more partners to invest. Relatively easy to form: Legal requirements are limited, but must include a partnership agreement of some kind. Tax benefits: Partners are taxed only on personal income.

Partnerships Disadvantages: Unlimited liability: Each partner is liable for all debts incurred in the name of the partnership, even if one partner incurs a debt without the knowledge of the other partners. Disagreements among partners: Partnerships have been known to ruin relationships between close friends and family members. Discussion: What are some possible safeguards against this happening? (Possibilities: Creating a fair, complete partnership, planning up front for all the contingencies you can think of, developing a fair exit agreement at the outset of the partnership.)

Partnerships Lack of continuity: When one partner leaves or dies, the original partnership dissolves, and must be reorganized if other partners want to continue. Within a partnership, a significant level of conflict can be healthy and creative, generating more effective solutions to a range of different obstacles. However, an exit plan is still crucial in case disagreements become unmanageable. Discussion: What should be included in the exit plan for a partnership? (Possibilities: How to dispose of and distribute assets, how to reorganize should one or more partners exit.)

Remember… “When two men in business always agree, one of them is unnecessary.” William Wrigley Jr. But… An exit plan is still crucial!

What is a Corporation? “An artificial being, invisible, intangible, and existing only in contemplation\ reflection of the law.”

Corporation Almost all large businesses use the corporate form of ownership, which has enormous influence on the U.S. economy, accounting for 89% of all sales revenue. Corporations may perform the following activities: Sue and be sued Buy, hold, and sell property Make and sell goods and services to consumers Commit crimes and be tried and punished for them Discussion: guess the largest Palestinian companies. Examples: PALTEL, PADECO, Bank of Palestine, Mortaja.

Corporations Advantages: Limited Liability Continuity Stronger fundraising capability Disadvantages: Double Taxation Fluid\difficult control Complicated and expensive to form

Corporation While many corporations are enormous, most are small and medium-sized. All share significant advantages and drawbacks. Advantages: Limited liability: The liability of investors (owners) for the debts of a corporation is limited to the size of their investments—a huge benefit! Continuity: Theoretically, a corporation may continue to exist forever, with ownership transferred via sale of stock. Stronger fund-raising capability: Lenders are more willing to grant loans. Larger corporations also have the option of selling stock to raise capital.

Corporation Disadvantages Double taxation: Profits earned by corporations are taxed at the corporate level, and then taxed again at the ownership level. Is it fair? Who benefits? Fluid \difficult control: Given the easy transfer of ownership, corporations are subject to hostile takeovers, which (at the very least) distract management from achieving the corporation’s goals. El-Fayed took over Harrots. Complicated and expensive to form: Costs include filing fees to meet government incorporation requirements, and usually legal fees as well.

Types of Corporations Closely Held (Private) Corporation (Ltd) Publicly Held (Public) Corporation (PLC) S Corporation Limited Liability Corporation (LLC) Professional Corporation Multinational or Transnational Corporation

Types of Corporations Specific types of corporations are widely varied: Private or closely held corporations: All stock is held by only a few people. Publicly held corporations: Stock is available for sale to the general public. S corporations: A hybrid\mixture of a closely held corporation and a partnership. Firms must meet strict legal requirements to qualify. Limited liability corporations (LLCs): A hybrid of a publicly held corporation and a partnership. Professional corporations: Typically groups of doctors, lawyers, accountants, etc. These groups do not have unlimited professional liability: individuals are still liable for professional negligence. Multinational \transnational corporations: Span national boundaries. Subject to regulation in multiple countries.

Stockholders Owners of Corporations Stock: Share of ownership in a corporation Common Stock Preferred Stock

Stocks Stockholders: The real owners of corporations. Profits are distributed to stockholders in the form of dividends, and managers of corporations serve at the discretion\interest of the stockholders. Types of Stocks: Common Stock: The most basic form of ownership. Common stockholders always have voting rights. Preferred Stock: Offers fixed dividends but no corporate voting rights. Discussion: How many of you own stock? Which companies? Why?

Corporate Governance Hierarchy Stockholders Board of Directors Officers

Corporate Governance Hierarchy Stockholders: Use their voting power to elect the board of directors. Board of directors: Elected members who are legally responsible for corporate actions and for hiring and overseeing corporate officers. They report to stockholders on performance. Discussion: What kind of people should serve on the board of directors of a corporation? Why? (Possibilities include major shareholders, attorneys, academics, officers of other companies, and former government personnel.) Discussion: What factors contribute to an effective board of directors? 1) accountability to shareholders, 2) quality of directors, 3) independence, and 4) corporate performance. GE was at the top of the list (board members each own an average of $6.6 million GE stock), along with Johnson & Johnson, and Campbell

Corporate Governance Hierarchy Corporate officers: Senior managers of corporations who are responsible for overall performance. They report to the board of directors. Discussion: The Chief Executive Officer (CEO) is typically the highest ranked corporate manager. Which CEOs received the highest pay in the last seven years. The answers: 2000: Steven Jobs, Apple Computer, $381MM 1999: Charles Wang, Computer Associates, $507MM 1998: Michael Dell, Dell Computer, $94MM 1997: Henry Silverman, Cendant, $194MM 1996: Michael Eisner, Walt Disney, $194MM

Special Issues in Corporate Ownership Joint Ventures & Strategic Alliances Employee Stock Ownership Programs (ESOPS) Institutional Ownership

Special Issues in Corporate Ownership Joint ventures and strategic alliances: Strategic alliances are when two companies collaborate on a project for mutual gain, and a joint venture is when the partners share ownership stakes in the joint project. Employee stock ownership programs (ESOPs): Allows employees to own a significant share of the corporation. Discussion: Why would a corporation choose to go this direction? What are the potential benefits and drawbacks? Institutional ownership: Large investors (e.g. pension funds, banks) who purchase large blocks of stock. Institutional investors now own almost 40% of all stock in the U.S.

Special Issues in Corporate Ownership Mergers & Acquisitions (M&As) Mergers & Acquisitions (M&As) Divestitures & Spin-offs Divestitures & Spin-offs Divestitures & Spin-offs

Special Issues in Corporate Ownership Mergers and acquisitions (M&As): A merger is the union of two corporations to form a new corporation, and an acquisition is the purchase of one company by another. Discussion: What are some of the reasons why companies engage in M&A activity? (The concepts of horizontal and vertical mergers usually arise through the discussion, but if not, you may want to introduce them.) Divestitures and Spin-offs: A divestiture is when a corporation sells one or more of its business units. When the company sell unrelated and underperforming business. Spin-off is when a firm decide to sell part of itself to raise capital. Or establish one or more corporate units as new, independent corporations.

Strategies in Action Vertical Integration Strategies Forward integration Backward integration Horizontal integration

Strategies in Action Forward Integration Example Defined General Motors is acquiring 10% of its dealers. Forward Integration Defined Gaining ownership or increased control over distributors or retailers

Strategies in Action Backward Integration Example Defined Motel 8 acquired a furniture manufacturer. Backward Integration Defined Seeking ownership or increased control of a firm’s suppliers

Horizontal Integration Strategies in Action Horizontal Integration Example Hilton recently acquired Promus. Defined Seeking ownership or increased control over competitors

Entrepreneurship vs. Small Business Entrepreneur: Accepts the risks and opportunities of creating, operating and growing a new business Small Business Owner: Does not have plans for growth

Trends in Small Business Start-ups Emergence of E-commerce Crossovers From Big Business Opportunities for Minorities & Women Global Opportunities Increased Survival Rates

Trends in Small Business Start-ups Emergence of e-commerce: E-commerce plays a small role in the overall economy, but it continues to grow rapidly, despite the current recession. Crossovers from big business: More and more people are leaving big corporations, and launching their own businesses. Opportunities for minorities and women: Over the past five years business ownership by minorities has increased significantly: African Americans: +46% Hispanics: +76% Asians: +56% Native Americans: +93% In addition, women own 38% of ALL businesses in the U.S. (!!!) Global opportunities: With the emergence of the Internet, foreign markets have become much more accessible to small businesses, both as a source of suppliers and as a source of customers. Increased survival rates: Today, the SBA estimates that at least 40% of all new businesses will survive for six years. This represents dramatically increased odds\chances vs. previous decades.

E-commerce Continues to Grow Rapidly

Reasons for Success and Failure Reasons for Failure Poor management Neglect Weak control systems Insufficient capital Reasons for Success Hard work, drive, dedication Market demand Strong management Luck!!!

Reasons for success and Failure Ultimately, 63% of all new businesses fail, due in large part to the following factors: Poor management: While common sense is important, not knowing basic business principles can hinder long-term success. Neglect: Starting a new business requires an overwhelming time commitment. Doing it “on the side” usually isn’t enough. Weak control systems: Without control systems, small business owners don’t know about problems until it’s too late. Insufficient capital: Many experts recommend that a new business should have enough capital to last six months to one year without earning a profit. Small businesses that succeed typically credit the following factors: Hard work, drive, and dedication: Commitment is essential. Nearly 44% of successful entrepreneurs interviewed by the Ontario Department of Industry and Commerce cited determination as the personal quality that contributed to success.

Reasons for Success and Failure Market demand: Clearly, if there is demand for a product, success will be easier. Careful up-front market analysis is crucial. Managerial competence: Training and experience make a real difference. Most successful entrepreneurs spend time working in successful companies or they partner with others who bring more expertise. Luck: Never underestimate the importance of luck, but keep in mind Thomas Jefferson’s adage: “The harder I work, the luckier I become”!

Buying an Existing Business Getting Started Buying an Existing Business Starting From Scratch

Sources: Finding the money Finding the money to finance a new business is clearly critical. Personal resources: Money from personal savings, friends, and relatives accounts for over two-thirds of all money invested in new small businesses, and one half of all money invested in the purchase of existing small businesses. Loans: Potential sources include banks and other lending institutions, independent investors, and the government. All of these sources require formal business plans. Venture capital companies: These firms invest in businesses with rapid growth potential, supplying capital in return for stock. Small business investment companies: These are government-regulated companies that borrow money from the SBA to invest in or lend to a small business. Past recipients include Apple, Intel, and Fed Ex. Small business association (SBA): The SBA offers a wide range of financing programs. In addition, the SBA has a number of virtually free management counseling and small business information services…great resources for entrepreneurs!

Financing the Small Business Personal resources Loans Venture capital companies Small-business investment companies Small Business Association (SBA) Financial aid and management advice

FRANCHISING Franchising is a very accessible path to entrepreneurship. A franchise is an arrangement that permits the franchisee (buyer) to sell the product of the franchiser (seller). Advantages: Proven business opportunity: There is much less risk in buying a business with brand recognition and a successful track record across a range of venues. Access to management expertise: Big business management skills and guidance further reduce the risk of failure.

FRANCHISING Disadvantages: Start-up costs: Franchise fees range widely, from $30,000 for a Fantastic Sam’s hair salon, to more than $650,000 for a McDonald’s, to several hundred million dollars for a professional sports team. On-going payments: Many franchisees are required to pay a percentage of sales to their franchisers. Management roles and restrictions: Owners have much less flexibility in operating a franchise business. Discussion: How many would like to own a franchise. What kind of franchise? Why?

An Ownership Opportunity FRANCHISING An Ownership Opportunity Advantages Proven business opportunity Access to management expertise Disadvantages Start-up costs On-going payments Management rules and restrictions

Chapter Review Why did the founders initially choose a partnership form of legal organization? Were there any risks in choosing this form? Answer: The founders chose a partnership because it was easy to set up, and they knew it would only be temporary. The biggest risk was unlimited liability. What advantages were gained from switching from a partnership to a corporation? Answer: The key advantages were limited liability and greater fundraising capability.

Chapter Review Why are small businesses important to the U.S.\Palestinian economy? They create new jobs, foster entrepreneurship and innovation, and supply goods and services needed by larger businesses. Why might a closely held corporation choose to remain private? Why might a closely held corporation choose to become a publicly traded corporation? Remain private: to retain control Become public: to generate additional funding What key factors typically contribute to the success and failure of small businesses? Contributing to success: hard work and dedication, market demand, managerial competence, and luck. Contributing to failure: inexperience, neglect, weak control systems, and insufficient capital. From the standpoint of the franchisee, what are the primary advantages and disadvantages of most franchise arrangements? Advantages: proven business opportunity, access to management expertise Disadvantages: high start-up costs, possible on-going fees, management rules and restrictions

Assignment Choose a private limited corporation operates in the Gaza Strip and conduct empirical study on it. Consider the following elements: Identify the company name and the type of business it belongs to (e.g., food industry, beverages..) How many partners it has. Why the choose such type of legal form. Why not PLC? What challenges (management, finance, political..) they face? What future strategies they plan to take (expansion, divesture, close-down, ..)? Be practical you need to visit the company in the field. Two can join efforts in one assignment. But it can be individual assignment.