Entrepreneurship

Tired of being at the beck and call of corporate executives and itching to use your energies to create wealth for yourself? Any entrepreneur will tell you that being successful in your own business calls for a bit of flair, a lot of critical analysis, an exhaustive amount of detailed planning and above all, plenty of hard work. We provide the blueprint for embarking on your own business.

For many people, it would be a dream come true to shake off the shackles of employment and run their own business. But without the necessary aptitude, skills and experience, the dream can become a nightmare.

The first question to ask yourself if you are considering self-employment is whether you have the particular qualities that make a successful entrepreneur. Not everybody does. It’s a tough world out there, with no concessions made for those who falter. The risks are high, the demands are often unfair, and only the fittest survive. It is a matter of whether you have the resilience to survive and grow.

If you want to be an entrepreneur, you should have an unflinching spirit, be creative, talented and have a good “feel” for business, says Hilke de Villiers, marketing manager at Business Partners, a national company that invests in small and medium businesses.

Entrepreneurs are tough people who regard problems as challenges, and who delight in finding solutions to seemingly impossible problems. Wise entrepreneurs acknowledge their weaknesses and try to correct them. They often surround themselves with people whose strong points complement their weaknesses.

De Villiers says entrepreneurs are also optimists who are, nevertheless, realistic, and they never underestimate the demands of the business world. They know what it means to manage a business effectively.

If it is your dream to be an entrepreneur, you should be made aware of certain truths that entrepreneurs around the world are all too familiar with:

• The demands on your personal life are enormous. A typical entrepreneur works long hours and is not guaranteed regular holidays;
• The stress levels you face as a solo business person could have a detrimental effect on your health and personal life – which could lead to family conflict;
• Working in a large organisation cushions you from the impact of bad decisions. A bad decision in your own business could mean failure;
• A successful entrepreneur is willing to take calculated risks, but is no gambler;
• A successful entrepreneur must be flexible and open-minded. Apart from the basic principles of good business practice, there are no hard-and-fast rules.
• You will need a burning desire to win because second best is not good enough;
• You must be willing to sacrifice a lot – such as your leisure time, holidays, security, luxury vehicles, fringe benefits and/or luxury office environments; and
• Owning a business demands total commitment. Once you embark on your own business, everything will be at risk – your money, your career, your status, your credibility and your existing lifestyle.

  Entry into the business world means your responsibility extends from yourself and your family to your creditors, staff and clients.

  Are you ready for the big jump from the comfort zone of employment to the brave new world of the business owner? If so, read on …

  Starting a new business
  If you plan to start a business, rather than buy into an existing one, you need to draw up a business plan. This must be a detailed action programme which outlines every aspect of your proposed venture.

  The business plan should set out, comprehensively, what you intend to do, how you intend to do it, when and where you intend to do it, and why you believe your idea is viable.

  In essence, a business plan is a blueprint of how to achieve your goals. It has the added advantage that you can use it to track your progress as you go along.

  Who should compile the business plan
  The people who will carry out the business plan – in other words, those who will have operating responsibility in the business – should prepare the plan.

  You can call in the assistance of an outside accountant for the preparation of the necessary financial documentation, such as balance sheets, income statements, and cash flow forecasts. The rest of the plan, however, should be created by you, the entrepreneur, with significant input from your partners or other key people in the venture.

  Why the business plan is important
  The importance of planning cannot be over-emphasised. It’s wise to put all your ideas down on paper from the very beginning, because:

• It forces you to arrange your thoughts in a logical order;
• It helps you create a structure for your business by defining activities and responsibilities;
• It gets you to simulate reality and anticipate pitfalls before they occur;
• It helps you identify objectives and develop realistic strategies to meet those objectives;
• It serves as a working action plan which you can use to measure your progress once your business is up and running; and
• It is an essential aid when applying for financial assistance, or when selling your idea to investors.

  The business plan as a financial tool
  Your business plan is the chief instrument for communicating your ideas to providers of capital – business people, bankers or potential partners – when you are trying to convince them to invest their money in your enterprise.

  If you decide to seek finance for your business, your business plan should become the foundation of your loan application.

  So the idea is to provide the information others require to evaluate your venture. Bear in mind that the lenders you approach have not been thinking about your business for as long as you have – they have not been researching it for months. They are seeing the project for the very first time, and only on paper, so don’t be afraid to be thorough.

  How to compile a business plan
  A good business plan covers four key areas:

  1. The people. Give details of the people who will start and run the venture, as well as any outside parties providing essential services or resources. You will need to ask yourself a number of questions regarding the people you plan to have involved, including:

• What experience do they have which is directly relevant to the proposed venture?
• What skills and knowledge do they have?
• How realistic are they about the venture’s chances of success, and the trials and tribulations they are likely to face before the venture is successful?

  2. The opportunity. Provide a profile of the business in which the following questions are answered:

• What will your business sell?
• Who will your customers be?
• Will the customer pay cash, or will you be expected to grant credit?
• Evaluate whether the business is likely to grow, and if so, how fast.
• What are the economics of the proposed venture? You need to consider who, and what, stands in the way of success.
• Do existing market conditions allow you to turn a profit?
• Who are your current competitors?
• How will the product or service be priced?
• How much does it cost to produce and deliver the product or service?

  3. The context. You need to take account of the “big picture” – the regulatory environment, interest rates, demographic trends and inflation.

  These factors change from time to time and you cannot control them, but you need to take them into account. Issues that you should consider include:

• How will the macro and market environment hinder, or promote, your venture?
• What kind of impact will changes in the environment have on the venture?
• What can you, the entrepreneur, do should the economic environment deteriorate?

  4. Risks and rewards. Provide an outline of how you and your entrepreneurial team would respond to the possible risks and rewards of the business. In this context, you should:

• Discuss the risks involved, and how these will be managed; and
• Consider what rewards the business will deliver, to whom, by when, and how much.

  Forms of business ownership
  One of the decisions you will need to make when starting your own business is what type of ownership is suitable for your business venture. The form of ownership you select will depend on your future plans – see our list of the pros and cons of the various types of businesses in “Types of ownership”.

  If it is your intention to sell your business eventually to a large competitor, or to list on the JSE Securities Exchange, it is a good idea to form a company from the outset. Large businesses and their accountants tend to trust audited financial statements, which are required in terms of company law.

  What is goodwill?
  Goodwill can be defined as the difference between the reasonable value of the assets and the purchase price of a business. The value of goodwill is often used as a reason to charge more for a business than it is worth – considering that what you are really buying anticipated future profits.

  You have to ask yourself:

• What value do I place on the fact that a business has a history, which includes a client base, possible profits, captured market share and trained employees?
• If I start my own small business, what will I pay for setting it up? This may save money, but is the higher risk worth it?

  The profit history of a business plays an important role in determining the value of goodwill. Many consultants use the formula of one to one-and-a-half times the annual profits after the owner’s remuneration to determine the value of goodwill.

  Other aspects that could influence the value of goodwill are:

• The ability to resell the business;
• The type of business; and
• The location of the business.

  In many cases the nature of the business will indicate what the value of goodwill should be. This is the case with businesses that change hands often. For example, the going rate for a filling station is between one and one-and-a-quarter times the average monthly litres sold.

  So if a filling station sells an average of 200 000 litres a month, the buyer can expect to pay between R200 000 and R250 000 for goodwill. In the case of a supermarket, the value of the goodwill is based on twice the monthly turnover.

  These are only indications, and the prospective buyer should investigate the going rate being charged for goodwill in the industry he or she is interested in. If the reason for the take-over is that the business would otherwise have closed down, you should not be prepared to pay any goodwill.

  Also, if you discover during your investigations that the business has been running at a loss, or needs a total “face lift”, you may also decide not to pay a goodwill premium.

  If the business has been operating at a loss, you as the potential buyer should ask the question: “Do I have the necessary skills and experience to turn the business around?”

  If your ability is not substantially better than the seller’s, then the chances that you can change a loss-making organisation into one providing enough profit to finance future growth are remote.

  Buying an existing business
  Buying a going concern offers you a lower-risk alternative to launching a brand-new business. There are five stages involved:
  1. Finding a suitable business.
  2. Getting the information you need.
  3. Determining the price.
  4. Negotiating the deal.
  5. Financing the transaction.

  These are the steps you need to take to make the dream a reality while minimising risk:

• Do a self-evaluation to ensure that running a business is compatible with your own goals, ideals, personality and abilities;
• Decide what type of business would correspond with your goals, and suit your needs and experience;
• Collect all relevant information on the business and related macro-aspects such as the market size, trends and technological advancement;
• Contact the prospective seller;
• Evaluate the business and its future prospects. Enlist the help of professionals to fill in the gaps in your knowledge or experience;
• Determine the price;
• Raise the necessary finance;
• Comply with the legal formalities; and
• Implement the take-over.

  At an early stage of the evaluation process, you should determine the real reason for the business being on the market. Some legitimate reasons for sale are the owner’s retirement, ill health, relocation, or involvement in other projects.

  There might be hidden reasons for the sale, which could include decline in the performance of the business, a change in buying patterns resulting in obsolete products, cash flow problems, poor trading conditions, problems with suppliers and poor management.

  For all the hazards, there are undeniable advantages to acquiring an existing business:

• A successful business should be less of a risk than starting a business from scratch – at least the buyer has some history and a track record;
• It takes time to establish a new business, often resulting in an initial trading loss. The possibility exists that an established, successful business can generate profit immediately, or within a relatively short period;
• An existing business often has established suppliers, whereas setting up a new business involves a trial- and-error process of selecting new suppliers; and
• With a going concern, you will probably get a trained workforce and an existing client base.

  Some of the disadvantages include:

• There is often a direct correlation between the success of the business and the owner. In other words, a business is often reliant on the flair and personality of the owner;
• You may inherit a workforce with entrenched attitudes toward their responsibilities. It could take time – and money – for them to adopt new policies;
• Old or out-dated equipment could result in work stoppages and expenses that could put a severe strain on the cash flow;
• Due to inexperience, you risk investing “fresh” money in “old” stock; and
• You risk paying too much for the business. Goodwill is frequently valued unrealistically, and if you pay too much, you will get lower profits and less return on your investment (see below).

  Is the price right?
  Invariably, the seller will want to capitalise on his or her hard work and dedication. The buyer wants to make a sound investment offering an acceptable return, which means paying as little as possible.

  When you buy a business, you’re investing in future prospects, and reviewing the past is only useful in helping you to determine what those prospects might be. There is no fixed set of rules for determining the value of any business, and every valuator uses his or her own criteria and interprets information differently. But any valuation should take into account:

• The past, since it shows trends, growth patterns, market shares and other important factors. It offers some indication of what can be expected in the future;
• The reason for the sale, which may influence the price. If the seller is under pressure to sell – because of ill-health, financial difficulties or the death of the operator – you can expect a more reasonable price. If the sale is urgent, the price goes down;
• Your ability to negotiate a cash purchase, or your need to raise finance. If you have to rely on finance, the seller will be less inclined to drop his price;
• The economic climate. The seller is in a stronger position when business conditions are good and the business is prosperous. During a recession in the industry, or when there is a poor general economic climate, the price of a business may be forced down; and
• The type of buyer. For instance, an experienced business person with extensive knowledge of the industry and strong negotiating skills could influence the seller.

  The bottom line is that there is no correct answer to the question of how much a business is worth. Ultimately, what you pay will be the price you are willing to pay and the seller is prepared to accept.

  Information is the key
  Unfortunately, reliable financial information can be hard to come by, which makes the investigation process complicated. In the case of close corporations and sole proprietorships, unaudited financial statements prepared for tax purposes could paint a distorted picture.

  Whatever information you are given, the golden rule is to probe, be sceptical and get help. These are some of the issues you should be looking at:

• Ask about the market share of the business that’s for sale, and consider whether the market share can be increased. Check out the size of the total market, and what portion of the market has been captured by competitors. Take into account the geographic area of the target market, and the total potential market.
• Analyse what stage of its life cycle the product is in. How many products are offered, and what is the contribution of each toward the total turnover of the business? Find out how the market perceives the product, and how the price and quality compares with the products of competitors. Consider whether the product range could be increased in the future.
• Investigate whether any legislation that might influence the viability of the product is on the cards, and what effect predictable political developments might have on the business.
• Assess whether you want to employ the present workforce, and whether they are willing to work for you. Check whether a proper organisational structure exists, and make it your business to evaluate each employee. Check whether the seller is willing to assist after the takeover date.
• Ask yourself whether you are familiar enough with the technical requirements of the business, and whether there are alternative skilled workers available.
• Contact major clients and get their views on the business. You should, however, get permission from the seller before approaching a client.
• Suppliers often know more about the business than the owner realises. The supplier can offer valuable information regarding the products, the market and the way the business has been run. They can confirm the quantities they supply, which will give you an indication of whether the turnover claimed by the seller is reasonable. The credit record of the business can also be established.
• The lease agreement of the business you want to buy may have to be transferred, and this may be the golden opportunity to ask a few pertinent questions of the landlord.
• Visit the adjacent businesses to get their views on the area and the business.
• Although the owner may have withheld his or her intention to sell from them, the employees have valuable information on issues such as technical problems, downward trends in turnover or even management problems. But you should handle this method of investigation with caution, because it may put the seller in an awkward position. Never speak to the staff without the consent of the seller.
• Other sources of information include central statistical centres, the Council for Scientific and Industrial Research, local municipalities, the National Productivity Institute, Business Partners, the small business units of universities, libraries, chambers of commerce, and newspapers, magazines and books.

  The deal
  As the buyer of an existing business, you have two basic options:

  The purchase of shares
  Buying the shares in a business means that you take over shares in a company, or interest in a close corporation. Depending on the arrangement with the seller, you will generally take over the entire business, with all its assets and liabilities. It is important to realise that undeclared liabilities, or contingent liabilities, could have repercussions for you in the future.

  Even if there are warranties in the buy-and-sell agreement giving you some protection against claims by creditors, it may not be good enough. Creditors could still claim – and even liquidate the business. While you may well have a counter-claim against the seller based on the conditions of the agreement, it might be unsuccessful for many reasons, or it might drag on for years. It is often an attractive option to buy the shares in a company that has an existing tax loss, because future profits can be offset against the loss – resulting in lower taxes for you in future.

  Acquisition of assets
  The best way to buy a business through the acquisition of assets, rather than by the purchase of shares, is for the buy-and-sell agreement to clearly state that only the assets are taken over, and that the seller is responsible for liabilities. This type of agreement offers the buyer less risk and uncertainty.

  When negotiating the purchase price, the stock should make up most of the purchase price because it will be recorded as cost of sales in your hands, and in this way you will be allowed a deduction for tax purposes. If the business is taken over as a going concern, net VAT is payable on the acquisition.

  Finding finance
  If raising funds through friends, family or business partners is not possible, there are various options, ranging from banks to non-governmental organisations such as the Women’s Bank.

  Remember though, financiers will provide money only if your business plan inspires confidence. For example, Absa Bank will investigate the product or service you wish to provide, and the demand for that product or service, Jenny Tyobeka, the general manager for medium business, says.

  Absa will also consider whether the price is realistic, and how it compares with similar products and services. Then the bank will assess the skills of those involved in the business, looking closely at financial management and technical management skills.

  Your cash flow projections will be scrutinised to see whether your business is viable, and the bank will also consider the credit and other risks that your potential business poses.

  Tyobeka says there is always a credit risk associated with lending of any kind, but the bank will focus on any special risks that might influence your ability to repay your loan.

  Security
  Tyobeka says that while the bank usually requires security from you before lending, Absa does not regard security as an argument for backing a poor business proposition. If your potential business is not viable, the bank would rather not lend you any money at all.

  The amount of security you are expected to provide for a loan can range from10 percent to 100 percent of the loan, depending on the risk involved in your particular business venture or the track record of an existing business.

  The bank will also take into account whether it can obtain security from loan guarantors such as the parastatal Khula Guarantee Scheme, which provides guarantees to financial institutions for lending into certain markets.

  Loan amounts
  The amount a bank will lend you, once again, depends largely on the business you want to buy or start up, as well as the risk capital that you are able to put into the business yourself. The banks have various models for calculating the optimal size of loans for a particular size and type of business.

  Tyobeka says Absa expects you to put some of your own money into your business, because it means you are less likely to walk away from your loan commitments. “We cannot be the major shareholder in any company,” she says.