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Chapter 5 Small Business, Entrepreneurship, and Franchises

LEARNING OBJECTIVES

5-1 Define what a small business is and recognize the fields in which small businesses are concentrated.

5-2 Identify the people who start small businesses and the reasons why some succeed and many fail.

5-3 Assess the contributions of small businesses to our economy.

5-4 Describe the advantages and disadvantages of operating a small business.

5-5 Explain how the Small Business Administration helps small businesses.

5-6 Explain the concept and types of franchising.

5-7 Analyze the growth of franchising and its advantages and disadvantages.

Small Business: A Profile

Small business – one that is independently owned and operated for profit and is not dominant in its field

Small businesses:

Represent 99.9 percent of all employer firms

Employ about half of all private sector employees

Pay 42 percent of total U.S. private payroll

Have generated 63 percent of net new jobs over the past 25 years

Create more than half of the nonfarm private GDP

Hire 37 percent of high-tech workers (scientists, engineers, computer programmers, and others)

Are 52 percent home-based and 2 percent franchises

Made up 97.7 percent of all identified exporters and produced 33 percent of export value in 2013

Produced 16.5 times more patents per employee than large patenting firms from 2007 to 2012

TABLE 5-1 Industry Group-Size Standards

Industry Group	Size Standard
Manufacturing, mining industries	500–1,500 employees
Wholesale trade	100–250 employees
Agriculture	$750,000
Retail trade, barber shops, beauty salons	$7.5 million
General and heavy construction (except dredging)	$36.5 million
Dredging	$27.5 million
Special trade contractors	$15 million
Travel agencies, tour operators	$20.5 million
Department stores	$32.5 million
Discount department stores	$29.5 million
Furniture stores	$20.5 million

The Small-Business Sector

Out of the 28.8 million businesses in the United States, only 18,600 of these employ more than 500 workers—enough to be considered large.

During the last decade, the number of small businesses in the United States has increased 49 percent.

According to a recent study by the U.S. Small Business Administration (SBA):

About 80 percent of businesses started in 2014 survived until 2015, the largest share since 2005.

From 2004 to 2014:

An average of 78.5 percent of new businesses survived one year.

About half of all firms survived five years or longer.

About one-third of firms survived 10 years or longer.

Industries That Attract Small Businesses (slide 1 of 2)

Industries that require only a low initial investment and some special skills or knowledge tend to attract new businesses.

Knowledgeable entrepreneurs choose areas with which they are familiar, and these are most often the more established industries.

Industries That Attract Small Businesses (slide 2 of 2)

The various kinds of businesses generally fall into three broad categories of industry:

Distribution

Includes retailing, wholesaling, transportation, and communications—industries concerned with the movement of goods from producers to consumers

Service

Includes both nonfinancial (medical and dental care, TV repair, hair styling) and financial services (accounting, insurance, real estate)

Production

Includes the construction, mining, and manufacturing industries

The People in Small Businesses: The Entrepreneurs (slide 1 of 3)

Researchers have suggested a variety of personal factors as reasons why people go into business for themselves.

Entrepreneurial spirit

Independence

A desire to determine one’s own destiny

A willingness to find and accept a challenge

Family background

Age

Motivation

FIGURE 5-1 How Old Is the Average Entrepreneur?

The People in Small Businesses: The Entrepreneurs (slide 2 of 3)

Women as Small-Business Owners

According to the latest 2017 data available from the SBA:

Women own at least 36 percent of all small businesses.

Women own 66 percent of the home-based businesses in this country.

About 9.9 million women-owned businesses in the United States provide almost 8.8 million jobs and generate $1.4 trillion in sales.

More than 40 percent of women-owned businesses in the United States have been in business for 12 years or more.

Women-owned businesses are financially sound and credit-worthy, and their risk of failure is lower than average.

Compared to other working women, self-employed women are older, better educated, and have more managerial experience.

The People in Small Businesses: The Entrepreneurs (slide 3 of 3)

Teenagers as Small-Business Owners

High-tech teen entrepreneurship is exploding.

Immigrants as Entrepreneurs

Entrepreneurship has been growing among immigrants.

Why Some Entrepreneurs and Small Businesses Fail

Lack of capital and cash-flow problems

Lack of management skills

Overexpansion

TABLE 5-2 U.S. Employer Business Start-ups and Closures

	New (In Thousands)	Closures (In Thousands)
2013	406	401
2012	411	375
2011	401	414
2010	388	425
2009	409	494
2008	491	477
2007	529	439

The Importance of Small Businesses in Our Economy (slide 1 of 3)

Providing Technical Innovation

Small firms produce two-and-a-half times as many innovations as large firms relative to the number of persons employed.

Small firms employ 43 percent of all high-tech workers such as scientists, engineers, and computer specialists.

More than half of the major technological advances of the 20th century originated with individual inventors and small companies.

Examples: Air-conditioning, FM radio, helicopter, instant camera, personal computer

The Importance of Small Businesses in Our Economy (slide 2 of 3)

Providing Employment

Seven out of the ten industries that added the newest jobs were small-business-dominated industries.

Small firms hire a larger proportion of employees who are younger workers, older workers, women, or workers who prefer to work part time.

Small businesses provide 67 percent of workers with their first jobs and initial on-the-job training in basic skills.

Small businesses represent 99.7 percent of all employers, employ more than 50 percent of the private workforce, and provide about two-thirds of the net new jobs added to our economy.

The Importance of Small Businesses in Our Economy (slide 3 of 3)

Providing Competition

Small businesses cause larger, established firms to become more efficient and more responsive to consumer needs.

Filling Needs of Society and Other Businesses

Small firms provide a variety of goods and services to each other and to much larger firms.

Example: General Motors relies on more than 32,000 companies for parts and supplies and depends on more than 11,000 independent dealers to sell its automobiles and trucks.

Advantages of Small Businesses

Personal relationships with customers and employees

Relationships with customers and employees tend to be closer in smaller businesses.

Ability to adapt to change

Being his or her own boss, the owner-manager of a small business does not need anyone’s permission to adapt to change.

Simplified record keeping

Independence

Profit retention

Ease and low cost of going into (or out of) business

Ability to keep business information secret

Disadvantages of Small Businesses

Risk of failure

Limited potential

Limited ability to raise capital

Two sources of funding:

Angel investors – private individuals who invest money in exchange for ownership in the company and who, at some point, hope to sell their ownership stake for a profit

Crowdfunding – an alternative to traditional financing in which entrepreneurs post descriptions of their project or business online and then invite people to contribute; contributors typically get a reward based on their contribution level

Examples: Kickstarter, Indiegogo

FIGURE 5-2 Sources of Capital for Entrepreneurs

LKauffman (LK) - Cengage: Note that the first bar above "Friends, relatives" should be purple instead of green.

The Importance of a Business Plan

Business plan – a carefully constructed guide for the person starting a business

A business plan has three basic purposes:

Communication

A business plan serves as a concise document that potential investors examine to see if they would like to invest or assist in financing a new venture.

Management

A business plan helps to track, monitor, and evaluate the progress.

It serves to establish time lines and milestones and allows comparison of growth projections against actual accomplishments.

Planning

The business plan guides a businessperson through the various phases of business.

TABLE 5-3 Components of a Business Plan (slide 1 of 2)

1. Introduction. Basic information such as the name, address, and phone number of the business; the date the plan was issued; and a statement of confidentiality to keep important information away from potential competitors.

2. Executive Summary. A one- to two-page overview of the entire business plan, including a justification why the business will succeed.

3. Benefits to the Community. Information on how the business will have an impact on economic development, community development, and human development.

4. Company and Industry. The background of the company, choice of the legal business form, information on the products or services to be offered, and examination of the potential customers, current competitors, and the business’s future.

5. Management Team. Discussion of skills, talents, and job descriptions of management team, managerial compensation, management training needs, and professional assistance requirements.

TABLE 5-3 Components of a Business Plan (slide 2 of 2)

6. Manufacturing and Operations Plan. Discussion of facilities needed, space requirements, capital equipment, labor force, inventory control, and purchasing requirement.

7. Labor Force. Discussion of the quality of skilled workers available and the training, compensation, and motivation of workers.

8. Marketing Plan. Discussion of markets, market trends, competition, market share, pricing, promotion, distribution, and service policy.

9. Financial Plan. Summary of the investment needed, sales and cash flow forecasts, breakeven analysis, and sources of funding.

10. Exit Strategy. Discussion of a succession plan or going public. Who will take over the business?

11. Critical Risks and Assumptions. Evaluation of the weaknesses of the business and how the company plans to deal with these and other business problems.

12. Appendix. Supplementary information crucial to the plan, such as resumes of owners and principal managers, advertising samples, organization chart, and any related information.

Components of a Business Plan

The business plan should answer four questions:

What exactly is the nature and mission of the new venture?

Why is this enterprise a good idea?

What are the businessperson’s goals?

How much will the new venture cost?

The Small Business Administration: Resources for Entrepreneurs

Small Business Administration (SBA) – a governmental agency that assists, counsels, and protects the interests of small business in the United States

SBA Management Assistance (slide 1 of 2)

The SBA’s Management Assistance includes free individual counseling, courses, conferences, workshops, and a wide range of publications.

Management Courses and Workshops

The management courses offered by the SBA cover all the functions, duties, and roles of managers.

Instructors may be teachers from local colleges or universities or other professionals, such as management consultants, bankers, and lawyers.

Conferences keep owner-managers up-to-date on new management developments, tax laws, and the like.

SBA Management Assistance (slide 2 of 2)

SCORE

The SCORE Association – a group of businesspeople who volunteer their services to small business through the SBA

SCORE consists of more than 11,000 retired and active businesspeople who have worked for corporations such as General Electric, IBM, and Procter & Gamble.

Experts in areas of accounting, finance, marketing, engineering, and retailing provide counseling and mentoring to entrepreneurs.

Help for Minority-Owned Small Businesses (slide 1 of 2)

The SBA makes a special effort to assist those minority groups who want to start small businesses and expand existing ones.

The Minority Business Development Agency awards grants to develop and increase business opportunities for members of racial and ethnic minorities.

The SBA’s Online Women’s Business Center is a state-of-the-art Internet site that provides women free information about business principles and practices, management techniques, networking, and counseling, as well as links to other sites and information about the many SBA services and resources available to them.

Help for Minority-Owned Small Businesses (slide 2 of 2)

Small-business institutes (SBIs) – groups of senior and graduate students in business administration who provide management counseling to small businesses

Small-business development centers (SBDCs) – university-based groups that provide individual counseling and practical training to owners of small businesses

SBIs and SBDCs are located primarily on college and university campuses.

SBA Financial Assistance (slide 1 of 2)

Regular Business Loans

Most of the SBA’s business loans are actually made by private lenders such as banks, but repayment is partially guaranteed by the agency.

That is, the SBA may guarantee that it will repay the lender up to 90 percent of the loan if the borrowing firm cannot repay it.

Guaranteed loans approved may be as large as $5.0 million.

The average size of an SBA-guaranteed loan is about $300,000, and its average duration is about eight years.

SBA Financial Assistance (slide 2 of 2)

Small-Business Investment Companies

Venture capital – money that is invested in small (and sometimes struggling) firms that have the potential to become very successful

Example: Apple was financed by a venture capitalist.

The average venture capital size has increased during the last five years to approximately $11.7 million.

Small-business investment companies (SBICs) – privately owned firms that provide venture capital to small enterprises that meet their investment standards

Example: Tesla, Costco, Federal Express, and Intel Corporation were all financed through SBICs during their initial growth period.

Since Congress created the program in 1958, SBICs have financed more than 124,000 small businesses for a total of about $84 billion.

Franchising

Franchise – a license to operate an individually owned business as though it were part of a chain of outlets or stores

Examples: McDonalds, H&R Block, AAMCO Transmissions

What Is Franchising?

Franchising – the actual granting of a franchise

Franchisor – an individual or organization granting a franchise

Supplies:

A known and advertised business name

Management skills

The required training and materials

A method of doing business

Franchisee – a person or organization purchasing a franchise

Supplies labor and capital

Operates the franchised business

Agrees to abide by the provisions of the franchise agreement

TABLE 5-4 Basic Rights and Obligations Delineated in a Franchise Agreement (slide 1 of 3)

Franchisee rights include:

Use of trademarks, trade names, and patents of the franchisor;

Use of the brand image and the design and décor of the premises developed by the franchisor;

Use of the franchisor’s secret methods;

Use of the franchisor’s copyrighted materials;

Use of recipes, formulae, specifications, processes, and methods of manufacture developed by the franchisor;

Conducting the franchised business upon or from the agreed premises strictly in accordance with the franchisor’s methods and subject to the franchisor’s directions;

Guidelines established by the franchisor regarding exclusive territorial rights; and

Rights to obtain supplies from nominated suppliers at special prices.

TABLE 5-4 Basic Rights and Obligations Delineated in a Franchise Agreement (slide 2 of 3)

Franchisee obligations include:

To carry on the business franchised and no other business upon the approved and nominated premises;

To observe certain minimum operating hours;

To pay a franchise fee;

To follow the accounting system laid down by the franchisor;

Not to advertise without prior approval of the advertisements by the franchisor;

To use and display such point-of-sale advertising materials as the franchisor stipulates;

TABLE 5-4 Basic Rights and Obligations Delineated in a Franchise Agreement (slide 3 of 3)

Franchisee obligations include:

To maintain the premises in good, clean, and sanitary condition and to redecorate when required to do so by the franchisor;

To maintain the widest possible insurance coverage;

To permit the franchisor’s staff to enter the premises to inspect and see if the franchisor’s standards are being maintained;

To purchase goods or products from the franchisor or his designated suppliers;

To train the staff in the franchisor’s methods to ensure that they are neatly and appropriately clothed; and

Not to assign the franchise contract without the franchisor’s consent.

Types of Franchising

Franchising arrangements fall into three general categories:

A manufacturer authorizes a number of retail stores to sell a certain brand-name item.

Used by sellers of passenger cars and trucks, farm equipment, and shoes

A producer licenses distributors to sell a given product to retailers.

Most commonly found in the soft drink industry

A franchisor supplies brand names, techniques, or other services instead of a complete product.

Used by travel-related companies (Avis, Hampton Hotels) and restaurants (McDonald’s, SUBWAY)

The Growth of Franchising (slide 1 of 2)

Franchising, which began in the United States around the time of the Civil War, was used originally by large firms to distribute their products.

Franchising has been increasing steadily in popularity since the early 1900s, and has experienced enormous growth since the mid-1970s.

The Growth of Franchising (slide 2 of 2)

Franchising is attracting more women and minority business owners in the United States than ever before.

One reason is that special outreach programs designed to encourage franchisee diversity has been developed.

Example: Wendy’s, McDonald’s, and Burger King have special corporate programs to attract minority and women franchisees.

Dual-branded franchises, in which two franchisors offer their products together, are a new small-business trend.

Example: An agreement between Doctor’s Associates, Inc., and TCBY Enterprises, Inc., now allows franchisees to sell SUBWAY sandwiches and TCBY yogurt in the same establishment.

Are Franchises Successful?

The success rate for businesses owned and operated by franchises is significantly higher than the success rate for other independently owned small businesses.

However, franchising is not a guarantee of success for either franchisees or franchisors.

Too rapid expansion, inadequate capital or management skills, and a host of other problems can cause failure for both franchisee and franchisor.

Advantages of Franchising (slide 1 of 2)

To the Franchisor

Gains fast and well-controlled distribution of its products without incurring the high cost of constructing and operating its own outlets

Has more capital available to expand production and to use for advertising

Can ensure, through the franchise agreement, that outlets are maintained and operated according to its own standards

Benefits from the fact that franchisee is likely to be very highly motivated to succeed, which translates into more sales and thus higher royalties for the franchisor

Advantages of Franchising (slide 2 of 2)

To the Franchisee

Gets the opportunity to start a business with limited capital and to make use of the business experience of others

Receives advice from the franchisor, often free of charge

Receives materials to use in local advertising and can take part in national promotional campaigns sponsored by the franchisor

May be able to minimize the cost of advertising, supplies, and various business necessities by purchasing them in cooperation with other franchisees

Disadvantages of Franchising

To the Franchisor

Failure of the franchisee to operate the franchise properly

Disputes with and lawsuits by franchisees over the terms of the franchise contract

To the Franchisee

The amount of control retained by the franchisor

The franchisor’s contract can dictate all aspects of the business.

Example: All Burger King French fries taste the same because all Burger King franchisees have to make them the same way.

Franchisors opening competing franchises within the franchisee’s market

Global Perspectives in Small Business

National and international economies are growing more and more interdependent as political leadership and national economic directions change and trade barriers diminish or disappear.

Globalization and instant worldwide communications are rapidly shrinking distances at the same time that they are expanding business opportunities.

Technology now gives small businesses the leverage and power to reach markets that were once limited solely to large corporations.

The SBA offers help to the nation’s small-business owners who want to enter the world markets.

U.S. Export Assistance Centers

SBS International Trade Loan program

U.S. Commercial Service

International trade will become more important to small-business owners as they face unique challenges in the new century.