MGMT 4100 Exam 2

Employee stock ownership plan (ESOP)

- A type of employee benefit plan in which a trust that is created - Employees purchase employer's stock - Employees do not make any out-of-pocket payments - Over time become owners in the company that employs them, - Entitled to share in its profits, and receive sizable retirement benefits.

To ensure a smooth transition:

- Concentrate on communicating with employees. - Be honest with and listen to employees. - Devote time to selling the vision for the company to employees and other key stakeholders, including major customers, suppliers, bankers, and others. - Consider asking the seller to serve as a consultant until the transition is complete. The previous owner can be a valuable resource.

Hybrid organization

- Distinct Functional and Output groupings - Retains some centralized control - Capture economies of scale where we can - Specialize where we must to compete

The Buyer's Goals

- Get the business at the lowest price and minimize up front cash. - Negotiate favorable payment terms. - Get assurances of business evaluation. - Avoid enabling the seller to open a competing business.

The Seller's Goals

- Get the highest price possible for the company. - Sever all responsibility for the company's liabilities. - Avoid unreasonable contract terms that might limit future opportunities. - Maximize the cash from the deal. - Minimize the tax burden from the sale. - Make sure the buyer will make all future payments.

Before you buy a business, ask...

- Is the right type of business for sale in a market in which you want to operate? • Must I move to Omaha Nebraska or Buffalo Gap-Texas? - What experience do you have in this particular business and the industry in which it operates? - Is experience critical to your ultimate success? - What is the company's potential for success? - What changes will you have to make (how extensive will they be) to realize the business's full potential? - 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 ground up rather than buying an existing one?

The three basic strategies to introduce a new product to market

- Market penetration - skimming - sliding down the demand curve

Trade credit

- Most important form of financing to small and medium businesses - This gives us extended dating in invoices - We can sell all goods or use the service before the invoice is due

Installment credit

- Over-time payments to you - Use Dun & Bradstreet, Standard & Poors or similar service - Evaluate customer credit worthiness before granting credit

Matrix Structure

- Uniquely suited to respond to competing demands - May deliver quicker results on complex projects - Violates concept of unity of command

Human capital

- Workforce and processes - Tacit knowledge

Methods to deal with Rising Costs

- add a surcharge - modify to lower costs - use cheaper raw materials - diversify or differentiate your product line - eliminate discounts., coupons and freebies - raise prices incrementally and consistently

The Five Stages of Buying a Business

1 search stage 2 due diligence stage 3 valuation stage 4 deal stage 5 transition stage

3 goals of introducing a new product to market

1.) Getting the product accepted ► Revolutionary products/services ► Evolutionary products/services ► Me-too products/services2 2.) Maintaining market share as competition grows 3.) Earning a profit

Customized or Dynamic Pricing

The company sets different prices on the same products and services for different customers using the information collected on the customers.

Product liability lawsuit

a lawsuit which claims that a company is liable for damages and injuries caused by the products or services it sells.

Advantages of Buying an Existing Business

a. Successful existing businesses often continue to be successful. b. These businesses usually have excellent locations. c. Employees, suppliers, and inventory are in place. 1. Negotiate the price of inventory. d. Installed equipment has known production capacity. e. Trade credit is established and the business is turnkey f. The new owner can use the experience of the previous owner. 1. Make introductions 2. Learn faster g. Typically easier access to financing representing higher value.

Covenant not to compete

an agreement tied to the sale of a business.

Pricing

• Is governed both by art and science. • Requires balancing a multitude of complex forces. • Cuts across every aspect of a small company.• Is an important signal of a product's or service's value to customers. • Involves both math and psychology • Has a greater impact on profits than corresponding increases in unit volume or reductions in costs.

Opportunistic pricing

At times, the value attached to a product may be much higher than its cost. This allows a startup to charge a premium price for their products for a limited time period. The gray area here is whether the startup should follow this practice in all instances

Below-Market Pricing

Attract a sufficient level of volume to offset the lower profit margins. • Trim operating costs by eliminating extra services such as: - Delivery - Installation - Credit granting - Sales assistance Risky!

Let consumers pay their way

Cash is not as popular as it was, credit cards, debit cards and apple pay are very popular today. Make sure you accept all payment methods!

Disadvantages to Buying an Existing Business

Cash requirements may be high or the business is overpriced. • The business may be losing money. • The owner asks us to pay for ill will. • Employees inherited with the business may not be suitable or have an attitude. • Unsatisfactory location.• Obsolete or inefficient equipment and facilities. • The challenge of implementing change. We will talk about this later in the course. • Obsolete inventory difficulty in valuing accounts receivable.

Straight Business Sale

Disadvantages: - Usually the most expensive way to sell a business. - Could result in a significant tax burden. - Unattractive for owners who want to surrender control gradually. • May involve seller financing.

The Valuation Stage

Methods for Determining the Value of a Business: - Business valuation is partly an art and partly a science. - Use a CPA or M&A firm to help.• Balance sheet method.Net worth (or owner's equity) - Net worth = Assets − Liabilities You will sign a Non-disclosure agreement (NDA).

Extra earning power

he difference between a company's forecasted earnings and the total opportunity costs of investing in that company.

The key to pricing is to understand the target market and...

identify how much customers are willing to pay rather than how much to charge.

Market penetration

increase market share among existing customers

Capitalized earnings approach

involves dividing a company's estimated net earnings by the rate of return that reflects the risk level of investing in the business.

Discounted future earnings approach

involves estimating a company's net income for several years into the future and ... - then discounts these future earnings back to their present value. - which provides an estimate of the company's worth.

Market (or price/earnings) approach

involves using the price/earnings ratios of similar publicly traded businesses to estimate the value of a company.

Structural capital

Patents, IP and KSA's

Letter of intent

A document that represents a firm commitment by both sides that they are ready to move toward closing the sale of a business

Sliding Down the Demand Curve

A strategy that involves setting a high price when a product is introduced and lowering it significantly as competitors enter the market

The Transition Stage

Closing documents include: - Asset purchase agreement - the formal agreement of the deal - Bill of sale - transfers ownership- Asset list - all assets that are included in the sale, including tangible assets and intellectual property - Buyer's disclosure statement - Allocation of purchase price - a formal document that must be filed with the Internal Revenue Service at the end of the tax year that allocates the price among the various - Non-compete agreement - Consulting/training agreement - Transfer of subsidiaries associated with the business - Transfer of utilities - Transfer of Web sites, social media addresses,and phone numbers - Documentation of the new entity that will own the business and documentation of the new bank account for that business - Transfer of merchant accounts - Notice to creditors

Simple Markup

Decide on the percentage markup, say 35%. Now multiple the cost by 1.35.- For example: $7.52 x 1.35 = $10.15

Gross Margin Markup

Decide what the gross margin should be (35%) .Now 100 - 35 = 65. Take your cost and divide by.65.- For example: $7.52 / .65 = $11.57- Round up to $11.59.

Geographic Output Structure

Grouping workers according to geographic outcomes

Hybrid Structure

Grouping workers according to outcomes and specialization.

Product Grouping

Grouping workers according to product outcomes.

Market Output Structure

Grouping workers according to specific market outcomes.

Functional Grouping

Grouping workers according to the nature of the work, tasks or equipment.

Due diligence - Financial condition

Is the business financially sound? *Audited Income, balance sheet, cash flows for 3 years. Income tax statements.

The Due Diligence Stage

Once you have a list:- What are the company's strengths?Weaknesses? Employees? - What is its overall financial condition? Cash flow cycle? How much cash will the company generate? - What is the physical condition of the business, its equipment, and its inventory? - Who are its major competitors? - How large is the customer base? Is it growing or shrinking?

Two-step Sale

One option is an earn-out an agreement: - The seller agrees to accept a percentage of the sales price and, - stays on to manage the business for a few more years under the new owner; - the remaining portion of the price is contingent on the company's performance; - the more profit the company generates during the earn-out period, the greater the payout to the seller.

Customer capital

Reputation, relationships, and good will

Focus on Value

The "right" price for a product or service depends on the value it provides for a customer. • Two aspects: - Objective value - Perceived value • Value ≠ low price, however.• $10,000 college degree?

The Deal Stage

The structure of the deal - the terms and conditions of payment—is more important than the price the seller agrees to pay. • Don't confuse price with value. - Value is what a business is actually worth; - price is what the buyer agrees to pay for it. - Identify the bargaining zone.

The Search Stage

There are three steps in conducting an effective search for the right business to buy: 1. Conduct a self-inventory 1. objectively analyzing skills, abilities, and personal interests to determine the type(s) of business that fit you best. 2. Develop a list of the criteria that define the"ideal business" for you. See next slide. 3. Prepare a list of potential candidates that meet your criteria.

Main street buyers

Want: Manageable and easy to run business (1-2 people) up to $1 Million revenue year Low Risk Seller often stays on to help with transition. Focus: past/current earnings Examples: car wash, dry cleaners, or cafe

Financial Buyers

Want: Profitable companies with "hot" products or services, want to grow rapidly. $10-$100 Million (or more) Medium to High risk Focus: Highly profitable exit within 5-7 years. Turbocharge companies growth. Examples: health care

serial entrepreneur buyers

Want: Profitable companies with sound management in place less than $10 million in revenue medium to high risk Focus: building a portfolio of companies in different industries, sectors or markets; want businesses they can run themselves Examples: computer services, or rental properties

Corporate Refugee buyers

Want: Service business with commercial clients and existing contract revenue less than $5 million in revenue a year low to medium risk Focus: ability to build experience Examples: consulting firms, landscaping firms, or advertising

Due diligence - Asset valuation

What is the real value of the company's assets?

Due diligence - Legal Issues

What legal aspects of the business are known or hidden risks?

Due-on-sale clause

a clause that requires the buyer to pay the full amount of the remaining loan balance. - Required to finance the balance at prevailing interest rates. - Preventing the buyer from assuming the seller's loan at a lower interest rate.

Liens

claims by creditors against a company's assets.

Excess earnings method

combines the value of existing assets (less its liabilities) and an estimate of future earnings.

Due diligence - Motivation

why does the owner want to sell?

Hidden market

low-profile companies that might be for sale but are not advertised as such.

Types of business buyers

main street buyers, corporate refugees, serial entrepreneurs, financial buyers

Odd pricing

prices such as xx.95 or xx.97

Geographical pricing

setting prices for customers located in different parts of the country or world

Opportunity cost

the cost of forgoing a choice; the cost of the next best alternative.

Goodwill

the difference between an established,successful business and one that has yet to prove itself that is based on the company's reputation and its ability to attract and retain customers.

Due diligence

the process of studying,reviewing, and verifying all the relevant information concerning an acquisition.

skimming

when a company charges the highest initial price that customers will pay then lowers it over time