Thursday, 23 February 2017

Entrepreneurship in red states versus blue states

Just finishing up some interesting research with my co-author Emanuel Oliveira this week. We will submit the paper to an economics or entrepreneurship journal shortly, but the findings are interesting enough that I feel the need to share them with our readers ahead of time.

The study

We analyzed 10 years of entrepreneurship data from the Kauffman foundation combined with data on the political orientation of every state in the U.S. We coded states at ‘red states’ if they were dominated by the Republican party (i.e., both state houses and the governor are from the same party) and ‘blue states’ if they were dominated by the Democratic party. We then ran regressions with control variables so see how the political orientation of a state affects it entrepreneurs.

Entrepreneurship in blue states

The results strongly suggest that blue states have higher rates of entrepreneurial entry by individuals with higher levels of education.

Democrats tend to tout the need for regulations, government spending, and the creation of a social safety net to protect the disadvantaged. Our research suggests that this creates conditions whereby educated entrepreneurs feel they can take risks because they will have a net to catch them if they fall.

Entrepreneurship in red states

By contrast, red states have higher rates of entrepreneurial entry by individuals with higher incomes.

I think this is really interesting, especially given that Republicans usually consider themselves the party of the entrepreneurs. Turns out they are the party of the entrepreneurs with greater financial capital. Perhaps these are individuals are enticed by tax-cutting, less regulation, and reduced government spending.

Conclusion

We didn’t find a main effect for political control by either party, which suggests that both parties’ policies can be good for entrepreneurs, but for different types of entrepreneurs. Perhaps a good follow on study would be to see if entrepreneurship by those with higher education is more valuable than that of those with higher prior income or vice versa.

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Wednesday, 15 February 2017

Solar opportunities: Theory and projections for entrepreneurs

Green opportunities

I’ve been tracking the annual drop in the price of solar power and what I keep seeing amazes me, and gives me great comfort. Let me explain.

It seems that the price per watt for solar keeps getting better from year to year. Much of the product innovation continues, but that is no longer the main driver. The reduction in cost now has more to do with economies of scale and the implementation of process innovations by manufacturers.

Innovation theory

The innovation cycle starts with product innovation. We’ve had those gains from solar already—the yields on new ‘commodity’ panels are better than those placed on early satellites.

The second curve, that of process innovation, started around the time that process innovations made it feasible to try to achieve economies of scale and climb the associated learning curves.

The arrow in the figure denotes about where we are today: right near the end of the product innovation curve, but beyond the point where product and process innovations were essentially equal contributors. Process innovations have accounted for the majority of recent gains as huge factories in the U.S., but especially in China, have upped their production and learned to make better panels more cheaply.

The demand keeps growing as lower prices make whole new regions viable for solar installations. The more sunlight a place gets, and the further away from cheaper alternatives, the faster the diffusion. But with each additional place, there come more process innovations, increasing the pace of the feasibility wave.

The bet

This leads me to place a big rhetorical bet. Given that no other energy technology comes close to the improvement curve in solar, and that process innovations are going to continue driving demand, we should bet on solar. Technology scholars often note that people are not very good at making estimates for non-linear curves. Early improvements seem slow when they start because they are starting from such a low point. They still look slow right now, but if we are at 1% global capacity, and we go to 2% next year and 4% the following year, then the jump to 8% will perhaps be the first one to really get attention. But by then, the time to invest will be over because by then everyone will believe it, and valuations will reflect it.

Solar enterprise opportunities

Entrepreneurs can get into every level. They can learn from the gains of big production facilities and build new facilities with newer, cheaper technologies. They can get into the business of moving and maintaining panels, repairing them, and optimizing them. They get into the distribution or sale of the panels. They can resell panels with marketing startups. They can finance projects in search of returns; even buy options on their neighbor’s roofs. Now seems to be the time.

Some opportunities we scored

While only one type of solar venture, Launchscore estimates the potential yearly earnings of Solar Energy Systems Dealers in 750 U.S. cities. The statistical model suggests that there are over 100 cities where the entrepreneurs could make over $100,000 in net profits within three years of entering the business, and also 100’s of cities where it is not yet viable as a business choice. Not surprisingly, some of the worst places are cloudy, like Bridgeport, Connecticut with 99 sunny days a year, and some of the best are in sunny places like Cupertino, California, with 265 days a year. Note that some of the sunniest places of all like Phoenix (AZ) are not in the top 100 because opportunities have been strong enough there for long enough that dealers are already ubiquitous (sorry but you need to sign in to see this one). But we didn’t just factor in sunny days. We used 30 other control variables, including demographic factors (e.g., median age and income), elevation, location (East, West, North, South), weather more generally, and cultural factors (e.g., red versus blue states) to make our estimates.

 

 

 

 

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Saturday, 11 February 2017

Entrepreneurs and the mythical machine takeover.

In the last few years, several big names have made statements they will likely have to take back in the future. In particular, Elon Musk recently made the claim that artificial intelligence is poised to take over so many human jobs, that the government will need to step in with a basic income to prevent chaos.

AI, is progressing quickly, that is sure, but the effect of its application for the broader economy is less well understood. Economist like Schumpeter have long reminded us that the ‘gales of creative destruction’ are actually a force for good, and should not be feared.

How will this play out?

Just for fun, let’s pick on The Inquirer’s 5 recent picks: personal assistants, cab drivers, technical support professionals, factory workers, and doctors (yes, medical doctors).

Drivers

What happens when human drivers become obsolete? Transportation costs fall, empowering people to do more importing and exporting. Entrepreneurs will more easily find new markets and consumers will more easily access goods and services.

Personal assistants

What happens when human personal assistants are replaced? Everyone can now afford a digital assistant, which means they can get more done. Entrepreneurs have a lot of work to do. Starting a business often entails taking on many of the organizational functions that will eventually be done by employees. What entrepreneur wouldn’t welcome a low cost personal assistant?

Technical support professionals

What about technical support specialists? Surely this will boost productivity for everyone, especially technology entrepreneurs. Faster, more competent technical support means that entrepreneurs can get their technology working and get their products out to market. It also means they can offer technical support for their own products and services more economically. Yet another barrier to entry out of the way.

Factory workers

Factory workers. Come on! Factory work has been evolving rapidly for 200 years. The more machines take on, the lower the cost of manufacturing, the better off we all are. It means more entrepreneurs can afford to have their prototypes put into production. It means more innovative new businesses popping up!

Doctors

This is probably the funniest example in the list. It’s hard to imagine doctors being replaced by AI, but let’s entertain that possibility for a minute. Doctors are well paid today because there are too few of them. For example, in Cuba, where doctors are in abundance, they are paid similar wages as school teachers. If AI takes over some of the jobs that doctors do, we can expect that doctors will move on to other higher value tasks. This is likely to result in better care at a lower cost. For entrepreneurs, that means that lower healthcare costs, and in places where employers chip in to pay for employee healthcare, it means the ability to hire more employees.

Don’t worry, entrepreneurs will step in!

In conclusion, the overall impact of AI will be to boost entrepreneurship, which in turn creates new jobs. That’s not something we need to fear.

 

 

 

The blog post Entrepreneurs and the mythical machine takeover. was initially published to The LaunchScore Blog



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Sunday, 29 January 2017

Impact of Protectionism and Trade Wars on Small Businesses

President Trump has recently signed executive orders that clearly indicate his administration’s intention to de facto heighten protectionism and global realpolitiks tensions. As they take effect, small businesses dependent on international trade are likely to undergo a cost increase, the magnitude of which will depend on how far they are in the supply chain. At this time, it appears that those businesses with trade relations with Mexico will be the first to experience it, but if the renegotiation of NAFTA becomes a reality, there could be a contagion effect to those dealing with Canada.

On the other hand we have the consumers.  Typically, cost increases lead to hikes in consumer prices and this pass-through effect tends to be quite close to the amount of the cost increase. Ceteris paribus (all else held constant), higher consumer prices will increase inflation rates and put upward pressure on nominal interest rates, and therefore on borrowing costs as well. In relation to profits, the likely outcome is a decrease in profits for businesses that sell goods and services with elastic demand, whereas those operating in markets with inelastic demand will be the least affected. Markets with an elastic demand are far more common that those with inelastic demand.

However, reality is in fact more complex.  For example, Mexican imports contain 40% of American made inputs on average.  Hence, domestic producers of those inputs will also be negatively impacted by tariff increases on Mexican products. Even more so if Mexico retaliates with tariff increases on American imports (i.e. beggar-thy-neighbor policies).

As most small businesses tend to be at the end of the supply chain (retailers, food and beverage establishments, etc.), business owners should considerer changing the country of origin of their supplies. This exercise should take into account not only the price listed by domestic suppliers but also foreign, and the tariff schedule that regulates imports per country – click here to access the US Harmonized Tariff Schedule (HTS).

For example, recent media reports suggest a potential additional tariff of 20% on Mexican imports. Such increase may justify changing suppliers.  More details about the specificities of the law will have to be disclosed in order to determine which products and services will be affected. Notwithstanding, regulatory changes often lead to additional costs for small businesses due to the time required to assess their impact and adaption to the new rules (e.g. logistics).

Another action that US importers and exporters should evaluate is the need to hedge exchange rates.  Protectionist policies tend to appreciate the domestic currency. This expected appreciation may be further augmented by plans to increase US investment in infrastructure.  As businesses dislike uncertainty, one may find it cost effective to buy or sell future contracts according to their needs – click here to access CME quotes and contract specifications.

Globalization is too big of a phenomenon to go away. It will not stop even if the US decides to shell itself from it. Globalization is just recently becoming truly global. Globalization keeps on growing as South American countries make new deals with the China, or African countries with the European Union. Lastly, one should not ignore history lessons. In the great recession of the 1930s there were similar populist outcries for protectionism in the US which led politicians to implement the Smoot-Hawley Tariff Act, raising tariffs on over 20,000 imported goods. The end result was a decline by more than 50% of US imports and exports, further exacerbating the depression and augmenting unemployment to 25% by 1933.

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Monday, 28 November 2016

Will Trump be absolutely fantastic for Entrepreneurs?

How much can one contextualize into a short slogan? Recent US Presidential campaigns suggest that a lot. "Yes We Can!" or "Let’s Make America Great Again!" definitely galvanized the masses. The new President-elected loudly promised countless times that absolutely fantastic, awesome, extraordinary, terrific, and wonderful changes are coming. The political campaign more closely resembled the useless small talk on a barber shop rather than the informed and comprehensive policy debate the nation really needed.

In the weeks after the election the media has bombarded us with pros and cons of several (potential) nominations by the Trump transition team. Out of all the noise, my wannabe-unbiased mind has mostly identified concepts like white supremacy, anti-gay, anti-abortion, conflict of personal business interests, and nepotism.  I suspect that for over 64 million US voters something does not feel right.  One is left wondering about the extent of media bias that President-elect Trump so much shouted about. If you turn on MSNBC or FOX news I guarantee you sporadic cynical laughs (more frequent while watching the latter), given the extent of partisanship bias. You turn on CNN and there is a clear effort to appear unbiased but their reputation has been hurting for while, being the Clinton’s CNN aphorism just a recent example.  PBS plays the role of “saint” among the media, attempting to alert the commoners for the need of an altruistic analysis of daily events. Audience shares for each of these media outlets provide useful insights about the society we currently live in. PBS is one of those rare instances that you may want thank God for taxes on behalf of the common good.

One of the reasons for the electoral results is that Mr. Trump is a business man, not a career politician. Entrepreneurs are wannabe business people and expect the creation of more favorable conditions from their self-proclaimed “Master of the Apprentices”.  However, no policy draft has yet been announced to specifically benefit small business entrepreneurs. Notwithstanding, the promise of tax cuts and big public investments in infrastructure may have some positive impact on small businesses. Unfortunately, such externalities will likely be incipient because most of government contracts are historically allocated to big businesses, which then may hopefully outsource specific tasks from small businesses. The rise of oligopolies across most US industries diminish any potential trickle-down economics.

More, the President-elect has promised to lower taxes for corporations to bring back their money stashed overseas and to grant tax credits for private investments in public infrastructures – both fiscal policies will disproportionally benefit big businesses rather than small ones. In addition, these private investments in public infrastructure will likely increase the costs for consumers. Look for example at the European experiment with highways. Many have been privatized and the tolls skyrocketed to such levels that have become as expensive as the amount of gas used for the trip (e.g. Portugal). Hence, the expected impact of better highway infrastructures on a nation’s competitiveness has been drastically buffered by the hike in tolls. More, the national public roads became overloaded with slow traffic avoiding highway tolls. Hopefully, the President-elect will not apply a similar recipe to the renewal of US infrastructures.

One outcome is apparently obvious if the President-elect fulfills his promises. The national debt will likely increase in the short run due to the big infrastructure expenditures and the concurrent lower taxes, thus augmenting our dependency on foreign US-debt holders and potentially damaging our sovereignty (e.g. policies imposed by lenders on borrowing nations).

Entrepreneurs need from the President-elect a clear plan to foster small businesses. The nation needs the creation of value, not protectionism for import-competing industries nor merely a partial redistribution of existing wealth. Thus, a national plan for entrepreneurialism must comprise incentives for small businesses, both traditional and innovative ones. The former redistribute existing wealth, the latter create new wealth. Given the rise of economic inequality in the post-1970 period, some redistribution will create better conditions for competitive markets, sustainable economic growth, and avoidance of social unrest. A potential policy could be the allocation of financial incentives to the unemployed to create their own businesses (e.g. Germany), such as subsidies, a grace period for taxes, and loans with below market interest rates. Concurrently, bigger incentives of similar nature should be given to the creation of innovative businesses, the ones that the US actually needs to preserve its economic leadership.

The US will remain the main world economic power only if its industrial policy focuses on innovation. If instead, it turns to aggravate protectionism (e.g. the 1930 Smoot-Hawley Tariff Act worsened the Great Depression), then sooner rather than later it will lose its economic leadership, as clearly implied by the science of economics and modern world history. Competitive (strong) nations want free markets, (weak) nations unable to compete want protectionism. More, protectionism regularly leads to beggar-thy-neighbor policies which further suppress trade. Only through technological leadership can the US (population of about 320 million) compete with large nations such as China (about 1.35 billion) or India (1.25 billion).

“(…) The supporters of tariffs treat it as self-evident that the creation of jobs is a desirable end, in and of itself, regardless of what the persons employed do. That is clearly wrong. If all we want are jobs, we can create any number - for example, have people dig holes and then fill them up again, or perform other useless tasks. Work is sometimes its own reward. Mostly, however, it is the price we pay to get the things we want. Our real objective is not just jobs but productive jobs - jobs that will mean more goods and services to consume. Another fallacy seldom contradicted is that exports are good and imports are bad. The truth is very different. We eat bananas from Central America, wear Italian shoes, drive German automobiles, and enjoy programs we see on our Japanese TV sets. Our gain from foreign trade is what we import. Exports are the price we pay to get imports. (…) ‘Protection’ really means exploiting the consumer.”  - in Milton Friedman’s “Free to Choose: A Personal Statement” (1990), p 40-41.

We all agree upon the desire to Make America Great Again! However, we may disagree on how the fulfillment of that promise can be achieved. Nonetheless, entrepreneurialism needs to remain a key US competitive advantage.

The article Will Trump be absolutely fantastic for Entrepreneurs? is republished from LS Blog



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Wednesday, 26 October 2016

How to Buy a Small Business – A Comprehensive Guide and Resource

Starting a new small business can be risky endeavor, which is why you should at least consider buying an existing business instead. LaunchScore.com is here to help you when buying a small business, with this comprehensive guide and resource.

An existing business may very well a better option given that it already has a location, supply-chain, trained employees, brand, customer base, historical cash flow statements, and tax returns.

There is already a formula in place to run the business and hopefully all it needs to boom is your vision, enthusiasm, and determination to put in place incremental innovations. Lenders are also more comfortable financing a business that already has financial records they can evaluate.

However, there are also disadvantages. Existing businesses typically cost more than starting one from scratch. Current employees and suppliers may have practices not to your liking and may be resistant to change.

Also, equipment and inventory may become a substantial financial burden, particularly if outdated.  The seller may omit or downplay existing business problems – and could even have “cooked” accounting records.

Though at first one may think that there must be something wrong if a business is for sale, that may not be the case. Hopefully, you will find a great business whose owner just wants to move on to another industry, life project, or retirement. Nonetheless, keep in mind that it is easier to fall into a lemon than a great business you can afford.

This guide is a comprehensive resource to help you fulfill your entrepreneur dream by buying a small business. It is separated into three sections to guide you to success:

  • Do you have what it takes to run a small business?
  • Doing the due diligence
  • Negotiating the price when buying a small business
Do You Have What it Takes to Run a Small Business?

The first step is to select the right type of business for you. Being passionate about a business does not suffice. A successful entrepreneur must be equipped with adequate human and financial capital.

During the process of selecting the right type of business, consider making an introspective assessment about the fit of your skills, abilities, and experience to the venture of choice. Even if that requires spending some months actually working for someone else that operates a similar business - perceptions are not knowledge. You need to get familiar with the industry and understand it.

Then, ask yourself if you are willing to spend sleepless nights worrying about a supplier, employee, customer, product, service, or regulator – business ideas are cheap but execution is dear.

Being a business owner is like parenting a restless toddler – it requires a growth plan, constant attention, intervention, persistence, and you need to be sufficiently intelligent to ask for help (e.g. hiring employees, consultants, accountants, lawyers, etc.), punish (e.g. firing employees, suppliers, etc.), and reward (e.g. promotions, bonuses, etc.) in a timely fashion. Also make sure that your spouse or partner is on board because this venture will likely have an impact on the time you spend with them and on your stress levels.

Concurrently, you also need to evaluate your financial capital and your relationship with money. Compile a personal financial statement detailing your assets, liabilities, and net worth – you will be required to deliver it at some point during the acquisition process. Note that you should be prepared to pay 30 to 50 percent of the business’ sale price in cash and finance the remaining amount.

Do you have sufficient startup funds for the selected business type and a good credit score to get financing? Do you have retirement funds or home equity that you can use to buy the business? Are you able to make rational financial decisions or are you a reckless gambler?

Having a non-emotional relationship with money contributes to wiser business decisions, especially when buying a business. The poor management of personal finances will most likely follow you into a business. A solid financial record along with a good credit score will ease negotiations and enable lower interest rates from lenders.

Doing the Due Diligence

Once you determine the type of business that fits your competencies and experience, you need to determine the target geographic location. LaunchScore.com provides a free tool to assist you with this task – just enter the business type of choice and our database will rank the best U.S. locations by potential yearly earnings (PYE).

Once you have a location you can search for available businesses for sale using one of the many online sources (e.g. BizBuySell), local newspaper classifieds, industry publications, franchises (e.g. FranchiseGator), and business brokers (e.g. SunBelt). Then go do some reconnaissance on the business, and if it appeals to you, contact the owners or brokers.

Once you have a targeted business or businesses, you need to know what to ask for in order to assess its operations and viability. Start by asking these questions:

  • what are the goods and services this business provides?
  • when was it first established?
  • why is it for sale?
  • how long has the current owner has been operating it?

You should also get the specifics of the small business's day-to-day management, such as:

  • the lease costs and expiration dates.
  • a list of licenses and permits.
  • proof of compliance with Occupational Safety and Health Administration (OSHA) requirements.
  • number of employees and suppliers.
  • sales and corporate tax information.
  • the business's revenue generating model.

Then you need to request legal and financial information. Here is a suggestion for documents you should review (source: FindLaw):

Organization and Good Standing
  • The Company's Articles of Incorporation, and all amendments thereto.
  • The Company's Bylaws, and all amendments thereto.
  • The Company's minute book, including all minutes and resolutions of shareholders and directors, executive committees, and other governing groups.
  • The Company's organizational chart.
  • The Company's list of shareholders and number of shares held by each.
  • Copies of agreements relating to options, voting trusts, warrants, puts, calls, subscriptions, and convertible securities.
  • A Certificate of Good Standing from the Secretary of State of the state where the Company is incorporated.
  • Copies of active status reports in the state of incorporation for the last three years.
  • A list of all states where the Company is authorized to do business and annual reports for the last three years.
  • A list of all states or countries where the Company owns or leases property, maintains employees, or conducts business.
  • A list of all of the Company's assumed names and copies of registrations thereof.
Financial Information
  • Audited financial statements for three years, together with Auditor's Reports.
  • The most recent unaudited statements, with comparable statements to the prior year.
  • Auditor's letters and replies for the past five years.
  • The Company's credit report, if available.
  • Any projections, capital budgets and strategic plans.
  • Analyst reports, if available.
  • A schedule of all indebtedness and contingent liabilities.
  • A schedule of inventory.
  • A schedule of accounts receivable.
  • A schedule of accounts payable.
  • A description of depreciation and amortization methods and changes in accounting methods over the past five years.
  • Any analysis of fixed and variable expenses.
  • Any analysis of gross margins.
  • The Company's general ledger.
  • A description of the Company's internal control procedures.
Physical Assets
  • A schedule of fixed assets and the locations thereof.
  • All Uniform Commercial Code (UCC) filings.
  • All leases of equipment.
  • A schedule of sales and purchases of major capital equipment during last three years.
Real Estate
  • A schedule of the Company's business locations.
  • Copies of all real estate leases, deeds, mortgages, title policies, surveys, zoning approvals, variances or use permits.
Intellectual Property
  • A schedule of domestic and foreign patents and patent applications.
  • A schedule of trademark and trade names.
  • A schedule of copyrights.
  • A description of important technical know-how.
  • A description of methods used to protect trade secrets and know-how.
  • Any "work for hire" agreements.
  • A schedule and copies of all consulting agreements, agreements regarding inventions, and licenses or assignments of intellectual property to or from the Company.
  • Any patent clearance documents.
  • A schedule and summary of any claims or threatened claims by or against the Company regarding intellectual property.
Employees and Employee Benefits
  • A list of employees including positions, current salaries, salaries and bonuses paid during last three years, and years of service.
  • All employment, consulting, nondisclosure, nonsolicitation or noncompetition agreements between the Company and any of its employees.
  • Resum├ęs of key employees.
  • The Company's personnel handbook and a schedule of all employee benefits and holiday, vacation, and sick leave policies.
  • Summary plan descriptions of qualified and non-qualified retirement plans.
  • Copies of collective bargaining agreements, if any.
  • A description of all employee problems within the last three years, including alleged wrongful termination, harassment, and discrimination.
  • A description of any labor disputes, requests for arbitration, or grievance procedures currently pending or settled within the last three years.
  • A list and description of benefits of all employee health and welfare insurance policies or self-funded arrangements.
  • A description of worker's compensation claim history.
  • A description of unemployment insurance claims history.
  • Copies of all stock option and stock purchase plans and a schedule of grants thereunder.
Licenses and Permits
  • Copies of any governmental licenses, permits or consents.
  • Any correspondence or documents relating to any proceedings of any regulatory agency.
Environmental Issues
  • Environmental audits, if any, for each property leased by the Company.
  • A listing of hazardous substances used in the Company's operations.
  • A description of the Company's disposal methods.
  • A list of environmental permits and licenses.
  • Copies of all correspondence, notices and files related to U.S. Environmental Protection Agency (EPA), state, or local regulatory agencies.
  • A list identifying and describing any environmental litigation or investigations.
  • A list identifying and describing any known superfund exposure.
  • A list identifying and describing any contingent environmental liabilities or continuing indemnification obligations.
Taxes
  • Federal, state, local, and foreign income tax returns for the last three years.
  • States sales tax returns for the last three years.
  • Any audit and revenue agency reports.
  • Any tax settlement documents for the last three years.
  • Employment tax filings for three years.
  • Excise tax filings for three years.
  • Any tax liens.
Material Contracts
  • A schedule of all subsidiary, partnership, or joint venture relationships and obligations, with copies of all related agreements.
  • Copies of all contracts between the Company and any officers, directors, 5-percent shareholders or affiliates.
  • All loan agreements, bank financing arrangements, line of credit, or promissory notes to which the Company is a party.
  • All security agreements, mortgages, indentures, collateral pledges, and similar agreements.
  • All guaranties to which the Company is a party.
  • Any installment sale agreements.
  • Any distribution agreements, sales representative agreements, marketing agreements, and supply agreements.
  • Any letters of intent, contracts, and closing transcripts from any mergers, acquisitions, or divestitures within last five years.
  • Any options and stock purchase agreements involving interests in other companies.
  • The Company's standard quote, purchase order, invoice and warranty forms.
  • All non-disclosure or non-competition agreements to which the Company is a party.
  • All other material contracts.
Product or Service Lines
  • A list of all existing products or services and products or services under development.
  • Copies of all correspondence and reports related to any regulatory approvals or rejections of any Company's products or services.
  • A summary of all complaints or warranty claims.
  • A summary of results of all tests, evaluations, studies, surveys, and other data regarding existing products or services and products or services under development.
Customer Information
  • A schedule of the Company's twelve largest customers in terms of sales thereto and a description of sales thereto over a period of two years.
  • Any supply or service agreements.
  • A description or copy of the Company's purchasing policies.
  • A description or copy of the Company's credit policy.
  • A schedule of unfilled orders.
  • A list and explanation for any major customers lost over the last two years.
  • All surveys and market research reports relevant to the Company or its products or services.
  • The Company's current advertising programs, marketing plans and budgets, and printed marketing materials.
  • A description of the Company's major competitors.
Litigation
  • A schedule of all pending litigation.
  • A description of any threatened litigation.
  • Copies of insurance policies possibly providing coverage as to pending or threatened litigation.
  • Documents relating to any injunctions, consent decrees, or settlements to which the Company is a party.
  • A list of unsatisfied judgments.
Insurance Coverage
  • A schedule and copies of the Company's general liability, personal and real property, product liability, errors and omissions, key-man, directors and officers, worker's compensation, and other insurance.
  • A schedule of the Company's insurance claims history for past three years.
Professionals
  • A schedule of all law firms, accounting firms, consulting firms, and similar professionals engaged by the Company during past five years.
Articles and Publicity
  • Copies of all articles and press releases relating to the Company within the past three years.

This process should be complemented by your own business plan for the targeted establishment, taking into account local competition, the current state of the industry nationwide and locally, a SWOT analysis – assessment of strengths, weaknesses, opportunities, and threats - and financial projections based on your input and historical performance of said business. You will need this document anyway when reaching out to lenders and/or venture capital investors.

Most people find the process of due diligence quite daunting given the time and skills it requires. If that is your case, you will be better off enlisting the help of professionals such as business consultants, accountants, or lawyers.

For example, a qualified attorney can help you review the legal and organizational documents as well as assist you in evaluating the business’ financial condition – concurrently, the attorney can also facilitate determining which form of business entity is best for you (e.g. C-corp, S-corp, LLC, etc.).

Negotiating the Price When Buying a Small Business

Upon review of all financial documents for the targeted business, you will be able to compare the seller’s asking price to your own valuation and that of similar businesses for sale in the surrounding area (which you may also be considering to buy as well).

Recall that extensive due diligence minimizes the problem of asymmetric information but does not eliminate it completely – the current owner has insider knowledge thus you have to thoroughly do your homework to have the best leverage possible during negotiations.

Be aware that the national, state, and local economic contexts also play a role – businesses tend to be cheaper during recessions and more expensive during expansions. In this realm, you should check the historical patterns of GDP per capita and  consumer spending in the metropolitan area of interest as well, which is published by the Bureau of Labor Statistics (BLS).

There are several methods of business valuation, such as the Net Present Value (NPV), Return on Investment (ROI), multiplier, and book value (BV). During this process some sellers will also try to get paid for intangible assets (e.g. brand/store recognition, etc.) and that is when things get tricky.

It is up to you to determine the true value of such non-physical assets. Ultimately, the fair business price should be calculated strictly upon financial accounts, and then separately add whatever dollar amount you are willing to pay for such intangible assets.

The Net Present Value (NPV) method is the most scientific approach to determine the fair price of a business in today’s dollars. It consists in determining the present value of all future net cash flows (inflows minus outflows) given a desired rate of return, thus it takes into account that a dollar received today is worth more than a dollar collected on a future date – the concept of Time Value of Money (TVM).

The difficulty in employing this method lies on estimating those future cash flows. However, there are several acceptable techniques. For example, one can use historical data gathered from the business’ financial statements, determine a trend for each rubric, and them assume that it will grow at a constant rate over the next years. Alternatively, those future net cash flows can be estimated based on the expected growth rate for the local industry, or some other metric of choice. The typical discount rate adopted for small businesses ranges from 15 to 30 percent – this is also often called the real rate of return or internal rate of return.

Note that LaunchScore.com provides Net Present Value estimates in its market research reports. If you're thinking of buying a business in a specific city, check LaunchScore as another way to determine if the sellers asking price is fair.

The Return on Investment (ROI) method is a simplified version of the real rate of return given that it ignores the Time Value of Money concept, that is, it does not take into account how long the investment will take. Therefore, it is a very popular metric because of its simplicity.

The typical technique to compute ROI consists on dividing the amount of profits after interest and taxes by the investment cost (and then multiply by 100 to get a percentage). In this setup, the investment cost is the business' sale price or this value adjusted for additional expenses that have to be made upfront.

The ROI for small businesses also typically ranges from 15 to 30 percent, depending on the industry. However, you should inquire the seller about the exact methodology employed to determine the sale price as people tend to use variations of it. For example, sometimes taxes and/or interest are omitted from the profit calculations, thus inflating ROI.

The multiplier method is another popular metric because of its simplicity. It determines the value of a business based on a multiple of sales, sales plus inventory, or after-tax profits. The factor by which one of these variables is multiplied by is not determined by rigorous science but rather based on the seller’s perceptions or historical data for similar businesses in the area – something typically difficult to verify. Hence, you must always ask about the detailed rationale adopted by the seller to arrive at the asking price.

The standard book value (BV) method basically equates the selling price to a multiple of the business’ net worth – the difference between the value of all assets and liabilities. Assuming that you asked for all financial statements, then the employed multiplier (typically ranging from 1 to 2) can be easily inferred by collecting data for the value of assets and liabilities from the business’ balance sheet.

However, there are several nuances that can occur when computing this metric, such as: a) the so-called modified book value technique, which adjusts the worth of assets to the current market value (not the same as the value they have in the accounting records); b) replacement value technique, where net worth is calculate based on the total cost of replacing those assets nowadays; c) liquidation value technique, which uses as a proxy for the value of the assets the amount of money that could be attained if the business was liquidated now.

These alternative techniques within the BV method emanate from the fact that the standard methodology evaluates the value of assets based on the acquisition cost minus accumulated depreciation - if the asset surpassed its expected accounting life then its book value would be zero. Thus it is important to ask the seller about which BV technique is being adopted to determine the business’ net worth given that such value will vary significantly depending on said choice.

Once you fully understand the methodology employed to determine the asking price for the targeted business then the next step is to negotiate the final sale price. This endeavor will also take into account how do you plan to finance the acquisition.

As typically one is expected to pay 30 to 50 percent in cash, you will need to get a deal with the seller, lenders, or venture capitalists for the remaining amount. This implies engaging in another parallel process that will have an impact on how much are you willing to pay for the business so that you feel comfortable about the expected return relatively to the amount of risk.

If you need financing, one option is to negotiate with the seller a “hold a not”, which basically means that a portion of the sale price would be paid by regular payments over a predetermined time period to the seller, just as you would do to a traditional lender.

This is a game of patience, so do not rush. If you show the seller that you are too enthusiastic about buying the business you may be charged a hefty premium. At the same time, try to find out through legal means if the seller has financial problems beyond those that you potentially identified during the review of business-related financial statements because in that case you will likely be able to buy the business at a discount.

Finally, keep in mind that everything stated here has merely the purpose of serving as a guideline. In reality, the process of negotiating a business has many unforeseeable nuances specific to each case.

Therefore, we strongly encourage you to get all the help you can enlist, and consider hiring professionals, such as consultants, accountants, and/or lawyers to assist you throughout this journey. You may want to start by searching the valuable resources provided by the U.S. Small Business Association (SBA), and benefit from the free business consulting services provided by your local Small Business Development Center (SBDC).

How to Buy a Small Business – A Comprehensive Guide and Resource was originally published on http://www.launchscore.com



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Thursday, 20 October 2016

Two-faced or multi-perspective stakeholder manager?

Probably the single most interesting moment of the debate cycle was Trump’s suggestion that Clinton was two-faced. Her response struck me. She said, and I’m paraphrasing, that sometimes a politician needs to have different arguments for different audiences, and that can often seem like having both a private and public face. She invoked Lincoln to say that only by having tailored arguments for different audiences, could he manage to get important legislation passed.

Let’s consider the efficiency of the 'single argument for all audiences' versus its effectiveness for a moment. A government is not like a corporation. Corporations have shareholders they are responsible to. A few may also care about a small set of stakeholders that have other motives than profit; for instance by using a balanced scorecard or triple bottom line approach. A government has many more stakeholders to contend with. For a corporation to function effectively, there has to be alignment between its functions. Whether it is marketing or IT or operations, the organization must move together to succeed.

For a government, getting total alignment is not possible. Unlike employees, who can be coerced and incented to tow the line, a government forms a compromise over time. In a compromise, each party gives something up to get something else. The arguments used to get, say, an oil company to accept a carbon tax, would not be the same as those used to get a pipeline built across the Canadian border. A politician who says to the oil companies that a carbon tax is necessary to preserve the climate would not be aligned with his other face that argues for the pipeline with economic reasoning (development and cheaper oil).

To a climate advocate, a politician that pushes for a carbon tax and a pipeline at the same time, would likely be judged as two-faced. However, the politician’s job is not really just to take a position. Maybe the politician’s job is to get some resolution of the issues that cause conflict in and divide society, even if it means making arguments that seem contradictory. But if regular use of conflicting arguments leads to a degradation of trust in the politician over time, then his reputation may be damaged and future arguments may not be as persuasive. Does multi-argument stakeholder management then require a kind of cloak of secrecy (non-disclosure of “private” statements)?

When Lincoln executed his great moment of political mastery, he relied on the slowness of mail communication and the secrecy of his colleagues. If they went around spreading doubt or disclosing private statements, the jig would have been up pretty quickly. In the information age, only by putting on an event behind a locked and guarded door, and by impounding technology at the door could such a feat be achieved. A single Tweet could have stalled freedom in 1862. People are generally very bad a keeping secrets. They leak out for many reasons—booze, love and fame come to mind. To some who want a secret kept, the deterioration of memories and the lack of recording devices combine with the staleness of a late reveal to work in favor of the politician with a short game to play; like preventing an economic depression, a war, or a revolution.

By contrast, a single-message politician can hope for efficiencies. If you are always saying the same thing, you can just say it once. It is easier to remember a single argument and easier to repeat promptly. There is less bickering about what is being said or not said, and there is more general confidence in the leader’s candidness and honesty. However, this efficiency seems to breakdown when more than one party is involved in the decision. A single message might move the parties closer to conflict, or force one of the key stakeholder groups to withdraw from the negotiating table without resolution.

Clearly, I don’t have a moral answer to resolve the paradox of justifying means with ends, but I thought it was an interesting exchange between the candidates. One seems to be arguing about means, the other about ends.

The blog article Two-faced or multi-perspective stakeholder manager? is available on blog.launchscore.com



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