Essentials of entrepreneurship and small business management 8th edition scarborough solutions manua

Essentials of Entrepreneurship and Small Business Management 8th Edition Scarborough

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CHAPTER 6. FORMS OF BUSINESS OWNERSHIP

Part 1: Learning Objectives

1. Explain the advantages and the disadvantages of a sole proprietorship and a partnership.

2. Describe the similarities and differences of the C corporation and the S corporation.

3. Understand the characteristics of the Limited Liability Company.

4. Explain the process of creating a legal entity for a business.

5. Understand the advantages and disadvantages of buying an existing business.

6. Define the steps involved in the right way to buy a business.

7. Understand how the negotiation process works and identify the factors that affect it.

Part 2: Class Instruction

The most important issues entrepreneurs should consider when they are evaluating the various forms of ownership include:

• Tax considerations

• Liability exposure

• Start-up and future capital requirements

• Control

• Managerial ability

• Business goals

• Management succession plans

• Cost of formation

The major forms of ownership discussed in this chapter include: Sole proprietorship, general partnership, limited partnership, corporation, S corporation, and limited liability company. Refer to Figure 6.1, Forms of Business Ownership (A) Percentage of Businesses; (B) Percentage of Sales: (C) Percentage of Net Income, to see the data regarding the distribution of the percentage of each business form and the percentage of total business sales revenues illustrates the dominate forms of business ownership.

Sole Proprietorships and Partnerships LO 1

The Sole Proprietorship. The sole proprietorship is the most popular type of ownership, defined as business owned and managed by one individual.

The Advantages of a Proprietorship. Advantages of the sole proprietorship include:

• Simple to create

• Least costly form of ownership to begin

• Profit incentive

• Offers total decision-making authority

• No special legal restrictions

• Easy to discontinue

The Disadvantages of Proprietorship. Disadvantages include:

• Unlimited personal liability means that the sole proprietor is personally liable for all of the business’s debts, as the owner is the business.

• Limited skills and capabilities

• Feelings of isolation

• Limited access to capital

• Lack of continuity for the business

The Partnership. A partnership is an association of two or more people who co-own a business for the purpose of making a profit. This association between the owners is defined by the partnership agreement, a document that states in writing the terms under which the partners agree to operate and that protects each partner’s interest in the business.

If no partnership agreement exists, the Revised Uniform Partnership Act (RUPA) codifies the body of law dealing with partnerships in the United States. It specifies three key elements of a partnership, which include common ownership, how the business’s profits and losses will be shared, and the right to participate in managing the operation of the partnership. It also sets forth the partners’ general obligations such as sharing any business losses, working without salary, settle disagreements, etc.

The Advantages of the Partnership. Advantages include:

• Easy to establish

• Complementary skills

• Division of profits

• Larger pool of capital

• Ability to attract limited partners

Types of partnerships include:

• General partners – partners share in owning, operating, and managing a business. All partners have unlimited personal liability.

• Limited partners – are financial investors in a partnership, cannot participate in the day-to-day management, and have limited liability. If the business fails they only lose the money they have invested in it.

• Silent partners – are not active in a business but generally are known to be members of the partnership.

• Dormant partners – are neither active nor generally known to be associated with the business.

• Limited partnership – composed of at least one general partner and at least one limited partner. There is no limit on the total number of limited partners. The general partner is treated the same as in a general partnership, while the limited partners are treated as investor.

Additional partnership advantages include: minimal governmental regulation, flexibility, and taxation.

The Disadvantages of the Partnership. Disadvantages include:

• Unlimited liability of at least one partner

• Capital accumulation

• Difficulty in disposing of partnership interest

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• Potential for personality and authority conflicts

• Partners are bound by the law of agency

Limited Liability Partnerships (LLP). Limited liability partnerships are composed of all limited partners, giving them the advantage of limited liability for the debts of the partnership. Most states restrict LLPs to certain types of professionals, such as attorneys, physicians, dentists, and accountants.

Consider using You Be the Consultant: “Making a Partnership Work” at this point.

Corporations LO 2

The U.S. Supreme Court has defined the corporation as “an artificial being, invisible, intangible, and existing only in contemplation of the law.” The corporation is a separate entity apart from its owners, and may engage in business, make contracts, sue and be sued, and pay taxes. This means that the owners of a corporation are not personally liable for the actions of the corporation. However, because start-ups are so risky, lenders and other creditors often require the founders of small corporations to personally guarantee loans made to the business. Courts ignore the limited liability shield when an entrepreneur uses corporate assets for personal reasons, fails to act in a responsible manner and creates an unwarranted level of financial risk for the stockholders, makes financial misrepresentations, or takes actions in the name of the corporation that were not authorized by the board of directors. Refer to Table 6.1, Avoiding Legal Tangles in a Corporation.

Corporations have the power to raise large amounts of capital by selling shares of ownership to outside investors. A closely held corporation has shares that are controlled by a relatively small number of people, and the stock is passed from one generation to the next instead of being traded on any stock exchange. A publicly held corporation has a large number of shareholders, and its stock usually is traded on one of the large stock exchanges.

The C Corporation.

A C corporation is the traditional form of incorporation. It is a separate legal entity and must pay taxes on its income at the federal level, in most states, and to some local governments as well. Before stockholders receive dividends, a C corporation must pay taxes at the corporate tax rate; then stockholders must pay taxes on the dividends they receive. This double taxation is a distinct disadvantage of the C corporation form of ownership. If a company intends to seek investment from venture capital or other form of private equity, it should be established as a C corporation. Advantages of a corporation include:

• Limited liability of stockholders

• Ability to attract capital

• Ability to continue indefinitely

Copyright © 2016 Pearson Education, Inc. Chapter 6, Page 104

• Transferable ownership

Disadvantages of a corporation include:

• Cost and time involved in the incorporation process

• Double taxation

• Potential for diminished managerial incentives

• Legal requirements and regulatory red tape

• Potential loss of control by the founder(s)

The S Corporation.

An S corporation was established specifically for small, closely held businesses to alleviate the owners from the double taxation that occurs with a C corporation. The S standing for “small,” is the same as any other corporation, except that they do not pay taxes on corporate income. Income instead is passed through to the owners, just like a sole proprietorship or partnership. Refer to Table 6.2, Tax Rate Comparison: C Corporation and S Corporation or Limited Liability Company.

The criteria for businesses seeking “S” status are that the venture must:

• Be a domestic (U.S.) corporation

• Limit shareholders to individuals, estates, and certain types of trusts

• Cannot include partnerships, corporations, or nonresident aliens as shareholders

• Not have more than 100 shareholders

• Have only one class of common stock so all shares have the same rights

• Must be an eligible corporation; certain financial institutions, insurance companies, and domestic international sales corporations are ineligible.

Advantages of an S corporation include:

• Retains all of the advantages of regular corporations

• Passes all profits/losses through to individual shareholders

• Avoids double taxation

• Avoids taxes paid on assets that have appreciated in value and are sold

Disadvantages of an S corporation include:

• Increase in individual tax rates above maximum corporate tax rate. The S corporation should follow the 1/3, 1/3, 1/3 rule of thumb: distribute one-third of earnings to the shareholders to cover the taxes they will owe, retain one-third of earnings to fund growth, and earmark the final one-third to pay down debt, fund debt, or distribute to the owners as a return on their investment.

• Many fringe benefits cannot be deductible business expenses

Choosing an “S” corporation wisely is important to optimize the advantages this entity offers.

Copyright © 2016 Pearson Education, Inc.

The Limited Liability Company LO 3

The Limited Liability Company (LLC), like an S corporation, offers its owners limited personal liability for the debts of the business, providing a significant advantage over sole proprietors and partnerships. LLCs, however, are not subject to many of the restrictions currently imposed on S corporations and offer more flexibility than S corporations. LLCs offer many of the advantages of both, but are not subject to the restrictions incurred by “S” corporations. LLCs offer the tax advantage of a partnership, the legal protection of a corporation, and maximum operating flexibility. These advantages make the LLC an attractive form of ownership for smaller companies across many industries. Creating an LLC is much like creating a corporation through establishing the articles of organization and an operating agreement.

There are some disadvantages as they can be expensive to create, and may be required in some states to pay special fees. LLCs have limited life spans, and the cost of employee benefits is not deductable as a business expense.

Copyright © 2016 Pearson Education, Inc.

How to Create a Legal Business Entity LO 4

C corporations, S corporations, and LLCs can be costly and time consuming to establish and to maintain. Many entrepreneurs hire attorneys to handle the process, but in most states entrepreneurs can complete all of the required forms themselves, but must be very cautious. Although it is cheaper to complete the process themselves, it is not always the best idea. This is especially true if there are multiple founders as shareholder or member agreements must be developed.

Once entrepreneurs decide to form a legal business entity, they must choose a state in which to establish the entity. Most will choose the state in which they will operate.

Refer to Table 6.3, Characteristics of the Major Forms of Ownership.

Buying an Existing Business LO 5

The process of evaluating a potential business acquisition is standard, and requires a due diligence process that involves analyzing and evaluating an existing business. If done correctly, this due diligence will reveal both the negative and the positive aspects of an existing business. A prospective owner must ask several key questions before buying an existing business.

• Is it the right type of business for sale in a market in which you want to operate?

• What experience do I bring to the venture?

• What is the success potential?

• What changes are needed and how extensive are they to realize the full potential of the value of the business?

• What price and payment method are reasonable for you and acceptable to the seller?

• Is the seller willing to finance part of the purchase price?

• Will the company generate sufficient cash to pay for itself and leave you with a suitable rate of return on your investment?

• Should you be starting a business and building it from the group up rather than buying an existing one?

People buy businesses for different reasons. As described in Figure 6.2, Types of Business Buyers, buyers can be categorized into four areas:

The Advantages of Buying an Existing Business. Advantages include:

• A successful existing business may continue to be successful.

• An existing business may already have a superior location.

• Employees and suppliers are established. Equipment is installed and productive capacity is known.

• Inventory is in place and trade credit is established.

• A turnkey business already has operating processes in place.

• The new owner can use the experience of the previous owner.

• Easier access to financing.

• High value is possible if the current owner must sell quickly. Disadvantages of Buying an Existing Business. Disadvantages include:

• Cash requirements may be higher than if starting a new business.

• Business may be losing money.

• Paying for ill will if the previous owner used improper business behavior or unethical practices.

• Employees inherited with the business may not be suitable.

• The business location may have become/is unsatisfactory.

• Equipment and facilities may be obsolete or inefficient.

• Change and innovation are difficult to implement.

• Inventory may be outdated or obsolete.

• Accounts receivable may be worth less than face value.

• The business may be overpriced.

The Steps in Acquiring a Business

LO 6

Fifty to seventy-five percent of business sales that are initiated fall through. Refer to Figure 6.3, The Acquisition Process. There are seven steps in the process.

Step 1: Analyze Your Skills, Abilities, and Interests. Conduct a self-inventory to analyze your skills, abilities, and personal interests. Sample questions include what business activities you enjoy most, which industries and markets have growth potential, what do you want to avoid, what you expect to get from the business, what you expect to put into the business, how much risk you’re willing to take, and if you’re able to turn around a struggling business.

Step 2: Develop a List of Criteria. Develop a list of criteria that define the ideal business for you. Use your answers to the self-inventory to develop a list of criteria that a potential business must meet.

Step 3: Prepare a List of Potential Candidates. List companies that meet your criteria. Do not limit your search to businesses that are advertised as being for sale, as there is a

hidden market of companies that might be for sale but are not advertized as such. These hidden businesses for sale may be found listed on the Internet, through business brokers, other professionals like attorneys or bankers, industry contacts, through networking, trade associations, asking the owner of a business if he or she would like to sell, or through newspapers or trade journals.

Step 4: Investigate and Evaluate Potential Companies. Investigate and evaluate candidate businesses to determine the best one. This due diligence process is to minimize the pitfalls and problems that will arise. This step will require patience. Obtain answers to questions such as: what are the company’s strengths and weaknesses, what is the overall financial condition, what is the cash flow cycle, who are the major competitors, how large is the customer base, how suitable are the current employees and will they stay, what is the physical condition of the business, and what new skills must you learn to manage the business.

Step 5: Explore Financing Options. Traditional lenders typically lend only a portion of the value of the assets of the business, and buyers often must search for alternative sources of funds. Often the seller is willing to finance the sale.

Step 6: Negotiate a Reasonable Deal with the Owner. The first rule is to avoid confusing price with value. Value is what the business is actually worth; price is what they buyer agrees to pay. Buyers and sellers seek the following:

• Buyers want the business at the lowest price, while sellers want the highest price.

• Buyers want to negotiate favorable payment terms, preferably over time. Sellers want to sever all responsibility for the company’s liabilities.

• Buyers want assurances that they are buying the business they think they are getting. Sellers want to make sure the buyer will be able to make all future payments.

• Buyers want to avoid putting the seller in a position to open a competing business. Sellers want to avoid unreasonable contract terms that might limit his or her future opportunities.

• Buyers want to minimize the amount of cash paid up front. Sellers want to maximize the cash they get from the deal, and minimize the tax burden from the sale.

Step 7: Ensure a Smooth Transition. To avoid a bumpy transition, the buyer should do the following:

• Concentrate on communicating with employees to reduce uncertainty and anxiety. Be honest with employees, and share your vision for the business to increase motivation and support.

• Listen to employees as they have firsthand knowledge of the business and its strengths and weaknesses, and usually can offer suggestions for improvement.

• Consider asking the seller to serve as a consultant until the transition is complete.

• Be prepared to take action if there are problem employees.

Negotiating the Deal LO 7

The negotiation process should not be “If you win, then I lose.” Instead it will go much more smoothly and faster if both parties work to establish a cooperative relationship based on honesty and trust and an attitude of “we both will win.” Both parties should examine and articulate their respective positions while trying to understand the other party’s. A buyer should go into the negotiation with a list of objectives ranked in order of priority, and anticipate what the seller’s priorities are in order to determine where the two mesh and where they conflict. The key is to use this analysis to look for areas of mutual benefit and use them as the foundation for the negotiation.

Conclusion

The entrepreneur will benefit from an intentional choice regarding the choice of business ownership. Take all the important factors into consideration – liability, taxes, capital requirements, control, managerial abilities, business goals, and a long-term succession plan. The ownership decision has far-reaching effects for both the entrepreneur and the business.

Part 3: Chapter Exercises

You Be the Consultant: “Making a Partnership Work”

1. Research relationships between partners and add at least three guidelines to those listed above. (LO 1) (AACSB: Interpersonal relations and teamwork)

Examples of students’ additions to this list may include the following:

• Determine what may help manage stressful or conflict-oriented situations to help manage those situations as they arise.

• A common vision of what the venture is to become with a shared work ethic.

• Establish clear guidelines regarding what each partner will invest in the relationship, from a financial and time perspective.

• Talk through possible “what if” scenarios to share the ideas and problem solving skills of each partner.

• A common and clear vision for the venture.

2. Develop a list of the types of behavior that are almost certain to destroy a partnership. (LO 1) (AACSB: Interpersonal relations and teamwork)

Student responses may include, and are not limited to, the following:

• Lack of follow though based on the agreed division of partner responsibilities and duties

• Lack of communication talking and listening

• Lack of mutual respect

• Misuse of company funds and resources

• Dishonesty and actions that lead to mistrust

• Conflicting behavior when interacting with people employees and customers

• Divergent behaviors regarding the management of business finances

3. Suppose that two of your friends are about to launch a business together with nothing but a handshake. “We’ve been best friends since grammar school,” they say. What advice would you give them? (LO 1) (AACSB: Interpersonal relations and teamwork)

Expect students to apply information from the chapter. For example, a common student response may be as follows:

Have a partnership agreement! This important tool defines the roles and responsibilities of each partner. This agreement can prove invaluable in times of conflict or when a partner wants to change their role or leave the business for any reason. It offers definition and direction for the business and for each partner involved. Seek the advice of an attorney to assist you in the process. The partnership agreement may save your business and your friendship.

Part 4: Chapter Discussion Questions

6-1. What factors should an entrepreneur consider before choosing a form of ownership? (AACSB: Reflective thinking)

Factors to consider before choosing a form of ownership include:

• Tax considerations – calculate the firm's tax bill under each form of ownership.

• Liability exposure – how much personal liability is involved in the ownership form?

• Start-up capital required – how much capital does the entrepreneur have and how much will he need?

• Control – how much control is involved for each type of business organization? How much is the entrepreneur willing to give up?

• Business goals – how large and profitable does the entrepreneur expect the business to be?

• Management succession plans – consider a smooth transition when passing

company to the next generation of buyers.

• Cost of formation – some forms are more costly to create.

6-2. Why are sole proprietorships so popular as a form of ownership? (LO 1) (AACSB: Reflective thinking)

Sole proprietorships are a popular form of ownership for several reasons. First, they are simple to create. Anyone wanting to start a business can do so by obtaining the necessary licenses from state, county, and/or local governments. This form is normally the least expensive to establish. In addition, the owner has the total decision-making authority, can keep all profits remaining after expenses are paid, and may discontinue the sole proprietorship fairly easily if he or she desires.

6-3. How does personal conflict affect partnerships? (LO 1) (AACSB: Reflective thinking)

The success/failure of a partnership depends on the cohesiveness of its partners. In the beginning, there is an “emotional high” when the startup of the business begins. Partners are so busy creating strategies and focusing on the new business, that they often do not consider the idea of future conflict with other partners. If this conflict does occur, the partnership may suffer. The mutual goals and general business philosophies may not be shared among the partners at this time. Thus, the demise of many partnerships can often be traced to interpersonal conflict if there are no procedures in place to resolve these problems.

6-4. What issues should the articles of partnership address? (LO 1) (AACSB: Reflective thinking)

The major provisions of a partnership agreement include the following:

• The name of the partnership

• The purpose of the business

• The domicile of the business

• The duration of the partnership

• The partners and their legal addresses

• The contribution of each partner to the business

• An agreement on how the profits (or losses) of the partnership will be distributed

• An agreement on salaries or drawing rights against profits for each partner

• The procedure to be followed in the event that the partnership wishes to expand through the addition of a new partner

• How assets of the partnership will be distributed if the partners voluntarily dissolve the partnership

• Sale of partnership interest

• Absence or disability of one of the partners

• Provisions for alteration or modification of the partnership agreement

6-5. Why are the articles important to a successful partnership? (LO 1) (AACSB: Reflective thinking)

The partnership agreement is designed to spell out in detail the legal and business issues of running a business, including the partners’ rights and obligations. It also resolves potential sources of conflict that could end a partnership. A partnership must have two or more essential elements above all others; mutual trust and respect. Any partnership missing these elements is destined to fail.

6-6. Explain why one partner cannot commit another to a business deal without the other’s consent. (LO 1) (AACSB: Reflective thinking)

If the partner was exercising good faith and reasonable care in the performance of his duties, the law of agency holds that the actions of a general partner binds the other partners to a business deal made in the name of the partnership, even without the other's consent. This is another example of why it is so important to be able to trust your partners!

6-7. What issues should the Certificate of Incorporation cover? (LO 2) (AACSB: Reflective thinking)

A Certificate of Incorporation normally will include the following:

• The name of the corporation

• A statement of the purpose of the corporation

• The time horizon of the corporation

• The names and addresses of the corporation

• Place of business

• Capital stock authorization

• Capital required at the time of incorporation

• Provisions for preemptive rights

• Restrictions on transferring shares

• Names and addresses of the initial officers

• The bylaws by which the corporation will operate

6-8. How does an S corporation differ from a regular corporation? (LO 2) (AACSB: Reflective thinking)

An S corporation offers many of the same advantages of a corporation limited liability, capital formation, and others while being taxed as a partnership. Thus, the S corporation avoids the corporate disadvantage of double taxation.

6-9. What role do limited partners play in a partnership? (LO 1) (AACSB: Reflective thinking)

In a limited liability partnership the limited partner is have the advantage of limited liability for the debts of the partnership. However, many states restrict the limited liability advantage of LLPs to the results of actions taken by other partners. For instance if an LLP sells a defective product that injures a customer, the injured customer could sue the business and the partners as individuals.

6-10. What happens if a limited partner takes an active role in managing the business? (LO 3) (AACSB: Reflective thinking)

Unlike a limited partnership, which prohibits limited partners from participating in the dayto-day management of the business, an LLC does not restrict its members’ ability to become involved in managing the company.

In the limited partnership if the limited partner does take an active part in managing the business, a limited partner may actually forfeit limited liability, taking on the liability status of a general partner.

6-11. What advantages does a limited liability company (LLC) offer over an S corporation? (LO 3) (AACSB: Reflective thinking)

An LLC eliminates many restrictions imposed by an S corporation such as: a maximum of thirty-five shareholders, none of whom can be foreigners or corporations; a limitation to one class of stock; restriction on members' ability to become involved in managing the company; and limited personal liability with imposed requirements. The LLC is not subject to such restrictions. There are two advantages an LLC has over a C corporation. First, an LLC offers limited liability and a C corporation does not. In addition, an LLC does not pay income tax and avoids the double taxation of C corporations.

6-12. What advantages does a limited liability company (LLC) offer over a partnership? (LO 3) (AACSB: Reflective thinking)

Partners in traditional partnerships are exposed to unlimited personal liability. A LLC limits the partners’ liability to their investments in the company.

6-13. How is an LLC created? (LO 3) (AACSB: Reflective thinking)

Creating an LLC is much like creating a corporation. An LLC is required to file two documents: the articles of organization and the operating agreement. The articles of organization establish the company's name, its method of management, its duration, and the names and addresses of each organizer. The operating agreement outlines the provisions governing the business’ conduct.

6-14. What criteria must an LLC meet to avoid double taxation? (LO 3) (AACSB: Reflective thinking)

To ensure that a LLC is classified as a partnership for tax purposes, entrepreneurs must draft the operating agreement carefully. It must create an LLC that has more characteristics of a partnership than of a corporation to maintain this favorable tax treatment.

6-15. What advantages can an entrepreneur who buys a business gain over one who starts a business “from scratch”? (LO 5) (AACSB: Reflective thinking)

The advantages of buying an existing business may include:

• A Successful Existing Business May Continue to Be Successful: Buying a thriving business increases the likelihood of success building upon an established customer base, supplier relationships, and business system. The new owner benefits from these important business factors already in place.

• An Existing Business May Already Have the Best Location: If the location of a business is critical to its success, it may be wise to purchase a business that is already strategically located.

• Employees and Suppliers are in Place: Experienced employees enable a company to continue to earn money while a new owner learns the business. Existing vendors can continue to supply the business while the new owner investigates the products and services of others.

• Equipment Is Installed and Productive Capacity Is Known: The buyer does not have to invest in equipment, and the previous owner may have established an efficient production operation. Thus, the new owner can use these savings in time and money to improve and expand the existing equipment and procedures.

• Inventory Is in Place and Trade Credit Is Established: Establishing the right amount of inventory can be costly. If there is too little inventory, customer demand cannot be satisfied. If too much is available, excessive capital is tied up, costs are increased, and profits decrease. There is a tremendous advantage if previous owners have established a balance in inventory. In addition, a proven track record gives the new owner leverage in negotiating credit concessions.

• A Turnkey Business: the buyer gets a business that is already generating cash and perhaps profits as well.

• Experience of Previous Owner: If the previous owner is around, the new owner can benefit from his/her expertise. Even if the owner is not present, business records can guide the new owner.

• Easier Access to Financing: Many existing businesses already have relationships with lenders. Many sellers help to finance the sale of their business.

• High Value: If the owner needs to sell on short notice, wants a substantial down payment in cash, or the business requires special skills, the number of buyers will be small, which may lead the owner to sell at a lower price.

6-16. How would you go about determining the value of the assets of a business if you were unfamiliar with them? (LO 5) (AACSB: Reflective thinking)

When evaluating an existing business, a potential buyer should assemble a team of specialists to help in determining the potential business opportunity. The team is usually composed of a banker, an accountant familiar with the industry, an attorney, and perhaps a small business consultant or business broker. Company records, interviews with management, and particularly financial statements will help the potential owner and the team of specialists to identify the assets. Once the assets are identified, it may be necessary to hire a professional to assess the value of the major components of the building structure; plumbing, heating, and cooling system; as well as inventory.

6-17. Why do so many entrepreneurs run into trouble when they buy an existing business? (LO 5) (AACSB: Reflective thinking)

Buying an existing business can be risky if approached haphazardly. They may not be aware of or look for the typical problems that exist in a business. They may fail to follow the steps involved in the right way to buy a business, or simply be in too much of a hurry. They may not be good negotiators.

6-18. Outline the steps involved in the right way to buy a business. (LO 6) (AACSB: Reflective thinking)

To avoid costly mistakes, an entrepreneur should follow a logical, methodical approach that may include the following:

• Conduct a self-inventory, to analyze your skills, abilities, and interests: Consider what business activities you enjoy most, what kind of business you want to buy, what you expect from the business, and how much time and energy you have to invest.

• Develop a list of the criteria that define the “ideal business” for you: Use your answers to the self-inventory to develop a list of criteria that a potential business must meet.

• Prepare a list of potential candidates: Examine businesses for sale, as well as those that may be in the “hidden market.”

• Investigate and evaluate candidate businesses and choose the best one: Investigate potential candidates in more detail. Perform a SWOT analysis on each. Examine company financial statements.

• Explore financing options: Consider the options for financing. Often, financing for an existing business is easier than for a new one. Although many traditional lenders shy away from deals involving purchases of existing business and others only lend a portion of the assets, most buyers still have access to a ready source of financing the seller. Many times, the seller will finance anywhere from 30 to 80 percent of the purchase.

• Negotiate a reasonable deal with the existing owner: The first rule is to avoid confusing price with value. Value is what the business is actually worth; price is what they buyer agrees to pay.

• Ensure a smooth transition of ownership: To avoid a bumpy transition, the business buyer should: concentrate on communicating with employees; be frank, open, and honest with employees; listen to employees they have knowledge of the business and consider asking the seller to serve as a consultant until the transition is complete.

6-19. What tips would you offer someone about to enter into negotiations to buy a business? (LO 7) (AACSB: Reflective Thinking)

Students may take an approach to develop recommendations that may include these ideas.

• Enlist the skills of a professional to establish a value for the business before negotiations begin.

• Bring in a third party to moderate the negotiation and transaction.

• Explore all financing options with the mutual goals of the buyer and seller in mind.

• Outline a transition plan that will be optimal for seller, the buyer, and employees.

• Document the terms and conditions of the sale.

6-20. One entrepreneur who recently purchased a business advises buyers to expect some surprises in the deal no matter how well prepared they may be. He says that every potential buyer must build some “wiggle room” into their plans to buy a company. What steps can a buyer take to ensure that he has sufficient “wiggle room”? (LO 7) (AACSB: Analytical Thinking)

Both parties should examine and articulate their respective positions while trying to understand the other party’s. A buyer should go into the negotiation with a list of objectives ranked in order of priority, and anticipate what the seller’s priorities are in order to determine where the two mesh and where they conflict. The key is to use this analysis to look for areas of mutual benefit and use them as the foundation for the negotiation.

Part 5: Case Studies

There are no case studies that apply to this chapter.

Part 6: Online Videos and Podcasts

These online videos may enhance class discussion and provide additional insight for the chapter topics.

• How to Avoid 3 Common Mistakes Small Business Owners Make 12:47 minutes

http://www.youtube.com/watch?v=zahVagoP3SU

• Forms of Business Ownership 3:54 minutes

http://www.youtube.com/watch?v=Wtmw1oxNiWg

© 2016 Pearson Education, Inc.

• Business Entities: Limited Liability Company 5:47 minute

http://www.youtube.com/watch?v=aq5zdacU4E4

• The Corporation – A Legal “Person” 5:48 minutes

http://www.youtube.com/watch?v=wkygXc9IM5U

• 5 Questions to Ask Before Buying a Business 5:34 minutes

http://www.youtube.com/watch?v=zro0E74_qZA&feature=related

• Buying a Business 1:42 minutes

http://www.youtube.com/watch?v=G6TRqfDcCUM&NR=1

• Buying a Business – Bill Bartmann 5:31 minutes

http://www.youtube.com/watch?v=j5Pz3Aweof4&NR=1

• New Business Tips: Buying an Existing Small Business 1:04 minutes

http://www.youtube.com/watch?v=KjW7eNB71kw&NR=1

Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.

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