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Buy-out Opportunities and Family Enterprise - Small Business


             Opportunities and
             Family Enterprise

                              PowerPoint Presentation by
                Patricia Peel, University of Guelph-Humber

Chapter 13                                      13-1
                   Looking Ahead

After studying this chapter, you should be able to:
1. List some reasons for buying an existing business.
2. Summarize four basic approaches for determining a fair
     value for a business.
3. Describe the factors that make a family business unique.
4. Identify the management practices that enable a family
     business to function effectively.
5. Describe the process of managerial succession in a
     family firm.
6. Analyze the major issues involved in the transfer of
     ownership to succeeding generations.
Chapter 13                                               13-2
             Reasons for Buying an
               Existing Business
1. To reduce some of the uncertainties and
   unknowns that must be faced in starting a
   business from the ground up.
2. To acquire a business with ongoing operations
   and established relationships.
3. To obtain an established business at a price
   below what it would cost to start a new

Chapter 13                                        13-3
          Finding an Existing Business to Buy

• Relying on Professionals
         Matchmakers
         Accountants
         Lawyers
         Other experienced business owners

Chapter 13                                      13-4
             Pros and Cons of Buying an
                  Existing Business

• Pros                            • Cons
     High chance of success         Existing problems
     Less planning                  Poor quality of current
     Existing customers/             employees
      suppliers                      Poor business image
     Necessary equipment            Modernization required
     Bargain price                  Purchase price based on
     Experienced employees           inaccurate data
     Existing business records      Poor business location
Chapter 13                                                 13-5
             Finding Out Why the Business
                      Is For Sale
• Owner’s reasons for selling the business
     Old age or illness
     Desire to relocate in a different section of the country
     Opportunity to start another business
     Decision to accept a position with another company
     Unprofitability of the business
     Discontinuance of an exclusive sales franchise
     Maturation of the industry and lack of growth potential

Chapter 13                                                       13-6
               Examining the Financial Data

1. Review financial statements and tax returns for
   the past five years.
2. Recognize that financial data can be misleading.
              Assets overvalued
              Expenses overstated/understated
              Income underreported
              Unrecorded debts

Chapter 13                                           13-7
                 Income Statement as
             Adjusted by Prospective Buyer

                                             Figure 13-1

Chapter 13                                    13-8
             Valuation of the Business

• Asset-Based Valuation
    Estimates the value of the firm’s assets; does not reflect
     the value of the firm as a going concern.
• Market-Based Valuation
    Considers the sale prices of comparable firms; difficulty
     is in finding comparable firms.
• Cash-Flow-Based Valuation
    Compares the expected and required rates of return on the
     amount of capital to be invested in the business.

Chapter 13                                                  13-9
               Asset-Based Valuation

• Modified Book Value Technique
    Historical value of firm’s assets is adjusted to reflect
     current market values.
• Replacement Value Technique
    Value of firm’s assets is adjusted to reflect current costs
     to replace the assets.
• Liquidation Value Technique
    Value of firm’s assets is adjusted
     to reflect their value if the firm
     ceased operations and disposed
     of the assets.
Chapter 13                                                    13-10
             Earnings-Based Valuation

• Earnings Multiple (Value-to-Earnings) Ratio
     Determine normalized earnings, and
     Divide this amount by a capitalization rate.
     Normalized earnings are earnings that have been
      adjusted for any usual items such as fire damage.

                             Normalized Earnings
      Firm’s Value =
                               Capitalization Rate

Chapter 13                                                13-11
     Determinants of a Firm’s Capitalization
              High                            Low Firm Value
                       Capitalization Rate

              Low            Low
                                              High Firm Value
                       Capitalization Rate

              High            Low             High Firm Value
Projected               Capitalization Rate

              Low                             Low Firm Value
                      Capitalization Rate

                                                       Figure 13-2

 Chapter 13                                             13-12
             Cash Flow-Based Valuation

1. Estimate the future cash flows that can be
   expected by the investor.
2. Decide on the investor’s required rate of return.

Chapter 13                                        13-13
                      Risk Premium

• The difference between the required rate of return
  on a given investment and the risk-free rate of
• Required rate of return =
       Risk free rate of return + Risk Premium
• Table 13-1 lists suggested risk premium categories

Chapter 13                                        13-14
             Nonquantitative Factors in
                Valuing a Business
• Competition
• Market
• Future Community
• Legal Commitments
• Union Contracts
• Buildings
• Product Prices

Chapter 13                                13-15
             Negotiating and Closing the Deal

• Terms of Purchase
    Assets purchase or total entity
    Indemnification clause
    Payment in full or partial payments over time
• Closing the sale
    Best handled by a third party
      • Bill of sale
      • Tax certifications
      • Payment-to-seller agreements
        and guarantees

Chapter 13                                           13-16
             What Is a Family Business?

• Family Business
     A company in whose ownership and/or functioning two
      or more members of the same family are directly
     A firm whose ownership passes from one generation of a
      family to another
                                       Logan Family Hardware
                                                Est. 1935


Chapter 13                                                     13-17
             Family and Business Overlap

• Family Concerns               • Business Concerns
     Care and nurturing of        Production and distribution of
                                    goods and/or services
      family members
                                   Need for professional
     Employment and                management
      advancement in the firm      Effective and efficient
     Loyalty to the family         operation of the firm

Chapter 13                                                    13-18
             The Overlap of Family
             and Business Concerns

                                     Figure 13-3
Chapter 13                           13-19
             Special Features of Family Firm

• Family concerns
              Nurturing
              Development
• Business concerns
              Profitability
              Survival

Chapter 13                                     13-20
             The Culture of a Family Business

• Organizational Culture
     Patterns of behaviours and beliefs
      that characterized a particular
• Cultural Configuration
     The total culture of a family firm,
      consisting of the firm’s business,
      family, and governance patterns

Chapter 13                                      13-21
             Founder’s Imprint on Culture

• The distinctive values that motivate and guide an
  entrepreneur in the founding of a firm may help to
  create a competitive advantage for the new firm.
       For example, the founder could have a special way of
        delivering customer service.
       The founder’s core values and business ethics will
        likely permeate the growing organization.

Chapter 13                                                 13-22
             The Need for Good Management

  •      A family firm must be able to rely on
         competence of its professional and managerial
  •      Favouritism in personnel decisions must be
  •      Plans for succession, steps in professional
         development, and intentions regarding changes
         in ownership must be discussed openly.

Chapter 13                                          13-23
             Nonfamily Employees in a
                  Family Firm
• The issue for a parent is to decide if an outsider
  will be promoted over a family member
• The potential for promotion for an outsider could
  be limited, and they may experience a sense of
  unfairness and frustration.

Chapter 13                                         13-24
              Nonfamily Employees in a
                   Family Firm

• Nonfamily Employees in a Family Firm
   Hazards:
     • Competition with family members for advancement
     • Getting caught in the crossfire and politics of family
       competition within the firm
   Solution:
     • Identify family-only reserved positions in advance.
     • Treat both family and nonfamily employees fairly in matters
       of reward and promotion.

Chapter 13                                                       13-25
               Family Councils

• An organized group of family members who
  gather periodically to discuss family-related
  business issues
• Function as the organization and strategic
  planning arm of a family
• Family members discuss values and policies and
  directions for the future

Chapter 13                                     13-26

• Canadian Association of Family Enterprise
  (CAFE) is a national not-for-profit association
  dedicated to research, education, and assistance
  for family businesses.
• CAFE has local chapters in most Canadian cities

Chapter 13                                       13-27
      The Process of Leadership Succession

• Available Family Talent
        • Guiding and supporting the work
          and development of a new or less-
          experienced organization member.
    Allowing only qualified competent
     family members to assume leadership
     roles in the firm increases the value of
     the firm for all who have an ownership
     interest in it.
Chapter 13                                      13-28
      Stage I                            Stage II                        Stage III
  Pre-Business                         Introductory                    Introductory
Child becomes aware of                Child is exposed to               Functional
                                                                   Child works as part-time
facets of firm and/or                 business jargon,
                                                                   employee. Work
industry. Orientation of              employees, and the
                                                                   becomes more difficult.
child by family member                business
                                                                   Includes education and
is informal.                          environment.
                                                                   work for other firms.

                                     Entry of Successor

              Stage IV                                        Stage V
                                                                                               A Model of
       Potential successor begins
                                                      Advanced Functional
                                                        Potential successor assumes
                                                                                              Succession in a
       work as full-time employee.
     . Includes all nonmanagerial
                                                        managerial position. Includes
                                                        all management positions prior
       positions.                                     . to becoming president.

                               Transfer of Leadership

                                                                                                                  Figure 13-4
               Stage VI                                       Stage VII                          Source: Adapted from Justin
                                                                                                 G. Longenecker and John E.
         Early Succession                               Mature Succession                        Schoen, “Management
     Successor assumes presidency.                     Successor becomes defacto                 Succession in the Family
     Includes period in which the                      head of company.
     successor becomes dejure head                                                               Business,” Journal of Small
     of company.                                                                                 Business Management, Vol.
                                                                                                 16 (July 1978), pp. 1–6.
 Chapter 13                                                                                                      13-29
             Transfer of Ownership

• The final step in conveyance of power from
  parent to child is distribution of ownership of
  the family business.
• In distributing their estate, parent-owners
  typically wish to treat all their children fairly,
  both those involved in the business and those
  on the outside.

Chapter 13                                         13-30
       Conditions Favouring Successful
    Leadership Succession in a Family Firm
• A sound, profitable business
• Stable, healthy family relationships
• Advance planning for leadership succession
• Positive family leadership and a team-oriented management
• Presentation of career opportunities without pressure
• Open communication on family business issues

Chapter 13                                              13-31

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