1. Pursuing New Venture Opportunities
part 3
Pursuing New Venture Opportunities 5
Startups and Buyouts
PowerPoint Presentation by Charlie Cook
12e
Copyright © 2003South-Western College Publishing.
All rights reserved.

2. Looking Ahead After studying this chapter, you should be able to:
Identify five factors that determine whether an idea is a good investment opportunity.
Give three reasons for starting a new business rather than buying an existing firm or acquiring a franchise.
Distinguish among the different types and sources of startup ideas.
List some reasons for buying an existing business.
Summarize four basic approaches for determining a fair value for a business.
Describe the characteristics of highly successful startups.
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3. Identifying and Evaluating Investment Opportunities
“Startups with products that do not serve clear and important needs cannot expect to be ‘discovered’ by enough customers to make a difference.”—Amar Bhide
Infatuation with an idea may lead to an underestimation of the difficulty of developing market receptivity and building a firm to capture the opportunity.
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4. Is an Idea a Good Investment Opportunity?
Is there a clearly defined market need for the product or service, and is the timing right?
Can the proposed business achieve a durable or sustainable competitive advantage?
Is the venture financially rewarding, and does it have significant profit and growth potential?
Is there a good fit between the entrepreneur and the opportunity?
Is there a fatal flaw in the venture that could make the business unsuccessful?
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5. Two Paths to Entrepreneurship
Startup Creating a new business from scratch
Buyout Purchasing an existing business
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6. Reasons for Starting a New Business
Developing a commercial market for a recently invented or newly developed product or service.
Taking advantage of available resources, ideal location, advances in equipment, employees, suppliers, and bankers
Avoiding precedents, policies, procedures, and legal commitments of existing firms
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7. Evaluation Criteria for a Startup
Marketing Factors
Need for product
Identified or unfocused
Customers
Reachable or not, brand loyal
Value created for customer
Significant or insignificant
Life of product
Recovery of cost by customer
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8. Evaluation Criteria for a Startup
Marketing Factors (cont’d)
Market structure
Emerging or mature
Market size (known or unknown?)
Market growth (how fast?)
Competitive Advantage
Cost structure
Degree of control over: price, costs, channels of supply
Barriers to entry: regulatory protection, response/lead-time advantage, legal, contacts and networks
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9. Evaluation Criteria for a Startup
Economics
Return on investment?
Investment requirements
Break-even point
Management Capability
Diverse skills or solo entrepreneur with no related experience
Fatal Flaws
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10. Basic Questions about Startups
What are the different types of startups you might consider?
What are some sources for new ideas?
How can you identify a genuine opportunity that creates value, for both the company and the company’s owners?
How should you refine your idea?
What might you do to increase your chances that the business will be successful?
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11. Kinds of Startup Ideas Type A Type B Type C
Startup ideas centered around providing customers with an existing product not available in their market
Type B
Startup ideas, involving new ideas, involving new technology, centered around providing customers with a new product
Type C
Startup ideas centered around providing customers with an improved product
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12. Types of Ideas that Develop into Startups
Example: Targeting the "New Age" beverage market by selling soft drinks with nutritional value
New Market
Type A Ideas
Example:
Using high-tech computers to develop a simulated helicopter ride
Type B Ideas
New Technology
Example:
Developing a personal misting device to keep workers cool
Type C Ideas
New Benefit
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Fig. 5.1

13. Sources of Startup Ideas
Family Business 6%
Friends/Relatives 5%
Personal Interest/Hobby
16%
Suggestion 7%
Education/Courses
Chance Happening
11%
Other 4%
Prior Work
Experience
45%
Source: Data developed and provided by the National Federation of Independent Business Foundation and sponsored by American Express Travel Related Services Company, Inc.
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Fig. 5-2

14. Reasons for Buying an Existing Business
To reduce some of the uncertainties and unknowns that must be faced in starting a business from the ground up.
To acquire a business with ongoing operations and established relationships with customers and suppliers.
To obtain an established business at a price below what it would cost to start a new business.
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15. Pros and Cons of Buying an Existing Business
High chance of success
Less planning
Existing customers/ suppliers
Necessary equipment
Bargain price
Experienced employees
Existing business records
Cons
Existing problems
Poor quality of current employees
Poor business image
Modernization required
Purchase price based on inaccurate data
Poor business location
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16. Investigating and Evaluating Available Businesses
Due Diligence
The exercise of prudence, such as would be expected of a reasonable person, in the careful evaluation of a business opportunity
Relying on Professionals
Accountants
Attorneys
Other experienced business owners
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17. Finding Out Why the Business Is For Sale
Owner’s reasons for selling the business
Old age or illness
Desire to relocate in a different section of the country
Decision to accept a position with another company
Unprofitability of the business
Discontinuance of an exclusive sales franchise
Maturation of the industry and lack of growth potential
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18. Examining the Financial Data
Review financial statements and tax returns for the past five years.
Recognize that financial data can be misleading.
Assets overvalued
Expenses overstated/understated
Income underreported
Unrecorded debts
Prepare adjusted adjusted statements to reflect the true state of the business.
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19. Income Statement as Adjusted by Prospective Buyer
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Fig. 5-3

20. Valuing the Business Asset-Based Valuation Market-Comparable Valuation
Estimates the value of the firm’s assets; does not reflect the value of the firm as a going concern.
Market-Comparable Valuation
Considers the sale prices of comparable firms; difficulty is in finding comparable firms.
Cash-Flow-based Valuation
Compares the expected and required rates of return on the amount of capital to be invested in the business.
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21. Asset-Based Valuation
Modified Book Value Technique
Historical value of firm’s assets is adjusted to reflect current market values.
Replacement Value Technique
Value of firm’s assets is adjusted to reflect current costs to replace the assets.
Liquidation Value Technique
Value of firm’s assets is adjusted to reflect their value if the firm ceased operations and disposed of the assets.
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22. Market-Comparable Valuation
Earnings Multiple (Value-to-Earnings) Ratio
Ratio is determined by dividing the firm’s value by its earnings.
Firm’s ratio is compared to representative ratios of recently-sold similar firms.
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23. Suggested Risk Premium Categories1
Established businesses with a strong trade position that are well
financed, have depth in management, have stable past earnings, and
whose future is highly predictable.
6 10% 2
Established businesses in a more competitive industry that are well
financed
, have depth in management, have stable past earnings, and
whose future is fairly predictable.
11 15% 3
Businesses in a highly competitive industry that require little capital to
enter, have no management depth, and have a high element of risk,
although past record may be good.
16 20% 4
Small businesses that depend on the special skill of one or two people
or large established businesses that are highly cyclical in nature. In
both cases, future earnings may be expected to deviate widely from
projections.
21 25% 5
Small “one-person” business of a personal services nature, where the
transferability of the income stream is in question.
26 30%
Risk Premium
Description
Category
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24. Determinants of a Firm’s Earnings Multiple
Risk
High
Low
Earnings Multiple
Low Firm Value
High Firm Value
Growth
Fig. 5.4
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25. Cash Flow-Based Valuation
Estimate the firm’s expected cash flows.
Compute the firm’s cost of capital—the investors’/owners’ required rate of return on investments in the firm.
Using the cost of capital, calculate the present value of the firm’s expected cash flows—the value of the firm.
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26. Nonquantitative Factors in Valuing a Business
Competition
Market
Future Community Development
Legal Commitments
Union Contracts
Buildings
Product Prices
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27. Negotiating and Closing the Deal
Terms of Purchase
Assets purchase or total entity
Indemnification clause
Payment in full or partial payments over time
Closing the sale
Best handled by a third party
Bill of sale
Tax certifications
Payment-to-seller agreements and guarantees
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28. Characteristics of Successful High-Growth Startups
Begin as a team effort
Are in service and manufacturing industries
Have competent founders who:
have related experience.
have started other businesses.
share in ownership of business.
Are somewhat better financed
Do not limit themselves to local markets
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