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LAUNCHING NEW VENTURES
An Entrepreneurial Approach
Kathleen Allen
University of Southern California
UPSTART PUBTISHING COMPANY, INC.

Chicago, Illinois
|^6"
Published by Upstart Publishing Company, Inc.
A Division of Dearborn Publishing Group, Inc.
155 N. Wacker Drive
Chicago, Illinois 60606-1719
(800) 448-3181 or (312) 836-4400
Copyright © 1995 by Upstart Publishing Company, Inc.

All rights reserved. No part of this work may be reproduced or transmitted in any form or by
any means without express written consent of the publisher.
Neither the author nor the publisher of this book is engaged in rendering, by the sale of this
book, legal, accounting or other professional services. The reader is encouraged to employ the
services of a competent professional in such matters.
Library of Congress Cataloging-in-Publication

Allen, Kathleen R.
Launching new ventures: an entrepreneurial approach / Kathleen R. Allen,
p. cm.
Includes index.
ISBN: 0-936894-73-3 (softcover)
1. New business enterprises—Management. 2. Small business—Planning. 3. Business plan¬
ning. I. Title.
HD52.5.A46 1995
658.1T41—dc20 94-44966
CIP
Interior design by ST Associates, Wakefield, MA.
Cover design by S. Laird Jenkins Design, Arlington, VA.
Printed in the United States of America

10 987654321
This book is dedicated to Jon Weisner, Kelly Stolpe, Sean Entin, and
their classmates in the Entrepreneur Program at the University ojSouthern California
with thanks for their inspiration throughout the process.
You are the reason 1 love teaching.
Contents in Brief
Part 1: The Entrepreneur and the Entrepreneurial Venture 1

Chapter 1 Understanding World-Class Entrepreneurship 3
Chapter 2 Recognizing and Testing Opportunity 23
Chapter 3 Developing the Business Concept 43
Chapter 4 The Founding Team 61
Case Study 1: Mrs. Gooch’s Natural Foods Markets
Part 2: Finding, Analyzing, and Testing Opportunity 81

Chapter 5 Understanding the Industry: Prelude to Success 83
Chapter 6 Evaluating the Target Market 99
Chapter 7 Distribution Channels: Getting the Product or
Sendee to the Customer 115
Case Study 2: Gentech Corporation 126
Part 3: The New Venture and the Law 133

Chapter 8: The Legal Structure of the Business 135
Chapter 9: Regulations Affecting New Businesses 149
Case Study 3: Toy Tips, Inc. 166
Part 4: The Operating Structure of a New Venture 171

Chapter 10 The Big Picture 173
Chapter 11 The Operational Plan 195
Chapter 12 The Marketing Plan 225
Chapter 13 The Management and Organization Plan 255
Case Study 4: OXO (A) 275
Part 5: The Financial Plan 281

Chapter 14: Financing the New Venture 283
Chapter 15: Preparing the Financial Plan 297
Case Study 5: Flight Time: Start-Up of an Air
Charter Broker 317
VI Contents in Brief
Part 6: A Plan for Growth 343

Chapter 16: Growing the Business 345
Chapter 17: Financing Growth 369
Case Study 6: OXO (B) 390
Part 7: Contemplating the Future 403

Chapter 18: Planning for Change 405
Chapter 19: Packaging and Presenting the Business Plan 423
Case Study 7: Simtek, Inc. 439
Part 8: A World-Class Venture 445

Chapter 20: Achieving World-Class Status 447
Table of Contents
Introduction xvii
Features of this Book xx
Acknowledgments xxii
Part 1: The Entrepreneur and the Entrepreneurial Venture 1

Chapter 1: Understanding World-Class Entrepreneurship
Overview 3
Death, Taxes, and Change—The Only Certainties 3
What Is an Entrepreneur? 5
Why Do Entrepreneurs Start Businesses? 8
Entrepreneur Myths 10
The Entrepreneurial Venture 11
The Role of the Entrepreneur in the Marketplace 15
Trends for the 1990s and Beyond 18
New Venture Checklist 21
Additional Sources of Information 22
Issues to Consider 22
Chapter 2: Recognizing and Testing Opportunity 23

Overview 23
Recognizing Opportunity 23
Enhancing Your Creative Skills 24
Sources of New Venture Ideas 25
Where Will the Opportunities Be Next Century? 30
Success and Failure 30
Testing the Idea Quickly 31
The Feasibility Components 32
The Business Plan Components 34
viii Table of Contents
Chapter 3: Developing the Business Concept 43

Overview 43
Protecting the Business Concept 43
Patents 45
Starting vs. Buying a Business 53
Describing the Business 55
Chapter 4: The Founding Team 61

Overview 61
The Solo Entrepreneur vs. the Team 61
The Founding Team 62
Outsourcing Savvy—Independent Contractors 70
The Management Team Section of the Feasibility Study or Business Plan 75
Case Study 1: Mrs. Gooch’s Natural Foods Markets 78
Part 2: Finding, Analyzing, and Testing Opportunity 81
Chapter 5: Understanding the Industry: Prelude to Success 83

Overview 83
Defining the Industry 83
Industry Structure 85
Competitive Strategies 89
Industry Analysis 91
Presenting the Industry Data in the Feasibility Study or Business Plan 96
Chapter 6: Evaluating the Target Market 99

Overview 99
Defining the Target Market 99
Table of Contents IX
Identifying the Competition 101

Researching the Target Market 103
Forecasting New Product/Service Demand 108
The Cost/Benefit of Market Research 110
Presenting the Market Analysis in the Feasibility Study or Business Plan 111
Preliminary Conclusions as to Feasibility 112
Chapter 7: Distribution Channels: Getting the Product or Service

to the Customer 115
Overview 115
Choosing a Distribution Channel 115
Consumer Channels of Distribution 116
Industrial Channels of Distribution 119
The Value of Graphing Distribution Channels 120
Presenting the Distribution Channel Information in the Feasibility Study
or Business Plan 123
Case Study 2: Gentech Corporation 126
Part 3: The New Venture and the Law 133
Chapter 8: The Legal Structure of the Business 135

Overview 135
The Legal Structure of the New Venture 135
Sole Proprietorship 137
Partnership 138
Corporation 139
The S-Corporation 143
Limited Liability Corporation 144
The NonProfit Corporation 146
Some Final Thoughts 147
X Table of Contents

Chapter 9: Regulations Affecting New Businesses 149

Overview 149
Regulation as a Way of Life 149
From Idea to Start-Up 151
Choosing a Business Site 152
Hiring Employees 154
Trade Issues 159
Case Study 3: Toy Tips, Inc. 166
Part 4: The Operating Structure of the New Venture 171
Chapter 10: The Big Picture 173

Overview 173
What Does the Business Look Like? 173
The Fantasy Tour of the Business 178
The Site for the Business 178
Choosing the ServiceAVholesale Site 183
Choosing the Manufacturing Site 184
The Building: The Lease-Buy-Build Decision 186
Starting the Business from Home 191
Final Thoughts 192
Chapter 11: The Operational Plan 195

Overview 195
Designing an Operational Plan 195
New Product Development 196
Product Development the Entrepreneurs Way 197
The Product Manufacturing Cycle 205
Table of Contents xi
Matenals Requirements 206

Inventory Requirements 207
Production Requirements 211
Quality Control 213
Product/Process Maintenance Requirements and Warranties 217
Financial Requirements 218
Including the Operational Plan in the Business Plan 219
Chapter 12: The Marketing Plan 225

Overview 225
Marketing in the 1990s 225
The Marketing Plan 227
The Product 229
Price 236
Place 238
Promotion 240
Online Market Research 251
Writing the Marketing Plan 252
Chapter 13: The Management and Organization Plan 255

Overview 255
The Organizational Chart—Fact or Fiction 255
The Entrepreneurial Approach to Organizational Structure 258
TQM—Panacea or Solution 261
Ownership and Compensation in a Corporation 261
Hiring-—Job Description and Specifications 266
The Employee Handbook 270
Other Policies 272
The Management/Organizational Plan Section of the Business Plan 272
xii Table of Contents

Case Study 4: OXO (A) 275
Part 5: The Financial Plan 281
Chapter 14: Financing the New Venture 283

Overview 283
Sources of Financing in the 1990s 283
Bootstrapping 284
Financing with Equity 287
Financing with Debt 292
Chapter 15: Preparing the Financial Plan 297

Overview 297
What Every Entrepreneur Should Know 297
Projecting Sales and Capital Expenditures 298
Preparing the Pro Forma Income Statement 301
How Much Start-up Money is Needed? 304
Preparing the Pro Forma Balance Sheet 310
Preparing the Pro Forma Sources and Applications of Funds Statement 313
Reporting the Financial Plan in the Business Plan 314
Case Study 5: Flight Time: Start-Up of an Air Charter Broker 317
Part 6: A Plan for Growth 343
Chapter 16: Growing the Business 345

Overview 345
Beyond Start-Up 345
Intensive Growth Strategies—Growing within the Current Market 351
Integrative Growth Strategies—Growing within the Industry 355
Table oj Contents xiii
Diversification Growth Strategies—Growing Outside the Industry 357

Growing by Going Global 359
To Grow or Not to Grow... 366
Chapter 17: Financing Growth 369

Overview 369
Finding Growth Capital 369
The Venture Capital Market 371
Private Placement 377
The Initial Public Offering (IPO) 379
Strategic Alliances 383
Valuing the Business 384
Final Thoughts on Growth Capital 388
Case Study 6: OXO (B) 390
Part 7: Contemplating the Future 403
Chapter 18: Planning for Change 405

Overview 405
The Contingency Plan 405
The Exit Plan 411
Chapter 19: Packaging and Presenting the Business Plan 423

Overview 423
Preparing the Business Plan 423
Writing with a Focus 425
What to Include in the Business Plan 429
xiv Table of Contents

Case Study 7: Stmtek, Inc. 439
Part 8: A World-Class Venture 445
Chapter 20: Achieving World-Class Status 447

On Becoming World Class 447
On Becoming Successful 458
Index 463
List of Figures
Figure 1.1: Should You Start a Business? 9
Figure 1.2: The New Venture Process 11
Figure 1.3: Why Is Entrepreneurship So Important Today? 16
Figure 2.1: Generating Business Ideas 28
Figure 2.2: Feasibility Study Outline 33
Figure 2.3: Business Plan Outline 38
Figure 4.1: The Entrepreneurs Team 63
Figure 4.2: The 20-Point Test for Independent Contractors 72
Figure 4.3: The Virtual Entrepreneurial Company 72
Figure 5.1: Manufacturing Industrial Classifications 92
Figure 5.2: Categories of Data for Industrial Analysis 93
Figure 5.3: Sources of Field Data for Industry Analysis 94
Figure 6.1: Steps to Market Research 103
Figure 6.2: Sample Demographics of the Target Market 104
Figure 6.3: Market Analysis 111
Figure 7.1: Channels of Distribution 116
Figure 7.2: Industrial Channels of Distribution 119
Figure 7.3: The Value Chain 121
Figure 7.4: Channels of Distribution 123
Figure 8.1: Comparative Legal Structures 136
Figure 9.1: Regulations that Affect Business 150
Figure 11.1 The Product Development Cycle 198
Figure 11.2 The House of Quality 203
Figure 11.3 New Product Checklist 204
Table of Contents xv
Figure 11.4: Gannt Chart 211

Figure 11.5: PERT Diagram 212
Figure 11.6: TechnicaiyOperational Plan 221
Figure 12.1: Online Sources for Market Research 252
Figure 12.2: Marketing Plan Outline 253
Figure 13.1: Traditional Line and Staff Organizational Chart for a Simple
Manufacturing Plant 256
Figure 13.2: Informal Networks in the Organizational Structure 257
Figure 14.1: Small Business IR Agencies 295
Figure 15.1: Sample Lists 302
Figure 15.2: Pro Forma Income Statement for NEW VENTURE INC. 303
Figure 15.3: Summary of Typical Pre-Start-Up and Start-Up
Cost Categories 304
Figure 15.4: Pro Forma Cash Flow for NEW VENTURE INC. 307
Figure 15.5: Pro Forma Cash Flow for NEW VENTURE INC. 309
Figure 15.6: Pro Forma Balance Sheet: End of First Year 311
Figure 15.7: Pro Forma Sources and Applications of Funds:
End of First Year 313
Figure 15.8: The Financial Plan 315
Figure 16.1: Phases of Growth 349
Figure 17.1: Risk vs. Rate of Return 373
Figure 17.2: Business Cycles and the Forecast Period 385
Figure 18.1: Restructuring a Business 414
Figure 18.2: ESOP Financing 415
Figure 19.1: A Portion of an Executive Summary 431
Figure 19.2: Sample Formatting for a Business Plan 434
List of Profiles
Profile 1.1: Turning Failure into Success 7
Profile 2.1: Making Creativity Work 24
Profile 2.2: A Creative Way to Generate Ideas 26
Profile 3.1: Making Pigs of Themselves: Inventors Turned Entrepreneurs 45
Profile 3.2: The Importance of Proprietary Rights 46
Profile 6.1: The Importance of Satisfying Customer Needs 102
Profile 6.2: The WaterBabies Prototype 110
Profile 7.1: CALYX & COROLLA Innovation in Distribution 120
Profile 9.1: Sub Pop Learns the Hard Way 152
xvi Table of Contents
Profile 9.2: Taking Care of Workers’ Comp 157

Profile 10.1: Taking the Virtual Concept to the Timit 176
Profile 11.1: Shortening Development Time Through Teams: The 3M
Experience 202
Profile 11.2: The Virtual Distribution Channel: The Case of Tee
Apparel Co. 213
Profile 11.3: The Baldrige Award Criteria 216
Profile 12.1: What’s in a Name? 229
Profile 12.2: Effective Niche Marketing: The Bombay Company 230
Profile 13.1: A Market Orientation for Thermos 260
Profile 14.1: The Importance of Ethics 286
Profile 16.1: The Case of a Commercial Printer 358
Profile 16.2: Domino’s Goes Global 365
Profile 17.1: The Private Placement Process 379
Introduction
Entrepreneurship is not about money, and its not just about starting businesses.
At the personal level it’s about passion—doing what you feel passionate about.
Talk to most of the truly successful entrepreneurs in this world, you will prob¬
ably find that the common denominator is that they are doing something they
really love. It has often been written that if you do what you love, money, and
success will follow. As trite as that phrase has become, it does appear to be true.
The logic makes sense. If you do what you love, you will probably be very good
at it; consequently you will establish a name for yourself. What you do will be in
demand, and people will pay handsomely for it. Of course, there are no guaran¬
tees that passion alone will bring success, but it is passion that drives the entre¬
preneur to succeed. Entrepreneurship is about passion, about doing what you love.
Every semester students attend my classes searching for the rules they need
to be successful in business. Everyone wants to learn the “keys to success,” but
sadly there are no keys—there are no rules. At least if there are, they change
from week to week and from situation to situation. You see, entrepreneurs
make their own rules. And thank goodness they do, because if they had all
followed the same rules when starting their businesses, we would never have
seen the stunning breakthroughs of the likes of Apple, Gentech, and Silicon
■ Graphics. It’s only what hasn’t been done before that excites the world—that
leap into the unknown that shakes us up and makes us take notice. It is often
said that “imitation is the sincerest form of flattery.” That may be true in public
relations, but it is the kiss of death for entrepreneurs. What worked last week
may not necessarily work this week. One change in any aspect of a business
environment can change the dynamics such that a product that was successful
one month cannot find customers the next. A technology that was “proven” one
year is obsolete the next. That is the excitement and challenge of entrepreneur-
ship today. Entrepreneurship is about innovation and change.
For the dynamic entrepreneur the path to success is not usually the path of
least resistance, for the path of least resistance does not return the most for the
effort. The opportunities that present the greatest challenge also bring the
greatest rewards, and so it is with entrepreneurs. They seek opportunities that
are innovative and show potential for growth. The challenge of turning such an
XVII
xviii Introduction
opportunity into a business is the passion of the entrepreneur. That passion leads
the entrepreneur forward with no thought of failure. Failure does not exist in
their vocabulary. What others judge as failure—a business that didn’t survive, a
product that didn’t find sufficient demand, the inability to secure growth
capital—is but a mere pause on the continual journey to success. For entrepre¬
neurs, success is not measured by how many times they fail but by how many
times they get up and try again. Each pause in their progress prepares them for
the next step ahead. Entrepreneurship is about challenge and persistence.
Often the students who come to my classes from other disciplines—engi¬
neering, cinema, English, international relations—feel intimidated by the fact
that they are sharing the class with business majors. It stems from the belief that
there must be some basic formula for business success, and if there is, business
students will certainly have learned it. Well, business students have learned
formulas, formulas that work fairly well for middle managers in large corpora¬
tions. But the mindset that business schools impose on students is actually the
antithesis of the mindset needed by someone starting a dynamic new venture.
Consequently, many business students come to entrepreneurship with precon¬
ceived notions about what the nature of business is. They have in essence lost
their innocence, their ability to creatively play with possibilities and do some¬
thing they weren’t taught to do. Business majors are starting from perhaps an
even more difficult position than those who are from other fields. They need to
regain some of their innocence by learning to look at everyday objects and
events from a different perspective so they can begin to recognize the opportu¬
nity that is all-round them. Entrepreneurship is about writing new formulas for how
things are done.
Entrepreneurship in the 1990s has taken on a new dimension. A global
economy, the tearing down of trade barriers, and the information superhighway
have created a competitive marketplace the likes of which has not been seen
before. Today large corporations are looking for ways to act small and flexible
so they too can be more competitive in the global marketplace. New ventures
will not succeed in this dynamic environment by doing business the way it has
always been done. Times have changed; circumstances have changed, and that
means the ventures that entrepreneurs create must change as well. Today it is
not enough to build a business around an innovative, quality product or
service—that’s expected. Today to sustain a competitive advantage in a global
marketplace means creating a world-class venture.
A world-class venture is one that is customer-driven, is lean and flexible, and
pursues excellence in all areas of the business. This book was written to help
Introduction xix
entrepreneurs and would-be entrepreneurs understand the nature of the new

entrepreneurial environment and how to deal with it. It purposely focuses on
starting growth-oriented ventures that will potentially impact the economy. But
even those who wish to start small, community businesses can learn much from
seeing how a world-class venture is created, for small business owners are also
facing an increasingly competitive environment and need to strive for excel¬
lence in their businesses as well. By the end of this book you will have a good
sense of what it takes to build a world-class venture and will understand the
competitive advantage that can be gained by doing so. You will realize also that
world-class status is not synonymous with big business. On the contrary, one of
the key aspects of a world-class venture is that it can remain relatively small and
flexible while still exerting a major impact in the marketplace. You will also be
in a better position to decide if you have the passion of the entrepreneur.
Entrepreneurship in the 1990s is about creating world-class ventures.
I believe that the passion of the entrepreneur is like energy. It can change,
but it can never be destroyed—it will simply take on another form. When an
entrepreneur fails, the passion doesn’t die; rather, it sustains him or her in the
effort to start again. Fortunately, life grants youth and entrepreneurs a grace
period in which to make mistakes, lots of mistakes, and still be able to start
over with a clean slate. For me, the joy of working with my students, no matter
what their age, is that they are willing to make mistakes in order to learn.
Because they are willing to fail, they are learning that failure is a healthy—in
fact, necessary—part of success, and they are gaining a real sense of what it’s
like to be an entrepreneur. I can teach them the tools of entrepreneurship, but
the spirit and passion cannot be taught, and no one has a monopoly on
passion. Some of the most successful entrepreneurs I know have been teachers,
engineers, psychologists, musicians, and film-makers. Many have had no
college education at all, but they were all lifelong learners. They built world-
class businesses out of a passion for what they believed in, and what they
believed in first and foremost was—themselves. Will Rogers once said:
Know what you are doing.

Love what you are doing.
Believe in what you are doing.
Fie must have been talking about entrepreneurs.

—Kathleen Allen
Features of this Book
Launching New Ventures: An Entrepreneurial Approach is written in a practical,

how-to style designed to allow any reader or student successfully plan and start
a world-class venture. For classroom use, the book includes several elements to
aid instructors and students in the start-up process.
Chapter Overviews outline the key topics for each of the 20 chapters.
Key terms are bold-faced when first introduced, and subsequently defined in
the text.
An informal self-test measures proclivity towards entrepreneurial activity
compared to typical entrepreneurs.
Chapters include Profiles of real-world entrepreneurs and businesses that
clarify the topic at hand and provide starting points for additional discussion
and thought.
Throughout the book, numerous elements facilitate the start-up process,
including:
• Outline of a feasibility plan

• Outline of a business plan
• Detailed outline of an operational plan
• Outline of a marketing plan
• A 20-point test to verify the status of Independent Contractors
• An incorporation checklist
• A new product checklist to help determine the likelihood of success.
New Venture Checklists at the end of each chapter help organize the start-up
process.
Additional Sources of Information are listed at the end of each chapter for more
in-depth reading on the topic at-hand, including on-line resources for market
research.
Issues to Consider, questions at the end of each chapter, focus the thinking of
entrepreneurs and provoke meaningful discussion in the classroom.
Case Studies at the end of each of the seven parts of the book, are designed to
illustrate the key components of the section that precedes them, and include
discussion questions for classroom use.
XX
Features of this Book xxi
An index at the end of the book aids location of key topics, people and
companies covered in the text.
An Instructor’s Manual, featuring lecture outlines, overhead transparency
masters, discussion points for the case studies and end-of-chapter questions, as
well as worksheets and a test bank, is available upon adoption for classroom
use. To request a copy, cg.ll Upstart Publishing at (800) 235-8866.
Acknowledgments
Thanks first of all to my tireless faculty assistant, Nancy Frost, who has since
gone on to establish her career in financial services. Without her research work,
this book would have never been completed on time. Thanks to all my students
in the Entrepreneur Program at the University of Southern California who used
the manuscript in class and made very helpful suggestions. I am grateful to my
wonderful husband who kept me on track and edited every chapter of this
book. I also appreciate the excellent suggestions of my academic reviewers:
Candida Brush, Boston University; Bill Gartner, San Francisco State University;
Keith Cox, University of Houston; and Dewey Johnson, California State
University, Fresno. Candy and Bill also contributed three of their original case
studies to the book. My appreciation to Marianne Szymanski of Toy Tips, Inc.,
Steve Johnson of Simtek, Inc., Patricia Zinkowski of Flight Time International,
and Sandy Gooch of Sandy Gooch Enterprises, Inc. for allowing me to explore
their businesses and their entrepreneurial psyches in-depth for the case studies,
and to Dan Lauer of Tauer Toys for his help with the Waterbabies doll. Thanks
to Jack Savage, my editor, for his sense of humor and patience, and to Spencer,
Jean, Karen, Brad, Nancy, and all the great people at Upstart.
xxn
PART i
The Entrepreneur and the

Entrepreneurial Venture
Develop a vision, and never lose sight of that vision.

-SANDY GOOCH, FOUNDER,
MRS. GOOCH’S NATURAL FOODS MARKETS
CHAPTER 1
Overview
• The importance of entrepreneurship in a volatile world market
• Entrepreneurial characteristics and reasons for wanting to start a business
• The new venture creation process
• Entrepreneurial ventures versus small businesses
• Factors in the entrepreneurial environment that will affect the start-up
• Business trends of the 1990s that affect the search for a business idea
Death, Taxes, and Change—The Only Certainties
The old adage that the only sure things in life are death and taxes needs to be
updated for the 1990s to include change, for it is clearly evident that change has
become a way of life. Today there are no safe companies, no sure customers, no
secure jobs, and no such thing as an established market share. The global
economy has opened up heretofore unknown opportunities and with it a new
network of suppliers, distributors, and outsourcing resources that will compete
with and for American goods. Electronic highways like Internet have given
virtually anyone instant access to people and information throughout the entire
world, giving entrepreneurs the chance to compete with large companies on a
more level playing field. The price of money in the global marketplace is
changing daily, making it nothing short of a miracle to forecast costs, prices,
and interest rates into anything but the very immediate future. Many of the
3
4 Part 1 • The Entrepreneur and the Entrepreneurial Venture
products and services businesses will offer ten years from now cannot even be
conceived of today. Technology is constantly changing the business of business,
from manufacturing to distribution to customer service.
Tom Peters predicted the dynamic nature of the world today and the conse¬
quent need to redefine “excellence” in business in his prophetic 1987 book
titled Thriving on Chaos. Now more than eight years later, the truth of what he
said is being felt. “...Excellent firms of tomorrow will cherish impermanence—
and thrive on chaos,” or they will not survive. Peters’s study focused on
America’s big companies and demonstrated how failure to adjust to a changing
world threatens to destroy them. Change has not been part of the vocabulary of
many of America’s biggest companies. However, to those who have devoted
their lives and energy to entrepreneurship, the concept of change as a constant
is not entirely new. Uncertainty is the ubiquitous companion of any new
venture. Born into an uncertain environment, start-ups by nature must
Born into an uncer¬ be flexible, able to change in response to changing needs and require¬
tain environment, ments. Joseph Schumpeter, a classical economist who often took off
start-ups by nature that hat when he spoke of entrepreneurs, said the job of the entrepre¬
must be flexible, neur is “creative destruction.” Entrepreneurs disrupt the economic
able to change in equilibrium. Schumpeter’s concept of the entrepreneur does not,
response to however, fit easily into the economic models espoused by the followers
changing needs and of Keynes, Friedman, and supply-side economists, whose goals are to
requirements. optimize existing resources and arrive at economic equilibrium.
Consequently, they have a difficult time accepting Schumpeters model,
which contends that economic disequilibrium caused by entrepreneurial inno¬
vation is a sign of a healthy economy.
Nevertheless, the volatile world market cannot be ignored, and no one is
better prepared to face the dynamics of the 1990s and beyond than entrepre¬
neurs. Dealing with the new global and technological environment requires a
different vision and a different mindset today than it did even a decade ago.
Where in the past new businesses started with a narrow geographic focus,
purchased equipment and technology to last for the long term, designed prod¬
ucts and services before finding customers to purchase them, and built large
bureaucratic organizations, today the rules have changed. Today these intrepid
risk takers who start their high-growth ventures in this decade have the distinct
advantage of starting with flexible, dynamic organizations poised to respond to
change and to even create change as well. Certainly it is easier to start a venture
with the expectation of change than to attempt to downsize a monolithic giant
and re-educate employees to new ways of doing things.
Chapter 1 • Understanding World-Class Entrepreneurship 5
Accordingly, this book refers to these new types of entrepreneurial ventures

as world-class ventures, created by entrepreneurs who have learned much
from witnessing the foibles, failures, and frantic downsizing of big business.
World-class ventures will come from a learning curve that says bigger is not
more efficient and the largest firms are not always the greatest sources of inno¬
vation. While world-class ventures take advantage of current technology for
product development and manufacturing, they are not necessarily “high-tech
ventures” in the strictest sense of the term. Typically, high-tech companies
include such things as computer software and hardware manufacturing and
biomedical technology firms. Instead, “world-class” as used in this book is a
quality term applied to firms that have certain characteristics. Achievement of
world-class status begins at start-up with a vision, strategy, and infrastructure
that models these characteristics. Therefore, the successful start-ups of the
1990s and beyond will:
• Be smaller and more responsive

• Look for niche markets at a global level
• Innovate with teams and fast-faced product development
• Be oriented toward quality and customer service
• Have a less hierarchical organizational structure
• Rely on outsourcing, the virtual corporation
• Create value by giving employees a major stake in the organization
This then is the legacy of big corporations of the past—they have effectively
carved a new market niche for the dynamic entrepreneur of the future.
What Is an Entrepreneur?
The term entrepreneur has existed in our vocabulary for more than 250 years.
The United States was founded on the principle of free enterprise, which
encouraged entrepreneurs to freely assume the risk of developing businesses
that would make the economy strong. However, it wasn’t until the 1980s that
entrepreneur came into popular use in the United States and an almost folkloric
aura began to grow around men and women who started rapidly growing busi¬
nesses. These formerly quiet, low-profile people suddenly became legends in
their own time with the appeal and publicity typically accorded movie stars or
rock musicians. Extraordinarily creative and enterprising business people like
Bill Gates, who created Microsoft, Anita Roddick, who founded The Body Shop,
and Steven Jobs and Steven Wozmak, who started Apple Computers, suddenly
found that the whole world was interested not only in their businesses but in
their personal lives as well.
At the same time, academic researchers sought to define what made these
entrepreneurs so successful and to look at the new venture process as something
quite different from starting a small business or managing an established
company. In the early stages, researchers, with little success, attempted to identify
psychological characteristics or traits associated with entrepreneurs to differen¬
tiate them from managers. What they discovered was that many of the character¬
istics normally encountered in entrepreneurs also exist in some managers.
What are the characteristics typically found in entrepreneurs? Research
points to the entrepreneur’s ability to take calculated risks and to have an
achievement orientation, a sense of independence, an internal locus of control
and a tolerance for ambiguity.
Risk-Taking
The consensus of the research on risk-taking in entrepreneurs is that they are
not big risk-takers.1 They are, instead, calculated risk-takers who define the
risks inherent in any venture and attempt to minimize them while remaining
focused on opportunity. In fact, the real risk for the entrepreneur seems to
come from the fear of failure and the potential for damage to his or her reputa¬
tion. Consequently, it is in the best interest of the entrepreneur to analyze a
potential opportunity to reduce the risk associated with it.
Need for Achievement

Entrepreneurs tend to have a high desire to be personally responsible for
solving problems and setting and reaching goals—in other words—a need for
achievement.2 This need for achievement has often been referred to as “the
burning gut.” Entrepreneurs are innately driven to start ventures and succeed.
They are not daunted by failure, but tend to keep trying until they succeed.
A Sense of Independence
Entrepreneurs also seem to purposely seek independence—to be their own boss
in situations that allow them to assume a higher degree of personal responsibility
'Brockhaus, R.H. (1980). “Risk-laking Propensity of Entrepreneurs." Academy of Management Journal, 23,
509-520; Drucker, P.E (1985). Innovation and Entrepreneurship. New York: Harper and Row.
2McClelland, D.C. (1965). “N-achievement and Entrepreneurship: A Longitudinal Study.” Journal of
Personality and Social Psychology, 1, 389-392.
PROFILE 1.1
Turning Failure into Success

No one knows more about how it feels to fail than Wally Amos, founder of Famous
Amos Cookies. After building an $80 million business as “the face that launched
1,000 chips,” he lost his fortune, his business, and even the right to use his name. He
says that failure came because he was irresponsible and didn’t take on professional
management to grow the company. Instead, he moved to Hawaii, 2,500 miles away
from the corporate headquarters, to enjoy the good life.
By the 1980s he was on the verge of losing the company. Out of fear he took on
investors who ultimately seized control of the company and left him out in the cold.
Taking full responsibility for the loss of his company, Amos set out to start another,
Wally Amos Presents: Chip and Cookie in 1991. It was not to be. Within 18 months,
the owners of Famous Amos enjoined him against using his own name. On the verge
of bankruptcy, Amos, ever persistent, started yet another cookie company in 1993,
The Uncle Noname [No-nahm-ay] Cookie Co., which he is promoting nationwide.
This time, however, he is donating one percent of net sales to an organization called
Cities in Schools, which offers a dropout prevention program. On every bag of
cookies is a recipe for lemonade, which reflects Amos’s philosophy about life: If life
hands you a lemon, turn it into lemonade.
for their decisions and achievements. This need for independence, however,
often makes it difficult for entrepreneurs to delegate authority to others.
Internal Locus of Control

“Locus of control” refers to the degree to which people believe events in their
lives are within their control. Those who believe they have control over aspects
of their environment and destiny are said to have an internal locus of control,
while those who feel controlled by their environment are said to have an external
locus of control. Many studies have determined that entrepreneurs have a strong
internal locus of control.3 In fact, the issue of the entrepreneurs need for control
has even been referred to as the “dark side” of the entrepreneur, since the entre¬
preneur often has difficulty delegating authority or giving up control in any way.
3Greenberger & Sexton, D.L. (1988). “An Interactive Model of New Venture Initiation." Journal of Small
Business Management, 1-7.
Tolerance for Ambiguity

The start-up process is by its very nature dynamic, uncertain, complex, and
ambiguous. Entrepreneurs, however, seem to work well in this type of environ¬
ment, possibly because it is challenging, exciting, and offers more opportunity
than a more structured environment.
If psychological characteristics are not a good measure of who the entrepre¬
neur is, how then do we describe the entrepreneur? Not by who the entrepre¬
neur is, but by what the entrepreneur does. It is the behaviors of entrepreneurs
that distinguish them.4
Therefore, the act of creating the business—perceiving an opportunity,
assessing and risking resources to exploit the opportunity, managing the process
of building a venture from an idea, and creating value—is the entrepreneurial
act. Those who have the passion to build innovative businesses from the idea
stage and who continue to act entrepreneurially, making strategic decisions that
engage the business in risk-oriented activity, growth, and consequent high
performance, are considered entrepreneurs.
Why Do Entrepreneurs Start Businesses?

Entrepreneurs start businesses for a variety of reasons. Sometimes they are
blocked in their achievement in the company for which they work. Such was
the case of Ruth Owades, who founded Gardeners’ Eden, sold it, and then
started Calyx and Corolla, both successful mail order catalogs. She was
working for a large mail order company when she saw a need for a catalog that
catered to upscale gardeners, offering interesting and unusual tools and other
gardening paraphernalia. Unfortunately, she could not win the support of her
company, which was nervous about investing in an idea that strayed from
what they were currently doing. She subsequently decided to leave that
company and start her own.
Some entrepreneurs have started their businesses as a result of a course in
entrepreneurship taken at a community college or university. For Talli Counsel,
taking an entrepreneurship course at the University of Southern California in
1985 inspired him to give up medical school and search for a business oppor¬
tunity. The opportunity came when he started a small business changing tires
on fleet vehicles owned and operated by various businesses, and subsequently
4Gartner, WB. (1988). “Who is an Entrepreneur is the Wrong Question.” American Journal of Small Business,
11-31; Vesper, K.H. (1990). New Venture Strategies. Englewood Cliffs, NJ: Prentice Hall.
met someone who gave him a contact with a Fortune 500 company. That
contact led to his starting Interfleet, Inc., now a successful business that services
the fleet vehicles of the Fortune 500 companies nationwide and consults to the
major auto makers.
Figure 1.1: Should You Start a Business?
No quiz can really tell you if you are the kind of person who should start a business. This little quiz
and its discussion at the end of the chapter will simply help you learn if you have some of the
typical characteristics found in many entrepreneurs. Answer the following questions without
spending a lot of time thinking about them. You are looking for a spontaneous reaction. There are
no right or wrong answers, but when you have finished, look at the end of the chapter to see what
research has found to be the typical responses made by entrepreneurs.
1. Are you
a. married c. widowed
b. single d. divorced
2. Are you
a. a man b. a woman
3. What is your primary reason for wanting to start a business?

a. to make money d. to give yourself a job
b. to be independent e. to be famous
c. to gain power
4. How comfortable are you with uncertainty and ambiguity?

a. very comfortable b. somewhat comfortable c. not at all comfortable
To be successful in an entrepreneurial venture, what do you believe you will need?

a. money d. good idea
b. luck e. all of the above
c. hard work
In terms of taking risk are you

a. a high risk taker (gambler) c. small risk taker
b. a moderate risk taker d. not relevant
7. Have you ever been fired?

a. At least once b. Never
8. Did you start any businesses before you were 20?

a. Many b. One or two c. None
Others start businesses for very personal reasons. This was the case for Sandy
Gooch, who suffered from severe reactions to artificial additives in food. They
actually became toxins in her body. Learning that many others also suffered in
this way, she decided to become an expert on natural foods, and in 1977 she
founded her first Mrs. Goochs Natural Foods Market in the Los Angeles area.
By 1993 the company had seven stores, was doing about $80 million in annual
revenues, and had over 800 employees.
Still others simply want to own their own businesses. After World War II,
Masaru Ibuka started a company in a rented room of a bombed-out department
store in Tokyo with $1,600 of his own savings and seven employees, but no
idea as to what the business was. After weeks of brainstorming, they decided to
produce a rice cooker, which, unfortunately, didn’t work the way it was
supposed to. However, Ibuka and his team persisted in spite of failure, and they
are known today as Sony Corporation.
Whatever the reason, most entrepreneurs have the intense desire—the
passion—to start a business long before they know what that business will be.
It is that internal need to be independent and create something, “the burning
gut,” that drives entrepreneurs.
Entrepreneur Myths
Before leaving the topic of what defines entrepreneurs, some of the myths that
have surrounded them over the years need to be dispelled.
Entrepreneurs are horn, not made. Entrepreneurs come in all ages and back¬
grounds. Even though research has demonstrated links to role models of
previous generations within a family, the entrepreneurial drive has not been
shown to be hereditary. Almost anyone who has a vision for a new venture,
tremendous drive, and the willingness to risk failure can acquire the technical
skills to be an entrepreneur through education and experience. Entrepreneurial
drive, however, is one thing that must exist naturally in a person. It cannot be
learned.
Entrepreneurs are gamblers. Entrepreneurs are not gamblers! In fact, as stated
previously, entrepreneurs attempt to minimize the risk of an undertaking by
calculating the consequences of their decisions before they implement them.
For this reason, they conduct feasibility studies to determine an ideas potential
viability with some degree of accuracy before they expend a lot of time and
money on it.
Money is the most important component of the start-up package. Researchers and
venture capitalists will tell you that while sufficiently capitalizing the new busi¬
ness is important to its survivability, the most important component is the
founding team. An excellent founding team can take an undercapitalized new
venture and make it a commercial success. On the other hand, a mediocre team
may have a difficult time making even a- sufficiently capitalized venture a
success. What constitutes an excellent management team is discussed in
Chapter 4.
Entrepreneurs are motivated solely by money. As you saw from the stories of
Talli Counsel, Ruth Owades, Sandy Gooch, and Masaru Ibuka, entrepreneurs
are motivated to start businesses for a variety of reasons, many of which are
personal and have nothing whatsoever to do with money. For people like Sandy
Gooch, for example, money is a means to an end, providing natural foods that
people can eat without worrying about toxic consequences.
The Entrepreneurial Venture

The entrepreneur is only one component in the process of new venture
creation. (See Figure 1.2.) The behaviors and experience of the entrepreneur
interact with all the other components of the new venture process to create a
business.
Figure 1.2: The New Venture Process

The second component, the environment, is the most comprehensive in the

venture creation process. It includes all those factors, apart from the entrepre¬
neurs personal background, that affect the entrepreneurs decision to start a
business.
Four categories of environmental variables significantly impact a new
ventures ability to start and grow:
1. Type of Environment
• Uncertain
• Complex
• Volatile
2. Resource Availability
• Land
• Skilled labor
• Capital for start-up
3. Mechanisms for Realizing Value
• Favorable markets for new ventures
• Access to distribution channels
• Favorable tax structure
• Favorable governmental policies
4. Incentives for New Venture Creation
• Enterprise zones
• Small Business Administration grants
• Favorable capital gains laws
All these environmental characteristics affect the new venture concept that
the entrepreneur develops and will vary depending on the specific nature of the
industry in which the new business will operate. For example, entrepreneurs
who start high-technology businesses, such as computer and electronics busi¬
nesses, face an environment at once highly dynamic (^changing) and very
complex. In contrast, entrepreneurs who start restaurants face a more techno¬
logically stable and less complex environment. The more of these components
that are present in their favorable form in the environment when the entrepre¬
neur starts the business, the better the chance the new venture will grow and
become successful.
While the details of the list of environmental variables will be discussed in
their appropriate chapters, in general, the environment for starting new
ventures in the 1990s and beyond is characterized by:
1. Global competition
2. Faster product development times
3. Rapidly changing technolog}7
4. Higher expected standards for quality and service
5. The need for strategic alliances
6. A decline in traditional financing sources
Within specific industries and in specific geographic regions, environmental

variables and the degree of their impact will differ.
The new venture concept, the third component in the entrepreneurial
process, is the development of the initial business idea, taking into considera¬
tion the entrepreneur’s goals and the environment in which the business will
operate. Developing the business concept is the subject of Chapter 3.
Entrepreneurial Ventures vs. Small Businesses

It is important to make a clear distinction between entrepreneurial ventures and
small businesses. While many of the venture creation processes discussed in
this book are applicable to both types of businesses, in a world-class entrepre¬
neurial venture there is a distinct difference in the vision of the entrepreneur
and the goals for the business.
Recall from the earlier description of the process of entrepreneurship that
entrepreneurial ventures are essentially
• innovative
• value-creating
• growth-oriented
An entrepreneurial venture brings something new to the marketplace,

whether it be a new product or service (the fax machine), a new marketing
strategy (Home Shopping Network), or a new way to deliver products and
services to consumers (Federal Express). The entrepreneurial venture creates
value through innovation and through bringing new jobs to the economy that
don’t merely draw from other businesses currently existing. Moreover, entrepre¬
neurial ventures are growth-oriented. The entrepreneur has a vision of where he
or she wants the business to go and, generally, the vision is on a regional,
national, or more often a global level.
By contrast, small businesses are generally started to generate an income and
lifestyle for the owner or the family. Often referred to as “Mom and Pop” busi¬
nesses, they tend to remain relatively small and geographically bound. A
specific example will illustrate the difference between entrepreneurial ventures

and small businesses.
If you were to start a company that remanufactures machine tools for local
manufacturers, you would be starting what is termed a small business, in this
case a job shop, because the concept in and of itself is not innovative. Your em¬
ployees would likely come from other similar businesses. If, however, you were
to specialize in re-manufacturing certain types of machinery, using the latest
technology or developing proprietary technology, marketing the company on an
international level with a plan to go public in seven years, then you
World-class entrepre¬
would have started an entrepreneurial venture. It would be innovative,
neurial ventures focus
and therefore create value by offering something that doesn’t currently
on people—empower¬
exist; it would create new jobs; and it would have a growth orientation.
ing employees,
Logically many small businesses have the potential to become world-
reshaping the tradi¬
class entrepreneurial ventures. The reason they don’t is often a conscious
tional hierarchies,
decision of the founder to remain a small, lifestyle business.
providing training
Additional characteristics are associated with world-class entrepre¬
and education, and
neurial ventures. They focus on people—-empowering employees,
giving employees
reshaping the traditional hierarchies, providing training and education,
responsibility, owner¬
and giving employees responsibility, ownership in the company, and
ship in the company,
opportunity. The result is more loyalty on the part of employees, less
and opportunity.
turnover, and spectacular performance. These world-class ventures are
also customer-need driven. More often than not, customers and the marketplace
dictate the products and services offered by the entrepreneur and even the direc¬
tion the new venture will take. They are also in constant pursuit of excellence in
all aspects of the business. Finally, they are flexible both in organizational struc¬
ture and strategy, ready to respond quickly to changes in the environment.
If you understand the differences between world-class entrepreneurial
ventures and small businesses, you will realize that knowing what kind of busi¬
ness you are starting is very important since it affects the decisions you make
from the outset and your goals for that business. For example, if your intent is
to grow the business to a national level, you will make different decisions along
the way than if your intent is to own and operate a thriving restaurant in your
local community. Generally, a small business requires good management skills,
since the owner must perform all tasks associated with the business as it grows.
By contrast, entrepreneurs typically do not enjoy the management aspects of
the business and would prefer to hire experts to carry out that function, leaving
the entrepreneurial team free to innovate, raise capital, and get involved in
public relations.
The Role of the Entrepreneur in the Marketplace

From the founding of this country, individuals with an entrepreneurial spirit
have started the businesses that-are the basis of the free enterprise system. With
a careful eye on trends and consumer needs, they have supplied us with new
technology and new products and services of every conceivable type while
creating jobs. Beyond all'this, the most successful entrepreneurs affect our lives,
the way we do things, and the choices we make. A legendary example is Steve
Jobs and Steve Wozniak, who, in 1976, created the personal computer through
their company, Apple, and started a revolution that in less than five years
resulted in a whole new industry with hundreds of ancillary businesses and
thousands of new jobs that had not existed previously Entrepreneurs like Jobs
and Wozniak shake up the economy. They look for unsatisfied needs and satisfy
them. In fact, the most creative entrepreneurs invent needs that consumers and
businesses never knew they had.
Today small business—by the Small Business Administration definition,
businesses with fewer than 100 employees—accounts for about 90 percent of
all new jobs created. How has this happened? Figure 1.3 on p. 16 summarizes
the evolution that has taken place since the 1960s.
In the mid-1960s, large companies were the norm. In fact, all but two
Today small
of the biggest companies in the world were American. It is estimated
business—by the
that General Motors in the 1960s earned as much as the ten biggest
Small Business
companies of Great Britain, France, and West Germany combined. The
Administration defini¬
reason American companies enjoyed such unrestricted growth was that
tion, businesses with
at that time they basically had no competition from Europe and Japan.
fewer than 100
The 1970s saw the beginning of three significant trends that would
employees—
forever change the face of business: macroeconomic turmoil, interna¬
accounts for about
tional competition, and the technological revolution. A volatile eco¬
90 percent of all new
nomic climate pervaded the 1970s, the likes of which had not been seen
jobs created.
since World War II. The Vietnam War economy brought with it infla¬
tion, the dollar was devalued, food prices skyrocketed due to several agricultural
disasters, and the formation of OPEC sent gas prices up 50 percent. Further¬
more, by the late 1970s the Federal Reserve had let interest rates rise to a prime
of 20 percent. The result was no borrowing, no spending, and a recession that
spilled into the 1980s, bringing with it an unemployment rate of ten percent.
To compound the effects of the economy on business, by 1980 one-fifth of
all American companies faced foreign competition which had far more favor¬
able cost structures. Imports, particularly in the automobile and machine tools
industries, were suddenly taking a significant share of the market from

American businesses.
The third event affecting business was the technological revolution brought
about by the introduction of the microprocessor by Intel in 1971, the Mits
Altair personal computer in 1975, and the Apple II computer in 1977.
Microprocessors succeeded in rendering whole categories of products obso¬
lete—such things as mechanical cash registers and adding machines, for
example—and effectively antiquated the skills of the people who made them.
Increasing the pressure for business, the government ushered in a new era of
business regulation with the Environmental Protection Agency, the Occupa¬
tional Safety and Health Agency, and the Consumer Product Safety
Commission, all of which increased costs to businesses. On the opposite front,
deregulation forced planes, trucks, and railroads to compete and, in general, big
companies no longer had control of the marketplace.
Figure 1.3: Why is Entrepreneurship So Important Today?

By the early 1980s, business was in terrible shape. The Fortune 500 saw a
record 27 percent drop in profits.5 Large mills and factories were shutting
down; manufacturing employment was declining; yet, ironically, productivity
remained the same or increased. It was found that new, smaller manufacturers
were still generating jobs—and not only manufacturing jobs, but service jobs as
well. How was this possible? To become competitive, smaller, more flexible,
entrepreneurial manufacturers hired subcontractors who could perform tasks
such as bookkeeping and payroll more efficiently. These service firms developed
to support the needs of the product sector, but they too inspired the creation of
other service firms as well—people who work often need day-care service or
maid service, so even more jobs were created.
With the creation of all these jobs, it is no wonder that the 1980s have been
called the Decade of Entrepreneurship by many, including the dean of
management science, Peter Drucker, who was not alone in asserting that the
United States was rapidly and by necessity becoming an entrepre¬
All these events neurial economy.6
have moved this Responding to this entrepreneurial drive, big business in the 1980s
country in the 1990s found it necessary to downsize and reverse the trend of diversification
toward a period that it had promulgated for so long. If big companies were going to compete
requires the vision, with the dynamic, innovative, smaller firms and fend off the takeover
the resources, and bids so prevalent in the 1980s, they would have to restructure and
the motivation of the reorganize for a new way of doing business. This restructuring and
entrepreneur. reorganizing actually resulted in improved performance, increased
profits, and higher stock prices. It also meant, however, that many jobs
would no longer exist, people would receive fewer benefits, and the only
“secure” jobs left would be found in civil service.
All these events have moved this country in the 1990s toward a period that
requires the vision, the resources, and the motivation of the entrepreneur to
seek new opportunities and create new jobs in a vastly different global environ¬
ment. One measure of the awareness of this entrepreneurial trend is the
increasing number of schools worldwide that now offer entrepreneurship
courses. Today nearly 400 colleges and universities offer at least one course in
entrepreneurship. Community colleges and community-based programs are
also seeking to give aspiring entrepreneurs the tools they need to succeed.
5Case, J. (1992). From the Ground Up. New York: Simon & Schuster.
6Drucker, RF. (1985) Innovation and Entrepreneurship. New York: Harper & Row.
Trends for the 1990s and Beyond

Today potential entrepreneurs thinking about starting a business need to
become aware of the trends that will affect global markets through the 1990s
and possibly into the next century. Understanding societal trends is also a good
way to prepare yourself to recognize opportunity. What major trends are
currently evolving?
The Downsizing of Major Corporations

As discussed in the previous section, the trend is definitely away from mono¬
lithic corporations like General Motors to smaller, more flexible companies. The
reason is that our economic environment has become more complex and
dynamic; businesses need to be able to quickly shift gears to meet changing
needs and requirements. The advantages that smaller companies—whose over¬
head is much less-—afford is recognized by major organizations like 3M, which
regularly subcontracts with small manufacturers to produce products related to
their core product, adhesive tape.
An Emphasis on Social Responsibility

Today an increasing number of businesses are doing more than simply making
profits. They are also concerned about giving something back to their commu¬
nity through community-aid programs, by being responsible about the pollu¬
tants they create in their production process, and by demonstrating an
awareness of their interconnectedness with society as a whole. Anita Roddicks
Body Shop, for example, in its commitment to social responsibility, established
trade agreements with underdeveloped countries to bring their raw materials to
the commercial market in the form of natural skin care products.
A Focus on the Environment

Not only are businesses becoming more responsible about not polluting the
environment, many entrepreneurs are starting environmental businesses to help
Americans in their efforts to clean up the environment. A good example is
Gardeners’ Supply, a mail-order company located in Burlington, Vermont,
which collects and composts grass clippings, leaves, and food scraps for free.
The compost is then passed on to gardeners. The program has been so
successful that they are now collecting 3,000 to 4,000 tons a year. Its goal is to
recycle 30 percent of the total waste in the community.
A Global Orientation
The old saying that the world is an increasingly smaller place seems to be true.
Technology has made access to other countries as easy as contacting the busi¬
ness in the next city. Exporting products and services to other countries has
almost become a necessity for a growing business to remain competitive. Today
it is just as likely you will purchase some of your supplies overseas as it is that
you will purchase them domestically. You may even, like Mattel Toy Company,
manufacture in another country.
Fitness and Health

The business of keeping people healthy and physically fit is a huge industry
that began taking shape in the 1980s. The ubiquitous baby boom generation,
which is fast approaching its 50s, provides the astute entrepreneur with an
enormous customer base of people who want to stay “young” as long as
possible.
The Aging Population

In less than 20 years, the oldest of the baby boomers will have reached retire¬
ment age. We are facing a major population shift; average age is increasing.
Consequently, opportunities abound for product and service businesses that
meet the needs of this enormous consumer group. Bruce Lunsford is an
example of someone who saw this trend and started Vencor, Inc., which
specializes in long-term care. Today he runs hospitals in 11 states.
Career Flexibility
Keeping the same job for 30 or more years is a thing of the past. Today adults
must be prepared for change, and they must constantly update their skills so
when change comes, they can adapt. Roe Hatlen found himself out of a job at
age 40. Fortunately, it was just the jump-start he needed to make the decision
to start his own company. He managed to build the very successful Old
Country Buffet chain of restaurants, offering home-style entrees.
Information is Power
You have no doubt heard the terms information age and information super¬
highway. With the advent of the computer revolution, information is more
readily available and in greater quantity than ever before. In fact, some would
say we are actually suffering from “information overload,” too much information
and too little time to process it all. Today a company’s power—or an individual’s
power for that matter—comes from staying on top of new information. We are
no longer a society that can educate people through age 21 and claim that they
are sufficiently educated. “Life-long learning” is the trend, and on just that
premise Jolme Godfrey founded Odysseum, Inc., an international learning
design company serving Fortune 500 companies.
Women in Business
Today women are starting businesses at a rate five times that of men. Moreover,
women now employ more people than the Fortune 500 worldwide. Why is
this? One reason is that women are no longer comfortable in a big business
culture dominated by men, which often prevents them from reaching the
highest levels of management. Women also start businesses so they can make
the major decisions and create a culture that reflects their different management
style. Emyre Robinson, for example, founded Barrios Technologies, an engi¬
neering contractor to NASA and major space contractors, to meet a need in the
industry but also for the opportunity to create a business culture based on the
nuclear family, where people come first. Her door is open to any employee of
the company, and all are encouraged to participate in its growth process and its
success.
The fact that more women are starting businesses is also important from an
economic standpoint; women now require the services they traditionally
supplied for their husbands: housecleaning, child care, cooking, and so on.
Consequently, some women are starting those very service businesses that help
other women move into economic sectors previously dominated by men. While
it is true that in general women start small businesses in the retail and service
sectors, we are now seeing a significant increase in the number of women who
start high-growth ventures in industries previously dominated by men.
Staying Home
Faith Popcorn, a noted market consultant to Fortune 500 companies, has
observed a trend she calls “cocooning.” Cocooning is simply staying home:
entertaining at home or working from home. What this means to entrepreneurs
is that people are demanding more delivery services for things such as restau¬
rant food, groceries, dry cleaning, and so forth. They want to entertain them¬
selves at home, so they are purchasing more in-home entertainment systems,
renting more videos, and shopping from home via computers.
In the decade of the 1990s and beyond, entrepreneurial skills will be the key
not only to economic independence and success, but literally to survival as
well. The marketplace places a premium on creativity, initiative, independence,
and flexibility, characteristics present in dynamic entrepreneurs. Starting a new
venture is a process that begins long before the business ever opens its doors.
Consequently, this book takes a process approach to starting a world-class
venture. By using the framework of a business plan, it guides the reader
through the process, emphasizing the new “rules” for start-ups in the 1990s and
giving the reader a clear sense of how to create a world-class venture.
|7( New Venture Checklist

Have you
□ Concluded that you have what it takes to be an entrepreneur?
□ Determined why you want to start a business?
□ Decided if you will start an entrepreneurial venture or a small business?
□ Determined how the trends for the 1990s will affect your search for a
business idea?
Answers to Questionnaire Figure 1.1: Should You Start A Business?

1. The average entrepreneur is married, probably because they are older when
they initiate their ventures and having a working spouse gives an additional
source of income during start-up.
2. Most entrepreneurs today are still men, particularly in high-growth ventures,
but women are now beginning to start businesses at a rate much higher than
men. And more and more women are starting high-growth ventures.
3. The primary reason most entrepreneurs give for starting a business is to gain
independence—the right to do things the way they want.
4. In general, entrepreneurs tend to be very comfortable with ambiguity and
uncertainty. An uncertain environment, which is characteristic of start-up
ventures, offers a challenge that entrepreneurs enjoy meeting. Moreover, a
dynamic, uncertain environment generally offers more opportunity.
5. Entrepreneurs will need all of these factors. But note that entrepreneurs
believe they make their own luck.
6. Entrepreneurs are moderate risk takers. They calculate risk and take on risks
that have a good probability of producing adequate rewards.
7. Entrepreneurs often report having been fired, probably because they don’t
easily fit into traditional company molds.
8. Most entrepreneurs have started several ventures before age 20.
Additional Sources of Information

Case, John. (1992). From the Ground Up. New York: Simon & Schuster.
Drucker, Peter F. (1986). Innovation and Entrepreneurship. New York: Harper
& Row.
Godfrey, Joline. (1992). Our Wildest Dreams. New York: HarperCollins.
Naisbitt, John and Patricia Aberdene. (1990). Megatrends 2000: Ten New
Directions for the 1990s. New York: Fawcett Columbine.
Peters, Tom. (1987). Thriving on Chaos. New York: Harper & Row.
1. Why is it is so difficult to assign “typical” characteristics to entrepreneurs in

Issues to
order to describe them?
Consider
2. Do you agree with the notion that entrepreneurs start businesses for more
4x than money? Why or why not?

3. What impact does the environment have on your ability to start a business?
4. What does “creating value” mean to you as a potential entrepreneur?
5. Take a typical “small business” in your community and discuss how you
could turn that business into an entrepreneurial venture.
6. What evidence do you find for the statement that we are becoming an
“entrepreneurial economy”?
7. Which of the trends for the 1990s do you believe holds the most promise for
business opportunity and why?
CHAPTER 2
Recognizing and
Testing Opportunity
Overview
• Creativity exercises to enhance latent creative skills
• Techniques for generating new business ideas
• The issue of success and what it means to you
• A quick test of the business idea to determine if a feasibility study is
warranted
• Overview of the feasibility study and business plan
Recognizing Opportunity
Have you ever wondered where people get those great ideas that turn into
extraordinarily successful businesses? Is the ability to recognize opportunity
something you’re born with? Absolutely not! Certainly some people have an
easier time generating ideas than others, but that’s only because they have better
developed creative and awareness skills. This is good news, because even if you
have never thought of yourself as a creative person, you have the ability to
become one.
What does creativity have to do with entrepreneurship? Very simply,
creativity is a key ingredient to entrepreneurial success. Today’s entrepreneurs
face a very volatile, uncertain environment: a banking industry that is restruc¬
turing and moving away from lending to growing businesses; factories that are
downsizing or closing; local, state, and federal bureaucracies that have burden¬
some regulations; and an economic climate that is challenging at best for
starting and growing new businesses. Sounds grim.
23
But even in the worst of environments—in fact, especially in the worst envi¬
ronments—creative men and women find innovative ways of adapting to the
environment and making it work for them. It is no wonder then that the worst
of times often brings out the best in entrepreneurs. The case of John Wiley and
Alan Ackerman is a good example. (See Profile 2.1.) No matter what the envi¬
ronment throws at entrepreneurs, if they put their creative talents to work, they
can find a way to succeed.
Enhancing Your Creative Skills

Creative people are curious people who exhibit a strong sense of awareness of
their surroundings. They ask questions and aren’t afraid to do things differently.
They are openly accepting of all ideas, figuring that every idea is worthy of at
least initial consideration; and they seem to have a high tolerance for ambiguity.
However, some people resist creativity and ambiguity; they are uncomfort¬
able in uncertain environments and don’t know how to use their creative skills
to survive. This is not surprising when you consider that many schools do not
challenge students to be creative, but instead expect students to follow a struc¬
tured environment laid out by the teacher, which includes coming up with only
the expected correct answers.
PROFILE 2.1
Making Creativity Work

In 1982 John Wiley and Alan Ackerman started a company called Microbits
Peripheral Products, Inc. to produce hardware for the Atari personal computer. Within
a year and a half, they were doing $3 million in sales and had 55 employees. Then in
1985 the Atari market collapsed, Microbits was unable to keep up its loan payments,
and its loan was called by the bank. The company could not be sold, so the bank
decided to package the assets and auction them through a sealed bid process. Wiley
and Ackerman could have given up at that point, but, instead, they saw a chance to
turn a disaster into a creative opportunity by rounding up ten investors who helped
them repurchase their assets at auction for 10 cents on the dollar.
With their investors they started Supra, which produces modems and communica¬
tion devices for a number of different computers. Starting in their garage, Wiley and
Ackerman turned a failure into a success within a year.
Chapter 2 • Recognizing and Testing Opportunity 25
Entrepreneurship is a creative, not a scientific, process. From the generation

of the business idea to the development of the market plan to the management
of the growing business, it is creativity in all aspects of the venture that sets the
most successful new businesses apart from those that merely survive.
Before considering some specific techniques you can use to generate business
ideas, you might want to try a couple of exercises to prepare yourself for
thinking creatively.
1. Pick a simple item you have in your home, perhaps a box of granola, and see
how many uses you can find for it. There are at least 30! Remember, don’t
limit your thinking. For example, you could glue the granola to a backing,
spray it with shellac, and use it as jewelry! As silly as this sounds, you will
find that the more you do this exercise with different products, the easier it
gets and the more ideas you are able to generate. Some of them may actually
turn out to be sound business ideas.
2. The next time you say to yourself, “I wish there were a way to...” or “I wish 1
had something that could...” stop yourself and start thinking about how to
get from here to there. This is, by the way, how breakthrough products like
the fax machine were developed. The question that led to the fax machine
was, “Flow can I get a written document to people as quickly as I can phone
them?” For the solution the inventor didn’t limit himself by looking only at
what was obviously possible. Think of all the inventions and services that are
part of life today that wouldn’t be here if the inventors had limited them¬
selves to what was “possible.”
Sources of New Venture Ideas

It is important to distinguish between an idea and an opportunity. Everyone has
ideas; in fact, you probably have hundreds of them every day. Every time you
make a decision to do something, it is based on an idea or thought that came to
you prior to making the decision. However, opportunity, in a business sense, is
an idea that can be turned into a business or commercialized in some manner.
In fact, the very act of moving through the process of creating a business plan
turns an idea into an opportunity.
Much of creativity and innovation today occurs within the confines of what
is already known: planes to spaceships, drive-in restaurants to drive-in banks. It
is only when a few very insightful people break those boundaries and leap into
an untried, unknown universe that products like the computer, for which there
really was no precedent, are created. Even a simple product like Velcro was
inspired by going beyond human boundaries and observing the sticky hook
spine of the common burr in nature.
What sets off the creative process is a very personal thing. How many times
have you come up with an idea while listening to a dry lecture or a boring
sermon? Some people find their best ideas come while they are driving their
car, reading a book, or exercising. Do you get ideas through dreams or in the
shower? If you can identify where and when you seem to get most of your
creative thoughts, you might want, if possible, to do that activity or a similar
one more often and actually write down the ideas you get when you get them.
There are several ways you can use your newfound creativity to generate
some ideas that may lead to an opportunity and help turn you into an
entrepreneur.
PROFILE 2.2
A Creative Way to Generate Ideas

Dr. Yoshiro Naka Mats is truly the essence of a creative, innovative person. He holds
more than 2,300 patents, more than double the number that prolific American inventor
Thomas Edison held. For example, Naka Mats is responsible for the floppy disk,
which he licensed to IBM, the compact disc and player, the digital watch and the
water-powered engine. Naka Mats even has a creative way of generating ideas. He
starts the creativity process by sitting calmly in a room in his home, which he calls the
“static room” because it has only natural things in it, much like the meditation gardens
in Kyoto, Japan. It is in this room that he opens his mind to the creative flow of new
ideas. He then moves to the “dynamic room,” a dark room with the latest audio/video
equipment. Here he listens to jazz, easy listening music and Beethoven’s Fifth
Symphony—one of his favorites. In this room the genesis of new ideas begins to
form. Following a period of time in the dynamic room, he heads for the swimming pool
where he swims underwater for extraordinarily long periods of time. It is underwater
that he finishes the process of “soft thinking" or playing with the idea and is ready to
move on to the more practical phase of considering how to implement the idea.
Naka Mats, by the way, also swears by the brain food he eats: dried shrimp,
seaweed, cheese, yogurt, eel, eggs, beef and chicken livers!
Keep an Idea File or Notebook

You have often heard about people who keep a notepad by their bed in case
they have a good idea during the night. Why not keep a notepad with you all
the time? Who knows when the spark of a great idea will come to you? Don’t
take a chance that you will remember it later. Chances are you won’t because
other thoughts and activities will invade your consciousness during the day,
leaving you struggling later to recall what that great idea was that you had.
Talk to People—Network
Dr. Naka Mats claims (see Profile 2.2) that networking with people wherever he
goes is a prime source of inspiration for new product ideas. In talking to people
you find out more about their needs, and an unmet need is an opportunity. Talk
to consumers, suppliers, your potential competition; there is something to be
learned from everyone you meet. When you talk to people, don’t just ask one
question, ask several, because it is not likely you will get the information you
need from the response to your first question. Many businesses like Toyota use
this technique with great success to uncover the root cause of problems. After
the first question, they ask at least three more. The technique might look some¬
thing like this:
1. Why is the business failing?

There is insufficient cashflow to cover expenses.
2. Why is there insufficient cash flow?

Sales volume is too low.
3. Why is sales volume too low?

We are not using the best distribution channels.
4. Why have we not used the best distribution channels?
Our management team has no marketing experience.
Solution: Hire an experienced marketing person.
If you had stopped after the first question, you. would have thought that
merely increasing cash flow by any means would correct the problem. By
continuing to ask questions, you arrived at the root of the problem, lack of
marketing experience, which is something quite different from solving a cash
flow problem. Insufficient cash flow was only a symptom of the real problem:
management deficiency
Read Voraciously
Read newspapers, business magazines, and trade journals from the industry
that interests you. Keep up with current trends in the marketplace, as well as
present and potential governmental policies that may affect your industry.
Remember, an idea can come from anywhere. The wealth of new environmental
businesses was spawned from the relatively recent awareness of what our busi¬
ness and life practices are doing to the world we live in and also from the regu¬
lations that ensued.
Try Thinking in Opposites

Try thinking about what a product or service will not do or be. Charles
Thompson, who wrote an excellent book on creativity, tells of an unusual tech¬
nique he developed to collect debts.1 He did it by thinking in opposites. Most
people send formal invoices to their customers reminding them of their debt.
He sent a cartoon of himself lying on the floor with a giant knife stuck in his
Figure 2.1: Generating Business Ideas
List some geographical areas that are not being serviced by a particular product/service.
1. _
2. _
3. _
List some market segments (populations) that are underserved.
1. _
2. ____
3. _
List some big or troublesome problems for which the solution could turn into a potential
business.
1. ______
2. _
3. _ _ _
'Thompson, Charles. (1992) What a Great Idea! New York: HarperPerennial

back and a bubble saying “1 trusted you.” Most people send bills to the clients
office. He sent it to the home. Most people send the bill in a business envelope
by regular mail; Thompson sent it in a three-foot package by next day UPS. The
technique was extremely successful and even turned into a small business
because he thought about a problem from a different perspective; he did the
opposite of what everyone else did.
Look for New Uses for Old Things

Johann Gutenberg took two unconnected ideas—the wine press and the coin
punch—and came up with the printing press and moveable type. The mecha¬
nism for roll-on deodorant was the inspiration for the ballpoint pen. You might
try looking a little closer at the products you use everyday and probably take
for granted. How many times have you given an item a new use simply because
you didn’t own the correct tool to do what you wanted to do? Look at every¬
thing you use a little more closely to see if there is a way you can improve on it
or come up with an entirely new tool. 3M scientist Arthur Fry was working on
developing bookshelf arranger tape when he came up with the idea for a sticky-
backed book marker, which ultimately became Post-it Notes®.
Brainstorm Your Way to a New Idea

Brainstorming is a technique whereby you come up with ideas one after the
other without stopping to consider if the idea is feasible. The advantage of
brainstorming is that it often puts you in a position to come up with ideas as
quickly as possible. Brainstorming opens your mind and helps you suspend
judgment. Challenging beliefs and assumptions through brainstorming about
what may be possible is why computers, fax machines, and space shuttles
exist today.
Look to the Government

The federal government or your state government can be a great source of new
venture ideas. New laws and regulations often require the use of a product or
service that didn’t previously exist. For example, the establishment of the
Occupation Safety and Health Administration (OSHA) provided an opportunity
for people who could provide training to businesses on everything from how to
meet the stringent requirements in the workplace to filling out the incredible
amount of paperwork associated with those requirements. City ordinances that
require that certain products, such as glass and plastic, be recycled have
produced many new businesses that provide new uses for these materials.
Where Will the Opportunities Be Next Century?

Organizations that monitor the growth of industry believe that the sectors of the
economy that will attract sales and investment in the coming years are in the
health industries and computer-related industries, specifically companies
working on networking and “the information superhighway.” Next are
consumer goods and telecommunications. The most successful firms in these
industries, generally high-tech and high-growth firms, flourish in an environ¬
ment of change. This is not to say the business opportunity you find must be in
these areas to be successful; it is, however, more likely your firm will grow
rapidly and have above average sales if it is. Of course, the way you run your
business and the amount of control you exert over its growth will be a function
of the type of entrepreneur you are and your goals for yourself and the business.
Success and Failure

Many studies have attempted to determine the factors that contribute to a new
business’s success, with success usually being defined as monetary—sales or
assets. While no one can guarantee a business that has particular attributes will
be successful, certain characteristics do seem to be associated with successful
ventures.
• They are started by teams

• The entrepreneur or team has experience in the industry
• The entrepreneur has started other businesses
• The business is well financed
• The business has a global market
The free enterprise system is based on the profit motive; consequently, profits
are often used by those outside the business—bankers and investors—to
measure venture success. But you also need to consider what success means to
you. How will you know when your business is a success? For some entrepre¬
neurs it’s when they have created a certain number of jobs; for others, like Anita
Roddick and The Body Shop, it’s when she has established successful trade initia¬
tives with underdeveloped countries. Only you can define success for your busi¬
ness, and that definition reflects both your business goals and your lifestyle goals.
By studying the factors that seem to be associated with success, the factors
that contribute to failure also become readily apparent. Research has found that
the primary cause of failure is a poor management team. Most books and
articles, however, shy away from talking about failure even though failure is an
important ingredient in success. It has been said that failure is just a rest stop
on the way to success. It was that way for Judy Sims who, with her husband,
started a games and educational retail software store that immediately failed.
Drawing on her successful experience with cold calling (making unsolicited
sales calls), she pulled herself up and began selling business software to local
businesses in Dallas. One of her first accounts was Ross Perots Electronic Data
Systems and the rest, as they say, is history. Today her company does over $160
million in sales. The point is that entrepreneurs don’t give up no matter how
many times an idea they have fails. Instead, they look at failure as a source of
opportunity, a wake-up call to listen more carefully to the customer and spend
more time observing what is going on in the marketplace.
Testing the Idea Quickly

You know you have a business idea worthy of further consideration when you
can’t stop thinking about it. When that happens it’s time to do a quick test to
see if a full-blown feasibility study is warranted. There are several ways to
accomplish this.
1. Talk to some trusted friends and get initial feedback on the idea. But don’t be
discouraged or write off the idea if they tell you it’s crazy. People thought
Fred Smith was crazy when he said he could deliver a package anywhere in
the United States overnight—that is, until he founded Federal Express.
2. Do a quick checklist of the forces working for your idea and the forces
working against it. How does the idea stack up? Are there more forces
working in favor of the idea than against it?
3. Ask yourself three very important questions.
Am I really interested in this business opportunity? If you develop this concept,
it is going to take all the time and energy you can give it, so it’s impor¬
tant that vou like it.
j
Is anyone else interested? You can’t have a business without customers and
you may need investors, so you’d better be sure that others are inter¬
ested in what you have to offer.
Will people actually pay for what I am offering? Often when people hear about
a new product or service they express interest, even excitement, over it.
But what are they willing to pay for it? If they are not willing to pay what
you believe it’s worth, that’s a clue you may need to rethink the idea.
If your business idea can pass these tests, it is time for the next level of inves¬
tigation: the feasibility study. A feasibility study gives you an indication of
whether there is sufficient demand for your product or service. The estimation
of demand is a vital step in deciding if you have a viable business concept, for
there is no business without enough satisfied customers. Once you have
concluded there is adequate demand for the product or service, other issues
such as the operational and financial requirements can be undertaken and a
business plan completed. There is no need to spend considerable time and
effort on those issues if the feasibility study indicates insufficient interest in
your product or service.
Even though the feasibility study is a tool geared primarily toward providing
information to the entrepreneur, it’s often possible to attract outside interest in
your product/service at that point if the results are positive. That interest may
result in some funding to help you complete a comprehensive business plan,
conclude product development, and start the business. The feasibility study may
also assist in attracting quality people to the founding team. As stated in the
introduction, this book has a process organization. It follows the new venture
creation process from its inception through start-up and growth. The feasibility
study and the business plan are part of that process: They, in effect, document
the process for the entrepreneur and others who are interested in the business.
The Feasibility Components

This section introduces the feasibility study and the business plan by giving an
overview of their components. Each of the components described below has its
own chapter detailing how to gather and analyze the information needed to
complete that section of the document. Figure 2.2 displays an outline of a feasi¬
bility study.
Product/Service Description
The first section of the feasibility study presents a complete description of the
product or service being offered, who the target customer is, the unique aspects
of the product/service, and the benefits to the customer. It is in this section that
the unique features of the product or service will be discussed, as well as possi¬
bilities for additional innovation in products, service, or distribution, called
spin-offs. If the product needs to be designed and built, this section describes
how this will be accomplished. Also note in this section any perceived or actual
environmental impact from your business and how to mitigate it.
Figure 2.2: Feasibility Study Outline
EXECUTIVE SUMMARY
I. PRODUCT/SERVICE DESCRIPTION
Purpose of the Business
Description and Uses
Design and Unique Features
The Primary Customer
Spin-Offs
Environmental Impact
II. MANAGEMENT TEAM

Qualifications
Gap Analysis
III. MARKET ANALYSIS

Industry Description
Industry size
Industry status (growing, mature, in decline)
Growth potential
Geographic locations
Trends and entry barriers
Profit potential
Sales patterns and gross margins
Target Market
Primary target markets
Secondary markets
Demographics
Customer needs analysis
Product/Service Differentiation
Unique features
Potential for innovation
Competitors
Direct and Indirect
market share
description
strengths and weaknesses
Emerging
Substitute products
Competitive Advantage
Proprietary protection
Other competitive advantages
IV. PRELIMINARY CONCLUSIONS AS TO FEASIBILITY

Is there a demand for the product/service?
Is there a suitable market opportunity?
Management Team
The management team, the second section, is a critical factor in determining
the potential feasibility of the new venture. This section of the study discusses
the key members of the founding team and the expertise they bring to the
venture. It also includes an analysis of any expertise that may be missing from
the team and how the entrepreneur intends to alleviate this weakness.
Market Analysis
The market analysis section of the feasibility study is a crucial section because it
presents support for the contention that there is a market and a demand for the
product or service. The section begins with a complete understanding of the
nature of the industry in which the business will operate. Industry knowledge
is enormously important, as it enhances your ability to find a niche market for
the product or service. The analysis in this third section of the study includes
such things as barriers to entry, stage of growth, competitors, market share, and
potential for growth. It also includes information on typical sales patterns and
gross margin percentages for the industry. A good understanding of the
industry facilitates zeroing in on your target market, the primary customer for
the product or service. An in-depth analysis of the customer includes the size,
location, buying habits, and needs of the customer base.
Also accomplished in this section is a comprehensive analysis of both direct
and indirect competitors. A description of emerging competitors and substitute
products demonstrates that the entrepreneur has considered all possible
competition. Finally, this section defines those unique competitive advantages
the business enjoys.
The Business Plan Components

What is the difference between a feasibility study and a business plan? A
feasibility study gives you a preliminary check on the viability of your venture
by estimating if you have sufficient demand for your product/service. By
contrast, the business plan is a more comprehensive analysis that includes, in
addition to the market research, a discussion of the operational and financial
management and controls of the new business. The business plan serves three
purposes:
• It serves as a reality check

• It is a living guide to your business
• It is a statement of intent for interested third parties
The Reality Check

Usually by the time the business plan is completed you will have an excellent
idea if this business concept has a chance of succeeding. You will also know if
you are still interested in starting the business. Frequently the period of concept
development is much like a “honeymoon” phase. The entrepreneur believes
completely this business will be a success and can picture exactly how it will
work. Unfortunately, going through the exercise of doing a business plan,
researching costs, preparing forecasts, and strategizing about operating proce¬
dures sometimes reveals potential problems previously unrecognized. Strong
negatives or difficulties can lead to the decision not to proceed. This is not
considered a failure for the entrepreneur. It merely indicates the value of doing
a business plan in the first place. It is certainly preferable to halt the effort at
that point than to go forward and possibly fail farther down the road when
significant time and money have been expended.
The Tiving Guide to the Business

The business plan is a blueprint for the start-up and growth of the new venture.
It is called a living document because it is subject to a changing environment.
The original business plan for a new business contains estimates of what the
entrepreneur expects will happen when the business starts-, and it is often
prepared with subjective data. Consequently, the entrepreneur typically
re-evaluates the plan and updates it periodically the first year, then annually
thereafter. This process compares the goals and projections from the original
business plan with the actual achievements of the firm during the period under
investigation. If significant differences in figures are observed, the entrepreneur
attempts to learn what may have caused the difference and adjust projections
for the next period to account for any changes. In this way the business plan
always reflects what the business is actually doing, thereby improving and
refining projections for the future.
Statement of Intent for Third Parties

In addition to the entrepreneur, it may be necessary to induce others to become
interested in the new venture. These third parties include:
• Investors
• Bankers
• Potential management
• Strategic partners
Each of these groups looks at the business plan from a different perspective.
Investors. Investors review closely both the factors that predict growth and the
qualifications and track record of the management team. This is because they
want to ensure their investment increases in value over the period of time they
are involved in the business and that it is in capable and experienced hands.
They look at the deal structure, that is, what their investment will buy them in
terms of an equity interest and subsequent ownership rights in the company.
They also want to know how they will be able to liquidate their investment at
some future date.
Bankers/Lenders. Bankers/lenders are primarily interested in the company’s

margins and cash flow projections because they are concerned about how their
loans or credit lines to the business will be repaid. The margins indicate how
much room there is for error between the cost to produce the product or
deliver the service and the selling price. If margins are tight and the business
finds itself having to lower prices to compete, it may not be able to pay off its
loans as consistently and quickly as the bank would like. Similarly, bankers
look at cash flow projections to see if the business can pay all its expenses and
still have money left over at the end of each month. Bankers also look at the
qualifications and track record of the management team and may require
personal guarantees of the principals.
Potential Management. At start-up or some later date, the entrepreneur may

want to attract qualified personnel to the key management team to fill the gaps
in experience. The business plan provides these people a complete picture of
the business and the role they could potentially play in its start-up and
growth.
Strategic Partners. Some entrepreneurs, particularly those who intend to

manufacture a product, choose to form a strategic alliance with a larger com¬
pany so they don’t have to incur the tremendous costs of purchasing equipment
for a manufacturing plant. They may, for example, license another firm to
manufacture and assemble the product and supply it to the entrepreneur to
market and distribute. Alternatively, they may enter into an agreement with a
supplier to provide necessary raw materials in exchange for an equity interest in
the start-up venture.
Strategic partners like these want to review the growth plans of the company
and the market strategy, as these plans indicate how much business the strategic
partner may get. They are also interested in the new ventures ability to pay
them for their work. Knowing in advance what these third parties are looking
for will prompt you to address their specific needs in your business plan, facili¬
tating your ability to achieve the goals of the business.
Having considered the value of doing a business plan, it should be noted
that some successful businesses were started without one—Crate and Barrel,
Pizza Hut, and Reebok, to name just a few. It is certainly possible to start a
business without a business plan—people do it every day; however, entre¬
preneurs today operate in an intensely competitive, complex, and
A business plan is dynamic environment. Unless you are starting a very simple, small
one way to compen¬ business or buying an established firm, you will probably not want to
rely solely on your talent or luck. A business plan is one way to
sate for knowledge
compensate for knowledge you don’t have and gives you credibility in
you don't have and
the eyes of others.
gives you credibility
What the business plan is not is a guarantee of success. Businesses
in the eyes of others.
have succeeded in spite of poorly done business plans and have failed
even when the plan was carefully crafted. The business plan is a tool
entrepreneurs use to enhance their chances of success. That is why it is important
that both the entrepreneur and the founding team be fully involved in the
development of the business plan. There are companies that will write your
business plan and do research for you, but you know the business better than
anyone. And you will understand it that much better if you and your team do
the work necessary to put together a business plan.
Figure 2.3, pp. 38-39, presents an outline of the business plan. The first
three sections of the business plan are identical to those in the feasibility study.
Operational Analysis
In this section of the business plan, a detailed description of the product/service
is presented, including engineering specifications and a description of the proto¬
type. The status of product development is addressed, as well as additional steps
that must be taken before having a product that is ready to sell to the public. The
time and cost requirements of completing the development tasks are also
included. In addition, this section contains a discussion of the distribution chan¬
nels used to move the product or service from the producer to the end user. A
major portion of this section is devoted to a description of how the business will
operate, where it will get its raw materials, how they will be manufactured
and/or assembled, and what type and quantity of labor is required to operate the
Figure 2.3: Business Plan Outline
EXECUTIVE SUMMARY
I. PRODUCT/SERVICE DESCRIPTION
Purpose of the business
Description and uses
Design and unique features
The primary customer
Spin-offs
Environmental impact
II. MANAGEMENT TEAM

Qualifications
Gap analysis
III. MARKET ANALYSIS

Industry Description
Industry size
Industry status (growing, mature, in decline)
Growth potential
Geographic locations
Trends and entry barriers
Profit potential
Sales patterns and gross margins
Target Market
Secondary markets
Demographics
Unique features
Competitors
Direct and indirect
market share
description
strengths and weaknesses
Emerging
Substitute products
IV. OPERATIONAL ANALYSIS

Technical Description of Product/Service
Uses, design, prototype
Issues of obsolescence
Figure 2.3. (continued)
Distribution Channels
Status of Development and Related Costs
Current status of development
Tasks to be completed, time and cost to complete
Potential difficulties, resolution
Government approvals
Manufacturing or Operating Requirements and Associated Costs
Manufacturing cycle
Materials requirements
Inventory requirements (also retail/wholesale business)
Production requirements (also retail/wholesale or service)
Labor requirements (all businesses)
Maintenance and quality control requirements (all businesses)
Financial requirements (all businesses)
V. MARKETING PLAN
Pricing
Venture versus competitors
Value chain
Purpose of Marketing Plan
Target market
Unique market niche
Business identity
Marketing Tools
Advertising & promotion
Media Plan
Uses and costs of specific marketing tools
Marketing Budget
Individual costs and total costs as a percentage of sales
VI. FINANCIAL PLAN

Assumptions
Pro forma Financial Statements
Cash flow
Income
Balance sheet
Capital Expenditures
Break-even Analysis and Payback Period
VII. CONTINGENCY PLAN

Deviations from the Original Plan and Solutions
VIII. DEAL STRUCTURE

Debt and/or Equity Funding Amounts
Projected Return on Investment
Harvest Strategy
business. The outline of the business plan notes where businesses other than
manufacturing have the same information requirements as manufacturing.
Financial Plan
The financial plan presents the entrepreneurs forecasts for the future of the
business. Generally these forecasts are in the form of financial statements
broken out by month in the first year or two, and then annually for the next
two to five years. This section demonstrates the financial viability of the venture
and the assumptions made by the entrepreneur in doing the forecasts. It is
designed to show that all the claims about the product, sales, marketing
strategy, and operational strategy can work financially to create a business that
can survive and grow over the long term.
The Contingency Plan

The contingency plan is simply a way of recognizing that sometimes the “best
laid plans” don’t work the way you intended. It presents potential scenarios,
usually dealing with situations like unexpected high or low growth or changing
economic conditions and then suggests a plan to minimize the impact on the
new business.
The Deal Structure

The deal structure section presents the offering to potential investors, including
how much capital is required, in what form (equity, debt, or a combination),
return on investment, and a plan for harvesting the investment at a later date.
This section should be written from the investors point of view and present the
benefits to the investor of putting money into the new venture.
Undertaking a feasibility study and completing a business plan are certainly
daunting tasks, but they are an absolutely essential exercise that helps the entre¬
preneur understand every aspect of the new venture and how all the pieces fit
together more clearly. Even successful entrepreneurs who have started busi¬
nesses without a written plan have had to write business plans when they
needed growth capital or a credit line from the bank. Those starting high-
growth, global ventures will find they need outside capital and resources fairly
quickly. The business plan will be revisited in Chapter 19, where the organiza¬
tion and presentation of the plan are addressed.
a New Venture Checklist

Have you
□ Tried the creativity-enhancing exercises in this chapter?
□ Started a file to keep track of business ideas?
□ Started networking and reading in your industry?
□ Visited the local Chamber of Commerce and Small Business Administration

office to see what information and help is available to small business owners?
□ Defined what success means to you?
□ Done a quick test on your idea?
□ Made a list of the information you will need to start collecting to complete the
feasibility study and business plan for the new venture?

Brandt, Steven C. (1982). Entrepreneurship: The Ten Commandments for
Building a Growth Company. Reading, MA: Addison-Wesley Publishing.
Dacey, John S. (1989). Fundamentals of Creative Thinking. New York: Free Pr.
Gumpert, David E. (1990). How to Really Create a Successful Business Plan.
Boston: The Goldhirsch Group.
Habino, Shozo and Gerald Nadler. (1990). Breakthrough Thinking. Rocklin,
CA: Prima Publishing.
Longsworth, Elizabeth K. (1990). Anatomy of a Start-up. Boston: Inc.
Publishing.
Timmons, Jeffry. (1990). New Venture Creation. Homewood, IL: Richard D.
Irwin, Inc.
van Oech, Roger. (1990). A Whack on the Side of the Head. New York: Warner
Books.
. Give an example to demonstrate that you understand the difference between

Issues to
an idea and an opportunity.
Consider
. Why do you suppose many people shy away from talking about failure?
ijjl . Pick a business in your community and find a creative way to change either
the product/service or the way it is delivered to the customers.
. What is the value of the feasibility study to the entrepreneur?
. Consider two types of new ventures: a service business and a manufacturing
firm. In what ways would the business plans for these two ventures differ?
. If you already had sufficient capital to start your new venture, would you still
do a feasibility study and business plan? Why or why not?
. What information does a business plan provide that the feasibility study does
not?
CHAPTER 3
Developing the
Business Concept
Overview
• Turning an idea into a business
• Common methods for protecting an idea
• Pr ocedures to follow when obtaining a patent
• Advantages and disadvantages of starting a business versus buying a business
• The Product/Service Plan section of the feasibility study or business plan
Protecting the Business Concept

Once an opportunity is identified, the next step in venture creation is to define
the business concept—that is, the description of the product or service and
what the mission of the business will be. While today more businesses are
started within the service sector than in any other, many of the high-growth
new business concepts involve manufacturing products. Consequently an
understanding of two issues related to the creation of product businesses is
important: the relationship between inventors and entrepreneurs, and the issue
of proprietary rights. Even if your business is a service, retail, or wholesale busi¬
ness, you may need to protect the use of your name, a logo, or a written
document, all of which come under the broad heading of proprietary or intel¬
lectual property rights.
43
Inventors and Entrepreneurs

People often confuse inventors and entrepreneurs, believing that the terms are
synonymous. But as with the terms idea and opportunity, inventors and
entrepreneurs are often very different concepts; inventors are normally involved
with implementing ideas, while entrepreneurs are involved with implementing
opportunity. The reason is that inventors are idea people, representing the
essence of creativity. They tend to look at every aspect of life as a problem to be
solved or a product to be improved. Sometimes this idea-seeking attitude can
serendipitously result in a new product idea. For example, one researcher who
was developing an anti-ulcerative drug accidentally licked his fingers and
discovered aspartame, which is now sold as Nutrasweet. Whether they are
scientists, engineers, mechanics, or just “tinkerers,” inventors are continually
generating ideas and prototypes for new products, many of which will never see
the marketplace. This is because inventors often lack the necessary skills to
commercialize their inventions—they are unable to create a business opportu¬
nity by which to bring their products to market.
That’s where entrepreneurs come in. Entrepreneurs possess the ability to
identify a market for the inventors product, gather sufficient resources to create
a business to market the products and create value for both the inventor and
the entrepreneur. This is not to say inventors and entrepreneurs cannot be one
and the same. Don Beaver and Ben Stapelfeld invented a method for cleaning
up industrial waste oil and went on as entrepreneurs to found The New Pig
Corporation (see Profile 3.1). Nevertheless, many times it is the serendipitous
teaming of an inventor and an entrepreneur that results in a successful new
business venture.
Proprietary Issues
If the new venture opportunity involves a product, it is especially important
that the inventor and/or entrepreneur investigate the potential for acquiring
intellectual property rights—that is, determine if there are legal ways to protect
the product idea from competitor duplication until after it goes to market. (See
Profile 3.2, p. 46.)
The issue of who owns an idea is a crucial one as it could mean the difference
between having a successful business and not having one. The primary legal
means to protecting an original idea is through a patent. Other methods of
protection include trademarks, copyrights, and contracts to protect trade secrets.
Chapter 3 • Developing the Business Concept 45
PROFILE 3.1
Making Pigs of Themselves: Inventors Turned Entrepreneurs

For years factories have struggled with the problem of how to clean up greasy spills
and leaks on their floors. The method most commonly used was kitty litter, but it
tended to be messy and get into the machinery. Don Beaver and Ben Stapelfeld,
owners of an industrial cleaning business, began playing around with absorbent
materials, putting them in everything from athletic socks to pantyhose, and throwing
the concoction away when it became saturated. At one point, facing financial disaster
with their business, they decided to push ahead and develop their absorbent sock
concept into a real product.
They tried every type of absorbent material and finally hit upon ground-up corn
cobs. With an investment of $500,000 from banks and private investors, they began
to build the company. Going through the traditional industrial distribution channels
was unsuccessful because their product provided relatively small commissions to
distributors in comparison with commissions on large hydraulic systems. So they
developed a unique market strategy that involved giving the company an unusual
name—The New Pig Corporation—using promotional items such as pig coffee mugs
and pig hats, and spending 40 percent of revenues on advertising.
The most important thing they did, however, was to define their business not as a
one-product business but as a problem-solving business. They encouraged their
customers to make suggestions and from these suggestions sprang numerous new
products. The company now employs over 140 people.
Patents
The U.S. patent system was designed 200 years ago by Thomas Jefferson to
protect the inventions of the independent inventor. Today, although most
inventors work in the research departments of large corporations, the basic
legal tenets of patent law still remain true to the independent inventor. In fact,
the number of patents issued to independent inventors increased 37 percent in
the last half of the 1980s. Since the first patent was issued in 1790, more than
five million U.S. patents have been granted.
A patent grants an inventor the exclusive right to an invention for a period
of years, depending on the type of patent. It also prevents others from
PROFILE 3.2
The Importance of Proprietary Rights
Bob Kearns was tired of windshield wipers that operated either too slowly or too fast.
He wondered why they couldn’t function like an eyelid and literally blink. Kearns had
a damaged eye, the result of being hit with a champagne cork on his wedding night,
and had great difficulty seeing while driving one night in a severe rainstorm. That’s
when the inspiration for intermittent windshield wipers came to him.
For Kearns, generating ideas for products that solved problems was a way of life.
His first invention was a comb that distributed hair tonic, then came an amplifier for
people who had undergone laryngectomies, followed by an innovative type of
weather balloon. Most of the ideas never went beyond the model stage, which is not
atypical for inventors. Kearns, who had a masters degree in mechanical engineering,
began working on the prototype of the intermittent wiper blade in 1963. When he had
a working prototype, which he installed in his car, he arranged to show it to engineers
at Ford. They encouraged him to field test it to see if it would achieve three million
cycles. When it did, he again contacted Ford which suddenly didn’t seem interested
any more. He then went to a friend who owned a mid-sized manufacturing firm that
supplied parts to the auto industry. Kearns assigned the rights to the patent to his
friend in exchange for his friend paying the costs of getting the patents and paying
Kearns royalties plus $1,000 a month to continue research and development.
Then, surprisingly, in 1969, Ford came out with an intermittent wiper blade that
used the Kearns design. GM followed suit in 1974 and Chrysler in 1977, along with
several foreign car companies. Kearns, who by that time had reacquired his patent
rights, filed suit against Ford in 1978 for patent infringement and later against
Chrysler. It took 12 years of intense work (Kearns represented himself) for the first
case to come to trial. In the first suit, Ford agreed to settle for $30 million after the jury
found in Kearns’ favor, but he turned them down (he was seeking $1.6 billion). In a
second trial, Kearns was awarded $5.2 million. Ultimately Ford and Kearns settled for
$10.2 million. The Chrysler case, which concluded in June 1992, gave Kearns an
additional $11.5 million, but he was still unhappy because the jury didn’t find that the
automaker had been willful in the infringement. Still, Kearns stands as a role model to
other inventors who regularly face patent infringement by large corporations.
manufacturing and selling the invention during the period of the patent. At the
end of this time, the patent is placed in public domain. Two types of patents
concern most inventors: utility and design patents. Utility patents are the most
common type. They protect the functional part of machines or processes, in
addition to computer programs associated with hardware. Some examples are
toys, film processing, protective coatings, tools, and cleaning implements. A
utility patent is valid for 17 years from the date of issuance. Design patents
protect new, original ornamental designs for manufactured articles. The design
must be nonfunctional and part of the tangible item for which it is designed.
Some examples are a gilding, an item of apparel, or jewelry. Design patents are
valid for 14 years from date of issuance.
Ever vigilant to changing technology, in 1980 the Patent Office created a new
category of protection: life forms. It covers such controversial things as altered
human genes and microbes that break down crude oil. Another special category
is the plant patent, which protects any new variety of a sexually or asexually
reproduced plant.
Computer programs present some special problems requiring several
methods of protection. For example, they may be protected by a trade secret
contract if the developer/owner merely licenses the program for distribution by
someone else to a narrow market. If wide dissemination is the goal, a patent
offers more protection and is available if the program contains at least one
unique algorithm that is part of the machine or physical process. Copyrights are
commonly used for programs that don't qualify for a patent. In addition, the
name of the program can be trademarked and the instructions copyrighted.
Is the Invention Patentable?

Before deciding to file for a patent, it is important to first determine the
patentability of the invention. There are four basic criteria:
1. It must fit into one of the five classes established by Congress:
• Machine (fax, rocket, electronic circuits)

• Process (chemical reactions, methods for producing products)
• Articles of manufacture (furniture, diskettes)
• Composition (gasoline, food additives)
• A new use for one of the above
Many inventions can be classified into more than one category. That does not
present a problem, however, since the inventor does not have to choose into
which category the invention fits.
2. It must have utility, in other words, be useful. This is not usually a problem
unless you have invented something like an unsafe drug or something purely
“whimsical.” The Patent Trademark Office (PTO) has been known to issue
patents on some fairly strange inventions, such as a male chastity device
(#587,994).
3. It must not contain prior art. Prior art is knowledge that is publicly available
or published prior to the date of the inventions—that is, a date before the
filing of the patent application. Accordingly, it is important to document
everything that is done in the creation of the invention. Also you must follow
the “one-year rule,” which says the invention must not become public or
available for sale more than one year prior to filing the patent application.
This rule is meant to ensure that the invention is still novel at the time of
application. Novelty consists of physical differences, new combinations of
components, or new uses.
4. It must be unobvious. The invention must not be obvious to someone with
ordinary skills in the field. This is a tricky definition but has been further
explained by the PTO as an invention that contains “new and unexpected
results.” If your invention is rejected on the first pass as not being “unob¬
vious,” it probably means the patent examiner wants you to demonstrate its
unobviousness.
The Patent Process

The process for obtaining a patent is well defined; however, it is advisable to
use the services of a patent attorney, especially when applying for foreign
patents. Attorneys understand the complicated system at the Patent Office in
Washington, DC, and can do a better job of expediting the process. The Patent
Office is staffed by attorneys and engineers, so a patent attorney may have more
success communicating with them than an inventor would.
Understanding the requirements for patents in other countries is a fairly
complex specialty given that the laws vary from country to country. An attorney
with experience filing foreign patents can ensure that you receive all the rights
to which you are entitled. The bottom line is that the patent should be applied
for correctly to avoid costly problems later on.
• Disclosure Document. The inventor will normally file a disclosure state¬

ment that documents the date of conception of the invention. This statement
is crucial in the event two inventors are working on the same idea at the
same time. The one who files the disclosure document first has the right to
file for a patent. The disclosure document is a detailed description of the
invention and its uses, and may include photos; however, it is not a patent
application. The inventor has a two-year grace period in which to file a
patent application, but must demonstrate diligence in completing the inven¬
tion and filing the application. If the inventor publicly uses or sells the
invention more than a year prior to filing the patent application, he or she
will be prohibited from gaming a patent. To file a disclosure statement, send
- a cover letter requesting that the PTO accept the disclosure statement,
- a check for the required fee,
- a copy of the disclosure statement, and
- a stamped, self-addressed, return envelope.
Do not use the tactic of mailing a dated description of the invention to your¬
self by certified mail. It has no value to the Patent Office.
• Patent Application. The patent application contains a complete description
of the invention, what it does, and how it is uniquely different from anything
currently existing (prior art). It also includes detailed drawings, explanations,
and engineering specifications. The claims section of the application specifies
the parts of the invention on which the inventor wants patents. The descrip¬
tion of these claims must be specific enough to demonstrate the inventions
uniqueness but broad enough to be difficult for others to circumvent the
patent, that is, modifying it slightly and duplicating the product without
violating the patent. Be sure you file the patent application no more than one
year after offering the product for sale or using it commercially. It is infinitely
preferable to file before any public disclosures are made.
• Oath. The application also contains an oath which the inventor signs testi¬
fying to the veracity of what has been said.
The cost, on average, of filing a disclosure statement and patent application

is between $1,500 and $2,000. However, the more complex the application,
the higher the patent attorney fees. These figures do not include the costs of
engineered designs and drawings, which must accompany the application and
vary significantly from product to product.
Once the application is received, the Patent Office will conduct a search of its
patent records. During this period the invention is said to be “patent applied
for,” which establishes the inventors claim and dates relative to prior art. An
invention can stay in the patent-applied-for stage for up to two years, the
primary advantage of this being that the public does not have access to the
patent application and drawings, which might allow someone else the chance
to design around the patent.
The Patent Office contacts the inventor and states that they either accept the
claims in the application or deny the application and give the inventor a period
of time to appeal and/or modify the claims. It is not uncommon for the original
claims to be rejected in their entirety by the PTO, usually because of prior art. If
and when the Patent Office accepts the modified claims, the invention is in the
“patent pending” stage, that is, awaiting the issuance of the patent. The
The entrepreneur inventor may market and sell the product during this period, but must
clearly label it “patent pending.” Once the patent is issued, however, it
does not have to
becomes public record.
own a patent to
If the patent examiner rejects the modified claims, the inventor has
benefit from it. the right to appeal to a Board of Patent Appeals within the Patent
Office. Failing to find agreement at this point, the inventor may appeal
to the U.S. Court of Appeals for the Federal Circuit. This appeals process may
take years.
The entrepreneur does not have to own a patent to benefit from it. In some
cases it may be possible to license the right to use a patent from the inventor.
For example, an inventor may license the entrepreneur to manufacture and
distribute the invention and receive a royalty on sales. Alternatively, it may also
be possible for the entrepreneur to purchase an assignment of a patent from
the inventor, transferring ownership rights to the entrepreneur. Be aware,
however, that the patent, once issued, is a powerful document that gives the
holder the right to enforce the patent against infringers in a court of law.
Under the law, the patent holder is entitled to a reasonable royalty from the
infringer and if the infringer refuses to pay, the patent holder can enjoin or
close down the operation of the infringer. If the entrepreneur is planning to
export products, patent applications should be filed in the countries in which
the product will be sold. This can be a costly process if the entrepreneur is
dealing with a number of countries. Furthermore, entrepreneurs have often
found their patents violated in countries that do not have as stringent patent
laws as the United States.
Other Forms of Protection

Trademarks. A trademark is a symbol, word or design that is used to identify a
business or a product. For example, Apple Computers uses a picture of an
apple with a bite out of it followed by the symbol ®, which means “registered
trademark.” A trademark has a longer life than a patent, with certain condi¬
tions. A business has the exclusive right to a trademark for as long as it is
actively using it. However, if the trademark becomes part of the generic
language like aspirin and thermos, it can no longer be trademarked. Further¬
more, a trademark cannot be registered until it is actually in use. Before that
time the entrepreneur should use ™ (or SM for services) after the name until the
trademark is registered.
To register a trademark, an applicant can use one of three methods:
1. If the mark has already been in use, the applicant can file a use application
requesting registration and ownership of the mark. You will also have to
submit three specimens showing actual use of the mark.
2. If the mark has not yet been in use, you can file an mtent-to-use application.
After the mark is in use, you must submit the three specimens showing
actual use before receiving registration.
3. Depending on international agreements with a specific country, an applicant
can file based on having a trademark in another country.
To apply, you need to submit PTO Form 1478 with a drawing of the mark
and the appropriate fee. The PTO does not require a search for potentially
conflicting marks prior to filing the application. However, it is probably wise to
do so since it isn’t difficult. You can conduct a search in the PTO public search
library or a patent and depository library, or hire a specialist to search for you.
The PTO determines whether the mark may be registered and notifies you. If
the PTO rejects the application, you have six months to respond.
Marks that cannot be trademarked include:
• anything immoral or deceptive

• anything that uses official symbols of the United States or any state or
municipality, like the flag
• anything that uses a persons name or likeness without permission.
Trade Secrets. Trade secrets are those aspects of the business that you wish to
protect from disclosure by employees or others involved with the business. The
only way to protect trade secrets is through an employment contract that specif¬
ically details any trade secrets. Then, should a former employee use a specified
trade secret, the company can use legal remedies, such as an injunction or
suing for damages.
Aspects of the business that may be considered trade secrets are recipes or
ingredients (Mrs. Fields Cookies), source codes for computer chips, customer
discounts, manufacturer costs, and so forth.
Copyrights. Copyrights protect original works of authors, composers, screen¬

writers, and computer programmers. A copyright does not protect the idea
itself but only the form in which it appears. For example, a computer
programmer can copyright the written program for a particular type of word
processing software, but cannot copyright the idea of word processing. This is
why several companies can produce word processing software without violating
a copyright. They are really protecting the unique programming code of their
software. A copyright lasts for the life of the holder plus 50 years, after which it
goes into public domain. Copyrighted works cannot be copied without permis¬
sion of the copyright holder.
To obtain federal copyright protection, the work must be in a fixed and
tangible form—that is, you must be able to see or hear it. It should contain
copyright notice (although this is no longer required by law) so that a potential
violator cannot claim innocence because there was no notice. The notice should
use the word “copyright” or the symbol ©, provide the year and the complete
name of the person responsible for the work.
Though it is not required, registration of the Copyright Office at the Library
of Congress in Washington, DC, is important in order to obtain full protection
under the law. Along with the application and fee, you must submit a complete
copy of an unpublished work or two complete copies of a published work.
The key point to remember about intellectual property rights is that they
can’t stop someone from infringing on your rights. What they can do is provide
you with offensive rights, that is, the right to sue in a court of law, a long and
costly process. Consequently, intellectual property rights should never be the
sole competitive advantage a business possesses.
How Will the Business Work?

Developing an idea for a product or service and securing proprietary rights are
just the beginning. It is difficult to determine if the product/service idea will
have value until the entrepreneur decides what kind of business he or she is
creating. Suppose you have developed a new computer program that will revo¬
lutionize the way manufacturers control inventory. You have a product; now
what is the business? There are actually several options.
1. Start a mail order business to market and sell the program

2. License the program to a major software company to distribute
3. Open a computer software store to sell your program plus other popular
business software
4. Give the program to computer software outlets on consignment—that is, the
store pays you if they sell the program
The choice of the kind of business to start is a function of your life goals and
how much time and money you have to devote to the business. Obviously,
opening a computer store is more time consuming, costly, and risky than
licensing, for example. It is important to consider all options and their associ¬
ated risks, costs, advantages, and disadvantages before settling on the type of
business you will create.
Starting vs. Buying a Business

Once you know what your product or service is and the kind of business you
are creating, you must decide whether to start a new business or buy an
existing business and turn it into an entrepreneurial venture that will satisfy
your needs. In general, entrepreneurs start businesses when they can’t find an
existing business compatible with their product/service idea or goals. Starting a
business is probably the most common route for entrepreneurs, but it’s not the
only way. Some entrepreneurs choose instead to buy an existing business.
Buying a Business
Buying a business has several advantages:
• It is less risky than starting from scratch because facilities, employees, and
customers are likely to be in place.
• It is an easier route to owning a business if the entrepreneur has limited busi¬
ness experience.
• The chances for success are increased, particularly if the business has a good
reputation.
• The business may have established trade credit, which is crucial because
relationships with suppliers and others take a long time to develop.
• The owner may be willing to stay on board for a time to help the entrepre¬
neur learn the business.
However, existing businesses rarely come without problems. In the first

place, the business may have been put up for sale because it was not successful.
It may have developed a negative reputation, its inventory may be outdated,
and its location may no longer be appropriate. On top of all this, chances are
the owner will price the business at more than it’s worth in the marketplace. To
further compound the risk, an owner is not likely to confess the real reasons
the business is being sold. These reasons may include:
• the company being squeezed out of the market by larger companies

• key employees leaving
• the threat of a major legal action
• competitors’ products are better
• the owner has a better opportunity
The owner is more likely to say the business is being sold because the owner
wants to retire or is suffering from some illness. With this in mind, there are
several questions to ask prior to purchasing a business.
• What is the potential for growth?

• Is the business profitable with a strong cash flow?
• Does it have valuable assets?
• Is it free of legal problems?
• Does it have a good reputation?
• Are you capable of running the business?
• Is the location suitable?
• Is the business compatible with your goals?
Buying a business will take the same kind of research as starting one. In fact,
although this book is geared toward starting a business from scratch, many of
the same skills apply to buying an existing business and making it grow. You
will need to:
• Understand the industry and the market niche in which the business will
operate
• Examine the records of the business
• Talk to employees, suppliers, and customers
• Examine equipment and facilities
• Examine all contracts
• Verify the value of the business based on industry statistics (See Chapter 17
for suggestions on valuing the business.)
There are several sources of information on business acquisitions. Probably

the best source is talking to bankers, attorneys, and accountants who regularly
work with businesses. The business opportunities section of newspapers such
as the Wall Street Journal ‘and trade publications are another source. It is also
possible to investigate business liquidation auctions, but unless you’re a turn¬
around specialist, taking on a business that has experienced severe problems
may be more risky than starting from scratch.
Starting a New Business
Creating a business has the principal advantage of allowing the entrepreneur to

do everything exactly the way he or she wants, in effect starting with a clean
slate. Often, however, starting a new business is a matter of necessity. With
limited funds, many entrepreneurs start out of their homes or garages because
they do not have the financial ability to purchase an established business. Then,
too, entrepreneurs frequently find it difficult to locate an ongoing business
sufficiently compatible with what they are trying to do. This was the case for
Mo Siegel, who wanted to live in Colorado but couldn’t find a business suitable
for his new venture idea. So he started his own: Celestial Seasonings, the highly
successful herbal tea company.
Starting a business, however, is generally more time-consuming and poten¬
tially more costly than buying an existing business. That “clean slate” referred to
earlier means the entrepreneur must purchase, rent, or borrow everything it
takes to run the business. Furthermore, employees, suppliers, channels of
distribution, and customers must all be identified and developed. By the end of
this book, you will have a good sense of what starting a business is all about.
Describing the Business

Whether the new venture concept is a product or a service, it will need to be
carefully described in as much detail as possible. The description of the busi¬
ness concept is a reflection of the entrepreneur’s goals, lifestyle, and philosophy.
When placed in the feasibility study and ultimately in the business plan, it will
give the reader a clear sense of what this business is intended to do.
Consequently, the description of the business concept goes well beyond the
mere discussion of the product or service being offered. Recall the example of
The New Pig Corporation in this chapter. Don Beaver and Ben Stapelfeld saw
the business in a much broader sense than just a product business. They actu¬
ally viewed it as a business that provided a service by solving people’s clean-up
problems. In that way their product offering increased substantially over the
initial product, the PIG.
The Product/Service Plan is the first section of both the feasibility study
and the business plan. Some of the things you should consider when
constructing this section include:
The Product/Service Plan

• The purpose of the business
• Description and uses of the product/service
• The unique features of the product/service
• Proprietary rights
• The primary customer
• Spin-offs
• Environmental impact
The Purpose of the Business

Defining the purpose of the business is a valuable exercise. It forces the entre¬
preneur to answer the question Why am I in business? In other words, what is
the reason for the business to exist? One potential entrepreneur with a service
business idea wrote:
Image Designs creates graphics and technical documents to help high-

technology companies enhance their image-building and publishing
efforts through quality, affordable graphics and technical documentation
from freelance professionals.
Description and Uses

It is important that the new venture product or service be described in detail
and that pictures be included if necessary for clarity. In the business plan
pictures help sell the idea. A color rendering or preferably a color photograph
of a prototype will enhance the credibility of the entrepreneur. One potential
entrepreneur described her products this way:
The product mix consists of clothing, ceramics, greeting cards, stuffed

animals, and prints using the licensed designs of Will Bullas. These
items are considered gifts or collectibles. The combination of the original
characters and the artist’s humorous quotes makes the artwork and prod¬
ucts attractive and one-of-a-kind.
She also included examples of Will Bullas designs.
Unique Features
Today, even if you are selling a commodity a standard item like hand soap that
people use in their everyday lives, you won’t get consumers to purchase your
product over the many others in the market if you can’t tell them why they
should. Consumers want to know the unique features your product or service
offers. These features will ultimately form the basis of the marketing strategy. In
the case of Image Designs, the entrepreneur was able to identify several unique
features, including “one-stop” shopping for all design needs and a management
team with a working knowledge of manufacturing, R&D, and high technology
company operations.
The Primary Customer

The primary customer is the main purchaser of your product or service. It is
crucial to the potential success of the venture that you identify as precisely as
possible who is most likely to purchase the product or service. Image Designs
targeted high technology firms that need outside graphic or technical documen¬
tation support. The New Pig Corporation, with an industrial cleaning product,
focused on manufacturers.
Proprietary Rights
It is important to note any ways in which the product/service concept can be
legally protected, whether it be through patents, copyrights, trademarks, or
trade secrets. Intellectual property rights add value to the product or service;
therefore they are an important consideration in new venture creation.
Spin-Offs
Including any related products or services that can derive from the initial one
adds more value to the business concept, as it points to directions for future
growth. For example, Image Designs could move into mixed-media arts,
animation, and 3-D or video production—in other words, expand its services
within the same target market. The New Pig Corporation identified many
potential spin-offs, such as collectibles with their logo emblazoned on them.

As a result of customer suggestions, they even developed a Hazardous
Materials PIG with DuPont.
Environmental Impact
Today businesses must be concerned with the impact they may have on the
environment either from their products or from the processes that produce
those products. Specifying what, if any, impact the new venture will have and
how it will mitigate any potential negative impact will go a long way toward
establishing a positive image for the company. Potential negative effects are
easier to identify in a product-oriented business; however, even a service busi¬
ness can demonstrate a concern for the environment. For example, Image
Designs intends to create environmental products using the licensed designs,
using recycled materials for all paper and packaging, and supporting local
efforts to clean up and protect the environment.
In sum, the detailed description of the business provides the entrepreneur
with a focus as he or she begins to study the potential market for the product or
service. Understanding the purpose and goals of the business makes the work
of determining feasibility more manageable.
[7f New Venture Checklist

Have you:
□ Decided the kind of business you intend to establish?
□ Determined if any aspect of your product/service idea can be protected by

means of patents, trademarks, or copyrights?
□ Considered if you will start the new business from the ground up or buy an
existing business?
□ Described your business concept by completing the Product/Service Plan?


& Franchise Opportunities Handbook, U.S. Department of Commerce
Publication.
Friedman, Robert. (1993). The Complete Small Business Legal Guide. Dover,
NH: Upstart Publishing.
Hedglon, Mead. (1992). How to Get the Best Legal Help for Your Business (At
the Lowest Possible Cost). New York: McGraw.
Henderson, Carter. (1985). Winners: The Successful Strategies Entrepreneurs
Use to Build New Businesses. New York: Henry Holt & Co.
Knight, Brian. Buy the Right Business - At the Right Price. Dover, NH: Upstart
Publishing.
Mosely, Jr., Thomas E. (1992). Marketing Your Invention. Dover, NH: Upstart
Publishing.
Ward, John. (1991). Creating Effective Boards for Private Enterprise. San
Francisco: Jossey-Bass.
Issues to 1. Compare and contrast buying a business with starting a business in terms of
Consider the advantages and disadvantages of each.
2. What is the difference between a disclosure document and a patent applica¬
tion?
3. Suppose you have an idea for a new type of “sunless” tanning lotion. What
procedures would you follow to protect your idea?
4. You have succeeded in protecting your new idea for sunless tanning lotion.
Name four types of businesses you could start using this idea.
5. What information will you need to have if you decide to consider buying a
business?
6. Using the sunless tanning lotion as your product, describe the essential
ingredients of the Product/Service Plan.
’;
CHAPTER 4
The Founding Team
Overview
• The value of a team approach for starting the venture
• Criteria for professional advisors to the new venture
• The benefits and legalities of using independent contractors for any or all
aspects of the business
• Outsourcing new venture functions
• The initial management team for the new venture and a gap analysis
The Solo Entrepreneur vs. the Team

By their very nature, entrepreneurs in their quest for independence often
attempt a new venture as a soloist. In this way they can retain sole ownership,
make all the key decisions, and not have to share the profits. This approach to
starting a business is still the most common in small businesses and in the
craft or artisan areas. Unfortunately, however, in todays market, it is becoming
increasingly difficult to succeed alone, particularly if the goal is to create a
world-class company. With more new ventures operating in complex,
dynamic environments and requiring more capital, it is highly unlikely any
one person will have all the knowledge and resources to start a world-class
company as a soloist.
Collaboration is, therefore, an essential ingredient in any world-class start¬
up. Studies of high technology start-ups in particular have demonstrated that a
61
team effort will provide a better chance for success than a solo effort.1 There are
several other important reasons for using a founding team.
• The intense effort required of a start-up can be shared.

• Should any one team member leave, it is less likely to result in the abandon¬
ment of the start-up.
• With a founding team that includes major functional areas—marketing,
finance, operations—the new venture can proceed further before it will need
to hire additional personnel.
• A quality founding team lends credibility to the new venture in the eyes of
lenders, investors, and others.
• The ability to analyze information and make decisions is improved because
the lead entrepreneur has the benefit of the varied expertise of his or her
team members; in this way ideas may be viewed from several perspectives.
The founders of Compaq Computers, three former senior managers at Texas

Instruments, used an integrated, interdisciplinary team approach to start-up
that resulted in a phenomenal $111 million in sales in the first year. Their
success was attributed to the “smart team,” whose philosophy was that every
member of the team should contribute to every facet of the venture. The engi¬
neer gave input to the market strategist, and the finance expert worked closely
with the design engineer. In this way they were able to cut their product devel¬
opment time in half, an important goal in an industry where new products are
outdated almost before they are manufactured.
The team approach to starting a business does not stop with the founding
members. The founding team, in an effort to ensure a successful start-up, also
forms alliances with professionals and industry experts to act as advisors and
form what can be called an extended founding team. (See Figure 4.1.)
The Founding Team

When an entrepreneur decides to use a team effort to create the new venture,
he or she generally looks for people who have complementary skills. In other
words, if the entrepreneur happens to be an engineer, finding a market expert
and someone who knows how to raise capital would be advantageous to the
new venture. Since the start-up of a new venture is a multifunctional process,
'Van de Ven, A.H., Hudson, R. &r Schroeder, D.M. “Designing New Business Start-Ups.’’ Journal of
Management, Vol. 10 (1984).
Chapter 4 • The Founding Team 63
Figure 4.1: The Entrepreneur’s Team
Professional
Advisors
Consultants
Attorneys
Management
Accountants
Sales
Bankers
Market Research
Insurance Agents
Training
Board of Directors
Advisory Board
Service Agency Governmental

Buying Office Agencies
Sales Support
Manufacturing
Manufacturer Reps
Support
Sales Agencies
Sub-contractors
Distributors
Design Engineers
Foreign Reps
the entrepreneur and the venture will benefit greatly from a team composed of
a variety of strengths and disciplines. Another advantage to forming a quality
team is that the founding team has a vested interest in the new venture. They
invest not only their time but often their money as well. Thus the burden of
raising the resources necessary to start the venture is distributed among the
team members, giving the lead entrepreneur access to the network of contacts
of the other members in addition to his or her own. This vastly increases the
information and resources available to the new venture and allows the venture
to grow more rapidly.
Of course, it isn’t always possible to put together the “perfect” team from the
start. You may not have yet found the right person to fill a particular need, or
you may have found the right person, but he or she is too expensive to bring on
board during start-up. No matter. Talk to that person anyway about joining the
team at a later date and keep that person up-to-date on what the company is
doing. You would be surprised at how many times an aggressive start-up
company can woo an experienced person away from a major corporation.
Professional Advisors
When a new venture is in the infancy stage, it generally doesn’t have the
resources to hire in-house professional help such as an attorney or accountant.
Instead it must rely on building relationships with professionals on an “as-
needed” basis. These professionals provide information and services not
normally within the scope of expertise of most entrepreneurs, and they can play
devils advocate for the entrepreneur, pointing out potential flaws in the busi¬
ness concept.
Attorneys. The first thing an entrepreneur should realize when dealing with
attorneys is that, for the most part, they are not business people. They are pro¬
fessionals who specialize in one area of the law: tax, real estate, business, patents.
Therefore, it is important to select an attorney who specializes in the particular
area needed by the entrepreneur. Attorneys can provide a wealth of support for
the new venture. Within their particular area of expertise attorneys can:
• Advise the entrepreneur in the selection of the correct legal organizational

structure—that is, sole proprietorship, partnership, or corporation.
• Advise and prepare documents for intellectual property rights acquisition.
• Negotiate and prepare contracts for the entrepreneur, who may be buying,
selling, contracting, or leasing.
• Advise the entrepreneur on the compliance with regulations related to
financing and credit.
• Keep the entrepreneur apprised of the latest tax reform legislation and help
minimize the venture’s tax burden.
• Assist the entrepreneur in complying with federal, state, or local laws.
• Represent the entrepreneur in any legal actions as an advocate.
Choosing a good attorney is a time consuming but vital task that should occur
prior to start-up. Decisions made at inception may affect the venture for years to
come, hence, the need for good legal advice. A few tips may facilitate the search.
• Ask accountants, bankers, and other business people for recommendations.

• Retain an experienced attorney who is competent to do what you want.
• Look for an attorney who is willing to listen, has time for you, and will be
flexible about fees while the business is in the start-up phase.
• Check out the firm by phone first. You can learn a lot about the law firm by
noting who answers the phone and with what tone of voice.
• Confirm that the attorney carries malpractice insurance.
Accountants. Your lawyer is your advocate, but your accountant is bound by

rules and ethics that do not permit advocacy. Therefore, where an attorney is
bound to represent you no matter what you do, the accountant, who is bound
by the Generally Accepted Accounting Principles (GAAP), cannot defend you
should you choose to do something that violates the GAAP.
Accounting is a fairly complex form of communication that the entrepreneur
needs to understand. In the beginning of the business, the accountant may set
up the company’s books and maintain them on a periodic basis. Or, as is often
the case, the entrepreneur may hire a bookkeeper to do the day-to-day
recording of transactions and go to the accountant only at tax time. The
accountant will also set up control systems for operations as well as payroll. A
growing business has to:
Verify and post bills Establish inventory controls

Write checks File yearly tax returns
Issue invoices Prepare budgets
Make collections Prepare stockholder reports
Get suppliers to cooperate Make payroll tax deposits
Balance the checkbook Secure insurance benefits
Prepare financial statements Keep employee records
The accountant can assist in all these areas. Once the new venture is beyond
the start-up phase and growing consistently, an annual audit is needed to deter¬
mine if the accounting and control procedures are adequate. Additionally, the
auditors may also require a physical inventory. If everything is in order, they
will issue a certified statement, which is important should the entrepreneur ever
decide to take the company public on one of the stock exchanges. Accountants
are also a rich networking source in the entrepreneurs search for additional
members of the new venture team. Much like attorneys, accountants tend to
specialize, so finding one who is used to working with young, growing busi¬
nesses will be an advantage. It is highly likely that the accountant who takes
your business through start-up and early growth may not be the same person to
take care of the company’s needs when it reaches the next level of growth. As
the financial and recordkeeping needs of the business increase and become
more complex, the entrepreneur may need to consider a larger firm with exper¬
tise in several areas.
Bankers There is a saying that all banks are alike until you need a loan. Today
that phrase is even more true. Having a qualified banker on the advisory team
of the new venture is an issue not only when you need a line of credit for oper¬
ating capital or to purchase equipment but from the moment you open the
business account. An entrepreneur should think of a banker as a business
partner who can:
• Be a source of information and networking

• Help the entrepreneur make decisions regarding capital needs
• Assist the entrepreneur in preparing proforma operations and cash flow
analyses and evaluate projections the entrepreneur has made
• Assist the entrepreneur in all facets of procuring financing
Selecting a bank should be as careful a process as that for an attorney or

accountant. The entrepreneur needs to develop a list of criteria that defines the
needs of the new venture with respect to the banking relationship to narrow the
search for a banker. The entrepreneur should also talk to other entrepreneurs in
the same industry to identify a bank that works well with the type of venture
planned. Talking to an accountant or attorney for suggestions of the best bank
for the new venture is another way to find a good banker.
When choosing a banker, seek out an officer with a rank of assistant vice
president or higher as these officers are trained to work with new and growing
businesses and have a sufficient level of authority to quickly make decisions
that affect the new venture.
Insurance Agents. Many entrepreneurs overlook the value of a relationship

with a competent insurance agent, but a growing venture will require several
types of insurance.
• Property and casualty

• Medical
• Errors and omissions
• Life on key management
• Workers’ compensation
• Unemployment
• Auto on firms vehicles
• Liability (product and personal)
• Bonding
Major insurance firms can often handle all types of insurance vehicles, but
many times the entrepreneur will need to seek specialists for certain kinds of
protection like bonding (which is common in the construction industry to
protect against a contractor not completing a project), product liability insur¬

ance, and errors and omissions (which protects the business against liability
from unintentional mistakes in advertising). The new ventures insurance needs
will change over its life, and a good insurance agent will help the entrepreneur
determine the needed coverages at the appropriate times.
Board of Directors. The decision to have a board of directors is influenced by

the legal form of the business. If the new venture is a corporation, a board of
directors is required. If the business requires venture capital, a board will be
necessary and the venture capitalist will probably demand a seat on it. Boards of
directors serve a valuable purpose: If chosen correctly they provide expertise that
will benefit the new venture. In that capacity they act as advisors. They also assist
in establishing corporate strategy and philosophy, as well as goals and objectives.
It is important to distinguish between boards of privately owned corporations
and those of publicly owned corporations. In a privately owned corporation, the
entrepreneurial team owns all or the majority of the stock, so directors
serve at the pleasure of the entrepreneur, who has effective control of
It is important to the company. On the other hand, directors of publicly traded compa¬
distinguish between nies have legitimate power to control the activities of the company.
boards of privately Boards can be comprised of inside or outside members or a combi¬

nation of the two. An inside board member is one who is either a
owned corporations
founder, employee, family member, or retired management of the firm,
and those of publicly while an outside member is someone with no direct connection to the
owned corporations. business. Which type of board member is best is a matter of opinion
and circumstance as research has not provided any clear results on this
issue. In general, however, outside directors are beneficial for succes¬
sion planning and capital raising. They can often bring a fresh point of view to
the strategic planning process and expertise that may not be held by the
founders.
Insiders have the advantage of complete knowledge about the business; they
are generally more available and have demonstrated their effectiveness. They
will usually have the necessary technical expertise as well. On the other hand,
there are political ramifications when the board members report to the CEO.
For that reason they may not always be objective and independent in their
thought process. Insiders may also not have the broad expertise necessary to
effectively guide the growth of the business.
Consider carefully whether the new venture requires a working board. Most
working boards are used for their expertise, for strategic planning, for auditing
the actions of the firm, and for arbitrating differences. These activities are not as
crucial in the start-up phase when the entrepreneurial team is gathering
resources and raising capital. However, a board of directors can assist the entre¬
preneurial team in those functions and can network with key people who can
help the new venture. At this juncture in the new venture some poten¬
The board members tial directors will ask to be included on the board so they can monitor
can offer the strug¬ their investment in the company. This is common with large private
gling team an objec¬ investors, bankers, and even accountants. To ensure that you get only
the best people on the board, standards should be set in advance and
tive point of view
strictly adhered to.
and the benefit of During the growth period of the new venture, the entrepreneurial
their considerable team is normally buried with operational details, the need to generate
experience. sales, and the problem of maintaining a positive cash flow. Dealing with
a board of directors is not something they will want to do. But the
board members can offer the struggling team an objective point of view and the
benefit of their considerable experience.
When choosing people to serve on the board of directors, you should
consider those who have:
• The necessary technical skill related to the business

• Significant, successful experience in the industry
• Important contacts in the industry
• Expertise in finance, capital acquisition, and possibly Initial Public Offerings
(IPOs)
• A personality compatible with the rest of the board
• Good problem-solving skills
• Honesty and integrity
If the entrepreneurial team is not careful, they may learn too late that a
director they have appointed to the board considers the position an appoint¬
ment for life, much like being appointed to the Supreme Court. To avoid a situ¬
ation—you’ll want new directors at times in order to bring new life to the
board—ask directors to serve on a rotating basis for a specified period of time.
The board is headed by the Chairman, who, in a new venture, is typically the
lead entrepreneur. The entrepreneur will also, most probably, be the President
and Chief Executive Officer (CEO). The additional positions of secretary and
treasurer may be held by a single person, often another member of the
founding team.
Boards normally meet an average of five times a year, depending on the type
of business. How often the board meets will largely be a function of how active
it is at any point in time. Directors typically spend about nine to 10 days a year
on duties related to the business and are usually paid a retainer plus a per-
meeting fee with their expenses also reimbursed. The compensation can take
the form of cash, stock, or other perquisites.
Today it is more difficult to get people to serve as directors because in some
cases they can be held personally liable for the actions of the firm, and the
frequency with which boards are being sued is increasing. For this reason,
potential directors may require that the business carry directors and officers’
(D & O) liability insurance on them; however, the expense of this insurance is
often prohibitive for a growing company. Additional expenses related to the
development of a board of directors include meeting rooms, travel, and food.
Advisory Board. The advisory board is an informal panel of experts and people
who are interested in seeing the new venture succeed. They are generally
unpaid and may meet once or twice a year to advise the entrepreneur. Advisory
boards are often used when a board of directors is not required or in the start¬
up phase when the board of directors consists of the founders only. It can
provide the new venture with the needed expertise without the significant costs
and loss of control associated with a board of directors. In a wholly owned
corporation there really is no distinction between the functions of a board of
directors and a board of advisors, as control remains in the hands of the entre¬
preneurial team.
Mistakes to Avoid
Putting together the extended founding team is a serious undertaking that, if
unsuccessful, could have severe ramifications for the future of the business.
Several common mistakes in forming the team should be avoided.
• Forming the team casually or by chance—that is, without careful considera¬

tion of the experience and qualifications each one brings to the team.
• Putting together a team whose members have different goals, which could
impede the growth of the company.
• Using only insiders for the board of directors—that is, friends and family
instead of the most qualified people to advise the business.
• Using family members or friends as attorney and accountant for the busi¬
ness. As these professional advisors must remain objective at all times to best
represent and assist the entrepreneur, choosing relatives can cause unneces¬
sary problems.
• Giving the founding team all stock in lieu of salary. The lead entrepreneur
does not want significant shares of stock in the hands of people who may
later leave the company. Furthermore, loose stock can land in the hands of
the firm’s competitors. In a later chapter, the issue of a buy-sell agreement to
prevent this problem will be discussed.
Outsourcing Savvy - Independent Contractors

New ventures typically do not have the resources to hire all the management
staff they might need to run the business. In fact, most entrepreneurs “boot¬
strap” in the early stages of growing a business. Bootstrapping in this context
means “begging, borrowing, or renting everything” to get the business off the
ground. Bootstrapping represents collectively all the creative techniques
employed by entrepreneurs in the start-up phase. The general rules of thumb
for bootstrapping include:
• Hiring as few employees as possible (employees are usually the single largest
expense of a business).
• Leasing rather than buying so as not to tie up limited funds in equipment
and facilities. With a lease, there is often no down payment and the cost is
spread over time.
• Arranging longer terms with suppliers.
• Where possible, getting customers to pay in advance.
The first rule of thumb above is relevant to this chapter. How does a new
venture survive with as few employees as possible and still grow? One solution
is to hire employees from a temporary service; another is to use independent
contractors, a process known as outsourcing. Independent contractors own
their own businesses and are hired by the entrepreneur to do a specific job.
They are under the control of the entrepreneur only for the result of the work
they do and not in the means by which that result is accomplished. There are
several advantages to the entrepreneur in using independent contractors.
• Independent contractors are usually specialists in their field.

• Hiring an independent contractor often costs less than hiring an employee

because the entrepreneur does not supply the contractor’s medical and
retirement benefits, unemployment insurance, Social Security tax, or with¬
hold income tax. These benefits can amount to as much as 32 percent of the
base salary.
If, however, the entrepreneur does not follow the rules regulating classifica¬
tion of workers as independent contractors, the entrepreneur can be held liable
for all back taxes plus penalties and interest, which can result in a substantial
sum. Entrepreneurs using independent contractors should:
• Consult an attorney.
• Draw up a contract with each independent contractor that specifies that the
contractor will not be treated as an employee for state and federal tax
purposes.
• Be careful not to indicate the time or manner in which the work will be
performed.
• Verify that the independent contractor carries workers compensation
insurance.
• Verify that the independent contractor possesses the necessary licenses.
More specifically, the IRS uses a 20-point test for classifying workers. (See
Figure 4.2 on p. 72.) Even if you follow all the IRS rules, however, there is no
guarantee the IRS won’t challenge your position. Therefore it is important to
document the relationship with an independent contractor through a legal
agreement that explicitly demonstrates that the independent contractor owns
his or her own business. The IRS can decide that a worker is an employee if
even one of the 20 points is true.
If all the IRS rules are followed, independent contractors can make the very
small start-up venture look like an established corporation to anyone on the
outside. A large corporation will generally have vice presidents for departments
of operations, sales, marketing, and finance. It is possible for the entrepreneur to
replicate the corporate bureaucracy using independent contractors thereby
lowering costs and remaining more flexible. Figure 4.3 on p. 72 shows how a
growing entrepreneurial venture can imitate the strength, stability, and expertise
of a much larger, more established company through the use of independent
contractors. The concept is called the “virtual corporation” and will be discussed
at length in Chapter 10.
Figure 4.2: The 20-Point Test for Independent Contractors
The worker is an employee if he or she:
1. Must follow the employer’s instructions about the work

2. Receives training from the employer
3. Provides services that are integrated into the business
4. Provides services that must be rendered personally
5. Cannot hire, supervise, and pay his or her own assistants
6. Has a continuing relationship with the employer
7. Must follow set hours of work
8. Works full time for an employer
9. Does the work on the employer’s premises
10. Must do the work in a sequence set by the employer
11. Must submit regular reports to the employer
12. Is paid regularly for time worked
13. Receives reimbursements for expenses
14. Relies on the tools and materials of the employer
15. Has no major investment in facilities to perform the service
16. Cannot make a profit or suffer a loss
17. Works for one employer at a time
18. Does not offer his or her services to the general public
19. Can be fired at will by the employer
20. May quit work at any time without incurring liability
Figure 4.3: The Virtual Entrepreneurial Company
Traditional Corporation
The Shadow Team

Many types of independent contractors operate behind the scenes of the new
venture but make a valuable contribution nonetheless.
Consultants. The consulting industry is one of the fastest growing industries in

the U.S., and they can provide a variety of services for the new venture.
• Train the sales staff and/or management

• Conduct market research
• Prepare policy manuals
• Solve problems
• Act as temporary key management
• Recommend market strategy
• Design and engineer product
• Design a plant layout and equipment
• Conduct research and development
• Recommend operational and financial controls
Since they tend to be fairly expensive, consultants are best used for critical
one-time advice or problem solving. However, this is a matter of perspective, as
a quality consultant can accomplish a mission or job more efficiently and effec¬
tively than an employee because their greatest strengths are usually problem
solving and working quickly within a strict budget.
Manufacturing Support. Even those new ventures that involve manufacturing a

product can avail themselves of the benefits of independent contractors. Because
the cost of building and equipping a new manufacturing plant is immense by
any standards, many entrepreneurs choose to subcontract the work to an estab¬
lished manufacturer. In fact, it is possible for the entrepreneur with a new
product idea to subcontract the design of the product to an engineering firm,
the production of components to various manufacturing firms, the assembly of
the product to another firm, and the distribution to yet another firm.
Sales Support. Hiring a sales staff can be an expensive proposition for any new
venture, not only from the standpoint of benefits but because they must be
trained as well. As new, high growth ventures seek a geographically broad
market, even global, it is vital to consider manufacturers representatives (reps)
and foreign reps who know those markets and can act as the entrepreneurs
representative. Using distributors allows the entrepreneur to reach the target
market without having to deal with the complex retail market. In addition, sales
agencies can provide fully trained sales persons to the new venture in much the
same manner as temporary services supply clerical help. Some can also provide
advertising and public relations.
Service Agencies. With many established firms downsizing and contracting

out for services, some entrepreneurs have seen an opportunity to provide those
services and have built highly successful, high growth businesses. As a result, it
is now possible for a new venture to subcontract for payroll services, computer
services, and temporary help, to name a few. The service firm employs the indi¬
vidual and provides the benefits while the entrepreneur pays a fee for the
sendees.
Buying Offices. When the entrepreneur is ready to consider a global market,

he or she may opt to use either an import/export agency or broker or the inter¬
national department of a major bank. These people understand the laws,
customs, and currency exchange rules in the countries with which the entrepre¬
neur will deal.
Governmental Agencies. There are many agencies at the federal, state, and
local levels that offer various services to new ventures. Notable among them are
the Small Business Administration, which provides education, loans, and grants
to small business; the Department of Commerce, which can assist the entrepre¬
neur on issues of trade; and state and local economic development corporations.
By taking advantage of the many services available, the entrepreneur can
literally start a business from home to reduce start-up capital requirements, yet
still operate like a major corporation. This was the route Talli Counsel of
Interfleet took (see Chapter 1). He now handles over $14 million worth of fleet
Outsourcing Your Staff
Leasing your staff, outsourcing as it is called, is a way for a new business to enjoy the advantages
of major corporations without incurring the expense. The way it works is that a leasing company
assumes the payroll and human resource functions for the business for a fee that generally
ranges from three to five percent of gross payroll. Each pay period the new venture pays the
leasing company a lump sum to cover payroll plus the fee. The National Staff Leasing Association
reports that there are about one million leased employees in the U.S. and the industry is growing
at an annual rate of 30 percent.
vehicles, and he and his wife are still the only employees of the company. This
is not to suggest that a company can always avoid hiring employees and still
grow. That will depend on the type of business started. However, it does
suggest that in the start-up, bootstrapping phase of a new venture the use of
independent contractors can help ensure that the business survives long
enough and generates enough revenues to hire employees.
The Management Team Section ot the Feasibility Study or Business Plan

There is an advantage to the entrepreneur going it alone initially, that is, doing a
feasibility study, formulating the preliminary business plan, incorporating, and
in general doing as much as possible until the rest of the team is actually
needed. By going beyond the mere conceptual stage, you establish ownership of
the business concept and will be in a better position to negotiate with potential
team members while remaining the lead entrepreneur. However, if you intend
to eventually persuade others—lenders, investors, potential management—that
the new venture is a good idea, you will need to convince them that not only is
your plan viable, but that you have key personnel with a diversity of expertise
and experience in place to implement the plan. That is the purpose of the
management section of the feasibility study or business plan.
The key questions that need to be answered in this section of both the feasi¬
bility study and the business plan are:
1. Who is on the management team?

2. What are their qualifications and what expertise do they bring to the new
venture?
3. What gaps in expertise need to be filled and how will that be accomplished?
The discussion of the management team should focus on persuading the

reader that a competent team has been formed and the entrepreneur has identi¬
fied areas in which expertise is still needed. In general, be sure you have
covered the three major functional areas of the business in describing the
team—marketing, finance, and operations—and can show you have someone
on the team who has demonstrated expertise in the industry or business you
are starting. Descriptions of the team should incorporate only relevant educa¬
tion and experience. Formal resumes can be placed in the appendices. The key
point to remember is that many investors and lenders read this section first, so
you need to impress them that the new venture is in good hands.
[7[ New Venture Checklist

Have you:
□ Identified the members of the founding team or at least the expertise
needed to start the venture?
□ Begun asking questions about potential professional advisors such as an
attorney or accountant?
□ Determined if you will need a board of directors, advisory board, or both?
□ Identified at least one type of independent contractor the new venture could
use?
□ Determined what expertise is missing from the management team and how you
will take care of it?
Baty, G.B. (1990). Entrepreneurship for the Nineties. Englewood Cliffs, NJ:
Prentice Hall. Chapter 5.
Covey, S.R. (1989). The 7 Habits of Highly Effective People. New York: Simon
and Schuster Trade.
Ford, R.H. (1992). Boards of Directors and the Privately Owned Firm. New
York: Quorum Books.
Timmons, J.A. (1990). New Venture Creation. Homewood, IL: Richard D.
Irwin, Inc., Chapter 7.
Ward, J. (1991). Creating Effective Boards for Private Enterprise. San
Francisco: Jossey-Bass.
Issues to 1. What are the advantages of starting a new venture with a team versus as a
Consider solo entrepreneur?

2. At what point in the growth of a new venture should an entrepreneur
consider creating a board of directors or an advisory board?
3. Attorneys are considered advocates; accountants are not. Why is this impor¬
tant for the entrepreneur to know?
4. How can you ensure you are using independent contractors correctly and
according to the law?
5. Suppose you are starting a computer service company that does custom
programming. What kinds of independent contractors can you use to help
you start this venture?
/( Case StudTn
Mrs. Gooch's Natural Foods Markets

ntrepreneurs start businesses for many reasons, but not many do it because
they want to save their lives. Sandy Gooch was one such entrepreneur. In
1974 she was a wife, mother, ex-teacher, and full-time homemaker who, like
millions of other Americans, often relied on convenience foods even though she
knew they contained potentially harmful chemicals. One day she woke up with
persistent sniffles for which the doctor prescribed tetracycline. A few days later,
however, she thought she suffered a heart attack and was rushed to the hospital.
The doctors could not find the cause for her symptoms. Two weeks later she
developed an ear infection and was again given tetracycline. This time her
“attack” lasted three days, and she nearly died. Her father, a biologist/chemist,
began what was to be a year of research into food manufacturing practices. He
found that Sandy was allergic to chemicals and additives commonly found in
food. They affected her body in such a way that it was unable to fight off disease.
From the information her father had gathered, Sandy decided a natural diet
was her best weapon and she proceeded to get rid of everything that was not
natural in her kitchen. Within a period of about three months she was feeling
better, and within nine months she was healthier than she had been for years.
As she began to study nutrition and whole foods, Sandy found others who
shared her problem. But, like Sandy, these people had to travel from health
food store to health food store, along with shopping at grocery stores, to find
the natural foods they needed.
Sandy felt frustrated. Coming from a family that had always helped people in
the community, it was natural that she began to explore ways to make life easier
for people who wanted to eat healthy foods. There were lots of things she could
do—start a newsletter, form a coop, give seminars—but the only idea that
allowed her to make a real impact on peoples lives was the idea of a natural
foods store that would carry only things that were good for you. Excited by the
possibilities, Sandy began to consult with herbologists, chemists, biologists,
cosmetologists, and physicians to gather all the information she could about
diet, wholesome foods, and food allergies.
Armed with a wealth of nutritional knowledge, Sandy realized that all the
knowledge in the world about food could not compensate for a lack of experi¬
ence in business. She would need to take on a partner. Fortunately, she had a
friend who was managing a health food store in the San Fernando Valley, and
she succeeded in convincing him to help.
They had to find a store location that was accessible and in a good area of
town. After much driving around and consulting newspapers, they found a
market on the west side of Los Angeles that had gone out of
business. It was obvious that the owners had run it into the
ground, but to Sandy it couldn't be more perfect. Using her
teacher retirement money and all of her savings, she opened
her first natural foods market on this site in 1977. The store
was an overnight success in spite of the fact that she had
done no location studies or psychographic studies. She was
not simply lucky, however. She had correctly determined that
there were a lot of people who shared her problems with unnatural foods. In
other words, she had innocently and intuitively found a niche in the market.
Customers lined up and kept her at the register for six hours straight without a
break.
High demand for what you have to offer has its obvious pluses and its not-
so-obvious minuses. One of the problems they faced early on was a shortage of
cash. Often cash flow problems are the result of poor management, but in
Sandy’s case, it was caused by the need to stock sufficient inventory to meet
demand. And that required a lot of capital, which they didn’t have. By keeping
overhead costs down and scrimping anywhere that it didn’t affect the customer,
they were able to keep up with demand pretty well.
Sandy’s passion for her business and her need to help people, coupled with
the tremendous demand for what she had to offer, led to the opening of a
second store within a year. To finance this store, Sandy offered limited partner¬
ships to raise $125,000. From then on, using internal cash flows, five more
stores followed over a period of 15 years, with each store reflecting Sandy
Gooch’s philosophy and mission for the business:
Mrs. Gooch’s is committed to offering the highest quality natural foods,

related products, service and information which optimize and enrich the
health and well-being of the individual as well as the planet. (From the
Company Mission of Mrs. Gooch’s)
The mission statement guided all of the decisions she made about the stores.
Accordingly, Sandy required that her suppliers guarantee the quality of their
products and be able to furnish laboratory analyses or signed affidavits if
requested. The products she carried could not contain chemicals, white flour,
sugar, preservatives, artificial colors or flavors, caffeine, chocolate, hydrogenated
vegetable oil, or irradiated food. The mission statement also gave her a way to
expand the product line to include, in addition to food, nutritional supple¬
ments and body care products. To increase efficiency as the company grew, she
opened a produce/grocery distribution center, a food commissary for the prepa¬
ration of deli and bakery foods, a design studio to create store
decor and a construction shop to build the displays.
A former teacher, Sandy Goochs love of education found its
way into her business. To help achieve her mission, her 800
employees were carefully trained to be knowledgeable about
the products she carried. Sandy believed strongly that their
product was really knowledge and information. That belief
formed the basis of her marketing strategy. She knew that an
informed consumer would be an advocate for the type of nutritional lifestyle
she was proposing. As advocates they would return again and again to purchase
those products and gain more knowledge. She promoted health awareness by
offering seminars, producing a newsletter, and giving her customers free
brochures on nutrition. A mini-bookstore in each store contained all the latest
research on foods and their relationship to the body Even the ads that appeared
in newspapers were educational in nature.
Sandy incorporated the business early in its development and set up a Board
of Directors, which included herself, her partner, the general manager, and their
attorney. As this privately held company began to grow, Sandy wondered if she
had made the correct decision putting all “insiders” on the board. Would they
continue to share her mission for the business?
1. Why is Mrs. Goochs considered an entrepreneurial venture?

2. How does the mission statement of Mrs. Gooch affect the decisions she made
as the business grew?
3. What intellectual property rights could she acquire?
4. What other kinds of businesses could Sandy Gooch have started given her
philosophy?
5. What potential effect could there be from using insiders on the Board of
Directors? What can she do to remedy the situation?
6. What are some spin-off products or services Mrs. Goochs could offer?
PART 2
i urn mi mm i in iwiii in mini 111 miiim iiimurmiii nurirwnnfiia
Finding, Analyzing,
and Testing Opportunity
The man with a new idea is a crank-

until the idea succeeds.
-MARK TWAIN
CHAPTER 5
Understanding the Industry:

Prelude to Success
Overview
• Identifying the industry in which the new venture will operate
• Industry carrying capacity, dynamism, and complexity
• Sources of secondary industry information
• Sources of field data on the industry
• Effective field interviews
• Presenting the industry profile in the feasibility study or business plan
Defining the Industry

One of the environmental variables that affects both the creation and strategy of
the new venture is the industry in which it will operate. A strategic position in a
growing, dynamic, and healthy industry can go a long way toward ensuring a
successful venture. On the other hand, a weak position in a mature industry
may sound a death knell for the business before it even opens its doors. A
young, growing industry with many new entrants will present at once a highly
competitive environment for the new venture and a chance to gain significant
market share if entry is early. This was the case in the software industry in the
1980s. A more mature industry, by contrast, may have already passed through
the period of “survival of the fittest” and will now be comprised of a few firms
83
84 Part 2 • Finding, Analyzing, and Testing Opportunity
with large market shares, as in the automobile, semiconductor, and airline

industries, to name a few.1
Research has identified three dimensions of the industry environment that
help the entrepreneur evaluate the new venture’s potential in the industry:
carrying capacity, dynamism, and complexity.2
Carrying Capacity
Capacity is the extent to which the industry can support growth. Entrepreneurs
will typically seek out an industry that can support expansion, thus allowing
the new venture to grow and obtain the resources it needs. Difficulty in entering
a specific industry suggests that the industry may be approaching its carrying
capacity—that is, the production capability of the existing firms equals or
exceeds the demand for industry products. The only way to enter such an
industry then is through the introduction of new technology or by discovering
a niche where a need has not been met. The was the strategy of Gentech
Corporation in introducing new technology in a niche market of the large and
very mature generator and compressor industries.
Dynamism
Dynamism is the degree of certainty or uncertainty in the industry, as well as
stability or instability; in other words, a dynamic environment is one that is
difficult to predict because it is in constant flux. Industries that operate in
volatile environments, like the computer industry, contain higher degrees of
uncertainty or risk. Consequently, the rewards are usually higher as well.
Complexity
Complexity is the number and diversity of inputs and outputs facing an organi¬
zation. Firms that operate in complex industries usually have to deal with more
suppliers, customers, and competitors than other industries, and they usually
produce a greater number of dissimilar products for global markets. Industries
with a high degree of complexity by their very nature make it difficult for new
'N.C. Churchill, J.A. Hornaday, B.A. Kirchhoff, O.J. Krasner & K.H. Vesper. “Venture Survivability.” Frontiers
of Entrepreneurship Research, Wellesley, MA: Babson Center for Entrepreneurial Studies. (1987).
2Starbuck. WH. “Organizations and Their Environments." (1976). In M.D. Dunnette (Ed.) Handbook of
Industrial and Organization Psychology. Chicago: Rand McNally. Pfeffer, J. & Salancik, G.R. (1978). The
External Control of Organizations. New York: Random House.
Chapter 5 • Understanding the Industry: Prelude to Success 85
businesses to enter. They are also extremely competitive; therefore, new

ventures often find a great deal of hostility rather than collaboration.
Industry Structure
In studying the industry in which the new venture will operate, develop a
broad picture of how the industry works, how friendly it is to new entrants,
and where it is going in the future. Michael Porter asserts that there are five
forces in any industry that affect the ultimate profit potential of a venture in
terms of long run return on investment. They are:
1. Threat of new entrants into the industry

2. The bargaining power of suppliers
3. Threat of substitute products
4. The bargaining power of buyers
5. Rivalry among competitors in the industry3
These are the forces that drive competition and affect the long run prof¬
itability of the new venture as well as other firms in the industry. Short run
profitability, by contrast, is affected by such things as economic forces, changes
in demand, material shortages, and so forth.
Threat of New Entrants

In some industries barriers to entry are high and will discourage new entrants.
These barriers may include:
• Economies of scale. Many industries have achieved economies of scale in

marketing, production, and distribution. This means that their costs to
produce have declined relative to the price of their goods and services. A
new venture cannot easily achieve these same economies, so it is forced into
a “Catch-22” situation. It can enter the industry on a large scale and risk
retaliation from those established firms in the industry, or enter on a small
scale and not be able to compete because of high costs relative to everyone
else. Another version of this dilemma is an industry where the major players
are vertically integrated; that is, they own their suppliers and/or distribution
channels. What most new ventures attempt to do when faced with
3Porter, Michael E. (1980). Competitive Strategy: Techniques for Analyzing Industries and Competitors. New
York: The Free Press, p. 3.
economies of scale is to form alliances with other small firms to share

resources and compete on a more level playing field.
• Brand loyalty. New entrants to an industry face products and services that
have loyal customers, so an extensive marketing campaign focused on re-edu¬
cating the customer about the benefits of the new ventures products will be
required. The cost of undertaking this strategy is a significant barrier to entry.
• Enormous capital requirements. The cost of entering many industries is
prohibitive for a new venture. These costs may include up front advertising,
R&D, and expenditures for plant and equipment to compete on par with
established firms in the industry.
• Switching costs for the buyer. Buyers in most industries don’t readily switch
from one supplier to another unless there is a demonstrated reason to do so.
This is because it costs the buyer money and time to retrain staff and poten¬
tially learn a new technology. For example, users of the Microsoft Windows
graphical interface will not easily switch to a different system because they
have spent a lot of time learning the Windows environment and are used to it.
• Access to distribution channels. The new venture must convince established
distribution channel members to accept the new product or service and
prove that it will be beneficial to distributors to do so. This persuasion
process can be costly for the new venture.
• Proprietary factors. Barriers to entry also include proprietary technology,
products, and processes. Where established firms hold patents on products
and processes that the new venture requires, they have the ability to either
keep the new venture out of the industry or make it very expensive to enter.
Most favorable location is another form of proprietary barrier. Often entre¬
preneurs will discover that existing firms in the industry own the most
advantageous business sites, forcing the new venture to locate in a less
competitive site. Established firms, being further along on the learning/expe¬
rience curve, are probably more cost efficient in their operations—something
that will take time for the new venture to achieve. These proprietary factors
are all substantial barriers to entry for a new venture.
• Government regulations. The government can prevent a new venture from
entering an industry through strict licensing requirements and by limiting
access to raw materials through laws or high taxes and certain locations via
zoning restrictions.
• Industry hostility. Some industries are extremely retaliatory toward new
businesses that attempt to compete in the industry. This typically occurs
where there are many well established firms that have sufficient resources to
spend the time and money going after a new entrant. It is also common in
mature industries where growth has slowed, so rivalry for market share
intensifies as profits decline. Weaker firms ultimately exit the industry.
Threat from Substitute Products

A new venture must not only compete with products and services in its own
industry but with those that are logical substitutes in other industries as well.
Generally, these substitute products and services accomplish the same basic
function in a different way or at a different price. For example, restaurants regu¬
larly compete with other forms of entertainment for the consumer’s disposable
dollars. The threat from substitute products is more likely to occur where firms
in other industries are earning high profits at better prices than can be achieved
in the new ventures industry.
Threat from Buyers’ Bargaining Power

Buyers of products and services can force down prices in the industry through
volume purchases. This is particularly true where the industry products
comprise a significant portion of the buyers’ requirements. Under this scenario,
the buyer is more likely to seek the lowest possible price. The largest buyers
also pose a threat of backward integration, where they actually purchase their
suppliers, thus better controlling costs and affecting price throughout the
industry. The more buyers understand the nature of the industry and the more
the products are standardized, the greater the likelihood that these buyers will
have significant bargaining power. In industries where buyers have bargaining
power, it is more difficult for a new entrant to gain a foothold and grow.
Threat from Suppliers’ Bargaining Power

In some industries suppliers exert enormous power through the threat of
raising prices or changing the quality of the products that they supply to manu¬
facturers and distributors. If the number of these suppliers is few relative to the
size of the industry, or the industry is not the primary customer of the
suppliers, that power is magnified. Moreover, if these suppliers are the primary
source of materials and components for the new venture, the ability to compete
on cost may be negatively affected. A further threat from suppliers is that they
will forward integrate—that is, they will purchase the outlets for their goods
and services, thus controlling the prices at which they are ultimately sold.
It is interesting to consider that labor is really a source of supply. In certain
industries where highly technical skills are required or where unions are
strong, labor as a supplier has enormous bargaining power and can signifi¬
cantly impact costs for the new venture.
Rivalry among Existing Industry Firms

In general, it can be said that a highly competitive industry will drive down
profits and ultimately the rate of return on investment. To position themselves
in a competitive market, firms will resort to price wars, advertising skirmishes,
and enhanced service. Once one firm decides to make such a strategic move in
the industry, others will follow. The clearest example is the airline industry;
when one airline discounts its prices significantly, most of the others immedi¬
ately follow. The problem with this tactic is that it ultimately hurts everyone in
the industry and may even result in forcing some firms out because competitive
prices drop below cost. Most new ventures can’t compete on price and can’t
afford costly advertising battles to build an image. To compete in an industry
that is highly competitive, they must find a market niche that has not been
served by the major industry rivals and enter the industry without causing
movement on the part of the major players.
The Special Case of Emerging Industries

Emerging industries are those that are just coming into being. Some examples
are interactive television and telecommunications. In these types of industries
there are no rules initially. Instead, technical uncertainty exists until the major
technology developers enter the industry and it becomes apparent which tech¬
nology is the best. Consequently, there is no standardization of products and
processes in the industry for some time, and as a result costs to produce are
high. Securing sufficient raw materials may also be difficult.
Buyers in an emerging industry are, for the most part, considered first-time
buyers. They will pay a premium for the product at its introduction but will
usually see that price decline significantly as competition increases and stan¬
dardization of technology occurs.
For entrepreneurs, an emerging industry is at once exciting, challenging, and
extremely risky. Certainly the strongest position is to own the technology being
introduced and be able to enter the market with sufficient resources to establish
a firm market share and brand identity If, however, others are also entering the
market at the same time with similar proprietary technology, resources will have
to be directed toward promoting the benefits and superiority of the entrepre¬
neur’s technology. This was the case for Microsoft’s Windows, which ultimately
overcame the threat of IBM’s OS/2 technology. If major companies from other
compatible industries are entering the new industry, the task is that much
harder. That is the situation for new ventures hoping to garner a piece of the
action in the telecommunications industry, where they are competing for

market share against the likes of QVC and Microsoft.
Competitive Strategies
The new venture’s entr-y strategy will largely be a function of the structure of
the industry into which it seeks entry. In general, three broad strategies are
available to the new venture: cost superiority, product/process/service differ¬
entiation, and niche.
Cost Superiority
Essentially, cost superiority entails entering the industry with an organizational
structure that is “lean and mean,’’ with tight controls on costs. To accomplish
this usually requires designing the production process and distribution mecha¬
nisms to operate under strict controls, meeting stringent quantity targets. This
strategy is very difficult for a new venture to achieve in that it most often results
from being further along on the experience curve and from producing in high
volumes. It is rare that a new venture will have the infrastructure and resources
in place, and sufficient product/service demand from the beginning to allow it
to use cost superiority as an entry strategy.
Differentiation
Differentiation is a strategy that involves distinguishing the new venture from
others in the industry through product/process innovation, or a unique
marketing or distribution strategy. Differentiation often creates brand loyalty
among customers, thereby making the product or service less sensitive to price.
Consequently, margins are usually increased, which better insulates the
company against supplier and buyer bargaining power, and moves the focus
away from the cost to produce. Additionally, substitute products are less likely
to be a threat where differentiation is the strategy.
Niche Strategy
The third strategy is often referred to as a niche strategy, which simply means
that the new venture focuses on a particular customer group or specific
geographic region not currently served by the industry effectively. Many a new
venture has entered an established industry via a niche. This strategy may
include either a cost leader or differentiation strategy as well, with the key
distinction being that the niche strategy tackles only a segment of the industry
rather than the industry as a whole. Where competition is weak and exposure
to substitute products is a minor issue, the niche strategy offers a safer route to
establishing a foothold in the industry. Gentech, whose PowerSource industrial
machine competes in the generator/compressor industries, is focusing on a
niche market in equipment rental outlets as a strategy to enter a large industry
with established firms.
Competing on a Global Level

Porter (1980) contends that while there are many differences when competing
in an industry on an international basis, structural factors and general market
forces are essentially the same. Entrepreneurs can go global through licensing
products and services to international firms, exporting, or investing in plant
and equipment in another country.
While the advantages of competing on a global level include increased
potential for growth, there are a number of difficulties that often impede the
process. Transportation and storage of product in other countries is often
difficult. Many times products made in the United States must be modified to
meet the specifications and demands of customers in other countries. For
example, sizes of clothing vary from country to country, and electrical
current, which is llOv in the United States is 240v in many other countries.
Distribution channels inside the borders of other countries usually operate
differently. Sometimes the problem is a matter of political clout or govern¬
ment regulation. Finally, the legal protections, such as patent laws, that are
enjoyed by entrepreneurs in the United States are not always respected in the
same manner in other countries.
The complexity of investigating an industry on a global level is exacerbated
by the fact that not only must you grasp how the industry works in that
country, but you must also have a good understanding of the culture and polit¬
ical process. These issues related to marketing on a global level are treated more
fully in Chapter 16.
Competitive Analysis
Within any industry, it is important to hypothesize about the competitive
strategy of the competition—in other words, to know the competition as well
as you know your own business. Studying the history and management style of
your major competitors will give insight into what motivates them and how
they may potentially react to your strategy. You need to identify their current
strategy to learn how they have positioned themselves in the industry. In the
same way that you would analyze your strategy’s strengths, weaknesses, oppor¬
tunities and threats, you should also study theirs.
Not all of your competitors will exhibit the same strategy, so it is useful to
categorize them to get a handle on what the new venture is facing. Once the
competitors have been categorized, you will more readily see into what strategic
grouping the new venture lies, that is, who your key competitors are. From
there the new ventures position in that group will be determined as well as the
strategic group’s position in the industry as a whole. To have the best chance for
success, the new venture should be positioned in the strategic group that offers
the best profit potential, yet a reasonable cost of entry.
Industry Evolution
Industries do not remain static or stable over time. In fact, they are in an almost
constant state of evolution. Like a business, an industry moves through a life
cycle that includes birth, growth, maturity, and ultimately decline. Of course, for
every industry the life cycle stages occur at different rates and last for varying
lengths of time. Some industries like the auto industry avoid decline by con¬
stantly innovating to meet market demand and satisfy governmental regulations.
As an industry grows, it sees demographic shifts, changes in costs of materials
and labor, product and process innovations, and changes in its customer
markets. Industry products tend to become commodities over time, so the com¬
petitive tendency to differentiate products is enhanced. With time, uncertainty is
reduced and proprietary rights become less exclusive, which may result in larger,
risk-averse firms entering the industry. These larger firms have the resources to
integrate vertically, gaining control of suppliers and distribution channels, and
instituting product and process innovations that can result in larger volumes of
goods being produced and sold. These actions can cause a change in the cost
structure of the industry and the exit of firms unable to compete in the new
industry structure. A few firms will finally dominate the industry.
Industry Analysis
The importance of understanding the industry in which the new venture will
operate cannot be overstated because the industry environment has a direct
impact on how the new venture does business and on its potential for success.
The nature of the industry certainly must be taken into consideration when
establishing the competitive strategy for accomplishing the goals of the venture.
An industry analysis requires a plan of attack to avoid wasting time hunting

for inadequate information and not knowing what to do with it once it is
collected. The analysis will include:
• Identifying the industry

• Examining secondary resources
• Talking to people in the industry
• Analyzing the data and drawing conclusions
Standard Industrial Classifications

It is possible to determine the specific industry in which the new venture will
operate by identifying the Standard Industrial Classification (SIC) for the
product or service. Knowing the four-digit SIC code for the business allows the
entrepreneur access to a wealth of information typically categorized by SIC
code. Standard Industrial Classification Codes were developed by the U.S.
Bureau of the Budget in 1972. The major classifications include such industries
as agriculture, mining, construction, manufacturing, and wholesale. For
example, under the major classification of manufacturing, the types of busi¬
nesses and their respective codes can be found listed in Figure 5.1.
Sources of Industry Information

An industry analysis usually begins with a search of secondary data sources—
journals, trade magazines, reference books, government publications, and
annual reports of public corporations—sources that are all normally found in
a university or community library. Historical data, such as annual reports over
Figure 5.1: Manufacturing Industrial Classifications
2400 Food & hindered Products

2600 Paper & Allied Products
2700 Printing, Publishing & Allied Industries
2800 Chemicals & Allied Products
3000 Rubber & Miscellaneous Plastic Products
3200 Stone, Clay, Glass & Concrete Products
3300 Primary Metal Industries
3400 Fabricated Metal Products, except machinery & transportation equipment
3500 Machinery, except electrical
3900 Miscellaneous Manufacturing Industries
Figure 5.2: Categories of Data for Industry Analysis
• Growth • Technology of production

• Complementary/substitute products • Distribution channels
• Competitors • Innovation
• Market strategies • Suppliers
• Economic environment • Product lines
• Regulatory environment • Buyer behavior
• Socio-political environment
a 10 to 15 year period, can often help the entrepreneur spot trends, cycles,
and seasonal variations in the industry. Trade magazines provide a good sense
of who the key firms are and the directions the industry may be taking.
Figure 5.2 provides a listing of some of the essential raw data on the industry
that should be collected. Some of this information will also be useful later for
the market analysis.
After the secondary data are collected, they must be organized and analyzed.
In general, the key questions about the industry that should be answered are:
• Is the industry growing?

• Where are the opportunities?
• What is the status of any new technology?
• How much does the industry spend on research and development?
• Who are the major competitors?
• Are there young, successful firms in the industry?
• What does the future look like?
• Are there any threats to the industry?
• What are the typical margins in the industry?
The Importance of Primary Data

Secondary research paints the broad brush of the industry; however, given the
lead time from data gathering to print, it is rarely the most current information
available. Therefore, to access the most timely information, it is extremely
important to gather primary field data on the industry. (See Figure 5.3 on
p. 94.) In other words, you need to talk to people in the industry—“pound the
pavement” so to speak. Some of the sources to tap are:
• Industry observers, those who study particular industries and regularly report
on them in newspapers, newsletters, or through the media.
• Suppliers and distributors, who are in an excellent position to comment on the

health of the industry in terms of demand for products and services, as well
as the financial strength and market practices of major firms.
• Customers, who can be a clue to satisfaction with the industry and the
product or service supplied.
• Employees of key firms in the industry, who are a good source of information
about potential competitors.
• Professionals from service organizations such as lawyers and accountants who
regularly work with a particular industry.
• Trade shows, which give a good indication of who the biggest competitors are
and who has the strongest market strategy.
Tactics for Talking to Key Industry People

Field research is usually accomplished via interviews or casual discussions with
people in the industry. Getting people to open up and talk to you will be easier
if you follow a few simple rules.
• Where possible, secure an introduction from someone who knows the inter¬
viewee. You will find that once you talk to the first person, that person will
recommend someone else, and you’ll be on your way to gathering more
information than you could ever use.
Figure 5.3: Sources of Field Data for Industry Analysis

• Seek out individuals who regularly deal with the media since they are easier
to approach; however, be aware that they are also used to being very careful
about what they say
• Allow sufficient lead time for the meeting since you are probably dealing
with very busy people on tight schedules.
• Offer something that might be of value to them such as a summary of the
results of the industry analysis or to take them to lunch.
• Be honest about your affiliation, either with a university or business.
Interviewees want to know you understand the value of their time.
• To give yourself credibility, demonstrate your knowledge of the interviewee’s
business. Of course, to do this you will have had to research the business
before the meeting.
• If possible, take a colleague or business partner along to ensure that you
obtain all the needed information and catch all the visual cues. This is partic¬
ularly true when talking to potential competitors.
• Carefully observe the surroundings. Physical clues and non-verbal commu¬
nication are often excellent indicators of the nature of the industry.
• Be sure your opening questions are easy and non-threatening and show a
genuine interest in the interviewee’s business.
The Ideal Industry
While no industry is perfect, an industry comprised of the following features offers more opportu¬
nity for a new venture.
• An industry with over $50 billion in sales will probably have niche markets of sufficient size to
allow for the attainment of an adequate market share.
• An industry that is generally growing at a rate greater than the GNP offers more potential for
growth of the new venture.
• An industry that allows for after-tax profits of greater than five percent of sales within three to
five years will enhance the new venture’s chances for success.
• An industry that is socially and environmentally responsible will be one that is compatible with
current societal and political trends and, consequently, may be eligible for special grants and
other types of funding.
New ventures entering an emerging industry will not have the luxury of a history and information
that can indicate potential for growth and profits. They can, however, look to the experiences of other
recently formed industries that are similar to theirs to predict patterns and potential market demand.
These characteristics are merely benchmarks. With so many variables involved, no one can
guarantee a new venture will survive or become a success even if the industry possesses all
these characteristics. However, as with anything, the more information the entrepreneur has, the
better chance there is of not making costly mistakes.
Presenting the Industry Data in the Feasibility Study or Business Plan

The industry analysis provides the entrepreneur and others with
Industry Profile the information necessary to determine if the industry in which the
• Current Size
business will be started appears conducive to new ventures. The
• Growth Potential
• Geographic Locations
data collected should be presented in the feasibility study or busi¬
• Industry Trends ness plan in a way that highlights the key points and answers the
• Seasonality major questions addressed in this chapter. Often this can be
• Profit Potential accomplished best through the use of tables and graphs. These can
• Sales Patterns
display data efficiently and should be used where appropriate;
• Gross Margins on
however, the entrepreneur must never assume readers will pick out
Products
• Technology
the most salient points from tables, graphics, or the narrative for
• Government Regulation that matter. It is important to point out key trends and patterns in
the data as the entrepreneur sees them.
A comprehensive industry analysis will include:
• The current size of the industry as measured by total sales volume, total
number of firms, and total number of employees.
• The growth potential, based on historical trends in size. Is the industry
growing, shrinking, or remaining stable?
• Geographic location, where the industry seems to cluster (i.e. semiconductors
in Silicon Valley, California; Route 128 in Massachusetts, and so forth).
• Industry trends in terms of products, services, innovation, and technology.
• Seasonality of demand for products and services, based on days of week,
months, or seasons of the year.
• Profit potential, based on performance of existing firms in the industry.
• Sales patterns as measured by frequency and quantity of purchase.
• Gross margins on products as an indicator of how easy or difficult it will be to
cover overhead.
• Technology, both process and product as an indicator of barriers to entry and
potential for innovation.
• Government regulation of aspects of the industry that may affect the new
ventures growth potential.
Both the entrepreneur and other interested parties will want to know that the
industry is healthy, growing, and provides an excellent window of opportunity
for the new venture.

Have you:
□ Identified the SIC code for the industry in which your new venture will
operate?
□ Collected secondary data on the industry?
□ Conducted field research by interviewing suppliers, distributors, customers,

and others?
□ Developed an industry profile that will tell you and others if the industry is
growing, who the major competitors are, and what the profit potential is?

Darnay. A.J. (Ed.). Manufacturing USA: Industry Analyses, Statistics, and
Leading Companies. Detroit: Gale Research Inc.
R. J. Elster (Ed.). Small Business Sourcebook. Detroit: Gale Research Inc.
Gumpert, D.E. <Sr Timmons, J.A. (1982). The Insiders Guide to Small Business
Resources. Garden City, NY: Doubleday &r Co.
Schwartz, C.A. Small Business Sourcebook. Detroit: Gale Research Inc.
Thomas Register
U.S. Census Data: State and County Business Patterns
1. How does your industry measure up in terms of dynamism and complexity?

Issues to
2. Which primary and secondary information will tell you if the industry is
Consider
growing and favorable to new entrants?
£jx 3. What kinds of information can suppliers and distributors give you?
4. What information about the industry can trade shows provide7
5. How should tables and graphs be used in the industry profile?
_
CHAPTER 6
Evaluating the Target Market
Overview
• Defining and describing the target market
• Direct, indirect, and emerging competitors
• Competitive advantage
• Secondary sources of data on the target market
• Techniques for estimating demand for the product or service
• Presenting the market analysis in the feasibility study or business plan
• Determining initial feasibility
Defining the Target Market

One of the most important tasks the entrepreneur must undertake is the identi¬
fication of the primary customer for the product or service being offered by the
new venture. The target market is that segment of the marketplace that will
most likely purchase the product or service. It is referred to as the primary
market. The secondary market, by contrast, consists of those customers
outside the target market for whom a different market strategy will be required.
The ability to identify the target market is based on an analysis of customer
need, which usually begins at the earliest stages of business concept develop¬
ment. In fact, often the idea for an innovative product or service springs from a
need observed by the entrepreneur (e.g., Bob Kearns and the intermittent wiper
blade). The preliminary needs analysis is then refined through target market
research and eventually becomes the focal point for many of the decisions and
99
strategies of the new venture. Unfortunately, most entrepreneurs don’t place

enough emphasis on in-depth market analysis. Instead they assume levels of
need and demand without any evidence to support them. As a result, they tend
to overestimate their market forecasts for demand by as much as 60 percent.1
The Market Niche

The term niche refers to that very specific segment of the market toward which
the new venture is targeting its efforts. It is usually a relatively small, well-
defined segment that is often not currently being served by the products and
services available in the industry. Sandy Goochs natural food markets is one
example of a niche product/service. The PIG industrial cleaning device is
another. The advantage of defining a market niche is that it permits entry by the
new venture into virtually any industry without having to compete at the level
of General Motors. The start-up venture in a niche market can more quickly
become the “big fish in the little pond,” establishing a secure customer base
before it expands into larger, more competitive markets. Starting with a niche
also facilitates a better understanding of customers’ needs and purchasing
patterns on a smaller, more manageable scale.
Describing the Target Customer

No matter what the size of the target market, it is crucial that the entrepreneur
know as much as possible about the customer. Gooch determined early in the
development of her concept for a natural foods market that her primary
customer is a well-educated, working woman over 30 years old who is
concerned about what she puts into her body. Over the years of growing her
business, Gooch has refined that description and can now describe her target
customer in even greater detail. The important point is that knowing as much
as possible about the customer will guide you in making decisions about how
to reach that customer. For example, since Mrs. Gooch’s customer is thirsty for
nutritional knowledge, Mrs. Gooch’s Natural Foods Markets distributes a
newsletter containing the latest nutritional information. Her stores are full of
educational pamphlets in addition to trained clerks who answer any questions
her customers might have. As long as she can meet the specific needs of her
customers, Gooch’s business will thrive. Therefore, defining the target market
'Hills, G.E. "Market Analysis and Marketing in New Ventures: Venture Capitalist Perceptions” in Frontiers of
Entrepreneurship Research. Babson Center for Entrepreneurial Studies, (1984), p.43.
Chapter 6 • Evaluating the Target Market 101
really means describing the primary customer for your product or service—that
customer who will help your business grow and succeed.
In the beginning stages of market analysis, you will probably have a fairly
loose description of the target market. This description will be refined and may
even change as you talk to the target customers during the field research. The
key questions you will be attempting to answer are:
• Who is my customer?
• What do they typically buy and how do they hear about it?
• How often do they buy?
• How can my new venture meet the customers’ needs?
Some techniques for gathering this information will be discussed later in

this chapter.
Identifying the Competition

There are three types of competitors for your product or service: direct, indi¬
rect, and emerging. Identifying specifically who these companies are—their
strengths, weaknesses, and market share—will put the new venture in a better
position to be a contender in the industry and particularly in the target market.
Direct Competitors
Those businesses that supply products or services that are the same or similar to
yours, or are a reasonably good substitute for yours, are direct competitors to
the new venture. However, be careful: the term competition is not quite that
simple. Suppose you are going to open an entertainment center that incorporates
virtual reality computer games in a shopping mall. One possible direct com¬
petitor that comes to mind is a video arcade. But if you consider your venture to
be in the entertainment business, you will see that other direct competitors for
the consumer dollars you are seeking are movie theaters, miniature golf courses,
bowling alleys, and video rental stores. That certainly complicates the picture,
and it’s not the only source of competition for the new venture.
Indirect Competitors
Indirect competitors may not even be in the same industry as the new
venture but who compete alongside it for consumer dollars. Using the example
above, consumers may choose to spend their limited dollars at restaurants
rather than on entertainment, or, perhaps, on a weekend vacation. Indirect

competitors, therefore, are often substitutes outside the entrepreneurs industry
or target market.
Emerging Competitors
When entering a market as a new business, it is vital not only to assess the
existing competition but also the potential for new competition—emerging
competitors—at some time in the future. In many industries today, technology
and information are changing at such a rapid pace that the window of opportu¬
nity to successfully start a new venture has been closing. Consequently the
entrepreneur must be ever-vigilant to new trends and new technology in both
the industry in general and in the specific target market.
Understanding who your competitors are is one step in learning what the new
venture’s competitive advantages are. If your product or service has intellectual
property rights—patent, trademark, copyright—that is a significant competitive
advantage. Other advantages may be found in the market strategy, the distribu¬
tion strategy, and the operations strategy. The bottom line in competitive advan¬
tage is innovation in all aspects of the business. What this suggests is that
knowing your competitors as well as you know your new venture allows you to
seek more ways in which the new venture can innovate, can distinguish itself
from its competitors, and can attain an important level of competitive advan¬
tage in the marketplace.
PROFILE 6.1
The Importance of Satisfying Customer Needs

Robert Shaw is chairman of International Jensen, a manufacturer of audio speakers
whose primary target market is the automotive industry. He supplies speakers to
companies like Ford, Chrysler, and Honda. Shaw believes that the success of his
company, even during slow years for the auto industry, is due in large part to his
company’s concern for what the customer wants, not what his company wants. He
empowers his workers at the local level to stay in touch with customers’ demands. If
the trend is for more sophisticated, lightweight speakers, Shaw is prepared to give
the customers what they want. Sales are increasing at a rate of about 10 percent per
year, suggesting that he is doing just that.
Researching the Target Market

The research conducted on the target market will provide some of the most
important data needed by the entrepreneur to decide if the new venture is
feasible. To ensure that useful and correct conclusions can be drawn the
research methods must be sound. A four-step process will ensure the informa¬
tion needed to make this crucial decision is gathered and used correctly. (See
Figure 6.1.)
Figure 6.1: Steps to Market Research
• Assess your information needs

• Research secondary sources first
• Measure the target market
• Forecast demand for the product or service
Assessing Information Needs

Before you can begin to collect market data, you must determine how that data
will be used in the market analysis section of the feasibility study and the busi¬
ness plan. Will it demonstrate a demand for the product or service? Will it
describe the target customer? You may be wondering how you can decide how
data will be used and analyzed when it hasn’t yet been collected. Precisely the
point. A good researcher will decide first what he or she is attempting to accom¬
plish with the research so the correct type of data needed for the analysis will
be gathered. Nothing is more discouraging to a researcher than finding out after
all the data are collected that a crucial piece of information is missing.
Also, once you know what it is you want to determine with the data, it will
be easier to choose a particular type of analysis that will lead to the desired
result. For example, if one of your research goals is to refine the description of
the target market, you may decide to seek the most common characteristics or
demographics (the statistical mode) of the customer—in another words, indi¬
cate the most common age, education level, income, and so on. To do this, you
will need to gather numerical data. Granted this is a rather simple and obvious
example; however, others are not so apparent.
Suppose, for example, you wish to calculate demand for the product or
service by using a statistical forecasting technique. The type of technique you
choose will dictate the kind of data you must collect. For example, if the tech¬
nique requires continuous numerical data (i.e. all values for an answer are
Figure 6.2: Sample Demographics of the Target Market
Average age of customer 32

Average income level $35,000
Average number of years of education 14
Marital status Married
possible), you would not gather data or design a questionnaire that would give
you “yes-no” answers. Fortunately, the market research most entrepreneurs do
involves simple, descriptive statistics as seen in Figure 6.2 above.
Recall that the entrepreneur collects both primary and secondary market
data. It is important, however, to gather the secondary data first so you have a
better understanding of the market prior to designing a sampling plan and
doing the field research.
Researching Secondary Sources

Secondary data on the target market give the entrepreneur an understanding of
the market before going into the field to talk directly with customers, suppliers,
distributors, and others. The library is an excellent starting point. The govern¬
ment publications section will contain Federal Census Bureau data which
allows you to define your market by region of the country, major metropolitan
area, city, or even neighborhood. The 1990 Census Basics provides demographic
information such as age, education, income, and workers per household. It
permits you to determine if the geographic area you have defined is growing or
declining, aging or getting younger, if the available work force is mostly skilled
or unskilled, along with other trends.
Some groups of demographics (age, income, race, occupation, and educa¬
tion) help identify the likelihood that a person will choose to buy a product.2
This is true even for industrial products. Demographic data also allow you to
segment the target market into subgroups that are estimably different from one
another. For example, if your target market is retired people over the age of 60,
you may find that buying habits (requirements and quantity of purchase) vary
by geographic region or by income level.
Finally, census data can be used to arrive at an estimate of how many target
customers are within the geographic boundaries of the target market. Then,
2 Hall, J.A. (1991) Bringing New Products to Market. New York: AMACOM.
within any geographic area, those who meet the particular demographic
requirements of the product/service can be segmented out.
Most communities have economic development departments or Chambers of
Commerce that keep statistics on local population trends and other economic
issues. Some communities have Small Business Development Centers (SBDCs),
branches of the Small Business Administration that contain a wealth of useful
information, as well as services, for small and growing businesses. Other
sources available in the library are reference books and trade journals on all
types of industries. Apart from the library, useful information can be found
from trade associations like the National Association of Manufacturers,
commercial research firms, and financial institutions. These resources will assist
you in determining the size and characteristics of the target market.
Measuring the Market with Primary Data

There are many ways to collect primary data in the target market. Among them
are mail surveys, phone surveys, interviews, focus groups, and product clinics.
Each has advantages and disadvantages over the other, and a decision to use
one or more of them is usually based on time and money.
Mail Surveys. Doing a mail survey entails designing a survey instrument,

usually a questionnaire, that provides the entrepreneur with the desired infor¬
mation. Questionnaire design is not a simple matter of putting some questions
on a piece of paper. There are, in fact, proven methods of constructing ques¬
tionnaires to help ensure unbiased responses. It is not within the scope of this
text to present all the techniques for questionnaire construction; however, a few
key points should be remembered.
• Keep the questionnaire short with lots of white space so the respondent is
not intimidated at the outset.
• Be careful not to ask leading, biased questions.
• Ask easy questions first, leading up to the more complex ones.
• Ask demographic questions (age, sex, income) last when the respondents
attention span has waned. These questions can be answered very quickly.
• For questions people generally hesitate to answer (age, income), group
possible responses in ranges (25-35 for age, $35,000-$45,000 for income) so
the respondent doesn't feel he or she is giving away very private information.
• Keep in mind that people generally increase their income classification one
class and decrease their age one class.
Mail surveys are a relatively easy way to reach a lot of people in the target
market and take less time than many other methods. However, mail surveys do
have a few weaknesses.
• The response rate is generally very low, usually around 15 percent, which
means that about 85 of every 100 persons sampled do not respond.
Consequently, the potential for non-response bias makes it difficult for the
entrepreneur to feel very comfortable about the reliability of the results.
• The entrepreneur does not have the benefit of non-verbal communication as
would be the case with an interview. This is significant when you consider at
least 85 percent of all communication is non-verbal.
• The entrepreneur has no way of questioning or clarifying a response.
• There is no control over the accuracy of the information given.
• Normally, a second, follow-up mailing is necessary to achieve the desired
response rate.
Phone Surveys. Like mail surveys, phone surveys also use questionnaires so
consistency in the questions asked can be achieved. Phone surveys have two
particular advantages over mail surveys. They allow for explanation and clarifica¬
tion of questions and responses, and the response rate is higher. However phone
surveys take more time to accomplish and are more prone to surveyor bias; that
is, there is more opportunity for the person conducting the survey to bias the
results by the tone in his or her voice or by unscripted comments. In addition,
phone surveys lack the benefits of observing non-verbal communication.
Interviews. Although more costly and time consuming than mail or phone
surveys, interviews have many advantages.
• They provide more opportunity for clarification and discussion.

• They enjoy the advantages of non-verbal communication. The entrepreneur
will be better able to discern the veracity of what the interviewee is saying.
• The response rate is high.
• Interviews permit open-ended questions that can lead to more in-depth
information.
• They provide an opportunity to network and develop valuable contacts in
the industry.
Where time and money permit, interviews are probably the best source of
valuable information from customers, suppliers, distributors, and anyone else
who can help the new venture. It is also possible, however, to use a combina¬
tion of techniques. For example, the entrepreneur may start with phone surveys
to obtain basic information and follow up with interviews with the most useful
sources.
Choosing the Sample. All three techniques described above require the selection
of a sample from the target market. This step in measuring the market should be
done with great care for it will determine the validity of the results achieved. In
general, you want to attempt to choose a random sample, that is, one in which
you have as little control as possible over who will be selected to participate in
the sample. Most entrepreneurs, because of cost and time, choose to use what is
called a convenience sample. This means that not everyone in the defined
target market has a chance of being chosen to participate. Instead, the entrepre¬
neur may, for example, choose to select the sample from people who happen to
be at a particular shopping mall on a particular day. Clearly, the entre¬
The credibility preneur will not be reaching all possible customers at that mall, but if
the target customer typically shops at malls, there’s a good chance of
of your market
achieving at least a representative sample from which results can be
research results derived fairly confidently.
will be measured by Even if a convenience sample is used, there are ways to ensure the
randomness of selection of the participants. Using the mall example,
the quality of the
the entrepreneur can decide in advance to survey every fifth person
sample you select.
who walks by. In this way, the person is not chosen based on their
attractiveness or lack of it, or any other reason for that matter. A
random number generator on a computer can select names from a telephone
book. Whatever system is employed, the key point is to make an effort not to
bias the selection.
Often you will hear potential entrepreneurs say they took a sample of friends
and relatives who loved the new product idea. Friends and relatives may be
able to give you some initial feedback, but they are not the best source of unbi¬
ased information. Remember, one of the reasons you are doing a feasibility
study and, ultimately, a business plan is to convince others about the viability of
the new venture concept. The credibility of your market research results will be
measured by the quality of the sample you select.
Focus Groups. One more efficient way to gain valuable information before
investing substantial capital in production and marketing is to conduct a focus
group. The entrepreneur brings together a representative sample of potential
customers for a presentation and discussion session. Assuming the new venture
involves a consumer product, the entrepreneur may choose to introduce the
new product in concert with other products to test the unsolicited response to
the product when presented with its competition. For example, suppose your
product is a new type of non-alcoholic beverage. You might serve the new
beverage along with several competitors’ beverages in glasses labeled with
numbers, and then solicit feedback on taste, aftertaste, and so on.
Some products and services do not easily lend themselves to blind studies
like the one just described. In those instances, the product can simply be
presented to the focus group and their opinions and feedback can be solicited.
It is important that the person leading the focus group have some knowledge of
group dynamics and be able to keep the group on track. Many times these
focus group sessions are videotaped so the entrepreneur can spend more time
analyzing the nuances of what occurred. Thus, in many ways, focus groups can
often prevent the entrepreneur from making the costly error of offering a
product or service for which there is little or no interest.
Clinical Studies. Clinical studies are one of the more expensive routes to gath¬
ering market data, and, in general, are used by large corporations introducing
new products. A clinical study takes place in a controlled setting and is most
often used for consumer products. Consumers are asked to visit a test center,
which may be set up as a small store. They are given a certain amount of money
and asked to choose among a variety of new products available in the test store,
which helps the company learn which products are most attractive to
customers. In another type of study, consumers may be asked to do blind
testing of products such as shampoos or food products to compare tastes and
preferences.
Forecasting l\lew Product/Service Demand

One of the most difficult tasks facing the entrepreneur is forecasting the
demand for the new product or service, particularly if that product/service has
never existed previously in the marketplace. Adding to this difficulty is the fact
that most entrepreneurs do their own research because they generally don’t
have sufficient resources prior to start-up to hire professional market research
firms. However, doing your own market research does have the advantage of
giving you a clearer sense of your target market and its needs. A number of
different techniques can assist you in arriving at a realistic forecast of demand.
Using Historical Analogy or Substitute Products

If the new product is an extension of a previously existing product, it may be
possible to extrapolate from that product’s demand to yours. For example, the
demand for compact discs was derived from the historical demand for cassette
tapes and records. In other cases it may be possible to substitute another
product in the same industry to give an indication of demand potential,
assuming the same target market.
Interview Prospective End-Users and Intermediaries

No one knows the market better than the men and women who work in it
every day. They are typically very astute at predicting trends and patterns of
buyer behavior. Spending time in the field talking to customers, intermediaries
(distributors or wholesalers, sometimes referred to as “middlemen”), retailers,
and the like can provide a fairly good estimate of demand.
Go into Limited Production

Sometimes the only way to test the reaction of potential customers is to
produce a small number of products and put them in the hands of people to
test. This is also an appropriate next step if the first two techniques have
produced positive results. Not only will limited testing of the product gauge
customer satisfaction, but it may suggest possible modifications to improve the
product. These samples of the product are called prototypes. Prototypes are
generally associated with product companies but, in fact, service businesses
must also develop a prototype of the operation or procedures involved in deliv¬
ering the service. Prototyping permits the testing of a product or service in the
actual environment in which it will be used. It is difficult to conduct mean¬
ingful market research without a working prototype as most potential
customers need to see and use the actual product before they can become
enthusiastic about it. Construction of a prototype will also facilitate estimating
costs to actually produce the product later on.
Do a Formal Test Market

Where the product is fairly complex and expensive to produce, doing a formal
test market in a selected geographic area can provide valuable information on
demand and acceptance of the product prior to spending substantial capital for
a major product roll-out. The movie industry regularly introduces new movies
with a “limited release” in a few strategic theaters. In this way, they can gauge
no Part 2 • Finding, Analyzing, and Testing Opportunity
PROFILE 6.2
The WaterBabies Prototype

Daniel Lauer became an entrepreneur by entering one of the most difficult industries
of all, the toy industry. At the annual International Toy Fair in New York, about 5,000-
6,000 toys are introduced, but fewer than 100 actually survive in this cutthroat
market. Daniel Lauer was one of the lucky ones. His first toy, the WaterBabies® doll,
sold 2 million copies in 1991. The prototype for the water-filled baby doll consisted of
two water-filled balloons for the head and body, and 4 water-filled condoms for the
arms and legs. No one was interested at that stage of development. It was not until
Lauer had raised the money to make the finished doll, the production quality proto¬
type, run television commercials, and sold the doll in 85 stores that he was able to
interest major toy companies. Playmates outbid two other companies for the doll. The
WaterBabies® doll is now in her fifth year with over five product extensions and sales
of over 4.5 million total units.
the audiences reactions and make changes based on them before releasing the
film on a national basis. Major product companies like Procter and Gamble will
put a new product into certain geographical test markets like Denver, Colorado
to get feedback from customers. Many a new product has met an untimely
death as a result of these test market studies.
The Cost/Benefit of Market Research

Market research is undoubtedly one of the more expensive aspects of starting a
business, and it is time consuming as well. For these reasons, and because
many entrepreneurs don’t know how to conduct market research or they
believe their product or service is so good that customers will automatically
desire it, the market analysis section is probably the least-well-researched and
written section of the business plan. Yet good market research answers the
question, “Is there a demand for my product or service?” Surely that is the most
crucial question an entrepreneur can answer.
Despite the importance of market research, the entrepreneur needs to weigh
the cost of doing certain types of market research against the benefits of getting
the product/service into the market quickly. In todays dynamic business envi¬
ronment, this is a real concern. Spending too much time on market research
can result in losing a window of opportunity for entering the market. Some
basic market research techniques can provide excellent information at very little
cost and relatively quickly.
• Use focus groups to gauge potential customer reaction.

• Observe buyer behavior at random times in outlets where the product may
be offered.
• Use small, representative segments of the target market to test the
product/service.
• Examine case studies of similar companies.
• Study census data for demographic information.
Presenting the Market Analysis in the Feasibility Study or Business Plan

As with the industry profile, the data collected during target market research
needs to be presented so the reader gets a clear picture of who the targeted
customer is and how much the new product/service is desired by that
customer. Following the outline in Figure 6.3 will help you organize this
section of the feasibility study or business plan.
Figure 6.3: Market Analysis
Target Market
Secondary markets
Demographics
Unique features
Competitors
Direct and Indirect
Market share
Strengths and weaknesses
Emerging
Substitute products
Preliminary Conclusions as to Feasibility

Once the market study is completed, the entrepreneur is in a good position to
answer the question:
Is there sufficient demand for the product or service

the new venture will offer?
If the entrepreneur has personally conducted the research and done all the
work to this point, he or she will not only have important information to help
make the decision but will also have an intuitive or “gut feeling” as to whether
the new venture concept is viable or not. If market indicators are positive, it is
time to consider other aspects of feasibility and proceed to test the business
concept further.
On the other hand, many entrepreneurs will find it difficult to abandon an
idea with which they have “fallen in love,” even in the face of market data indi¬
cating demand for the new product/service is weak. When this happens, it is
important to remember that without customers there is no business. It is far
better to abandon a business concept at this point than to venture ahead to the
more costly aspects of a business start-up and ultimately fail.
[7[ New Venture Checklist

Have you:
□ Defined the target market for your product or service?
□ Identified direct, indirect, and emerging competitors?
□ Described your product or service’s competitive advantage?
□ Listed the information you need to gather to do the market analysis?
□ Researched secondary data sources such as census data on demographics?
□ Determined the most effective method for gathering primary data on your
target market?
□ Estimated demand for the product or service?
D Organized, analyzed, and presented the data to answer the key question: Is
there sufficient demand for the product or service?
fr— ' ^ Andreason, A.R. (1988). Cheap But Good Marketing Research. Burr Ridge, IL:
Irwin.
Breen G. &r Blankenship A.B. (1989). Do-It-Yourself Marketing Research. New
York: McGraw-Hill, Inc.
Crispell, Diane. (1990). The Insider’s Guide to Demographic Know-How.
Chicago: Probus.
Findex: The Directory of Market Research Reports, Studies and Surveys. (1990).
Gaithersburg, MD: Cambridge Information Group Directories.
Levinson J.C. (1984). Guerrilla Marketing. Boston: Houghton Mifflin.
Issues to 1. What is the value of defining a market niche?
Consider 2. Why is it important to do secondary market research before primary market

research?
4l 3. What advantages do interviews have over other data collection methods?

4. Suppose you want to determine the demand for your new product, a new
type of fast food dessert. What methods would you use to forecast demand?
5. Market research can be an expensive, time-consuming process. What can
you do to minimize the costs while still achieving your goals?
■J'
CHAPTER 7
Distribution Channels: Getting the

Product or Service to the Customer
Overview
• Consumer versus industrial distribution channels
• The role of the distributor in the marketing of a product
• The role of manufacturers’ reps
• Adding value through distribution channels
• Distribution channel information in the feasibility study and business plan
Choosing a Distribution Channel

With a target market well defined and sufficient demand estimated to exist, the
entrepreneur faces the important task of deciding how to get the product or
service to the customer. A distribution channel is, quite simply, the route a
product takes from the manufacturer to the customer or end-user. Depending
on the type of new venture, there are many choices available. Each choice will
have distinct advantages, disadvantages, and consequences, and will to some
extent dictate the kind of organization the new venture becomes.
Recall the business concept of the computer program that will revolutionize
the way manufacturers control inventory in Chapter 3. Each of the different
methods of getting the product to the customer involves the development of a
different type of business: retail, mail order, licensing, and so forth. Further¬
more, the channel of distribution determines to some extent your products
cost, the potential for loss or damage through transit, and how quickly the
product reaches the customer. Finding the most efficient and effective channel
can provide a new venture with a distinct competitive advantage.
115
There are two types of distribution channels: direct and indirect. In a direct
channel of distribution, the product or service moves from the manufacturer or
producer directly to the customer. Service businesses generally operate in this
fashion. For example, when you call a plumber to fix a pipe or call your
accountant to do your taxes, the work is handled directly by the company you
called with no one else involved. Selling through mail order is another way of
using a direct channel. When manufacturers sell to the customer through one
of their manufacturer’s outlets, they are also using a direct channel.
An indirect channel of distribution involves one or more intermediaries,
people who move products from the manufacturer or producer to the end user.
They include wholesalers, retailers, distributors, and agents. For example,
suppose you are producing paper products such as cups and plates, etc. When
the product leaves the production facility, it may go to a wholesaler who will
then secure retailers. The retailers job is to advertise and find customers who
will buy the product. Depending on the kind of business the entrepreneur
plans to start, he or she will be dealing either with consumer channels or indus¬
trial channels of distribution.
Consumer Channels of Distribution

Consumer market channels are used by businesses that sell to people who
purchase consumer goods at the wholesale or retail level. There are several routes
by which manufacturers can reach their target customers. (See Figure 7.1.)
Figure 7.1: Channels of Distribution
CUSTOMER CUSTOMER CUSTOMER CUSTOMER CUSTOMER

Chapter 7 • Distribution Channels: Getting the Product or Service to the Customer 117
Direct Selling
The most direct channel in the consumer market is to sell to the customer
using no intermediaries. As discussed earlier, service businesses usually fall
into this category. However, in the past few years a number of manufacturers
have also begun bypassing intermediaries and selling directly to their
customers. Clothing, household, and furniture manufacturers, to name a few,
have opened “outlets” in special factory outlet malls located away from major
metropolitan areas. Generally manufacturers sell direct after they have an
established following through their normal channels so name recognition is
present and little marketing effort is necessary. The outlets are a good way to
get rid of excess inventory and slightly defective merchandise that can’t be sold
in their normal retail outlets. The substantial discounts attract customers from
considerable distances.
Retailers
The most common way for manufacturers to get their products to customers is
through retail stores, which are responsible for sales and advertising of the
product. Using this channel, the manufacturer does not have to incur the
expense of maintaining a sales staff or stores. However, without a distributor,
the manufacturer needs manufacturer’s reps or in-house sales people to locate
potential retail customers and arrange for distribution of the product.
Wholesalers/Distributors
Wholesalers or distributors (the terms are interchangeable in common usage)
buy products in bulk from manufacturers and then seek retail outlets to reach
the consumer. The wholesaler removes from the manufacturer the responsi¬
bility of finding suitable retail outlets for the products. A distributor can mean
the difference between success and failure for a business. When you realize
you are entrusting your most valuable assets—your customers—to the distrib¬
utor, it becomes clear that selecting a distributor is a crucial part of the start¬
up process. Not only will good distributors contribute to increased sales, but
they will help with product planning for the future.. The specifics of what a
distributor may do depend on the distributor. Some of the tasks performed by
them are:
• Warehousing products
• Advertising and promotion
• Packaging and displays

• Training retail sales personnel
• Assisting with transportation to retailers
• Providing service back-up
• Restocking retailers’ shelves
The key to finding a good distributor is knowing whom to ask. Some of the
sources of information on distributors are:
• Customers
• Suppliers
• Lawyers
• Business consultants
• Bankers (they have knowledge of a distributor’s payment record)
Look for a distributor who provides good service, prices competitively to

retail outlets, and is trustworthy. When that distributor is chosen, execute a
written contract with the distributor and monitor performance on a regular
basis by sampling retail customers to determine if they are satisfied with the
product and the service they are receiving from the distributor.
Logistics Firms
It takes a long time before a new venture can justify having its own distribution
center. Consequently many growing companies are outsourcing their pack¬
aging, warehousing, inventory control, and trucking requirements to third-
party logistics firms. In distribution terminology, logistics is the timely
movement of goods from the producer to the consumer. In addition to other
services, logistics firms can negotiate the best deals and the most efficient
carriers, potentially saving the growing venture thousands of dollars.
Agents/Manufacturers’ Reps
Often manufacturers/producers retain agents, brokers, or manufacturers’ reps to
find suitable outlets for their products. These agents arrange agreements with
wholesalers and retailers for the manufacturer. Agents usually do not buy or
hold an inventory of goods from the manufacturer; instead, they bring together
manufacturers and distributors or retailers to establish the most efficient
distriution channel. The manufacturer or producer shares the cost with other
manufacturers represented by the agent and pays a commission only on what
the agent sells.
Manufacturers’ representatives are essentially independent salespeople who
handle the manufacturers business in specific territories and are paid on
commission. Unlike agents who bring buyers and sellers together for indi¬
vidual transactions, manufacturers’ reps work with a specific manufacturer on
a continuing basis, receiving a commission per product sold. Reps may also
provide warehousing in a territory and handle shipping the product to the
retailer.
Industrial Channels of Distribution

Industrial markets consist of customers who purchase goods for use in their
businesses. In these markets the manufacturer is targeting another business,
perhaps even another manufacturer, for the sale of its products. The options
for industrial markets are similar to those in the consumer market. The manu¬
facturer can choose to sell directly to the industrial user using no intermedi¬
aries or can use distributors or manufacturers’ reps, who market to end-users.
Another alternative is to work with agents, who act as a sales force for the
manufacturer and either go through a distributor or directly to the industrial
user. (See Figure 7.2.)
Figure 7.2: Industrial Channels of Distribution
INDUSTRIAL INDUSTRIAL INDUSTRIAL INDUSTRIAL INDUSTRIAL

CUSTOMER CUSTOMER CUSTOMER CUSTOMER CUSTOMER
PROFILE 7:1
CALYX & COROLLA

Innovation in Distribution
Jumping from a catalog called “Gardener’s Eden,” which sold specialty gardening
tools, to a fresh flower catalog does not seem like a tremendous feat, but for Ruth
Owades it was a true leap of faith. Her goal in starting Calyx & Corolla was to give
customers the ability to see the fresh flowers they were buying in the catalog one day
and receive them the next. How was this idea different from sending flowers through
FTD?
Most flowers are cut (often in South America), shipped to a wholesaler (equiva¬
lent to a manufacturer/producer), then to a distributor and finally to a retailer. Before
they reach the customer, the flowers are six to ten days old. Owades wanted to
streamline this complicated distribution system to get the flowers to the customer
more quickly.
To accomplish her dream, Owades had to convince growers to be in the gift busi¬
ness and send smaller quantities than usual. She also had to find an overnight
shipper who was used to dealing with perishable items, and a way of shipping the
flowers undamaged. Federal Express agreed to work with her on the project.
Ruth Owades ultimately succeeded by making the people in her distribution
channel part of her start-up team, having them give input during each phase of the
start-up process. The alliances were formed to be mutually beneficial to all parties,
and as a result, Calyx & Corolla completed the start-up phase of the business more
quickly than most new companies.
The Value of Graphing Distribution Channels

Apart from the obvious value of seeing the various options available to get the
product or service to the customer, graphing the distribution channels will help
the entrepreneur do the following:
• Judge the time from manufacturing to purchase by the customer

• Determine the ultimate retail price based on the required markups by the
intermediaries
• Figure the total costs of marketing the product
All these factors are a function of the distribution channel chosen. Suppose
you are manufacturing a consumer product in the sporting goods industry.
Here is how you might compare the distribution options available to you. The
most common route to the consumer is:
Manufacturer —> Wholesaler —> Retailer —> Consumer
At each stage the channel member adds value to the product by performing a
service that increases the chances the product will reach its intended customer
(see Figure 7.3). The wholesaler seeks appropriate retail outlets, and the retailer
advertises and promotes the product to its customers. This value created allows
each channel member to increase the price of the product to the next channel
member. For example, the manufacturer charges the wholesaler a price that
covers the costs of producing the product plus an amount for overhead and
profit. The wholesaler, in turn, adds an amount to cover the cost of the goods
Figure 7.3: The Value Chain
Manuf acturer
Cost = $3
Differenc:e = Overhead + Profit
Sells at $6
Wholesaler / Distributor
Cost = $6
^ Differenc:e = Overhead + Profit
Sells at $10
Retailer
Cost = $10
^ Differenc:e = Overhead + Profit
Sells at $19.95
purchased and his or her overhead and profit. The retailer does the same and
charges the final price to the customer. That price can typically be 4-5 times
what it cost to manufacture the product (labor and materials).
Suppose you decide to bypass the wholesaler and sell directly to retailers:
Manufacturer —» Retailer
It appears on the surface that the final retail price could be substantially
lower, perhaps even priced at the rate the wholesaler sold to the retailer in the
first example. However, there is a flaw in this reasoning. The wholesaler
It is important for performed a valuable service. He or she made it possible for the manu¬
the entrepreneur to
facturer to focus on producing the product and not incur the cost of
consider all the
maintaining a larger marketing department, a sales force, additional
costs, advantages,
warehouses, and a more complex shipping department. All these activi¬
disadvantages, and
ties now become a cost to the manufacturer of doing business with
consequences of
choosing a retailers and must be factored into the decision to choose this distribu¬
particular market tion channel. This is not to say it never makes sense for manufacturers
channel to reach to sell direct to retailers. However, it is important for the entrepreneur
the customer. to consider all the costs, advantages, disadvantages, and consequences
of choosing a particular market channel to reach the customer.
Other aspects of starting the new venture can also be examined by studying
the distribution channel options. For example, location and transportation
decisions will be affected by the method chosen to reach the customer. Suppose
you have chosen the following channel:
Manufacturer —> Retailer
In this instance it may be advantageous to locate the manufacturing plant

near major transportation networks to hold down shipping costs. Now consider
the following channel:
Manufacturer —> Wholesaler —> Retailer —> Consumer
Here it is not important for the manufacturer to be located conveniently near

the retailer. Having a location that minimizes shipping costs to the wholesaler
becomes a more relevant issue.
If the entrepreneur is a retailer (or wholesaler), he or she looks at the distrib¬
ution channel from both directions. The customer will be reached directly but
looking back down the distribution channel, the retailer is also concerned with
finding a good distributor who represents quality manufacturers.
Presenting the Distribution Channel Information

in the Feasibility Study or Business Plan
Upon completing the market analysis, you can make a preliminary determina¬
tion of the feasibility of the business concept, at least to the extent of whether
there is sufficient demand for the new product or service. If sufficient demand
appears to exist, you can "proceed to gather and analyze the information needed
to complete a full business plan, which will show whether the business concept
makes sense from a financial and operations perspective. Describing the distrib¬
ution channels for the new product/service is the first step in gathering that
information. (See Figure 7.4.)
As the business plan outline indicates (Figure 2.3, p. 38), the distribution
channel section is a relatively small, albeit critical, section of the plan. It is
eminently important the entrepreneur seek out the most efficient and effective
means to reach the customer. For service businesses such as consulting or finan¬
cial services, the issue of the distribution channel is quite simple. The entre¬
preneur normally sells those services directly to the customer. Where the
entrepreneur is a manufacturer/producer who sells to a distributor, he or she
needs to be concerned about how the product will reach the customer and at
what price, because, ultimately, the end-user determines the entrepreneurs
success as a manufacturer.
The information on the distribution channel is normally placed in the
operations section of the business plan where the details of logistics and
distribution partnerships can be addressed. However, a general statement of
the channel of distribution to be used by the business should also be placed
in the Product/Service Plan as part of the description of the business. The
issue of distribution channels is revisited in Chapter 12, which discusses the
marketing plan.
Figure 7.4: Channels of Distribution
Define the Channel of Distribution

Channel Members
Comparison to Industry Norms
Justification for the Channel
Future Distribution Channels
El New Venture Checklist

Have you:
□ Decided if your new venture will operate in a consumer or industrial distribu¬

tion channel?
□ Determined the most effective channel of distribution to get your product or

service to the customer?
□ Planned how you will get information on the members of your distribution
channel so you can choose the best people to serve your business?
□ Figured the costs associated with the distribution channel you have chosen?
□ Determined the length of time it will take to get your product to the customer?
□ Organized the distribution channel section of the business plan?

American Logistics Management Association, 2000 Santa Cruz St., Anaheim,
CA 92805. 714-937-8970; FAX 714-937-0402.
Davidson, J.P. (1989). Marketing Sourcebook for Small Business. New York:
John Wylie Publishing.
Davidson, J.P. (1991). Selling to the Giants. Blue Ridge Summit, PA: Liberty
Hall.
Inbound Logistics Magazine. 5 Penn Plaza, Eighth Floor, NY 10001.
Levinson, J.C. (1989). Guerilla Marketing Attack: New Strategies, Tactics and
Weapons for Winning Big Profits for Your Small Business. Boston: Houghton-
Mifflin.
Lele, M. M. (1988). The Customer is Key. New York: John Wiley and Sons.
North American Logistics Association, 1300 W Higgins Road, Suite 111,
Park Ridge, IL 60068. 708-292-1891; Fax 708-292-1896.
Transportation and Distribution Magazine. 100 Superior Ave., Cleveland, OH
44114. 216-696-7000; Fax 216-696-4135.
1. How does direct selling in the consumer and industrial channels of distribu¬
Issues to
tion differ?
Consider
2. Is it possible to prepare a market plan for the new venture without identi¬
iji fying a distribution channel to reach the customer? Why or why not?
3. What kinds of companies may be involved in both consumer and industrial
channels?
4. What are the advantages of using distributors/wholesalers?
5. How does a distribution channel affect the price of the product or service?
I n 1988, John Allen was doing commercial real estate development in the San
Joaquin Valley in California. Allen had a group of subcontractors whom he
regularly hired to do various construction tasks. One of these subcontractors was
a man named Bill Nelson, a finish carpenter with a penchant for tinkering and
inventing things. Through prior conversation, Nelson had learned that Allen had
advanced degrees in engineering and had been previously employed as an engi¬
neer by an aerospace firm. Nelson had invented a portable machine to provide a
single source of power for electric and pneumatic tools. On the job, Nelson had
seen the need for such a product but felt that he didn’t have the skills to
commercialize the product. Consequently, Nelson approached Allen with his
invention to explore the possibility of retaining Allen for technical and financial
advice and support. He believed that Allens unique knowledge of engineering,
finance, and construction would result in a good match for his invention.
The original invention was a generator and compressor sitting on twin four-
gallon air tanks, and coupled to a small gasoline-drive engine. The concept was
quite simple: when the user started a power tool, a signal was sent to the
compressor head to open a valve and vent the compressor to the atmosphere,
thus reducing the demand on the drive motor and allowing full power to go to
the generator. This feature allowed the unit to be powered by a smaller, less
costly, lighter-drive motor. Prior attempts by other manufacturers to make a
combined unit resulted in heavy, bulky, and expensive products. Nelson felt he
had discovered the answer to this with his invention and had applied for a
patent to protect his idea.
Allen was intrigued by the concept but lukewarm on getting involved. As a
favor to Nelson, Allen made several inquiries to engineering and business asso¬
ciates but received very little encouragement for Nelsons invention. The topic
was dropped.
In 1989, Nelson came back to Allen and claimed that he had invented an
improvement to his original machine that would make it much more
marketable, unique, and innovative than his first attempt; however, he couldn’t
divulge his new invention until he had completed the prototype and had a non¬
disclosure statement signed by Allen. He then asked Allen for financial assis-
tance in patenting and developing this new invention without disclosing what
the invention was. Allen was naturally hesitant; however, he agreed to consider
getting involved after a demonstration of the working prototype.
Several months later, Nelson called Allen to ask if he could come over to
demonstrate his new invention. Nelson showed up in a dilapidated old Toyota
pick-up with the machine in the back, along with several other tools, electrical
cords, air hoses, and general clutter. The invention matched the general appear¬
ance of the vehicle and its cargo. It looked like it was put
together in a blacksmith’s shop from spare parts. Nelson
removed the unit from his truck and plugged an electrical cord
into one of the household receptacles attached to a piece of
wood, which was attached to his machine. The other end was
plugged into a power tool. He proceeded to walk away from
the unit with the power tool in his hand. At approximately
100 feet from the unit he pulled the trigger of the power tool
and the drive motor of the unit started up, and then the power tool started
working instantaneously. When he lay the tool down, the motor stopped. He
repeated this process several times. Needless to say, Allen was impressed.
Nelson had a modified air starter (small air drill) coupled to the drive motor
that would start the motor with a signal sent from the power tool. He was using
compressed air in the tanks (storage from the compressor) as a “battery” for the
air starter. It was ingenious. Allen agreed to get involved and assist in the finan¬
cial needs to file the patent and construct an engineered, functional prototype.
About this time, Allen formed Gentech Corporation to manufacture, sell, and
distribute the product. Through five years of engineering and prototype
building, the invention was improved to incorporate a solid state, program¬
mable controller which, with its additional features, has made the functions of
the machine more efficient and intelligent.
The Corporation
Gentech Corporation, a privately held California corporation, was established to
manufacture and distribute portable power equipment incorporating patented,
state-of-the-art technology and satisfying a need for efficient, energy-saving, and
environmentally friendly power equipment. PowerSource, the first product to be
offered by Gentech Corporation, is a combination air compressor and generator
unit mounted on a typical twin-tank, wheelbarrow-style frame. Driven by a
single gasoline engine, the dual purpose PowerSource provides both AC electric
power and air power from one portable, lightweight unit. When operating as a
generator, it supplies electrical power to 110-volt outlets. When an electrical
tool is in use, an electronic switching unit automatically sends a signal to open
a valve to vent the compressor piston to the atmosphere, thus significantly
reducing the demand on the engine. As long as there is air stored in the tanks,
air tools and power tools can be used simultaneously. A powerful AC generator
and a high output air compressor, the PowerSource eliminates the need to trans¬
port both a generator and compressor to the work site.
The benefits to the user are that PowerSource:
• Substantially reduces operating costs, using the power of one engine to

provide the output of two in a single, portable unit
• Significantly reduces fuel consumption, pollution, and costly maintenance
repairs with its on demand start/stop system
• Reduces the normal nuisance level of noise associated with gasoline engine-
powered generators and compressors that must run continuously
Improvements were accomplished through the use of programmable solid-

state electronics with a central control system containing the unique features
and functions of the invention on a 3 x 7 printed circuit board. The control
board is lightweight, relatively inexpensive, durable, and reliable. It is also
easily adapted and incorporated into other machinery benefiting from its func¬
tions. Patents for the switching unit (utility patent) and the configuration of the
combined unit (a design patent) were issued, while patents for a
demand/sensor, start/stop feature, timer delay mechanism, and idle down
feature are patent pending.
Allen negotiated with the inventor for a world-wide exclusive license to
manufacture, distribute, and sell the patented control system as a free-standing
“black box” for use on existing machines. A worldwide non-exclusive license
was granted to manufacture, distribute, and sell the combination unit incorpo¬
rating the patented control system. A royalty based on wholesale selling price
will be paid to Nelson.
The company intends to develop several different configurations and sizes of
the PowerSource so that it can be used in a variety of industries.
The Management Team

John Allen has a broad spectrum of education and experience in engineering
and business. With bachelors degrees in aerospace and industrial engineering
and master degrees in operations research and business administration, Allen
was an engineer for McDonnell-Douglas Astronautics. In the late 1970s, he left

engineering to start a successful company specializing in real estate develop¬
ment and investments. To date, he has managed matters pertaining to the engi¬
neering, development, patenting, and licensing of PowerSource for Gentech
Corporation.
Kathleen R. Allen, Rh.D. is an assistant professor in the Entrepreneur
Program of the University of Southern California and published author in the
field of entrepreneurship. She brings to Gentech Corporation ten years of busi¬
ness experience including the cofounding of two businesses. She also consults
to growing businesses on project feasibility, business planning, and market
strategy. She is responsible for the development of the business plan, marketing
strategy, and creating the infrastructure for the organization of Gentech
Corporation.
Michael D. Ream brings 20 years of experience in mechanical engineering,
marketing, sales management, and manufacturing to Gentech. He has success¬
fully developed and launched new products into U.S. and international
construction rental markets. He has extensive experience with JIT manufac¬
turing and Quality Function Deployment as well as P &r L responsibility. He is
presently a vice president and officer of a leading international manufacturer of
serial work platforms.
Industry Profile
Gentech Corporation and its product PowerSource will operate in the motors and
generators (SIC 3621) and air and gas compressors (SIC 3563) industries,
which are mature industries with many companies. The industries and leading
75 companies in each industry in the United States are summarized as follows:
Motors & Air & Gas

Generators Compressors
Number of establishments in total industry 467 241
Total sales in leading 75 companies ($ million) 80,554 4,370
Total employment 72,600 24,500
Proportion of total industry in GENTECH’s
target market 5.2% 8%
The motors and generators industry in the United States is dominated by

General Electric (GE), which does over $59 billion in annual sales as compared
to its closest competitor, Emerson Electric Co, which does over $7.5 billion. By
comparison, more than half of the leading 75 companies do under $100

million in annual sales. It should be noted that most of GEs motors go into
their own products, such as household appliances.
The air compressor industry is comprised of much smaller companies. The
largest producer is Thomas Industries Inc., with annual sales of $462 million.
Three-quarters of the 75 leading American companies have sales under $100
million.
Several manufacturers of either gas or electric air compressors and gas gener¬
ators produce individual generator and compressor units for the market under
consideration by Gentech Corporation. Thomas, Emglo, Ingersol-Rand, Rol-Air,
and Campbell-Hausfeld are strong in air compressors, while Honda, General
Electric, Generac, Kohler, and Winco are their counterparts in generators. Rol-
Air and Emglo were the only companies found to produce a
combined unit; however, their units weigh in excess of 600
pounds and cost over $2,400. Also, the air compressor and
generator functions cannot be used simultaneously, but must
be manually switched at the machine. Therefore, as far as
could be determined through a preliminary search, there is
no comparable product on the market today providing all
the functions and features of this unit. Utilizing the patent
rights protection and an aggressive market strategy, this situation has a high
probability of continuing into the foreseeable future.
The number of new motor and generator companies increased at an annual
rate of about three percent per year for the past two years. Employment
declined by six percent between 1989 and 1990; similarly the value of ship¬
ments declined by six percent during the same period.
The number of air compressor companies has been declining at about three
percent per year; however employment was up three percent between 1989 and
1990, and the value of shipments increased nine percent during the same
period.
Both industries are mature, fairly stable, with little room for substantial
growth using the current technology. For this reason Gentech Corporation is
targeting a niche market and incorporating new technology with proprietary
rights that can also be used on existing motors, generators, and compressors.
The industry in general has experienced little or no significant technological or
innovative advancements for several years. The use of a patented, solid state,
programmable control system to enhance the efficiency and function of the
power plant is unique and will result in a competitive advantage during the
market entry and roll-out program.
Target Market
Initially the target market is the niche market of the small building contractor or
subcontractor. During the first year of operation, the marketing effort will be
limited territorially to California and the western states, with the initial entry
through construction equipment rental outlets. There are over 12,000 equipment
rental outlets nationally and over 2,000 in California alone. Equipment rental
outlets typically replace their equipment annually, selling the used equipment.
This practice allows Gentech Corporation the ability to generate clients who will
have a need to purchase PowerSource on a regular basis. Using a preproduction
quality prototype, demonstrations to potential distributors, end-users, and
investors were conducted. The response indicated that there is a need for this
product, and the special features make it competitive with existing single
purpose units. The consensus has been that this niche market product could
have a significant customer base; those participating in the demonstrations were
extremely enthusiastic about the product potential. Based on these findings
Gentech Corporation is conservatively estimating demand at 1,800 units in the
first year, 3,600 in the second year in the western United States.
As the market and product mix are expanded, additional users will be identi¬
fied and targeted. Other classes of users may include farmer, mechanics,
commercial fishermen, domestic do-it-yourselfers, the military, utility compa¬
nies, and federal, state, and local government services and agencies.
Assembly and Distribution

During the early stages in the development of the business Gentech Corporation
does not intend to manufacture any parts but will subcontract to specialty
manufacturers for parts that cannot be purchased “off the shelf’ from suppliers.
Initially, the product will be assembled in California, but discussions are under
way with a compressor manufacturer/distributor on the east coast with the
potential for either subcontracting with the east coast company or merging the
two companies and producing the product on the east coast. One advantage to
this strategy is that the bulk of Gentech Corporation’s suppliers are located east of
the Mississippi River, which would cut transportation costs and delivery time
significantly.
The initial distribution strategy will be direct shipment to equipment rental

outlets and the use of manufacturers reps to contact wholesale distributors.
After the start-up phase is successfully completed, other distribution channels
will be examined.
• Direct shipment to customers from the plant

• Contracting with existing wholesale distributors
• Setting up factory-owned regional wholesale distribution outlets with some
direct sales to customers
• Exporting the product
At this time, the founding team is not certain what the post start-up strategy
should be.
1. What is the competitive advantage that Gentech Corporation has?

2. What are Gentech Corporations options for types of businesses to start?
3. How would you evaluate the management team for start-up?
4. Given the information in the case, should Gentech Corporation move to the
next level of evaluation? Why or why not?
The New Venture
and the Law
If laws could speak for themselves, they would first

complain of the lawyers who wrote them.
-LORD HALIFAX
CHAPTER 8
The Legal Structure

of the Business
Overview
• The legal structure options for new ventures
• The pros and cons of incorporating
• The requirements, advantages, and disadvantages of a sub-chapter S election
• Forming a 501 (c)(3) non-profit corporation
The Legal Structure of the New Venture

All businesses operate under one of several legal structures—sole proprietor¬
ship, partnership, or corporation—with variations on each. The legal structure
of a new venture has both legal and tax ramifications for the entrepreneur and
any investors; consequently the entrepreneur must carefully consider the
advantages and disadvantages of each form. It is also quite possible a business
might change its legal form sometime during its lifetime, usually for financial,
tax, or liability reasons. These situations will be discussed as each legal form is
considered.
Before examining the various legal forms, consider the following questions,
as they affect your ability to select certain legal structures:
1. Do you have all the skills needed to run this venture?

2. Do you have the capital required to start the business alone or can you raise
it through cash or credit?
3. Will you be able to run the business and cover your living expenses for the
first year?
135
136 Part 3 • The New Venture and the Law
4. Are you willing and able to assume personal liability for any claims against
your business?
5. Do you wish to have complete control over the operation of the business?
If you answer “yes” to all these questions, you may be able to use the sole
proprietor form of organization for the new venture.
Typically, issues arise when setting up your company. Figure 8.1 compares
the various legal forms of ownership.
Figure 8.1: Comparative Legal Structures
Sole
Issues Proprietorship Partnership C-Corporation
Number of Owners One No limit No limit on
shareholders
Start-Up Costs Filing fees for DBA Filing fees for DBA. Attorney fees for
and business license Attorney fees for incorporation
partnership agreement documents,
filing fees
Liability Owner liable for all General partners liable Shareholders liable
claims against for all claims. Limited to amount invested.
business only to amount of Officers may be
investment personally liable
Life of Business Dissolution on the Dissolution on the No effect

death of the owner death or separation of
a partner unless
otherwise specified in
the agreement. Not so
in the case of limiteds
Transfer of Interest Owner free to sell General partner requires Shareholders free to
consent of other sell unless restricted
generals to sell interest. by agreement
Limiteds’ ability subject
to agreement
Distribution of Profits Profits go to owner Profits shared based on Paid to shareholders

partnership agreement as dividends according
to agreement and
shareholder status
Management Control Owner has full control Shared by general Rests with the board
partners according to of directors who are
partnership agreement appointed by the
shareholders
Chapter 8 • The Legal Structure of the Business 137
Sole Proprietorship
Nearly 76 percent of all businesses in the United States are sole proprietor¬
ships, most probably because it is the easiest form to create. In a sole propri¬
etorship, the owner is the only person responsible for the activities of the
business. Likewise, the owner is the only one to enjoy the profits and suffer
the losses.
To operate as a sole proprietor requires nothing more than a DBA if the
entrepreneur does not use his or her name as the name for the business. A
DBA is a “Certificate of Doing Business Under An Assumed Name” and can be
obtained by filing an application with the appropriate local government
agency. The certificate, sometimes referred to as a “fictitious business name
statement,” ensures that yours is the only business in the area (usually a
county) using the name you have chosen and provides a public record of busi¬
ness ownership for liability purposes. For example, Anthony Jackson and
Associates does not require a DBA if the entrepreneurs name is Anthony
Jackson, but Corporate Consultants does.
Sole proprietorships have several advantages.
• They are easy and inexpensive to create.

• They give the owner complete authority.
• The income from the business is taxed only once at the owners personal
income tax rate.
There are, however, some disadvantages that deserve serious consideration.
• The sole proprietor has unlimited liability for all claims against the business;
that is, any debts incurred must be paid from the owners assets. Therefore,
the sole proprietor puts at risk his or her home, bank accounts, and any
other assets. In the current litigious environment, exposure to lawsuits is
substantial. To help mitigate this liability, a sole proprietor should obtain
business liability insurance, including errors and omissions coverage.
• It is more difficult to raise debt capital because the owners financial state¬
ment alone often may not qualify for the amount needed.
• The sole proprietor usually relies on his or her skills alone to manage the
business. Of course, employees with specific skills can be hired to comple¬
ment the skills of the owner.
• The business’s ability to survive is dependent on the owner and, therefore,
the death or incapacitation of the owner can be catastrophic for the business.
Often small businesses such as shoe repair shops and boutiques are run as
sole proprietorships. This is not to say that a high-growth venture cannot be
started as a sole proprietorship; it just will in all likelihood not remain a sole
proprietorship for long as the entrepreneur will typically want the protections
and prestige a corporation afford.
Partnership
When two or more people share the assets, liabilities, and profits of a business,
the legal structure is termed a partnership. The partnership form is an
improvement over the sole proprietorship from the standpoint that the business
can draw on the skills, knowledge, and financial resources of more than one
person. Like the sole proprietorship, however, the partnership requires a DBA
when the last names of the partners are not used in naming the business.
Professionals like lawyers, doctors, and accountants frequently employ this
legal structure.
A partnership is essentially a sole proprietorship involving more than one
person in terms of its advantages and its treatment of income, expenses, and
taxes. However, where liability is concerned, there is a significant difference. In a
partnership, each partner is liable for the obligations another partner incurs in
the course of doing business. For example, if one partner signs a contract with a
supplier in the name of the partnership, the other partners are also bound by the
terms of the contract. However, creditors of an individual partner can only attach
the assets of that individual partner, including their interest in the partnership.
Partners also have specific property rights. For example, each partner owns
and has use of the property acquired by the partnership unless otherwise stated
in the Partnership Agreement. Each partner has a right to share in the profits
and losses, and each may participate in the management of the partnership.
Furthermore, all elections such as depreciation and accounting methods are
made at the partnership level and apply to all partners.
Though the law does not require it, it is wise for a partnership to draw up a
written partnership agreement, based on the Uniform Partnership Act, that
spells out business responsibilities, profit sharing, and transfer of interest. This
is because partnerships are inherently fraught with problems that arise from the
different personalities and goals of the people involved. A written document
executed at the beginning of the partnership will reduce the eventual disagree¬
ments and provide for an orderly dissolution should irreconcilable differences
arise. Partnerships are burdened by the same disadvantages as sole proprietor¬
ships with the additional encumbrance of personal conflicts, usually over
power and authority, that can result in the dissolution of the partnership. Many
partnerships have solved much of this problem by assigning specific responsi¬
bilities to each of the partners.
There are two types of partnerships: general and limited. In a general part¬
nership, all the partners assume unlimited personal liability and responsibility
for the management of the business. In a limited partnership, by contrast, the
general partners seek investors whose liability is limited to their monetary
investment; that is, if a limited partner invests $25,000 in the business, the
most he or she can lose if the business fails is $25,000. It is important to note,
however, that limited partners have no say in the management of the business.
In fact, they are restricted by law from imposing their will on the business. The
penalty for participating in the management of the business is the loss of their
limited liability status.
Corporation
A corporation is different from the preceding two forms in that it is a legal
entity in and of itself. The U.S. Supreme Court has defined the corporation as
“an artificial being, invisible, intangible, and existing only in contemplation of
the law.” It is chartered or registered by a state and can survive the death or
separation of the owner(s) from the business. The owners of the corporation are
its stockholders who invest capital in the corporation in exchange for shares of
ownership. Like limited partners, stockholders are not liable for the debts of the
corporation and can only lose the money they have invested.
Most businesses form what is known as a closely held corporation; that is,
the corporate stock is owned privately by a few individuals and is not traded
publicly on a securities exchange such as the New York Stock Exchange. This
chapter will focus on private corporations. The issue of “going public” typically
arises after the business is established and desires to raise substantial capital for
growth by issuing stock through an initial public offering (IPO). The IPO and
public corporations in general are the subject of Chapter 17.
A corporation is created by filing a Certificate of Incorporation with the state
in which the company will do business and issue stock. It also requires the
establishment of a board of directors, which meets periodically to make
strategic policy decisions for the business. The regular documentation of these
meetings is crucial to maintaining the corporations limited liability status. The
board also hires the officers who will run the business on a day-to-day basis.
The C-corporate form (a variation of this most common form, the S-corp.,
will be discussed later) has several important advantages.
• It enjoys limited liability in that its owners are liable for its debts and obliga¬
tions only to the limit of their investment. The only exception to this protec¬
tion is payroll taxes that may have been withheld from employees’ paychecks
but not paid to the Internal Revenue Service.
• Capital can be raised through the sale of stock up to the amount authorized
in the corporate charter; however, the sale of stock is heavily regulated by
federal and state governments. A corporation can create different classes of
stock to meet the various needs of its investors. For example, it may issue
non-voting preferred stock to conservative investors who, in the event
A corporation can
the corporation must liquidate its assets, will be first in line to recoup
create different
their investment. Common stock is more risky because holders of it are
classes of stock to
paid only after the preferred stockholders. Common stockholders are
meet the various
entitled to vote at stockholders’ meetings and divide the profits
needs of its
investors. remaining after the preferred holders are paid their dividends, assuming
these profits are not retained by the corporation to fund growth.
• Ownership is easily transferred. This is at once an advantage and a disadvan¬
tage as the entrepreneur will want to be careful, particularly in the start-up
phase, that stock does not land in the hands of undesirable parties such as
competitors. This problem is normally handled through a buy-sell clause in
the stockholders’ agreement that states that stock must first be offered to the
corporation at a specified price before being offered to someone outside the
corporation.
• The corporation can enter into contracts, sue, and be sued without the signa¬
ture of the owners. In a start-up or young company, bankers, creditors, and
such will likely require that majority stockholders or officers personally guar¬
antee loans. This is because often a new corporation will be wholly owned
by the entrepreneur; that is, the entrepreneur or the founding team holds all
the issued stock. As the company does not have a track record and is in a
high-risk phase of development, creditors protect themselves against the
potential failure of the corporation by requiring the signatures, thus giving
them the ability to pursue the assets of the owners.
• Corporations often enjoy more status and deference than do other legal
forms, principally because they are a legal entity that cannot be destroyed by
the death of one or all of the principal shareholders. Moreover, to enter the
public equity markets, a business must be incorporated. Also, the perception
is that corporations probably keep better records than other forms of owner¬
ship because they tend to be under greater scrutiny from governmental agen¬
cies. The reason for this scrutiny is the fact that the assets of the corporation
are separate from the assets of the individual owner/shareholders.
• Corporations can take advantage of the benefits of retirements funds, Keogh

and defined-contribution plans, profit-sharing, and stock option plans.
These fringe benefits are deductible to the corporation as an expense and not
taxable to the employee.
• The entrepreneur can hold certain assets such as real estate in his or her own
name and lease the use of the assets to the corporation.
Corporations do, however, have disadvantages that must be carefully consid¬

ered. They are certainly more complex, subject to more governmental regula¬
tion, and cost more to create. While it is possible to incorporate without the aid
of an attorney, it is not recommended. Too many cases can be cited of busi¬
nesses that ultimately failed or endured significant financial hardship because
they did not incorporate properly at the start of the business.
A more cumbersome disadvantage derives from the fact that the corporation
is literally a person for tax purposes. Consequently, if it makes a profit, it must
pay a tax whether or not those profits were distributed as dividends to
C-corporations pay
taxes on the profits the stockholders. And unlike the partnership or sole proprietorship,
they earn and their stockholders of C-corporations do not receive the benefit of losses (in
owners (stock¬ the next section a corporation form that does enjoy these benefits will be
holders) pay taxes discussed). In a C-corporation those losses, if they can’t be applied in
on the dividends the year they were incurred, must be saved to be applied against future
they receive, hence, profits. Accordingly, C-corporations pay taxes on the profits they earn
the drawback of and their owners (stockholders) pay taxes on the dividends they receive,
"double taxation. ” hence, the drawback of “double taxation.” It is principally for this reason
that many entrepreneurs who operate alone or with a partner do not employ this
form. However, if the entrepreneur draws a salary from the corporation, that
salary is expensed by the corporation, effectively reducing its net income subject
to taxes, and is taxed instead only at the entrepreneur’s personal income tax rate.
By creating a corporation and issuing stock, the entrepreneur is giving up a
measure of control to the board of directors. Many an entrepreneur has found
himself or herself “out of a job” because he or she did not retain sufficient stock
to prevent this type of occurrence. It is not always necessary, however, that the
entrepreneur retain 51 percent of the stock to maintain control. As long as the
entrepreneur’s skills and vision are vital to the success of the venture, and as
long as most of the shareholders share that vision, the entrepreneur will have
effective control of the organization no matter how much stock has been given
up. Nevertheless with a corporate form, unlike the sole proprietorship or part¬
nership, the entrepreneur is accountable principally to the stockholders and
secondarily to anyone else.
A corporation must endeavor in all ways to act as an entity separate from its
owners. It must keep personal finances completely separate from corporate
finances, hold directors meetings, maintain minutes, and not take on any finan¬
cial liability without sufficient resources to back it up. Failing to do any of the
above can result in what is known as “piercing the corporate veil,” which leaves
the officers and owners open to personal liability.
Apart from legal considerations, where to incorporate is also an important
issue. It is normally advantageous to incorporate in the state in which the entre¬
preneur intends to locate the business so that it is not under the regulatory
powers of two states (the state in which it is incorporated and the state in which
it must file an application to do business as an out-of-state corporation.)
Normally, however, a corporation will not have to qualify as a “foreign” corpo¬
ration doing business in another state if it is simply holding directors/share¬
holders meetings in the state, or holding bank accounts, using independent
contractors, or marketing to potential customers whose transactions will be
completed in the corporations home state. It has often been said that you should
incorporate in Delaware because it has laws favorable toward corporations. If
you don’t intend to do a substantial amount of business in Delaware, however,
Incorporation Checklist
1. Determine in which state to incorporate.

2. Select the name of the corporation.
3. Find a registered agent who will receive legal service for the business in another state, if
necessary.
4. Fill out a certificate of incorporation and file with the Secretary of State with filing fees.
5. Hold a meeting to elect directors and transact necessary business.
6. During the first organizational meeting of the Board of Directors, select the corporate seal,
stock certificates, issue shares, elect corporate officers (Chief Executive Officer, President,
etc. as necessary).
7. Open bank accounts and apply for an Employer Identification Number.
8. Chose the corporation’s fiscal year.
9. If necessary, file a DBA certificate.
10. Fill out applications to do business in other states if necessary.
11. Apply for required state and local licenses or permits.
12. If appropriate, elect an S-corporation status.
the cost and hassle of qualifying in another state may overcome the benefit of a
Delaware incorporation. The entrepreneur should also consider the favorable¬
ness of the laws governing corporations in the state chosen. Some states, like
California, have a required, minimum annual corporate income tax whether or
not the business has a taxable income.
The S-Corporation
An S-corporation, unlike the C-corporation, is not a tax-paying entity. It is
merely a financial vehicle that passes the profits and losses of the corporation to
the stockholders. It is treated much like the sole proprietorship and the part¬
nership in the sense that if the business earns a profit, that profit becomes the
income of the owners/stockholders, and it is the owners who pay the tax on
that profit at their individual tax rates.
The rules for election of the S-corporation option are very specific.
• The business must first be incorporated.

• It can have no more than 35 stockholders.
• Shareholders must be U.S. citizens or residents (partnerships and corpora¬
tions cannot be shareholders). It is important that the shareholder agreement
protect shareholders against termination of the S-corporation election
through transference of shares to an unqualified person or entity.
• It can have only one class of stock issued and outstanding, that is, either
preferred or common.
• The S-corporation cannot be a financial institution, a foreign corporation, or
a subsidiary of a parent corporation.
It is always wise to check with an attorney to make certain the election

of S-corporation status is valid. If a C-corporation elects to become an S-cor¬
poration and then reverts back to C-corporation status, it cannot re-elect
S-corporation status again for five years.
The S-corporation is different from the C-corporation in several ways.
• The entrepreneur is taxed on corporate earnings whether they are distributed

as dividends or retained in the corporation.
• Any losses incurred by the S-corporation can be used as a deduction on the
entrepreneurs personal income tax up to the amount invested in the corpo¬
ration. If there is more than one shareholder, the loss is shared according to
the percentage of ownership.
• If the entrepreneur sells the assets of the business, the shareholder pays a tax
on the amount of appreciation. With a C-corporation, the gain is taxable to
the corporation and the balance paid to the stockholder is also taxed.
The businesses that benefit most from an S-corporation structure are those
that don't have a need to retain earnings. In an S-corporation, if the entrepre¬
neur decides to retain, say, $100,000 of profit to invest in new equip¬
The businesses that ment, the stockholders must still pay taxes on that profit as if it had
benefit most from an been distributed. Furthermore, while most deductions and expenses
are allowed, S-corporations cannot take advantage of deductions based
S-corporation struc¬
on medical reimbursements or health insurance plans. Another consid¬
ture are those that
eration is that unless the business has regular positive cash flow, it
don’t have a need to
could face a situation where the business makes a profit which is
retain earnings.
passed through to the owners to be taxed at their personal rate, but
generates insufficient cash to pay those taxes.
The S-corporation was a valuable financial tool under the 1986 Tax Reform
Act because personal tax rates were significantly lower than corporate rates.
However, there is some question about the tax advantages under the 1993 Tax
Code, as top personal rates have increased and surcharges have been imposed
so that a C-corporation might be preferable at higher profit levels. For some
small businesses, however, the S-Corporation may still be less costly in the long
run because it avoids double taxation of income. A good tax attorney or CPA
should advise the entrepreneur on the best course of action.
Ventures that typically benefit from election of the S-corporation status
include service businesses with low capital asset requirements, real estate
investment firms during times when property values are increasing, and start¬
ups that are projecting a loss in the early years. Entrepreneurs should probably
not elect the S-corporation option if they want to retain earnings for expansion
or diversification or if there are significant passive losses from investments such
as real estate.
Limited Liability Corporation

A new corporate form has recently emerged and is now available in a number
of states. It is known as a Limited Liability Corporation (LLC) and, like the
S-corporation, enjoys the pass-through tax benefits of partnerships in addition
to the limited liability of a C-corporation. It is, however, far more flexible in its
treatment of certain ownership issues, income tax, and in its implementation.
Only privately held companies can become LLCs and they must be formed
following very strict guidelines.
• The owners of an LLC are called “members” and their interests are known as
“interests.”
• An LLC will have two or more members and is formed via filing articles of
organization, which resembles a limited partnership agreement.
• The management of the company can be undertaken by the members or by
people they have elected to do so.
• The members create an “operating agreement,” which is very similar to a
partnership agreement that spells out rights and obligations of the members.
• Managers, officers, and members are not personally liable for the company’s
debts or liabilities except as they have personally guaranteed these debts or
liabilities.
• Most LLCs will be organized for tax purposes like partnerships so that
income tax benefits and liabilities will pass through to the members. In New
York and California, however, the LLCs will be subject to state franchise
taxes or fees. To avoid being taxed like a corporation, the LLC must not have
at least two of the four corporate characteristics: limited liability, continuity
of life, centralization of management, and free transferability of interests. The
two that are least likely to be eliminated to meet the test are continuity of life
and free transferability of interests. In fact, several states have “bulletproof’
statutes that insure that LLCs will always be classified as partnerships for
federal income tax purposes.
• Transfer of ownership is with the consent of members who in the aggregate
own at least a majority of the company.
• Unless the members owning the majority interest in the aggregate deem
otherwise, the LLC will dissolve upon the death, resignation, expulsion or
bankruptcy of a member.
• Interests in LLCs where members participate in the management and control
of the company are considered securities for federal and most state securities
laws, very much like limited partnership interests. This means that the
offering or sale of interests must be registered, which then exposes the orga¬
nizing members to potential liability for material omissions and misrepresen¬
tations of fact under securities laws.
The LLC is most often compared to the limited partnership and the
S-corporation. There are, however, differences. In a limited partnership, one or
more people (the general partners) agrees to assume personal liability for the
actions of the partnership; this is not the case with an LLC. Unlike a limited
partnership, in an LLC a member does not have to forfeit the right to participate
in the management of the organization to retain his or her limited liability status.
In an LLC, unlike in an S-corporation, there are no limitations on the
number of members or their status, such as corporation, pension plans, or non¬
resident aliens. Also, while S-corporations can’t own 80 percent or more of the
stock of another corporation, an LLC may actually have wholly owned
subsidiary corporations. LLCs are not limited to one class of stock and in some
ways they receive more favorable tax treatment. For example, unlike an S-
corporation shareholder, the LLC member can deduct losses in amounts that
reflect the members allocable share of the debt of the company.
If at a later date, the entrepreneur decides to go public, the LLC can become
a C-corporation by transferring the LLC assets to the new corporation. It is,
however, a bit more difficult to go the other way, as you must pay capital gains
tax on the appreciation.
LLCs are also becoming a popular vehicle for companies that may have
global investors, as the S-corporation does not permit foreign ownership. As
this is still a fairly new legal structure, an attorney should be consulted to find
out if this form is available in the entrepreneurs state and to help the entrepre¬
neur understand and abide by the requirements associated with it.
The Nonprofit Corporation

It is not outside the realm of possibility for a nonprofit corporation to be a high-
growth, world-class company; however, they are not generally started with that
goal in mind. A nonprofit corporation is a corporation established for chari¬
table, public (i.e. scientific, literary, and educational), religious, or mutual
benefit (i.e. trade associations, tennis clubs) purposes as recognized by federal
and state laws. Like the C-corporation, the nonprofit corporation is a legal
entity and offers its shareholders and officers the benefit of limited liability.
There is a common misconception that nonprofit corporations are not allowed
to make a profit. As long as the business is not set up to benefit a single person
and is organized for a nonprofit purpose, it can make a profit on which it is not
taxed if it has also met the IRS test for a tax-exempt status. However, income
derived from for-profit activities is subject to income tax.
There are two distinct hurdles that nonprofit corporations must pass if they
want to operate as a nonprofit corporation and have tax-exempt status:
1. meeting the state requirements for being designated a non-profit corporation

that can operate as such in a given state, and
2. meeting the federal and state requirements for exemption from paying taxes
(IRS 501(c)(3)) by forming a corporation that falls within the IRS's narrowly
defined catgories.
In . forming the nonprofit corporation, the entrepreneur gives up proprietary

interest in the corporation and dedicates all the assets and resources of the
corporation to tax-exempt activities. If a nonprofit corporation is ever dissolved,
its assets must be distributed to another tax-exempt organization.
Some Final Thoughts

Choosing the legal structure of the new venture is one of the most important
decisions an entrepreneur can make, for it affects the tax strategy of the
company for years to come. The correct selection depends on the type of
venture the entrepreneur is starting, the profits the venture generates, the
personal tax bracket of the entrepreneur, the assets used by the business, its
potential for growth, and state incorporation laws. Again, particularly in the
case of incorporation, it is important that an attorney review the documents to
ensure that you have followed the rules and will receive all of the benefits to
which the business is entitled.
21 New Venture Checklist

Have you
□ Answered the questions that will determine if you can operate as a sole
proprietor?
□ Considered the advantages and disadvantages of the partnership structure for

the new venture?
□ Examined the advantages and disadvantages of the corporate structure for the
new venture?
□ Talked with an accountant or attorney to determine if the S-corporation elec¬

tion with be advantageous to the new venture?
Bangs, D.H. (1994). The Start-Up Guide, 2nd edition. Dover, NH: Upstart
Publishing Co.
Barlett, J.W (1988). Venture Capital—Law, Business Strategies and Investment
Planning. New York: John Wiley & Sons.
Friedman, R. (1993). The Complete Small Business Legal Guide. Chicago:
Dearborn Enterprise.
Mancuso, J.R. (1988). Mancuso’s Small Business Resource Guide. New York:
Center for Entrepreneurial Management.
Nicholas, T. (1993). The Complete Guide to “S” Corporations. Chicago:
Dearborn Publishing Group, Inc.
Whitmyer, C., S. Rasberry & M. Phillips. (1988). Running a One-Person
Business. Berkeley, CA: Ten Speed Press.
1. What are three important issues the entrepreneur should consider prior to
Issues to
electing to operate the new venture as a sole proprietorship?
Consider
2. What advantages does a partnership have over a sole proprietorship?
ijx Disadvantages?
3. Assuming you had a successful business being run as a sole proprietorship,
what would induce you to change the legal form to a corporation?
4. Why would an entrepreneur elect S-corporation status over C-corporation?
5. What types of organizations qualify as nonprofit corporations and 501(c)(3)
tax-exempt status?
CHAPTER 9
Regulations Affecting
New Businesses
Overview
• The importance of laws and regulations on all aspects of a new venture
• The requirements for a valid contract
• Laws and rules that will affect the choice of a site for the business
• Laws related to the hiring and firing of employees
• Laws that regulate dealings with consumers
• Taxes for which the business is responsible
Regulation as a Way of Life

No matter what size your business is or becomes, it will be affected on a daily
basis in a myriad of ways by the laws, regulations, requirements, and restric¬
tions of federal, state, and local government authorities. A number of govern¬
mental agencies write and enforce the various regulations by which businesses
are bound. Probably no one would dispute the need for government regulation
where it protects businesses, employees, and the general public from actions
and products that would cause harm or deny people their rights. Many,
however, believe that the red tape and paperwork have become so over¬
whelming that it now costs businesses over two billion hours per year just to fill
out government forms. They are concerned that this burden and its accompa¬
nying costs appear to exceed any benefit that might be accrued from regulation.
The United States is considered by many international business owners, such as
149
Figure 9.1: Regulations that Affect Business
The Idea
• Patents
• Copyrights Trade Issues
• Trademarks • Price Discrimination
Start-up • Consumer Protection
• Permits • UCC
• Licenses • Truth in Lending
• Contracts • Truth in Advertising
X
BUSINESS
Business Site Employees

• Zoning • EEOC
• Building Codes • Fair Labor Standards
• Leases • OSHA
• Disabilities Act
Gordon Roddick of The Body Shop, to be the most regulated country in the
world. Roddick believes that compliance with regulations adds at least five
percent to the cost of doing business, reducing the number of businesses that
are able to start1 because a new venture must often spend its scarce resources
on attorneys and accountants to ensure compliance with the law.
This chapter looks at the process of starting a business from a regulatory
point of view, considering which regulations affect which aspects of the new
venture. As can already be observed from Figure 9.1, a young business—any
business for that matter—is affected in every arena of its existence by laws and
regulations.
^‘Regulation Time: 60 Seconds with...Gordon Roddick.” Inc. magazine, June, 1993, p. 16.
Chapter 9 • Regulations Affecting New Businesses 151
From Idea to Start-Up
One of the first areas where the entrepreneur is affected by laws and regulations
occurs at the idea stage before the new venture even begins. Laws determine
whether or not an invention or design can be protected by intellectual property
rights, and whether a symbol or logo that represents the business can be trade-
marked so no one else can use it. These legal protections can give the business a
significant competitive advantage.
In all likelihood, you will enter into several contracts before the business is
up and running. These may include agreements with suppliers, a lease for the
business site, a partnership agreement, independent contractor agreements,
employment contracts, and so forth. If you have established a relationship with
a business attorney, he or she will probably be able to create standard contract
forms reflecting the specific needs of your business that can be used over and
over again in similar situations. On the other hand, when presented with a
contract created by a third party (your suppliers attorney, for example), you
should ask your attorney to review the document to make sure you are
protected and are not agreeing to something that could ultimately harm the
business. In general, contracts should be drawn in such a way as to be legally
binding so you will have legal remedies should the other party not comply with
the terms of the contract.
To be a legally binding contract, there must be an agreement, which is an
offer or promise to do something or refrain from doing something. For
example, a vendor may offer to sell you a copy machine, which constitutes an
offer to do something. For the agreement to be valid, however, there must also
be consideration, which is your promise to supply or give up something in
return—a check or purchase order, for example. Furthermore, to be legally
binding, the parties to the contract must have capacity; that is, they must be
legally able to enter into a contract. Contracts cannot be entered into legally by
intoxicated persons, persons who are not of sound mind and body, or minors.
If these people do enter into an agreement, the contract may be contested and
ruled to be void, as never having existed.
A lawyers time is normally very expensive, but lawsuits can be devastating to
a growing business, not to mention time-consuming. It may, however, be
possible to save money by taking advantage of some of the new self-help legal
software and books now available. While they should not be used as a substitute
for sound legal advice on complex issues, they are excellent for basic legal issues
such as simple agreements. Both software and books usually provide standard
PROFILE 9.1
Sub Pop Learns the Hard Way

Breaking into the multi-billion dollar recording industry as an independent label is no
easy trick. But that didn’t stop transplanted mid-westerners Bruce Pavitt and
Jonathan Poneman from starting an independent recording company in Seattle
known as Sub Pop, which featured local rock groups. Their first production was an
album by a group called Soundgarden, which was marginally successful. A year later
Soundgarden left Sub Pop to sign with A & M Records and produce Badmotorfinger,
a record that sold over 900,000 copies. Unfortunately, Sub Pop didn’t receive a dime
because they had never had a contract with Soundgarden.
Sub Pop quickly learned they needed to have tough contracts that made it difficult
for a group to leave them without paying something. Fortunately, they learned that
lesson early because another of their groups, Nirvana, went on to sign with David
Geffen’s DGC label. Because of the contract with Sub Pop, DGC had to pay a royalty
of over two percent to Sub Pop on Nirvana’s future record sales. Nirvana’s
Nevermind album alone brought over $1 million in royalties to Sub Pop. They also
own the rights to songs that Nirvana recorded before leaving Sub Pop. Having a valid
contract in the beginning was a valuable lesson!
forms with blanks to fill in. Some interactive programs even guide the entrepre¬
neur through a series of questions that lead to a customized document. When
using these programs, be aware that the deletion or addition of even one word
can change the meaning of a sentence with potentially disastrous consequences.
Choosing a Business Site

When considering a place to locate the new business, you can’t just go any¬
where that seems appropriate to you. Cities and counties have laws restricting
businesses from locating in areas designated for residential dwellings, agricul¬
tural development, and open land. Within areas designated for businesses,
there are even more regulations, called zoning laws, that dictate what type of
business can locate at a certain location. In general, business zoning laws fall
into four categories: commercial, office/professional, light industrial, and heavy
industrial. Commercial zoning includes retail stores, restaurants, and super¬
markets. Office zoning permits general office uses plus some banking/finan-
cial, but no manufacturing. Light industrial zoning allows for distribution and
warehousing, while heavy industrial includes major manufacturing and assem¬
bling of products. In general, as you move from commercial zoning to heavy
industrial, the cost per square foot of the land declines. Consequently, manu¬
facturing facilities that normally require considerably more square footage of
buildable space enjoy less expensive land and rent costs. This is because as
you move from commercial to industrial zoning, the importance of the specific
location for business success decreases. Therefore, you are more likely to find
commercial zoning in the vicinity of residential zoning than you are to find
industrial. This subject is treated more fully in Chapter 10. You can learn more
about city and county zoning ordinances from the planning department or
building and safety department of the city in which the business will be
located. Unincorporated areas normally have their own county planning
department.
Not only will the business have to abide by zoning ordinances, but
Most municipalities also by building codes. Whether you build the facility or buy an
existing facility, you have to ensure that the building meets local and
require that a
state building standards. Such things as structural codes for earth¬
business have a quake safety, fire codes, and electrical codes are all mandated by these
license to operate standards. If you are building, you should hire an experienced,
licensed general contractor who will see that all requirements and
within the limits of
inspections are met. If you are buying an existing building, you can
the city or town. hire a professional contractor or inspector to verify that the building
meets all codes. If you are renting, make sure the landlord can provide
proof that the building meets all code requirements so you don’t face having to
move when a building inspector condemns the building after your business is
already there.
Most municipalities require that a business have a license to operate within
the limits of the city or town. If the business is located within the unincorpo¬
rated areas of a county, it may also be required to obtain a license. License
requirements vary from city to city, but you can find out your city’s require¬
ments by going to the business license division, usually located in the city hall
or planning department. Depending on the nature of the business, you may
also be required to hold a permit, which can be obtained m the same location
as the license. Some typical permits that may be required are building, health,
electrical, fire, and sign permits.
More recent environmental regulations affect the choice of site. Most states
now have environmental quality regulations that protect against businesses
emitting pollutants into the ground, air, or water. They also define who can
handle toxic wastes and how they must be disposed of. Check with local
government agencies to determine if any permits are required for your business
(this is normally for manufacturing or extraction businesses). Also contact
federal and state agencies like the Environmental Protection Agency, the Office
of Health and Emergency Planning, and the Occupational Safety and Health
Administration (OSHA) for information. Some states like California have
Environmental Business Resources Assistance Centers that provide access to the
latest environmental regulatory compliance resources for small and medium¬
sized businesses by phone, fax, or electronic bulletin board as well as through a
personal visit to the center.
Hiring Employees
Several laws exist related to hiring, firing, and compensating employees, so the
entrepreneur must be aware of his or her obligations under the law before hiring
anyone to avoid any future problems. An employer’s obligation begins with the
language used in advertising for positions in the company and extends to the
interviews conducted with potential hires. The Equal Employment Opportunity
Commission (EEOC) is charged with protecting the rights of employees. It
mandates that you cannot refuse to hire someone based on age, race, national
origin, religion, gender, or physical challenge. The only time sex or race can be
a valid consideration for a job is when it is a bona fide occupational qualifica¬
tion, for example, an acting job calling for an Asian male over the age of 40.
This also means written job descriptions must be accurate and defensible and
contain clear language that differentiates essential tasks of the job from non-
essential ones. It is only on the basis of the essential tasks that you can seek
someone who is of a certain gender, who has no physical disability, or who can
speak a certain foreign language.
If you have written a good ad, you will probably receive several resumes. With
jobs being generally more difficult to find, applicants are likely to embellish their
resumes somewhat to be more competitive in the marketplace. You, however,
must protect yourself against hiring someone whom you may later have to fire,
because firing someone is no longer as easy as it used to be. The laws protecting
the employee, combined with a litigious society in general, make for a very deli¬
cate situation for any employer attempting to fire an employee. It is, therefore,
probably dangerous to take any resume on face value. A few phone calls to refer¬
ences can give you a sense of the veracity of the resume.
Tips for Looking at Resumes and Selecting a Qualified Candidate
1. Don’t feel that just because the person has experience in only one arena, he or she is not qual¬
ified to do what you want them to do. Look for core skills like writing, speaking, organizing,
leading, and so forth. These basic abilities can be put to use in a variety of scenarios.
2. Consider promoting from within—training current employees so that they can move up when
the time comes.
3. Look for people with successful experience in the general field in which you are interested.
4. Look for people who have successfully worked in teams.
5. Look for demonstrable success, not just statements like, “I was a successful salesperson for
ABC,” but rather statements like, “Over the past five years I have increased my sales volume
by 20 percent per year."
6. Look for people who have stayed with a company for a reasonable length of time.
At the interview stage, certain questions are not permitted by the EEOC.
These include questions about
• Health
• Disabilities (You may ask, “Do you have any conditions that would preclude
your doing this job?”)
• Age (To protect those under 21 and over 40)
• Medical history
• Living arrangements
• Religious preference
• Type of military discharge
• Pregnancy plans
• Arrest record (You may ask: “Have you ever been convicted of a felony
crime?”)
• Ancestry
In general, the rule is to keep all questions related to the job requirements,
including skills, experience, and attitudes. One last point on this issue: It is
illegal to request a photo with a job application or resume unless the job is
specifically known to be predicated on appearance, such as a modeling job.
Wage and Hour Laws

Consider the following situation. You hire an employee on salary. The employee
asks if she can stay an hour late each day so she can catch a ride home with a
co-worker. A year later you fire her, and she files a federal wage-and-hour claim
for back pay for the extra hour each day she spent during the year. It is likely
she will win her claim. Why? Because even salaried employees are entitled to
protection under the Department of Labors Fair Labor Standards Act, which
establishes minimum wage. There are a disparately large number of claims
against small businesses as opposed to large organizations. This is because small
businesses rarely have personnel departments with people whose responsibility
is to make sure the hiring and firing of employees is handled correctly so as to
avoid claims.
In general, four types of job categories are exempt from minimum wage and
hour laws: executive, administrative, professional, and outside sales. This is
only true, however, if strict guidelines are followed. The Department of Labors
basic criteria for establishing an employee as exempt are:
• Does the employee receive a salary?

• Does the employee make more than $250 a week?
• Does the employee perform managerial duties over a unit at least 50 percent
of the time?
As there are so many regulations designed to protect employees, every new

business owner should become aware of federal and state laws regarding
employees’ hiring, firing, and working conditions. If you do not comply, you
could find yourself being sued by the Department of Labor for back pay and
liquidated damages, as well as attorneys’ fees and costs of litigation. Some of the
key laws are discussed in this chapter.
Occupation Health and Safety

Nothing strikes fear in the heart of a business owner like workers’ compensation.
Workers’ compensation insurance is a no-fault system under which workers
receive guaranteed compensation for injury at work and employers are protected
from unlimited liability by covering the cost of the premiums. Nevertheless, the
cost of worker accidents and false claims has threatened the life of many a busi¬
nesses. On average a business spent $564 per employee on workers' compensa¬
tion insurance in 1992, double the amount spent seven years ago, according to
the Small Business Administration. The dollar amount of claims has also risen to
an average of $23,000 per claim, double that in 1985. To further exacerbate the
situation, premium rates, which are based on the type of business you are in and
your accident history, vary from state to state, resulting in some states having a
competitive advantage over others in certain industries. Among the fastest
growing and most vexing claims are those for repetitive motion injury (such as
carpal tunnel syndrome) and stress-related disabilities.
The high cost of workers’ compensation premiums has led many small busi¬
nesses to join consortiums to self insure. While this is a complex process, there
are many consultants who are able to help businesses through it. In some
instances, trade associations have formed a consortium for self-insuring busi¬
nesses in the same industry and facing the same potential injury claims.
Fortunately, the bright spot in all this is that a business can control its costs
through active accident prevention and education programs. The issue of safe
and healthy work environments is the purview of the Occupational Safety and
Health Act of 1970 (OSHA) and its administrative unit. OSHA requires that
employers eliminate hazardous areas in the workplace and maintain health and
safety records on all employees. OSHA inspectors regularly target businesses
that have certain hazards inherent in the nature of the business, such as
asbestos, and conduct rigorous inspections, liberally dispensing fines and
penalties where violations have occurred (the basic fine is $7,000).
Before the new business is faced with an OSHA audit, call OSHA and ask to
receive some of their helpful pamphlets (See Additional Sources of Information on
p. 165) or ask an OSHA consultant to conduct a free, confidential, on-site test
of your business and give you compliance advice. Also local colleges usually
offer seminars in safety management.
PROFILE 9.2
Taking Care of Workers’ Comp

Mid-Atlantic Packaging, Inc., a corrugated box producer, faced severe workers’
compensation premiums in 1991 that threatened the financial health of the business.
In one year Mid-Atlantic’s 80 employees experienced 17 injuries totaling more than
$400,000 in workers’ compensation claims. The result: premiums for insurance rose
sharply, foreshadowing the downfall of the company.
They decided to take a pro-active approach with regard to accident prevention.
Corporate gave the general manager “carte blanche" to pursue a safety program. He
started by setting up an accident prevention committee comprised of representatives
from every department. They set up financial incentives and a method for reporting
unsafe actions. Finally they brought in instructors to train workers in how to lift and
bend properly to avoid injury. In the year after the new program was implemented,
Mid-Atlantic posted no injuries and no claims.
Several tips will help you avoid high premiums and the stress of OSHA
audits.
• Develop a safety program.

• Get employees back to work as soon as possible after an injury.
• Increase job satisfaction. Happy employees translate into fewer claims.
• Pay premiums only on straight time (not overtime or vacation time).
• Check the rate categories for all employees carefully.
• Pay the smaller claims yourself.
• If your company has a higher safety record than average, ask for a discount
in premium.
• Check your insurance records carefully, especially for claims from people
who don’t currently work for you or haven’t for a long period of time.
• Shop around for the best rates and don’t be afraid to change agents mid¬
stream.
• Take care of injuries quickly.
• Help employees understand that high premiums mean lower profits, so less
money in their pockets.
Americans with Disabilities Act

In July of 1992 the Americans with Disabilities Act (ADA) became law and
represented the most sweeping employment reform in over 30 years.
Essentially, the ADA prohibits discrimination against anyone with a physical or
mental impairment or disability that substantially limits one or more life activi¬
ties like walking, seeing, or hearing. Other disabilities specifically mentioned in
the law are diabetes, cancer, AIDS, arthritis, epilepsy, and emotional illness. The
law also protects those who have had drug and alcohol dependencies in the
past but have undergone treatment. It does not, however, protect those who are
dependent at the time they apply for a job. The candidate, in any case of
disability, must qualify for the job in terms of skills and experience in the first
place. Of the estimated 45 million Americans with disabilities, approximately
15 million are of working age.
The law applies to businesses with fifteen or more employees. For those busi¬
nesses that deal with the public, the public-access provisions provide that restau¬
rants, theaters, stores, and the like must modify their facilities to provide access
to people with disabilities as long as the modification doesn’t create an undue
hardship on the business. These modifications might include entry ramps,
Braille control panels on elevators, or wider aisles to accommodate wheelchairs.
The public access rules fall under the purview of the Department of Justice,
while the employment rules are regulated by the EEOC. As the law is stated in
broad terms such as “undue burden” and “reasonable accommodations,” many
business owners are concerned that this ambiguity translates into more litigation
for them. The laws related to disability will evolve over time, so it is important
that the entrepreneur maintain an awareness of the status of ADA.
Sexual Harassment
The rulings regarding unwanted attention and harassment on the job began to
get very tough in the 1980s. The courts have expanded the definition of sexual
harassment, and businesses are now developing policies in an effort to ward off
embarrassing and expensive lawsuits. The EEOC reports that sexual harassment
complaints grew from 4,400 in 1986 to 5,600 in 1990. In its first ruling on the
subject, the Supreme Court held that sexual harassment violates Title VII of the
1964 Civil Rights Act when the act is unwelcome and represents an abuse of
power in the workplace. Generally, harassment can be divided into two cate¬
gories: quid pro quo where advancement on the job or a raise is conditional on
certain sexual favors, and hostile working environment cases where the employee
is subjected to a sexually offensive environment against his or her will. Harass¬
ment includes but is not limited to verbal and non-verbal assaults of a sexual
nature, and physical harassment. As a result, business owners should establish
policies that educate and make clear to employees what conduct is not acceptable
in the workplace. In doing so, entrepreneurs can solicit guidance from the EEOC.
Trade Issues
In the United States great value is placed on the free marketplace, and generally
any attempts by government to interfere in the free market process are
shunned. Nevertheless, since the 1800s the government has imposed certain
laws specifically designed to preserve competition and the free market. The
Sherman Antitrust Act of 1890, one of the first, prohibited any restraint of free
trade. Other regulations followed, and they are discussed in several categories.
Price Discrimination
The Clayton Act of 1914 and the even stricter Robinson-Patman Act of 1936,
enforced by the Federal Trade Commission, assert that businesses cannot sell
the same product to different customers at different prices without justifica¬
tion. In other words, they must demonstrate that the lower price was based
on a quantity-sold discount, quality of the product (seconds or slightly
damaged), or a cost savings on the part of the seller (the manufacturer

discounted the product to the retailer beyond the normal purchase price).
Therefore, the entrepreneur must be careful to be fair to all customers when
setting prices.
Consumer Protection
The greatest number of laws affecting trade come under the heading of
consumer protection. They include:
• Unscrupulous sellers
• Unreasonable credit terms
• Unsafe products
• Mislabeling of products
One of the largest federal agencies monitoring product safety is the Food and
Drug Administration (FDA), which is responsible for research, new product
testing, and inspection of the operations of food and drug manufacturers. If your
new product is a cosmetic, a drug, a food item, or anything applied to the skin,
like suntan lotion, you will need FDA approval before marketing the product.
The Consumer Product Safety Commission was established in 1972 as the
watchdog for consumers over products considered hazardous. Additionally, it is
charged with setting standards for such things as toys for children under the age
of five. If your product falls into one of these categories, you will need to be aware
of the standards and requirements for marketing and producing that product.
The Fair Packaging and Labeling Act was designed to provide consumers
with information so they could shop more wisely. The act mandates that manu¬
facturers truthfully list all raw materials used in the production of the product
on a clearly marked label. This is in addition to the size and weight of the pack¬
aging. If your product is a food product, the percentages of nutrients, vitamins,
carbohydrates, calories, and fat contained in one normal size serving of the
product must be displayed. By becoming aware of the regulations affecting
products manufactured for public consumption, you can avoid both the
possible recall of your product and potential lawsuits.
The Uniform Commercial Code

The Uniform Commercial Code (UCC) is really a group of laws that affects
everything from bank deposits and investment securities to sales. It is this latter
category that impacts the entrepreneur. Any time you enter into an agreement to
sell a product, you create a contract governed by the laws of contract. However,
if you are a merchant, you must also abide by the laws of the UCC, which can be
different. To use a simple example, suppose you have ordered some supplies
from a manufacturer under a contract that contains the tenns of place, delivery
date, and quantity, but you have failed to ask the price. The supplies arrive and
the price is higher than expected. Under the regulations of the UCC, a price that
is reasonable at the time of delivery is assigned, based on the fact that both you
and the manufacturer are professionals who understand how the business oper¬
ates. You can’t claim lack of knowledge the way a lay person can; you are
presumed to know the rules of the game since you are in business.
The UCC also deals with product liability issues. Historically, the philosophy
of the marketplace in the United States has been caveat emptor or “let the buyer
beware.” In contemporary times, the burden of that philosophy has shifted to
“let the seller beware” as consumer groups and advocates like Ralph Nader have
forced businesses to take responsibility for the quality and safety of what they
produce. Whenever you sell goods, you also sell a warrant of merchantability,
which is an implied warranty that the product is of at least average quality and
suitable for the purpose for which it was intended. Consequently, the shift in
the burden of responsibility has resulted in numerous lawsuits by consumers
and higher premiums for product liability insurance. For example, it is esti¬
mated that about 25 percent of the cost of a football helmet pays for product
liability insurance. Any entrepreneur who intends to manufacture and sell a
consumer product should be careful to include clear instructions on its use and
warnings about the consequences of misuse.
Consumer Credit
Like consumer protection laws, the laws regulating consumer lending are
pervasive in an effort to protect consumer rights. The Equal Credit Opportunity
Act (ECOA) provides for fair and equitable treatment of all borrowers without
regard for marital status, source of income, race, color, or national origin. It also
requires prompt disclosure of the reasons for any denial of credit. It applies to
all banks, credit unions, retailers, and business creditors. Before any credit
granting can be completed, the Truth-in-Lending Act (Regulation Z) mandates
detailed disclosures concerning the cost of credit. It also requires disclosures on
the method of billing on open-ended contracts, personal property leases, and
credit card accounts as well as the number and amount of payments required,
and the type of collateral given to secure the loan. It applies to anyone who
regularly extends credit, imposes a finance charge, or permits an obligation to
be repaid over more than four installments.
The Fair Credit Billing Act (FCBA) provides procedures for dispute resolu¬
tion, and the Fair Credit Reporting Act (FCRA) mandates standards for
reporting information on credit recipients to credit reporting agencies. If you
intend to grant credit to your customers, you must make yourself aware of all of
the applicable regulations. The bottom line is: merchant lender beware!
Truth in Advertising
The Federal Trade Commission is charged with protecting the rights of
consumers against false or misleading advertising. It has come down hard on
many businesses for misleading customers about what a product can do,
offering a reduced (sale) price on an item that was never advertised at a higher
price, using list price as a comparison if the business has never sold the item at
list, and using bait-and-switch techniques to lure customers into the store only
to switch them to a higher-priced item.
Taxes
As a business owner, you are also legally responsible for paying certain taxes in a
timely fashion. Since no one wants to pay more taxes than required, business
owners must understand which transactions qualify as tax-free and what the tax
consequences are of any transaction. For example, a $2,000 transaction is worth
$2,000 to the business if it is tax-free; however, if it is taxable it may only be
worth $1,400—a sizable difference. In general, the following are tax-free receipts:
• Compensation from accident and health plans for injuries or illness and life
insurance benefits
• Contributions by the employer to a qualified accident and health plan
• Workers’ compensation benefits
• Meals and lodging provided for the convenience of the employer, as in busi¬
ness trips
• Interest on municipal bonds.
• Income from the discharge of indebtedness if the taxpayer is insolvent or
bankrupt
Beyond these items, most business transactions are taxable.
Payroll Taxes
One of the payroll taxes you will deduct from an employees paycheck is F1CA
(social security tax). The deduction is based on a percentage of the employees
income and as of 1994 was 7.65% on wages up to $60,600 (this includes
1.45% for Medicare). Beyond the $60,600, 1.45% for Medicare must still be
deducted as there is now no limit on wages for this deduction. In addition, the
employer contributes an amount equal to the FICA deduction from the
employees pay, hence the fact that it costs more to employ a person than the
mere face value of the paycheck. State and federal income taxes must be with¬
held according to the current tax law and the employees W-4 form. This
amount is a percentage of taxable gross pay after allowable deductions.
You as the employer are also required to make contributions under the
Federal Unemployment Tax Act (FUTA), which provides compensation to
workers who are temporarily unemployed. This tax amounts to 6.2% of the
first $7,000 of gross pay. If you pay your state unemployment tax in a timely
fashion, it is credited against the federal unemployment taxes paid. For
example, in California the unemployment tax rate is 5.4%. Subtracting that
from the federal rate of 6.2% leaves a net federal tax rate of .8%. Some states
like Pennsylvania, Alabama, Alaska, and New Jersey also collect FUTA from
employees.
In some states you may be required to pay state disability insurance. In
California, for example, this amounts to 1.30% on wages not to exceed
$31,767.00 and paid by the employee.
If your business accumulates $100,000 or more of FICA and federal income
tax withholdings during any pay period, you are required to deposit that
amount in an approved depository by the close of the next business day or face
a penalty of 2 to 15 percent of the amount. Consequently it is very important to
monitor payroll taxes carefully, particularly if you have a labor-intensive busi¬
ness. Don’t assume all banks have the same rules for date-of-deposit. You
should either deposit withholding tax on the same day you pay employees or
by the end of the banks next business day, and deposit in a commercial bank
rather than a Federal Reserve bank, which always credits deposits to the next
day. A one-day error can cost your business a lot of money.
Sales and Use Taxes

Regardless of the legal form of the business, anyone who sells tangible products
or services is required to collect sales tax. A use tax is collected from the
purchaser if a sales tax has not been paid and is equivalent in amount to the
sales tax. Local jurisdictions may tax occupancy, personal property, real estate
property, stock transfer, real estate transfer, and alcoholic beverages, to name a
few. As local governments look for additional sources of revenues, they often
find them in the business community. State laws regarding sales and use taxes
vary considerably, however, so the entrepreneur should discuss the business’s

obligations with the appropriate state authority.
Business Income Tax

The business itself must pay federal, state, or local taxes on income it earns as
well, depending on the legal form of the business. A sole proprietor or a partner
in a partnership pays these taxes one time as personal income from the busi¬
ness. If you are a self-employed business owner, you also pay a F1CA tax of
15.3 percent, double that of an employee because you are both the employer
and the employee. A corporation, on the other hand, pays a corporate income
tax. If you receive a salary from your corporation, you also pay a personal
income tax on it.
The number of regulations, taxes, and laws affecting a new business can be
daunting, hence the need to consult a good attorney and accountant. In most
cases, particularly in those involving the IRS, the penalties for failure to pay or
follow the rules are severe. Many a new business owner has discovered this too
late. You must prepare in advance for the start of the business by understanding
your obligations and planning to meet them.

Have you
□ Identified the types of laws and regulations that will impact your particular type
of business?
□ Protected aspects of your business concept that fall into the intellectual prop¬
erty rights categories?
□ Found an attorney who can review any contracts you enter into?
□ Written clear and legally defensible job descriptions?
□ Identified all the taxes for which you are responsible and set up a plan for
meeting payment deadlines?
Chapter' 9 • Regulations Affecting New Businesses 165

u All About OSHA and OSHA Inspections. Call OSHA at 202-219-4667.
The OSHA Handbook for Small Businesses. Call 202-783-3238.
What Businesses Must Know About the Americans With Disabilities Act. U.S.
Chamber of Commerce; call 1-800-638-6582. Ask for publication No.
0320.
U.S. Equal Employment Opportunity Commission, 1801 L Street, NW,
Washington, DC 20507. ADA Helpline: 1-800-669-EEOC.
Job Accommodation Network, P.O. Box 6123, 809 Allen Hall, WVU,
Morgantown WV 26506-6123. Call 1-800-232-9675.
Issues to 1. How will you know when you have a legally binding agreement?
Consider 2. What is the purpose of zoning laws?

3. What does the Truth-in-Lending law require of businesses, and which busi¬
ijx nesses are affected by it?

4. Which laws is the Equal Opportunity Commission charged to regulate?
5. You have an interview with a candidate for a position as bookkeeper for your
business. What are some questions you can ask, and what cannot be asked
of this candidate?
I n September of 1991, 23 years old and only two years out of college,
Marianne Szymanski left her job and started Toy Tips®, Inc., a toy research
and consulting firm. For most people this would have been a very frightening
thing to do, but Marianne had no doubts her new business would succeed.
Having graduated from Marquette University with a bachelor of arts degree in
psychology and marketing, she had been working for a toy manufacturer selling
toys to retailers and sometimes stocking shelves. Naturally customers would
come up to her and ask questions. Often they were grandparents who didn’t
recognize any of the new toys and consequently had no idea what to purchase.
As a result, Marianne decided to find out if there was any information out
there on the best toys to buy for kids of various ages. Consulting the major
magazines related to children, she found they all seemed to have their own
version of the “Top Ten” list of toys. Upon closer inspection, however, she
discovered that invariably the toys on the lists were made by the manufacturers
who had purchased advertising space in the magazine. Moreover, she found
that the self-proclaimed “experts” in the field were actually paid by the manu¬
facturers to review their products. This was certainly not a very unbiased way to
judge these toys. Marianne, who hadn’t yet decided what she wanted to do with
her life, immediately saw an opportunity to provide a much needed service and
create a career opportunity for herself.
The Start-Up
Marianne puzzled about the best way to start this business so that she could
reach the most people. At the time, 900 telephone numbers were becoming a
popular business venture that could be started quickly and with relatively little
capital. Marianne decided to try this avenue. So Toy Tips began as the National
Toy Information Hotline, a 900 number, that people could call to receive the
latest information on toy safety, product recalls, and tips on age-appropriate
toys. To start the business, Marianne drained her savings account and then took
her business plan to nearly every banker in Milwaukee. She was turned down
time and time again with “This is great; this is wonderful—-good luck.” But no
money.
Tortuitously, two days before actually starting the business, she was asked
by a local talk show to appear. That free publicity was worth more than any
bank loan. From that point on, the media picked up on what she was doing,
and her business grew much more quickly than she expected. By the end of
the first year, little town gazettes all over Wisconsin had picked up on the
hotline; but when the AP and USA Today got hold of it the
business exploded. She started receiving phone calls from all
over the United States.
At the same time she had also sent some information about
her hotline to the Toy Manufacturers of America in New York,
which is the voice of the toy industry, and they published her
information in their monthly PR release to toy manufac¬
turers. All of a sudden she was inundated with information
and hundreds of samples from toy companies. Still working out of her home
testing toys on the living room floor with neighborhood children, she decided
she needed to look for another site for the business because the toys were taking
over her home. She went to a pediatrician she knew and worked out a barter
arrangement that allowed her to fill up four rooms of his office with toys for his
patients to “test.” That worked for a while, but soon she had overgrown the
space and needed to move again. By now her ability to convince people of her
credibility was well honed, so she went to the President of Marquette University,
Father D1U1I0, who helped to come up with the idea of working out of the child
care center at Marquette. The arrangement was that the children would test the
toys, she would observe them, and the toys would be donated to the university.
And so it was that Toy Tips, Inc. moved into the child care center, a series of
rooms bursting with primary colors, bustling with activity, and alive with the
sounds of children.
By the end of 1991, she was working with 50 manufacturers. By the end of
1992, that number had swelled to 140, and her revenues had doubled. She had
also created a magazine to carry her message and publish the notices of toy
recalls. The magazine also contains Mariannes “Top Ten” lists: “The Top Ten
Travel Toys,” “The Top Ten Educational Toys,” and even “The Top Ten
Environmental Toys.”
Bootstrapping Genius
Even though the company was growing, Marianne did not have enough money
to hire the employees she needed to help her handle the ever increasing load of
work. But Marianne, who is the essence of the bootstrapping entrepreneur, knew
that there must be a way to get help by bartering, the way she had done for her
office space. Once again she went to the university and suggested that they offer
an internship program with Marquette students who would work for university
credit in her research center. The university agreed and “Toy Tips 101” was born.
Engineering students tested the toys and even designed a “toy crusher” for her.
Working with one of the engineering professors, she was able to develop new
tests for toys, such as tests for flammability and toxicity Journalism students
helped her do fact checking and gather information for articles, while a public
relations student helped her with her media tour. Psychology and education
majors were involved in the focus groups and testing. She also used marketing
students to develop questionnaires and research on the needs of parents. Until
just recently, Marianne had no “employees” in the traditional sense. She has now
hired two assistants to help her carry the load.
With all the media attention she was receiving, Marianne had to travel, but
she didn’t have an appropriate wardrobe, and since all her money was going
into the business, she didn’t have the money to go out and buy one. So
Marianne again demonstrated her bootstrapping creativity when she went to JH
Collectibles clothing company and bartered for a new wardrobe for her media
tour. In exchange for the wardrobe, JH Collectables was given a page of adver¬
tising in her magazine, which was handed out during the tour.
Marianne used a similar technique to “buy” time with an attorney. She
happened to attend a seminar on “Global Marketing in Europe” given by the
Wisconsin trade center. Being the only woman at the seminar became an advan¬
tage, because when she later called the attorney who led the seminar, he
remembered her. She arranged for an appointment ostensibly to talk to him
about trademarks, but actually this was just an excuse to approach him about
becoming the attorney for her small, but growing, business. She asked if he
would consider working with her at a reduced rate with the understanding that
when she got bigger and had the money, she would pay his regular rate. He
laughed appreciatively at her assertiveness and agreed to work with her. He
continues to do so, always charging for his time but being flexible in billing
depending on her business’s financial situation.
Growing the Business

As the business grew, it became obvious that the 900 hotline was becoming a
problem. Young children, who had seen her on TV and knew that she worked
with toys were finding her 900 number and calling asking for “the toy tester.”
She imagined their parents weren’t too happy about the phone bills, so she
discontinued the line. The 900 number had by then served its purpose. It gave
her the resources to get her business off the ground and also gave her extraordi¬
nary media attention. She now has over 850 media contacts and appears as a
regular “toy guest” on “Good Morning America.”
Marianne incorporated the business to protect herself and her
assets from liability, but also to give the business a perception of
permanence and credibility. This became increasingly impor¬
tant as she began to do more than toy testing. She started
consulting to private companies (never toy manufacturers),
including McDonalds, Rayovac, HDI Engineering, and Candy
& Kids Shoes. One battery manufacturer, for example, asked
her to test their batteries in her toys to see exactly how long
they last. A French company wanted to learn how American
children play, which gave her a chance to go to Europe and study
how European children interact and play.
Toy Tips was hired by Toys “R” Us to conduct research on toys for “differ¬
ently abled” kids. The contract allowed her to set up 18 testing centers at hospi¬
tals and clinics and use kids with special needs to test the toys. The result was a
special guide for parents of “differently abled” kids that helps them choose toys
that children with special needs can enjoy and learn from.
Growing a business means looking beyond current markets to new ones.
Marianne understood that children aren’t the only people who like toys, so she
organized The Annual Toy Tips “Executive Toy Test.” Each year she invites 50
executives from all industries to play with toys to discover which are the best
stress relievers. This event is held in a different city every year, which gives her
a chance to observe differences in toy play from region to region. Marianne also
now has six summer camps where kids test computer software.
Toy Tips has a five-year plan and is currently ahead of schedule in terms of
growth. Marianne’s goal is to make Toy Tips the only unbiased source of infor¬
mation on toys in the nation. The philosophy of Toy Tips has remained
constant as a guide for the growth of the business: “Top Tips does not endorse
or warrant any toy that it reviews.” It considers itself an independent source for
informed decision-making on the purchase of toys. With this mission in mind
Marianne must decide where she should take the business from here. She has
considered forming a non-profit corporation for research purposes as this
would give her access to foundation grants. But establishing a non-profit
corporation is more complicated and has more rules and regulations than a
C-corporation. At this point, she is not sure what the advantages and disadvan¬
tages would be.
1. What regulations will specifically impact Toy Tips?

2. Into which other markets can Marianne take her business?
3. Are there any problems this business is likely to face?
4. Is there another corporate form that might work for this business?
PART 4
The Operating Structure

of a New Venture
Until someone has a small business, they have no

comprehension of how hard it is. People who start
businesses from scratch, if they survive,
are the toughest people on the face of the earth.
-SUE SZYMCZAK, SAFEWAY SLING
'
■
CHAPTER 10
The Big Picture
Overview
• The nature of a virtual enterprise
• The steps in seeking a site for the new venture
• Characteristics of retail, service, and manufacturing sites
• The advantages and disadvantages of building, buying, or leasing a building
What Does the Business Look Like?

If the entrepreneur has concluded there is a need or market for the new busi¬
ness concept, the first test of feasibility has been passed. The second test
involves determining if the business is operationally feasible; that is, is there a
viable way to produce the product or deliver the service to the customer prof¬
itably? What must be considered is:
• Where the business will be located

• How it will operate
• Whapthe market strategy will be
• What the organizational infrastructure will look like
Defining and establishing the operational strategies will assist in answering

these questions and the ultimate question,
Is the new venture operationally feasible?
173
174 Part 4 • The Operating Structure of a New Venture
Doing this section of the business plan will also force the entrepreneur to
seriously consider how the business will work. It’s one thing to come up with a
great idea that people love. It’s quite another to turn that idea into an operating
business.
The Virtual Enterprise

When entrepreneurs contemplate starting businesses, perhaps they picture a
traditional office, manufacturing plant, or retail outlet with employees. But that
vision is changing. Out of necessity, the 1990s have ushered in a new type of
business—the “virtual enterprise.” The term virtual enterprise comes from the
computer industry’s latest offering in entertainment—virtual reality—which
essentially allows the user to be an integral part of a video game’s environment
without leaving the safety of the real world.
In business, a “virtual enterprise” has much the same purpose. It allows the
owner to actively build a company in an industry without incurring the risk of
employees, costly equipment, and enormous overhead. The virtual enterprise’s
goal is to deliver to the customer the highest quality product at the lowest
possible cost in a timely manner. To do this requires the participation and
management of the entire distribution channel from producer to customer
through a series of strategic alliances. Traditionally this was accomplished by
building the business to the point where it could afford to buy out its suppliers
and/or distributors, giving the company more control over quality and delivery.
This strategy is known as vertical integration.
Today, however, it is much more difficult for a new venture to accomplish
total in-house control of its value chain. The global marketplace is more
complex, time to market has decreased, and it is difficult for any one company
to have the expertise needed to master all the functional levels of the distribu¬
tion channel. Today a growing company is more likely to increase its flexibility
by choosing one function to concentrate on and sub-contracting other func¬
tions it does not want to handle. The general rule is, if the resources to manu¬
facture, assemble, and distribute the product effectively already exist in the
market in which you wish to do business, don’t duplicate the effort. Form
alliances. Besides streamlining the operation, these alliances have the added
benefit of establishing peer-to-peer relationships rather than hierarchical ones as
is seen in a vertically integrated channel. It becomes more of a team effort, with
everyone having the ultimate goal of producing a successful product.
For example, a new equipment manufacturer, Gentech Corporation (See
Case Study 2, p. 126), decided the only way to get off the ground and succeed
Chapter 10 • The Big Picture 175
in a very competitive market was to purchase existing components from estab¬

lished manufacturers so it wouldn’t have to incur the heavy costs of tooling up
a manufacturing plant. Gentech chose to establish an assembly operation and
distribute its product initially through an established channel of equipment
rental outlets. Gentech also formed alliances with its suppliers so the parts it
received were made to their specifications, saving time and money.
Often a business whose competitive advantage lies in proprietary rights on
its product will choose to maintain control of strategic functions and outsource
such things as warehousing, transportation, and some aspects of marketing.
Becoming a virtual company allows the new venture to be more innov¬
Becoming a virtual ative, closer to the customer, and quicker to market. Of course, the
ultimate in virtual enterprises is one where the entrepreneur literally
company allows the
outsources all business functions and acts as the ringmaster in a three
new venture to be
ring circus. Profile 10.1 on p. 176 is an excellent example.
more innovative, Yet another way that businesses are becoming more flexible and
closer to the responsive is by forming alliances or teams of businesses to share

resources and reduce costs. These alliances accomplish more than
customer, and
simple outsourcing. They may purchase major equipment jointly, or
quicker to market. share the costs of research and development, and training. Par¬
ticularly in the area of R&rD, it is very difficult for any one small
company to manage the expense alone. For example, the Massachusetts
Metalforming Network put together $25,000 of its own money, which gave it
the ability to secure $40,000 in grants. That $65,000 allowed the network to
collaborate on research to find a good solvent to clean metal parts. This
example demonstrates that even competing companies can enjoy the benefits
of networking.
Small manufacturers like Erie Bolt Company were instrumental in starting a
network of 16 suppliers in their industry. The network operates like a “virtual
enterprise” that sub-contracts jobs to the network members who can do them
most efficiently. The fact that they also share resources and facilities has given
them an economy of scale that has produced a savings of 30 percent to the
customers and more than doubled their business.
Networking and business alliances allow smaller businesses to bid success¬
fully against large companies. They offer the convenience and savings of one
source for everything, shared quality standards, and coordination of vendors.
The key to success with a small business alliance is being willing to share
internal information such as manufacturing processes, quality control practices,
and product information for the good of all.
PROFILE 10.1
Taking the Virtual Concept to the Limit

Walden Paddlers is a one-person, start-up business located in Acton, Massachusetts.
Its purpose is to design, produce, and market a technically advanced kayak made
from recycled plastic that outperforms and under-prices the competition. Walden
Paddlers’ founder, Paul Farrow, comes out of the corporate world, having lost his job
to restructuring. Not wanting to build his way back up in the corporate world, he
sought to start a business that would allow him to work in the environment he enjoyed
most—outdoors—and provide him with plenty of exercise. It took a vacation with his
sons, kayaking on a lake, to come up with the perfect idea. Paul quickly realized that
the kayak they were using, which was fairly basic, probably cost all of $17.50 to make
(it was plastic); yet it retailed for $400. An opportunity was presenting itself.
Upon returning home, he dove into the world of kayaks, talking to anyone who
knew anything about them and learning everything he could about design, products,
manufacturing, and distribution. As a result of his research, he believed he could
carve out a niche in the entry-level kayak market—which was not being well served
by the three major manufacturers of kayaks—with a boat that was cheaper than
others yet performed better. He identified his target market as a middle-aged person
just learning to kayak and who would probably use it in fairly calm waters.
Paul knew he didn't have the resources to do it all himself and he wanted to get
into the market very quickly, so he set out to form a series of alliances with estab¬
lished companies. The first alliance was with Hardigg Industries, a Massachusetts
rotomolder of plastics. Paul convinced them to put to use some of their unused
capacity molding kayaks. This was a fortuitous relationship as Hardigg believed in
what Paul was trying to do and knew they held the key to his business getting off the
ground. They also saw this as an opportunity to develop a new customer and another
profit center for the business.
Paul also needed a designer. Through a series of contacts with various people, he
finally found who he was looking for in Jeff Allott. They agreed to spread the
payments for his work over the stages of development of the prototype.
The third alliance was with boat dealers. Paul decided to provide prospective
dealers with demo boats they could use for 30 days. His only stipulation was that at
the end of 30 days they either paid him or returned the boat. The plan worked and
soon he had sold his first 100 boats. Farrow’s operational strategy is to outsource as
long as he can and ultimately create a deal with a major national distributor to reach
a mass audience.
Building a virtual corporation and dealing with strategic alliances is not

without its problems. For the entrepreneurial team that wants to maintain
control of every aspect of the growing venture, it is frustrating to have to give
up some of that control to other companies. It can also be a long and difficult
process getting virtual partners to meet entrepreneurs’ demands for quality,
timeliness, and efficiency. Consequently, it is important that the entrepreneur
and the virtual partner come to written agreement on their duties and responsi¬
bilities and that the relationship be beneficial to both parties. Many entrepre¬
neurs have found that the benefits of virtual partners far outweigh the problems
and that the virtual corporation is the most efficient and effective way to get the
venture off the ground.
Looking Like a Major Corporation from the Start

The virtual enterprise is a concept whose time has come, but to take advantage
of it the entrepreneur must understand what kind of business he or she will
have and where it lies in the value chain. In Chapter 3 you learned about how
to turn an idea for a product or service into a business. In Chapter 7 you saw
how many different ways you can deliver a product or service to a customer. By
this time you probably have a good idea whether you will have a retail business,
a service business, a distributorship, or a manufacturing plant. This is an
important first step because the operational decisions you make will depend in
large part on the kind of business you have. Even if you have decided after
reading about the virtual enterprise that this is what you want to accomplish,
you will still need to visualize the big picture of how the business will work.
It is possible through the use of independent contractors and alliances to
create what appears to be a large, complex organization. A major corporation
has several key functional areas that are usually headed by upper level manage¬
ment—vice presidents. It may look something like this:
CEO
VP Sales VP Marketing VP Operations Chief Financial Officer
An entrepreneur generally does not have the financial resources to take on

the high salaries and benefits of this type of management team. However,
through the judicious use of independent contractors, an operational team that
accomplishes these functions can be achieved through subcontractors without
high-cost overhead.
Entrepreneur
Sales Agents Marketing Consultant Subcontract CPA

Sales Reps Manufacturing Bookkeeper
To the business world the entrepreneur is accomplishing the same functions

as the major corporation; he or she is just not doing it with employees.
Technology has also contributed to helping start-up ventures perform like
major corporations for relatively little money. Desktop computers and the latest
software, such as computer-aided design, allow new ventures to do things that
previously required experts. Electronic networks make it easier to communicate
with strategic alliance partners and to access commercial information databases
around the world. Computerizing control systems on machine tools permits
growing entrepreneurial manufacturers to compete with major companies.
The Fantasy Tour of the Business

To make the job of defining the operations and requirements of the business
easier, take an imaginary tour of the business. In this way you can begin to list
all the functions, people, equipment, supplies, and space required to run the
business. As you enter the imaginary door of the business, ask yourself three
questions:
1. Who does the work in this business?

2. Where do they work?
3. What do they need to do the work?
Then begin making lists of tasks, equipment, and people needed to run the
business. This information will also be useful when you need to figure expenses
for financial projections later on.
The Site for the Business

You may already be familiar with the three key factors for determining value in
real estate: “location, location, location.” The location of the business has a
serious impact on its success. Location determines who sees the business, how
easily they can access it, and whether or not they will want to access it. And
since many business owners consider their business site as permanent, selecting
the best site becomes one of the most crucial decisions to make, one that will
need to be justified to the readers of the business plan.
Site decisions begin at a macro level with the state or region of the country
and work their way down to the parcel on which the facility is located. That is
the process followed in the discussion of the site.
Choosing the Region or State

Locating a site for a high-growth venture normally begins by identifying the
area of the country that seems best suited to the type of business being started.
“Best suited” may mean that firms in that industry tend to congregate in a
particular region, such as the high-tech firms that gravitate to Rte. 128 in
Massachusetts. For some businesses “best suited” may mean that a state is
offering special financial and other incentives for businesses to locate there. In
yet another case, “best suited” means a manufacturer choosing to locate near
major suppliers. Unfortunately, often the entrepreneur starts the business in a
particular region because that’s where he or she happens to live. This may be
fine during the incubation period, but the area must be considered carefully for
what it contributes to the potential success of the business.
Of course, there is another important factor that must be included in the
decision mix, and that is the entrepreneur’s desire for a certain lifestyle.
Sometimes the desire to maintain a particular lifestyle in a particular location
far outweighs the potential negative effects of locating the business in a less
than optimal location. Mo Siegal, Founder of Celestial Seasonings, was one
such entrepreneur. He was adamant about remaining in his beloved Colorado
when he started his now enormously successful venture. Doing business there
may have cost more and not have been as convenient for shipping purposes,
but the ability to run his business from his home town was more important. In
fact, as it turns out, the image of Colorado with its Rockies, cool streams, and
beautiful blue skies actually enhanced the image of his herbal teas.
Choosing a Community
The community in which you currently reside may not necessarily be the best
place in which to start the business. Certainly it is always easier to deal with
something you know well, particularly when starting something as risky as a
new business, but don’t assume the location factor applies only to decisions
within your own neighborhood. Many potentially successful new ventures have
failed because they were not located in a region or community that supported
that type of business.
To start, it is important to examine the major competitors in the industry to

see where they tend to locate. Is it in particular areas of the city, in specific
regions of the country, or near major transportation routes? Doing this will give
the first clue to a potentially successful location with the required infrastructure
and a skilled work force. You also want to define your business’s specific needs
in terms of labor (skilled/unskilled), land (amount and type), and transporta¬
tion (highways, ports, international airports). Three important factors about any
area under consideration should be examined: economic base, financial incen¬
tives, and demographics.
Economic Base. The economic base of a region or community is simply the

major source of income for the area. Communities are viewed as primarily
industrial, agricultural, or service-oriented. In general, industrial communities
export more goods out of the community than they import into it. For example,
suppose the community’s principal income is derived from farming and the
associated products it ships to other communities. This activity brings money
into the community. Now suppose the citizens of the community must travel to
another community to do major shopping. This activity takes money out of the
community. The important thing to learn about the community is whether the
money brought in from farming exceeds the money leaving for shopping. If that
is so, the community appears to have a growing economic base, which is a
favorable factor for new businesses.
You can learn more about the economic base of any community in which
you are interested by contacting the state or regional economic development
agency in the area. These organizations exist to bring new business into the
region, so they have to stay on top of what is going on. They can give you all
the statistics you will need on the economic condition of the region as well as
estimate the cost of doing business there.
Financial Incentives. Most community governments are faced with cash needs
that go well beyond the tax tolerance level of its citizens; consequently, they
work diligently with economic development agencies to attract new businesses
and the accompanying tax revenues into the community. One of the ways they
attract business is to offer incentives such as lower taxes, cheaper land, and
employee training programs. Some communities have enterprise zones, which
give the businesses that locate in them favorable tax treatment from the state
based on the number of jobs created, as well as lower land costs and rental
rates. They also expedite permit processes and help in any way they can to
make the move easier.
Look carefully however, at communities that offer up-front cash in compen¬
sation for the community’s lack of up-to-date infrastructure. They may be
hiding a high corporate tax rate or some other disincentive that could hurt your
business’s chances of success. In general, the larger the incentives, the more
careful you should be in doing your homework.
Demographics. In addition to studying the economic base and the community’s

attitude toward new business, look carefully at the population base. Is it
growing or shrinking? Is it aging or getting younger? Is it culturally diverse?
The level of and quantity of disposable income in the community will indicate
whether there is enough money to purchase whatever you are offering.
Demographic information is usually based on the U.S. Census, which tracks
changes in population size and characteristics. The U.S. is divided into Standard
Metropolitan Statistical Areas (.SMSAs), which are geographic areas that include a
major metropolitan area like Los Angeles or Houston. These are further divided
into census tracts, which contain approximately 4,000-5,000 people, and neigh¬
borhood blocks. With this information you can readily determine, for example,
if the city in which you want to locate a new software development firm has
enough people with sufficient technical and educational skills to support it.
Population data also indicate the number of people available to work.
Demographic data is easily obtained from the economic development agency,
the public library, or the post office, which tracks populations by zip code.
Incubators. Some entrepreneurs find it helpful to start their new venture’s life in
a business incubator, which has the same purpose as an incubator for an
infant—to create a controlled environment that will enhance the chances of the
business surviving the start-up phase. Private and state-sponsored incubators
can be found in nearly every region of the country for almost any type of busi¬
ness. They offer space at a lower than market rate to several businesses who may
then share common support functions like receptionist, copy machine, and
conference room. The incubator may even offer business courses and training to
help new entrepreneurs with the myriad details involved in running the busi¬
ness. After about three to five years, depending on the incubator, the young
business is required and helped to move into its own site elsewhere in the
community.
Some incubators cater only to high-tech firms or to service firms. Others like
the Entrepreneur Partnership Program at the Mall of America in Bloomington,
Minnesota, help entrepreneurs determine if their retail or service businesses are
suited to the demands of a major mall. This particular program helps the entre¬
preneur formulate a business plan and open a store. It also provides incentives
such as waiving the costs of improving the store space and consulting in
marketing and operations.
Choosing a Retail Site. With a retail business, the entrepreneur is dealing

directly with the consumer, so, naturally, one of the first considerations is being
near the customers. Since a retail business lives or dies based on the number of
consumers who have access to the business, it is important to locate where
there are suitable concentrations of consumers.
The Trade Area

The trade area is the region from which the entrepreneur expects to draw
customers. The type of business will determine to a large extent the size of the
trade area. For example, if the business sells general merchandise that can be
found almost anywhere, the trade area is much smaller as consumers will not
travel great distances to purchase common goods. On the other hand a
specialty outlet, for example a boutique clothing store with unusual apparel,
may draw people from other communities as well.
Once the location within the community is identified, the trade area can be
calculated. With a map of the community, designate the site for the business;
then, using a compass, place the epicenter on the proposed site and draw a
circle that represents the distance (the radius) you expect people to drive to
reach the site. Within the circle is the trade area, which can now be studied in
more detail. Using the demographics and a census tract map, identify census
tracts within the trade area and look at the census data to determine how many
people reside within the boundaries of the trade area. The demographic infor¬
mation will also describe these people in terms of education level, income level,
average number of children, and so forth.
Competition
Within the trade area you can also identify the competition. To do this, drive
through the area (assuming it is not too large) and spot competing businesses.
Note their size and number, and also gauge how busy they are at various times
of the day by observing their parking lots or actually entering the business. If
competitors are located in shopping malls or strip centers, look for clusters of
stores similar to yours and low vacancy rates. This would indicate a strong
attraction for the site. Look at the stores near your proposed site to check for
compatibility. Often locating near a competitor is a wise choice because it
encourages comparison shopping. Observe the character of the area. Does it
appear to be successful and well maintained?
Accessibility
It is important to identify the routes your customers might take to reach the
proposed site: highways, streets, and public transportation routes. If the site is
difficult to locate and hard to reach, you can be certain potential customers will
not exert the effort to find you. Also check the parking situation. Most commu¬
nities require a sufficient amount of parking space for new construction, either
through lots or garages; however, in some older areas, street parking is the only
available option. If parking is a problem to find or too expensive, you will lose
customers.
Do a foot and car traffic count for your proposed site to determine how busy
the area is. Remember, retail businesses rely heavily on traffic for customers.
Whether you need a high volume of foot traffic is a function of the type of busi¬
ness. Obviously, a coffee house benefits immensely from a high volume of foot
traffic, whereas for a warehouse hardware store it may not be as vital. A traffic
count is easily accomplished by positioning yourself near the targeted site and
tallying the customers going by and into the business. City planning depart¬
ments and transportation departments maintain auto traffic counts for major
arterials in the city
Choosing the Service/Wholesale Site

If a service or wholesale business has customers who come to the place of busi¬
ness, the needs for a site will parallel those of the retailer in some respects.
Accessibility, attractiveness, and a trade area of sufficient size are all important
factors in the selection of a site. The entrepreneur does not, however, need to
choose from the more expensive commercial sites as the expectations of the
customers may not be as great for a wholesale outlet that sells to the public, for
example. Customers going to these types of businesses usually want to save
money, so they don’t expect the “Cadillac” version of a business site. Some
service businesses, on the other hand, require attractive office space that is
easily accessible. These are usually professional businesses—lawyers, accoun¬
tants, consultants and so forth. The image they present through the location
and appearance of their office is crucial to the success of the business.
Many service and wholesale businesses do not have customers coming to
their places of business. Some examples are distributors, contractors, and
certain types of consultants. In these cases, it is more prudent for the business
to be located in less expensive, less high-profile areas of town where they are
still near the customers they serve but can take advantage of a savings in rent or
land costs.
Choosing the Manufacturing Site

For the manufacturer, the location choices narrow significantly. Communities
have zoning laws that limit manufacturing companies to certain designated
areas away from residential, retail, and office commercial sites to reduce the
chance of noise, odor, and pollutants affecting the citizens. Often these areas are
known as industrial parks, and they usually are equipped with electrical
power and sewage plants appropriate to manufacturing. By locating in one of
these parks, the new business may also benefit from the synergy of other manu¬
facturing nearby. Opportunities for networking and sharing resources and costs
are enhanced.
Another common location for manufacturing is enterprise zones, which are
public-private partnerships designed to bring jobs to inner cities, downtown
areas, and rural areas suffering from the shift of jobs and population to the
suburbs. There are 35 states (plus the District of Columbia) with authorized
enterprise zones. The draw for businesses is tax incentives, regulatory relief,
and employee training programs. However, the enterprise zone program is not
without its critics. The principal criticism is that there is no net economic gain
for the community. Since businesses often move from one area of town to the
enterprise zone simply to take advantage of tax breaks, no new jobs are created.
Yet another criticism comes from established businesses in the area who
complain that the zones are nothing but incubators for competitors. In spite of
these criticisms, enterprise zones are likely to continue as one method for
creating jobs and rebuilding decaying inner cities.
Wherever an entrepreneur looks for a manufacturing site, he or she is
concerned with four key factors: access to suppliers, cost of labor, access to
transportation, and cost of utilities. These factors may not be equally weighted.
Depending on the type of manufacturer, one or more factors may have greater
importance in evaluating a site.
Access to Suppliers
Manufacturers and processors usually try to locate within a reasonable distance
from their major suppliers to cut shipping time and save transportation costs.
Certainly a food processor attempts to set up business near the growing fields
so the food is as fresh as possible when it arrives at the processing plant.
Similarly, a manufacturer that uses steel as one of its main raw materials might
want to locate in the same region of the country as the steel mills to save the
high costs of trucking heavy steel great distances.
Cost of Labor
Today many manufacturers choose a location based on the cost of labor rather
than proximity to suppliers, since labor is generally the single highest cost in
the production of goods. Wages and laws relating to workers, such as workers’
compensation, vary from state to state, and sometimes from city to city. For
example, California laws and cost of living tend to make it a more expensive
place to hire employees than those same employees might cost in Missouri.
Some labor-intensive businesses have found that the only way they can
compete is by having plants in Mexico or China, where labor costs are a frac¬
tion of those in the U.S., and where laborers are not protected by as many laws.
Mattel Toy Company, for example, has a plant in China to produce the hun¬
dreds of different toys it markets every year. The bottom line is that the entre¬
preneur must weigh the costs in terms of access to labor carefully when
considering a particular location for a manufacturing plant.
Access to Transportation
Most manufacturers prefer to locate near major transportation networks: rail¬
ways, major highways, airports, and ports of call. The reasoning is obvious: The
greater the distance between the plant and a major transportation network, the
higher the cost to the company and ultimately the customer. Also, the more
transportation people who handle the product, the greater the cost. Thus, in
terms of simple economics, to remain competitive manufacturers must consider
the cost-benefit of locating away from a major transportation network. The
higher transportation costs will result in a smaller profit margin for the
company or higher costs for the customers. Either way you lose.
Cost of Utilities
Utility rates vary from state to state, and usually from city to city within a given
state. If the new venture is heavily dependent on electricity, gas, or coal, this
factor could be a significant variable in the cost of producing a product and
therefore should be examined carefully
The Building: The Lease-Buy-Build Becision

To this point, only the site itself has been considered. Naturally there is a
building or facility involved as well, which makes the site decision that much
more complex. If the site contains an existing building, the question becomes
whether to lease or buy. If the site is bare land, building a facility is the only
choice. As a significant portion of a new ventures start-up costs is contained in
a facility, each of these scenarios is looked at in more detail.
The Existing Building

Any existing building on a potential site must be examined carefully with
consideration to the following questions:
• Is the building of sufficient size to meet current and reasonable future needs?
• Do the building and site allow for future expansion?
• Is there sufficient parking?
• Is there space for customers, storage, inventory, office space, and rest rooms?
Allowing for future growth is essential. The initial higher cost of a larger
building is often offset by avoiding the extraordinarily high costs of moving and
the potential for lost sales and time away from the fundamental work of the
business while the business is in transition.
When examining an existing building, begin with the exterior and ask the
following questions:
1. Does the building have curbside appeal, assuming customers will come to
the site?
2. Is the building compatible with its surroundings?
3. Does it have enough windows of sufficient size?
4. Is the entrance inviting?
5. Is the signage attractive and does it satisfy the local regulations?
6. Is the parking adequate to meet customer and employee demand and satisfy
local building codes?
7. Does the interior of the building meet your needs in terms of walls, floors,
and ceilings?
8. Are there sufficient lighting fixtures, outlets, and enough power to run
equipment?
These are just a few of the questions to ask before finalizing a decision on a
building. Most entrepreneurs can answer the above questions to their satis¬
faction, but to be certain the building is not hiding anything that could come
back to haunt the entrepreneur and be costly for the business, it is wise to hire
a licensed contractor or inspector to examine the building for structural
soundness.
Leasing a Building
The speed of change, innovation, and technological advancement has and will
continue to shorten product and service life cycles, and this has an impact on
the facilities in which businesses operate. Buildings, on the other hand, have
long physical lives and typically are very expensive to refurbish and remodel.
Consequently in many communities factories and retail outlets can be seen lying
vacant for long periods of time, even years. Ultimately they sell for or are leased
at an amount far below what it cost to build the building in the first place.
It has been suggested that one solution to the problem is for businesses to
hold short leases of five years or less. In this way the company does not tie up
precious capital that it may not be able to recover, and it has the ability to move
on when a product or service is deemed technologically antiquated and no
longer in demand. There are, however, some serious disadvantages to short¬
term leasing.
Rents are escalated more frequently due to short-term renewal. Many a
business has found itself in this awkward position. Demand for the product or
service has been successful beyond initial predictions, so the business needs to
remain in its current location beyond the term of the lease. When the entrepre¬
neur goes to renegotiate the lease terms, he or she inevitably finds the landlord
intends to raise the rents for a new lease. This is usually justified by increasing
market rents; however, at the same time, the landlord is aware that it would be
costly for the tenant to relocate. The business would have little time to do so
and still maintain its current production rate. Furthermore, the potential for
having to replace employees and create new logistics for suppliers and buyers is
daunting. All these factors put the entrepreneur in a very weak position to
negotiate a new lease.
To strengthen your position, when the lease is first negotiated, include a

clause that permits the option to renew at a specified rate, and an escape clause
in case the business must be closed. These two clauses may cost a bit more
initially, but can yield long-term savings.
It will be more difficult to remodel mid-term. If you have a short-term lease,
the landlord will be less likely to approve any substantial tenant improvements
if they do not increase the value of the building to future tenants.
When the lease is first negotiated, come prepared with a five-year plan for
the facility and be able to demonstrate the benefits to the landlord of allowing
the remodeling of the building.
You will not be able to show a substantial asset on the balance sheet.
Therefore, it will not be a good vehicle for raising capital.
If you own the building, you can later sell it to raise needed capital and lease
it back, thereby avoiding moving costs and providing the new landlord with an
instant tenant, a factor that increases the value of the building to the new owner.
The cost of leasing a building is a function of the demand in the marketplace
for rentals as well as a number of other factors.
• Buildings that are newer, suitable for a variety of uses, and well-located
generally enjoy higher lease rates, as do buildings in short supply.
• Since rent is normally paid based on square footage of space, the larger the
space, the more costly the lease.
• Retail and service business sites are generally more expensive than industrial
sites.
• A retail site in a regional mall will likely be the most expensive.
Be aware, though, that while manufacturing sites enjoy low rental rates, they
usually pay higher amounts for water, power, and sewage. That is why it is
important to consider all the costs related to leasing a facility. Not including the
cost of expensive utilities or a common use area fee could spell disaster to the
business’s cash flow.
Businesses face three basic types of leases.
• Gross lease. This lease allows the entrepreneur to pay a fixed rate per
month, with the landlord covering the cost (and getting the benefit) of insur¬
ance, taxes, and building operating expenses such as outdoor lighting, secu¬
rity, and so forth.
• Net lease (Also known as triple net). This lease has the entrepreneur
paying a fixed monthly rate plus taxes, operating expenses, essentially every-
thing but the mortgage and the building insurance, which the landlord pays.
What the entrepreneur actually rents is a shell with stipulated improvements.
• Percentage lease. This is the most complicated of all the lease types because
it has several variations. It can be written as a percentage of the net income
of the tenant or as a flat rate plus a percentage of the gross revenues. The
latter is very common in retail operations.
Fortunately for businesses seeking lease facilities, it’s a renters’ market and
will probably remain so for the foreseeable future as demand lags the over¬
supply created in the 1980s. Moreover, savvy customers in the 1990s expect
businesses to reflect the trend toward “less is more” by controlling costs and
simplifying operations. In a renters’ market, businesses can expect to negotiate
leases that provide a certain period of free rent, free parking, allowances for
tenant improvements, and greater flexibility to extend or shorten the lease. For
example, one Chicago-based company renegotiated its high-rent lease, reducing
its obligation from $36 per square foot to $22. In addition, the landlord agreed
to cover the $1 million tenant improvements, which would be recovered over
the term of the new ten-year lease.
Even more savings in a lease can be achieved by reading it carefully.
• Make sure there is a provision for examining the books of the landlord to
view the costs related to the building. In this way you may discover “pass¬
throughs,” or costs in the form of capital improvements that should not be
passed on to the tenants, such as the cost of a new security system. You may
also find charges to the tenants for expenses that are rightfully the owner’s,
such as personal services to the owner who is also a tenant of the building.
• Check carefully for clerical mistakes, particularly the easily overlooked
simple items like addresses, suite numbers, square footage, and rental
amounts.
• Talk to other tenants of a building to find out common needs that may be
achieved through a unified effort.
• Ask for a breakdown of taxes and operating expenses for the previous three
years and projections for the next five years.
• Ask for a work letter that explains all improvements the landlord will make
for the tenant as well as work the tenant must complete and all costs associ¬
ated with the completion of these improvements.
• Make certain the building meets requirements and safety levels prescribed by
the Environmental Protection Agency.
Remember first and foremost, leases are written from the landlords point of
view and are, therefore, negotiable. Just because something appears in printed
form does not mean it is true or that you have to agree to it. A lease represents a
significant portion of a business’s overhead, and you will most likely have to
live with it for a long time, so make sure it’s what you really want. Leases are a
great way for start-up businesses to get into the marketplace, but don’t let your
enthusiasm for starting the business blind you to the potentially disastrous
terms of a poorly written lease. The best advice is to seek the assistance of an
attorney who can represent your interests.
Buying a Building
If the entrepreneur has the resources, buying a building has some advantages. A
valuable asset is immediately created on the balance sheet, which can be lever¬
aged later on when growth capital is needed. For example, the building could
be sold and leased back (called a sale-leaseback), withdrawing equity for other
uses and negotiating favorable long-term lease terms. Sale-leasebacks are attrac¬
tive options for investors and so these buildings generally sell quickly. Of
course, when you sell the building, you effectively lose control of it, so be
certain to negotiate terms that allow you to remodel and extend the lease
should you wish to do so.
One advantage of owning a building is that it can be traded in a tax-deferred
exchange for other property you need. For example, suppose you owned an
office building but needed a distribution warehouse to support a new direction
your business was taking. You might take advantage of a tax-deferred exchange
by trading the office building for the warehouse. The exchange would defer
capital gains tax on the sale of the office, and you would have the warehouse
you need.
One other option to consider is a joint venture between you, the entrepre¬
neur, and a real estate developer on a building in which you will be one of the
tenants. If you are able to occupy a substantial portion of the building, it is
easier for the developer to acquire a mortgage and additional tenants. Of
course, this type of arrangement has the inherent problems of any partnership
and should be considered carefully with the advice of an attorney before any
agreement is executed.
Buying a building requires a contract, much like a lease agreement. It spells
out the terms of the purchase and the items included and excluded from the
purchase agreement. As always, read it carefully to make sure that what you
agreed to verbally has been translated correctly on paper. It would be wise to
hire a due diligence team (inspector, contractor, CPA, attorney) to inspect the
building and the agreement so your interests are protected.
Building the Facility

When you can’t find the type of building in the location you want, building
the facility from the grPund up becomes the only option. This will entail an
architect, permits, possibly zoning variances, a construction bidding process,
off-site improvements (curbs, gutters, water and power lines, roads), and a
lengthy building and inspection process. This option should not be under¬
taken without the aid of a licensed general contractor. Be sure to check the
reputation of any contractor you are considering. This is important should the
contractor have a dispute with any of the subcontractors hired for the various
aspects of the job. The subcontractors have a right to lien the property,
Constructing a which is owned by you. You will then have to sue the contractor to
building is no doubt resolve the issue and remove the lien (you cannot receive a Certificate
the most complex of Occupancy if any liens are present), and this is a time-consuming
option; however, you and costly process.
will end up with a Also, as you are most probably responsible to the lender for the
building that construction loan, you can ensure that any subcontractors are paid by
completely meets 1) using a voucher system, which is a cumbersome method whereby
your needs. the subcontractor receives a voucher for work completed and must
take it to the lending bank for payment and release of liens, or 2) by
paying the subcontractors directly and receiving lien releases. The latter is
known as “jointing a check.” It prevents the general contractor from using the
funds for other purposes and potentially not having the money to pay the
subcontractor.
Constructing a building is no doubt the most complex option; however, you
will end up with a building that completely meets your needs. This option is
most suitable when the needs for the building and/or the location are unique,
when you have the time to wait, and when you intend to remain in the facility
long term.
Starting the Business from Home

Almost 20 percent of the 92 million households in America have home offices
that produce an income for the owner. It is estimated that more than 1,200
new home businesses begin every day. Add to that the increasing number of
people employed in traditional offices who work at least part of the week from
home as telecommuters and you have approximately 38 million people who

work from home!
Some of the largest, most successful companies in the world today started
from home, including Apple Computers, to name just one. The biggest reason
so many new ventures start from home is cost, as one of the biggest line items
in the budget of a start-up is rent or the cost of buying a building. Conse¬
quently, many new companies choose to start with minimal overhead until their
product or service gets off the ground to better ensure that the company
survives the risky start-up phase. Once orders or clients start coming in regu¬
larly, the business can move to a more permanent location.
For some entrepreneurs, however, the goal is to never leave home, but to sub¬
contract all activities that cannot be accomplished from home. This new type of
business is a phenomenon of the 1990s and is likely to continue in populanty as
people seek more control over their lives, to reduce stress, and to avoid interrup¬
tions and traffic jams. With a phone, fax, copier, and computer, technology has
made possible the era of the telecommuter and the virtual enterprise.
Anyone considering working from home, even for the short term, should
consult with local government agencies to see what the zoning ordinances are. In
general, most communities frown on home-based businesses in residential areas,
especially if the business receives a lot of auto traffic. For example, Los Angeles
prohibits home-based businesses, even those of typical home-office users like
consultants, free-lance writers, and artists. However, in spite of the ban, it is esti¬
mated that more than 2.2 million households in the Los Angeles area contain a
full- or part-time home business. To avoid potential penalties, check the laws
and restrictions regarding home-based businesses in your local community.
Final Thoughts
The information collected on where to locate the business and whether to lease,
buy, or build the facility will be used in various parts of the business plan. For
example, the information on the trade area for the product/service will be
useful in the marketing plan section where you elaborate on how to reach the
target market. One of the “Four P’s” of that marketing plan is place—where the
business will be located. Information on rental rates and building costs will
certainly play a role in the financial plan section of the business plan.
New Venture Checklist

Have you
□ Determined how your business will operate?
□ Found ways to operate like a virtual enterprise?
□ Located a site for the business?
□ Examined the economic base, incentives, demographics, and trade area?
□ Decided whether to lease, buy, or build the facility?

“The Survey of Buying Power,” Sales and Marketing Management (Annual).
Choosing a Retail Location, SBA Pub. No. MP10.
Locating or Relocating Your Business, SBA Pub. No. MP2.
Practical Business Use of Government Statistics, SBA Small Business
Management Series, Stock No 045-000-00131-8.
Using Census Data to Select a Store Site, SBA Pub. No. MA2.023.
1. How can a virtual enterprise be created and what is its value?

Issues to
2. What are five key clauses that a commercial lease should contain?
Consider
3. How is the economic base of a community determined?
iji 4. If you were going to start a manufacturing plant, what characteristics in the
site would you be looking for?
5. How does a sale-leaseback work?
6. How is a trade area determined, and what is the value of defining and
studying a trade area?
CHAPTER 11
The Operational Plan
Overview
• The technical/operational analysis of the business concept
• The product development process
• The product manufacturing cycle and the role of the various interdependent
functions
• Inventory systems that will allow for the minimum inventory possible while
still meeting demand
• A quality control philosophy for the new business
• Preparation of the operational plan section of the business plan
Designing an Operational Plan

Many high-growth ventures involve new, innovative products. For these
product manufacturing or assembly ventures, the operational plan for the busi¬
ness consists of a fairly complex analysis that includes product development,
prototyping, production processes, and inventory control mechanisms. The
depth of analysis is a function of the type of product or service being offered,
the technological newness of the product, and the number of different ways the
product can be produced. Generally speaking, product companies must
undergo more in-depth, thorough technical analysis than service companies,
although a lack of thoroughness in either case can spell disaster for a new
venture.
195
While this chapter focuses on product development and manufacturing, it

does so only because generally speaking, that type of business is the most
complex. Those readers who have an interest in service, retail, wholesale, or
other types of businesses can pick and choose from the chapter the information
appropriate to their type of operation. The fundamental issues of designing a
prototype, testing it, and planning for how the business will produce the
product are the same for all types of businesses.
New Product Development

The processes, techniques, and time lines—in fact the whole area of product
development in the United States, has undergone profound change. Those who
study this area are convinced this change has been brought about by three
factors:
• International competition
• Sophisticated customers in fragmented markets
• Widely diversified and changing technologies1
International Competition
Since the 1980s the number of companies competing in the global marketplace
has increased enormously. Couple that with the fact that similarity in product
concepts has expanded and you have the makings of an intensely competitive
arena for product development. An American company finds it is no longer
competing simply with other American companies, but with companies from
diverse regions of the world who bring their own trademark to the process and
the products.
Sophisticated Customers from Fragmented Markets

The ability of todays customer to differentiate products on a very subtle level
and the demands of customers for products that reflect their lifestyles and
value systems make it incumbent upon product developers to create products
that differentiate themselves on many levels in the marketplace. Where once
product performance and price were the main competitive measures, today
these two factors are givens. They must be present for a company to even
begin to be competitive. This means that a manufacturing company can never
'Clark, K & T. Fujimoto. (1991). Product Development Performance. Boston: Harvard Business School Press.
Chapter 11 • The Operational Plan 197
stop improving its design and manufacturing processes if it wishes to remain

competitive.
Widely Diversified and Changing Technologies

Certainly it is recognized that technology is important and essential to product
development, and today the marginal cost of added technological capability is
small. But a growing business cannot build its competitive advantage around
technology alone. Customers are primarily interested in a product that will
meet a need or desire, and not necessarily interested in the technology or tech¬
nological processes that produced it. Often a customer is not willing to pay for
or is not interested in having added technology just because it’s easily available.
A company operating in a technology-based industry like electronics must
keep up with changing consumer demand as well as the technological innova¬
tions of its competitors. Competitive advantage can be built around a line of
market-differentiated products, but is enhanced by proprietary processes. In
the case of a new product, it must not only create value for the customer, but
must also be difficult for someone else to produce at the same quality level and
for the same cost.
Product Development the Entrepreneur's Way

Most large corporations have separate departments responsible for research and
development, engineering, and testing. In many cases, the budgets for these
particular departments are astronomical, since new product development, as
well as the continual improvement of existing products and processes, is
considered one of the most important and challenging tasks of high-
performing, world-class businesses.
In the case of start-up ventures, the task is equally challenging; however,
most new ventures, unlike large corporations, have very limited or nonexistent
budgets. Funding research and development, engineering, and testing for a new
company is considered the highest risk stage by most investors; consequently,
this type of funding is difficult, if not impossible, for entrepreneurs to secure.
They are left with a dilemma: how to perform the R & D that will result in a
factory-quality, engineered prototype as quickly as possible yet as inexpensively
as possible. It is not surprising then that many good product ideas fail to
achieve market introduction.
Other difficulties faced by entrepreneurs at this pre-start-up stage include
finding the right consultants to do the engineering, material and parts sourcing,
and model building. This effort can be expensive and time consuming, so choos¬
ing the wrong consulting firms can be devastating. As engineers tend to specialize
(mechanical, electrical, civil), it is possible that one product may require the
services of more than one type of engineer. Some of the areas of product develop¬
ment that require engineering analysis, design, and expertise include:
• Component design
• Materials specifications
• Machinery to process
• Ergonomic design
• Packaging design
• Assembly drawings and specifications
• Parts and material sourcing (suppliers)
• Operators and owner’s manuals
Entrepreneurs who develop products usually go through a process much like

that shown in Figure 11.1.
Figure 11.1: The Product Development Cycle
Opportunity Recognition
Concept Investigation
1
Initial Design Preparation
Prototype Building & Field Testing
I
Initial Test Production Run
I
Market Introduction & Ramp-Up
Opportunity Recognition
Recall from Chapter 2 that the first stage in the development of a business
concept is opportunity recognition: identifying a niche that has not been
served, detecting an improvement in an existing product, or seeing an opportu¬
nity for a breakthrough product. Once the opportunity has been identified, it is
critical to move forward with the next stage, concept investigation, to shorten
the product development cycle as much as possible.
Concept Investigation
Concept investigation is simply doing some investigation to determine if the idea
currently exists, if there is a potential market, how much it will cost to produce
the product, and how much time will it take. This last piece of information is
crucial since an enforced shorter development cycle allows the company to have
a first-mover advantage, better meet its customers’ needs, lower the costs of
production, and cut off the tendency by the entrepreneur or inventor to keep
“improving the product,” instead of getting it out into the market.
Initial Design Preparation

The first stages of design preparation go hand in hand with concept investiga¬
tion because the entrepreneur normally needs some preliminary working draw¬
ings of the product to estimate costs and manufacturing processes. These
preliminary drawings are also used to apply for a patent if the product is
patentable. However, once it has been determined the product has real poten¬
tial, it is time to bring in the design engineers and the other members of the
functional team—marketing, operations, and finance—to put together accurate
drawings of the product and initial specifications.
Prototype Building and Field Testing

From the initial engineered drawings will come the prototype or model of the
product. Often the first prototype does not closely resemble the final product in
appearance, but usually does in function. In fact, today it is important to reach
the physical stage of prototyping as quickly as possible because involving key
functional team members is much less expensive at this early stage. The impor¬
tance of involving key functional players in the development of the prototype
cannot be overstated. It is far less costly to discover at this stage from the
marketing expert that the customer will not like the ergonomics of the product,
or from the operations and finance experts that the equipment to produce the
product is beyond the current budget. With little money invested, team
members are free to simulate the use of the product and make mistakes while
finding the best version of the prototype.
Technolog}' has even entered the prototyping stage of product development
in the form of “rapid prototyping." Today you can purchase a device that,
working from information in your computer, will cut and shape metal or other
raw materials into three-dimensional parts. In this way you can actually design
a part on the computer screen and then cut it into a real prototype virtually
instantly in your office. The obvious advantage of this is avoiding the shipping
of two-dimensional drawings to a parts manufacturer and then waiting for the
part to be made.
With a prototype it is also easier to acquire more accurate target market
demand information, more accurate cost estimates, and a clearer sense of
whether the product will work as proposed in the design phase. The
added benefit is that eliminating features that do not create value in the
Businesses that do
mind of the customer can reduce manufacturing costs 25-40 percent.
not manufacture
Moreover, through field testing the prototype, adjustments and modifi¬
products—service, cations can be made, leading to a production-quality prototype: in
retail, wholesale, essence, the final product.
and so forth—still Various engineers can be employed to take the crude prototype and
determine the best assembly design, the types of materials to use. the
need to design a
most effective components, the required suppliers, and which other
prototype.
subcontractors might be needed to make the product readv for produc¬
tion. From the engineered assembly drawings, parts lists, and specifica¬
tions, the production-quality prototype can be assembled. Small engineering
firms or solo engineers who support entrepreneurs and inventors, small iob
shops, machine shops and/or model builders may be used to complete the
prototype. These sources are normally quicker and less expensive than the
larger, better-known finns. When seeking an engineer or model builder, the
entrepreneur must use caution. Careful analysis of qualifications, experience,
and references relative to the task are essential. A good source of referrals is a
major university engineering department and/or other engineers.
Businesses that do not manufacture products—sendee, retail, wholesale, and
so forth—still need to design a prototype, but the prototype in this case wTd not
be physical. Instead it will be a design for how the business will provide a
service or product to its customer, maintain and control inventories, hire
employees, and guarantee quality and satisfaction. Entrepreneurs who intend to
start nonmanufacturing businesses should read this chapter substituting the

design for their service as the product where appropriate.
One of the time-consuming aspects of this stage of product development is
sourcing the components and raw materials for the product. Deciding which
switch to use, who should mold the plastic, or which vendors provide the best
materials at the lowest prices requires a lot of leg work. Of course, the entrepre¬
neur could leave these decisions to the design engineers, but at $150 an hour, it
doesn’t make sense to have the engineer searching for and comparing all the
parts and materials. The engineer may, however, offer suggestions based on
experience, but the actual leg work is usually done by the entrepreneur and the
founding team. What the engineer does is ensure the product meets OSHA
standards (assuming it needs to) and suggest warning labels that may be
required on the product.
Initial Test Production Run

The number of prototypes used in the field testing stage is limited. The entre¬
preneur has usually not yet met the suppliers volume level for discounts, so the
cost to produce at this stage is very high. After conducting a small initial test
production run in a limited market, the product is honed to completion and
market-ready status. It is also the first opportunity for the entrepreneur to test
the manufacturing and assembly processes and determine accurate costs of
production at varying levels of volume.
Product Market Introduction and Ramp-Up

At this stage the product is ready for introduction into the market, and the
manufacturing processes are in place to meet projected demand.
Today it is simply not enough to produce a high-quality product at a fair price.
To become and remain competitive, the new business must strive for a product
development cycle that achieves low cost and high quality as quickly as possible.
Quality Function Deployment

The team-based approach to product development referred to previously is
known as Quality Function Deployment (QFD). QFD was developed in 1972
at Mitsubishi’s Kobe shipyards and was later adopted by Toyota because it was
thought to reduce design costs by 60 percent and design time by 40 percent.
QFD was introduced in the United States in 1986 at Ford and Xerox.
PROFILE 11.1
Shortening Development Time Through Teams:

The 3M Experience
While 3M manufactures a variety of consumer and industrial products, it is probably
best known for its adhesives, namely Scotch Tape® and Post-it Notes®. Because it
focuses on unpatentable products whose origins lie in customer needs, it is crucial
that 3M be able to identify and solve problems quickly to get new products to market.
Using the traditional engineering development cycle would put 3M at a disadvantage,
as it would be fairly easy for a competitor to replicate the production process and
come out with a competing product shortly after 3M’s introduction of its product.
To solve this problem, 3M built a research and design center in Austin, Texas, and
housed both its engineers and its marketing staff there. Working together, the Austin
group found they could work from physical prototypes almost immediately without the
need for detailed drawings. In fact, it made more sense to customize and modify the
design using a physical prototype, resulting in the right version being reached much
more quickly. This was true, for example, with their mechanical splicing device for
optical cables; they were able to go into full production without detailed blueprints,
and the product worked. Interestingly enough, when they ultimately did create the
blueprints according to the original design, the product didn't work!
The purpose of QFD is to insert customer input throughout the design,

manufacturing, and service delivery phases of product development. The
market research done for QFD addresses strategic decisions such as perfor¬
mance versus comfort, and functional or ergonomic decisions such as where to
place a handle. It does this through customer input known as “Voice of the
Customer,” which is a prioritized, hierarchical set of “customer needs.”
QFD is depicted through the use of four houses:
Customer Needs. Customer needs is a description in the customers own words

of what their needs are with regard to the product. For example, in the case of a
new portable computer, the customer may say, “It must be easily carried in a
briefcase.” A list of several hundred needs may be developed, but they generally
fall into three categories: basic needs or assumptions about the product (e.g.
that it must be small); desired functions (e.g. what they want it to do); and
unusual or unexpected desires (e.g. needs that may surprise or excite the
customer).
Figure 11.2: The House of Quality
Hierarchy of Needs. Customer needs are structured into three categories:

primary, secondary and tertiary. Primary needs are strategic and consist of the
top five to ten customer needs. These direct the engineers as to whether, using
the laptop computer as an example, the size, weight, or functions of the
computer should be the focus of their efforts. Each primary need then is
expanded into three to ten secondary or tactical needs—in other words, what
the product development team must do to satisfy that primary need. For
example, how is the desired size achieved, or what is the optimal shape?
Tertiary or operational needs provide the engineers and R&D personnel with
details needed to develop the solutions to the tactical requirements. For
example, how you know when the desired size is achieved.
Importances. Importances are the priorities customers place on certain features

like size, weight, and so forth. These priorities are then weighed against the cost
and feasibility of satisfying a particular need.
Customer Perceptions of Performance. Customer perception is a measure of

how customers perceive other products in the market that are currently
satisfying the need. Where no such product exists, it measures the way that
customers attempt to satisfy the need.
From the House of Quality, the team identifies those design attributes that will
affect customers’ perceptions of the product if modified to meet their needs. The
team also considers the realities of engineering and the costs. What has been
presented here is merely an overview of the QFD process. What has not been
covered are the possibilities for mathematical operations to develop indices and
scales for enhancing decision making. Check Additional Sources of Information at
the end of the chapter for more information on this subject. The key point to
remember about QFD is that it represents a philosophy of product development
that brings all members of the team in at the beginning of the design phase,
including the most important member of the team—the customer. Many entre¬
preneurs have used this team approach successfully without implementing the
complete QFD process, a fairly complex method which usually requires the
assistance of an outside consultant with experience in QFD.
Figure 11.3: New Product Checklist
The Market Yes No Perhaps

Is there an existing need for this product in the marketplace? _ _ _
Will I be first in the marketplace with this product? _ _ _
Can I protect the product legally? _ _ _
Can I erect entry barriers? __ _ _
SWOT Analysis
Do the strengths of this product exceed any weaknesses? _ __ _
Are there various opportunities for commercializing this product? __ _ _
Do any significant threats exist to the development of this product? __ _ _
Design/Development/Manufacturing
Is the product innovative? __ _ _
Can it be developed quickly to market-ready state? _ _ _
Can it be easily manufactured? _ _ _
Do I have the resources to manufacture the product? _ _ _
Is it more practical to subcontract the manufacturing? _ _ _
Is there a possibility for spin-off products? _ _ _
Financial
Is the return on this investment sufficient to justify the effort? __ __ _
Are the development costs within reason? _ _ _
Can the manufacturing investment be minimized while still maintaining
quality and control? _ _ _
Is the money needed to produce the product available? _ _ _
The Product Manufacturing Cycle

A typical manufacturing plant has five functional areas:
The Product Manufacturing Cycle
The purchasing function is responsible for the purchase of raw materials or

components. Its effectiveness is judged by the quality of the raw materials, the
cost, and the timeliness of their delivery. The materials management/production
scheduling section is responsible for moving the raw materials through the
production process and storing them. Its effectiveness is judged by the cost of
inventory and its ability to meet demand for raw materials. Production converts
raw materials into finished goods. Its effectiveness is judged by the quality of
the goods produced, their cost, and the timeliness of production. These effec¬
tiveness factors also apply to assembly plants. The quality function is respon¬
sible for the quality of the finished product and is judged by its ability to detect
defective goods before they leave the factory and to develop methods to reduce
the number of defects during production. The maintenance function maintains
and upgrades the manufacturing equipment. Its effectiveness is judged on the
basis of cost as well as the percentage of unscheduled downtime that the equip¬
ment experiences.
Manufacturing firms are typically organized as product-focused or process-
focused organizations. A product-focused organization generally is highly
decentralized so it can respond better to market demands. Therefore, each
product group acts essentially like a separate company, a profit center. This type
of organization is well suited to products that don't require huge economies of
scale or capital-intensive manufacturing technologies. Process-focused organiza¬
tions, on the other hand, are common among manufacturers with capital-
intensive processes such as those seen in the semiconductor industry. These
organizations are highly centralized in order to control all the functions of the
organization. Whether the company is product or process-focused, it must be
able to extend its control beyond the five functional areas so it is not at the
mercy of its suppliers at one end and its distributors at the other. This control is
usually accomplished through strategic alliances.
As discussed in Chapter 10, the virtual enterprise, consisting of strategic

alliances between every link in the value chain, is one way to achieve control of
the entire process from raw materials to distribution, while still remaining small
and flexible enough to meet changing needs and demands. This model is
similar to that of the Japanese keiretsu, which links banks, suppliers, electronics,
and auto firms together through a series of cross-ownerships.
The United States’ model, however, leaves ownership in the hands of the
individual owners but links the organizations into a virtual entity that acts as
a team with a common goal. Wal-Mart is probably the best example of this
type of partnership and integration. It has established point-of-sale linkups
with its suppliers and given its manufacturers the responsibility for handling
inventory. The ultimate goal is to construct one organization with a common
purpose that encompasses the entire supply chain from raw materials
supplier to retailer, with each link along the chain performing the task that it
does best.
Materials Requirements
Any business that purchases raw materials or parts for production of goods for
resale must carefully consider the quality, quantity, and timing of those
purchases. Quality goods are those that meet specific needs. The quantity
purchased is a function of demand, manufacturing capability, and storage capa¬
bility. Planning purchases so that capital and warehouse space are not tied up
any longer than necessary is the result of good timing. As materials account for
approximately 50 percent of total manufacturing cost, it is important to balance
these three factors carefully.
Locating vendors to sell you raw materials or goods for resale is not difficult,
but finding the best vendors for your purposes is another matter entirely. The
first decision is whether to buy from one vendor or more than one vendor.
Obviously, if a single vendor cannot supply all your needs, that decision is
made. There are several advantages to using a single vendor where possible:
• You will probably get more individual attention and better service.
• Your orders will be consolidated so you may be able to get a discount based
on quantity purchased.
However, the principal disadvantage of one vendor is that if that vendor

should suffer a catastrophe (its facility burns to the ground like the Japanese
company that was the prime supplier of RAM chips), it may be difficult or
impossible to find an alternate source in a short period of time. To ensure
against this contingency, you may want to follow the general rule of using one
supplier for about 70 to 80 percent of your needs, and one or more additional
suppliers to supply the rest.
When considering a specific vendor as your source, ask yourself several
questions:
1. Can the vendor deliver enough of what you need when you need it?
2. What is the cost of transportation using the vendor you are considering? If
the vendor is located far away, costs will be higher and it may be more diffi¬
cult to get the service you require.
3. What services is the vendor offering you? For example, how often will sales
representatives call on you?
4. Is the vendor knowledgeable about the product line?
5. What are their maintenance and return policies?
It is also important to shop vendors to compare prices, just as you would if

you were purchasing equipment. Check for trade discounts and quantity
discounts that may make a particular vendor’s deal more enticing.
The computer technology revolution has made materials planning more of a
science than ever before. Information systems can now provide purchasing
managers with detailed feedback on supplier performance, delivery reliability,
and quality control results. Comparing results across suppliers gives the
purchasing person more leverage when it’s time to renegotiate the annual
contracts with suppliers.
Inventory Requirements
Today businesses that hold inventories of raw materials or goods for resale have
found they must reduce these inventories significantly to remain competitive.
Instead of purchasing large quantities and receiving them on a monthly basis,
businesses are purchasing daily or weekly in an effort to avoid costly invento¬
ries. Of course, some inventory of finished goods must be maintained to meet
delivery deadlines; therefore, a delicate balance must be achieved between
goods coming into the business, work in progress, and goods leaving the busi¬
ness to be sold.
Inventory Costs
There are many costs associated with inventories that can add as much as 25
percent to the base cost of the inventory. They include:
• Financing Costs. The interest paid on the money you borrow to purchase
the inventory.
• Opportunity Cost. The loss of use of the money tied up in inventory.
• Storage Costs. The amount spent on warehouse space to store the inventory.
• Insurance Costs. The cost of insuring the inventory.
• Shrinkage Costs. The money lost from inventory that is broken, stolen, or
damaged.
• Obsolescence. The cost associated with inventory that has become obsolete.
Inventory Turnover
It is important to understand how often inventory turns over in your industry
to help determine how much inventory, and specifically what goods, to main¬
tain in greater quantities. Inventory turnover is the average number of times an
inventory is sold out during the year for a particular product line. If you know
the turnover rate for an industry (men’s clothing is 3; restaurants, 22; and some
chemical manufacturers, 100), you will be able to estimate how much inven¬
tory to keep on hand. For example, suppose an industry has an inventory
turnover rate of 5.
12 = 2.4 month’s supply

5
A 2.4 month’s supply of inventory needs to be on hand. Once this quantity is

known, you can calculate the cost. Do this by dividing the company’s forecasted
sales for the upcoming year by the cost of goods sold (COGS). For example, if
you are forecasting $200,000 in sales and the COGS is 50 percent of sales, then
$200,000 x .50 = $20,000

5
It will cost $20,000 to maintain a 2.4 month’s supply in inventory. Naturally,

if you deal in several product lines or use a variety of raw materials, calculations
for each need to be done as they may have varying turnover rates.
Tracking Inventory
In a start-up venture, keeping track of inventory may simply be a matter of
visually inspecting and counting, since the business is growing in a fairly
controlled manner in the beginning. However, once the business is really off the
ground, these simple techniques will no longer suffice, and it is best to be

prepared for this eventuality early on.
Perpetual Inventory Systems. Perpetual systems keep a running count of
items in inventory. As items are sold, they are subtracted; as they are purchased,
they are added. An electronic point-of-sale system (such as those now used in
most grocery and retail stores) allows a business to have instant access to the
status of its inventory
Physical Count System. Most businesses do physical counts even if they
have an electronic system to detect errors in the system and account for items
that may have been stolen or lost and wouldn’t show up as a sale. To make the
counting process more efficient, it’s important to get the inventories down as
low as possible before the count takes place.
Combined Inventory Systems. Some businesses use both perpetual and
physical count systems simultaneously, perpetual for the items that make up
the bulk of their sales, and physical counts for less commonly sold items.
Just-in-Time System
In the past, inventories were built up based on the state of the economy or in
reaction to problems in their inventory control system. If times were good,
producers increased stocks of inventory to meet expected demand. Then when
the economy slowed, they were usually left with shelves of leftover stock.
Reductions in inventory succeeded in exposing typical problems: equipment
imbalances, paperwork backlog, excessively long setups, vendor problems, and
problems with purchase lead time.
Newer systems, like Just-in-Time (JIT), help manufacturers maintain better
control of their inventories by eliminating production and inventory problems
and then reducing inventory to only that which is needed. The Just-in-Time
system of materials and inventory management deserves its own heading as it is
fundamentally different from other inventory systems. Coming originally from
Japan, JIT is beginning to take hold in the United States. The philosophy
behind JIT is “to produce the minimum number of units in the smallest
possible quantities at the latest possible time.”2 A well-devised and imple¬
mented JIT system can:
• Increase direct and indirect labor productivity

• Increase equipment capacity
• Reduce manufacturing lead time
2Hay, E.J. (1988). The Just-in-Time Breakthrough. New York: John Wiley &r Sons.
• Reduce the cost of failure

• Reduce the cost of purchased materials
• Reduce inventories
• Reduce space requirements
In essence, the goal is to eliminate waste in the manufacturing process.

Consequently, to implement JIT it is necessary to look beyond mere inventory
to all other aspects of the manufacturing process as well. Starting with the last
operation, which is usually the customer requirement, work backwards through
the manufacturing process. Customer demand determines how many products
are produced. The number of products to be produced determines the produc¬
tion capability requirements, which in turn determine the amount of raw mate¬
rials needed. In general, a firm maintains an inventory no larger than needed to
support one day of production. To do this, it has to have the cooperation of its
suppliers and its distributors with severe penalties for not being on time, either
too early or late. This, of necessity, reduces the number of suppliers a JIT firm
typically deals with. JIT also requires strict quality control because with
minimal inventories, there is no excess inventory to cover rejects.
A traditional factory is laid out by functional department, usually based on a
particular process or technology. The result is that products are produced in
batches. This is the antithesis of JIT, which specifies that the plant be laid out
by product. With JIT the equipment is positioned in the order in which it is
used to produce a particular product or family of related products. It is also
important to plan production so you only produce enough to meet demand.
For example, suppose you expect to sell a total of 100 units of your product
next month. Then:
100/20 work days = 5 units a day

5/8 work hours = .63 unit per hour
or 1 unit every hour and a half
This calculation must be reworked every month as demand changes.

One way suppliers are meeting the needs of a company using JIT is to
involve independent contractors specializing in “time-sensitive” deliveries. For
example, one company has installed two-way satellite communication on its
trucks so shipments can be tracked in real time. Other businesses like American
Distribution Systems, Inc. help businesses that need to ship to retailers. They
stock merchandise in their warehouses, process orders, make deliveries, and
handle billing. In that way retailers don’t incur the costs associated with a
backup supply of items. Avoid carrying too much inventory seems to be the
trend in the 1990s. It requires, however, careful coordination and cooperation

of all members of the supply chain to work effectively.
Production Requirements
The production function of a manufacturing business is its life blood. Decisions
made in this area directly impact output level, product quality, and costs.
Planning for production, therefore, is key to manufacturing efficiency and effec¬
tiveness. Most manufacturers begin by scheduling, that is, identifying and
describing each activity that must be completed to produce the product and the
amount of time it takes to complete each activity. Two methods traditionally
used to aid the scheduling process are Gannt Charts and Pert Diagrams.
Gannt Charts. Gannt Charts are a way to depict the tasks to be performed and
the time required for each. Consider Figure 11.4, The task to be completed is
outlined on the vertical axis, with the time to completion on the horizontal.
Notice that the solid line represents your plan for completion, while the dashed
line depicts where you are in the process toward completion. Gannt Charts are
best for simple projects that are independent of each other.
PERT Diagrams. PERT is an acronym for Program Evaluation and Review

Technique. This method is helpful when the production being scheduled is more
complex and subject to the interdependence of several activities going on either
simultaneously or in sequence. In other words, some tasks cannot be started
until others have been completed. To begin, you must identify the major activi-
- ties involved in producing the product and arrange them in the order in which
Figure 11.4: Gannt Chart
Order Order September October November

Number Quantity 6-9 12-16 19-23 26-30 3-7 10-14 17-21 24-28 1-5 7-11 14-18 21-25
5348 1,000
5349 1,500
5350 500
Scheduled Time
Actual Progress
Figure 11.5: PERT Diagram
Activity Description Preceding Event

a Initial working laboratory prototype
b Patent application a
c Hire design engineer a
d Engineered prototype with assembly plans and specs c
e Field testing/market testing b, d
f Sourcing final material and parts suppliers d, b
9 Production quality prototype e, f
they occur. Be sure to identify any activities that must occur in sequence; that is,
one activity cannot occur until another is finished. Construct a pictorial network
that describes the process. Then estimate the time to complete each activity and
note it on the chart. This is usually calculated as most optimistic, most likely,
and most pessimistic. The statistics involved in analyzing the network are
beyond the scope of this book, but essentially consist of 1) identifying the critical
path, which is the longest path and is important because a delay in any of the
activities along the critical path can delay the entire project; 2) computing slack
time on all events and activities (difference between latest and earliest times);
and 3) calculating the probability of completion within the time allotted.
The numbered nodes on the diagram (Figure 11.5) refer to the start and
completion points for each event. The dummy line was placed in the diagram
to account for the completion of Event e being preceded by Events b and d.
Both must be completed before Event g can start.
There are several popular software products on the market, such as Micro
Planner X-Pert and Microsoft Project, that can help entrepreneurs schedule
their production capacity. Tracking production from the outset of the business
allows entrepreneurs to make more realistic strategic decisions about growth
and expansion.
PROFILE 11.2
The Virtual Distribution Channel:

The Case of Lee Apparel Co.
Based in Merriam, Kansas, the Lee Apparel Company learned that creating strategic
alliances up and down its distribution channel would allow it to fine-tune its production
and better meet the demands of its retailers. Using Point-of-Sale (POS) data trans¬
mitted electronically from the retailer to Lee on a daily or weekly basis, the retailer is
able to replenish high-demand products within a matter of days instead of weeks. In
some cases Lee has agreements with retailers to ship automatically when POS data
indicate stock has reached a critical level based on demand.
To accomplish this, Lee sends every item from its factory with a Universal Product
Code (UPC) bar code attached. When the bar code is scanned, the retailer's
computer records the item number, color, and size. This information then helps Lee
adjust its manufacturing process to meet demand. The success of this program is
ultimately dependent on businesses’ willingness to share information. In the end,
everyone benefits.
Identifying all the tasks in the production process makes it easier to deter¬
mine what equipment and supplies are needed to complete the tasks. If it is
determined the equipment necessary to produce the product is beyond the
start-up resources of the entrepreneur, it may be time to consider outsourcing
part or all of production to a manufacturer who has excess capacity with the
needed equipment.
After the production tasks are identified, a preliminary layout of the plant to
estimate floor space requirements for production, offices, and services can be
made. It may be beneficial to consult with an expert in plant layout to ensure
you make the most efficient use of the limited space you have.
Quality Control
Quality control is the process of reconciling product output with the standards
set for that product. It has been said that one thing manufacturers have learned
from history is that “the primary objective of the company is to put the quality of
the product ahead of every other consideration. A profit or loss notwithstanding,
the emphasis will always be on quality.”3 Today thousands of manufacturers have

embraced the philosophy of quality first, but have focused principally on equip¬
ment and processes rather than on the human element. Both must be done as
total quality control must permeate every aspect of the organization.
The Inspection Process

One way manufacturers control quality is to implement a regular inspection
process that takes place during several stages of the manufacturing operation.
Often, primarily due to cost, a random sample of products is chosen for the
inspection. This method catches potential defects early in the process before the
products become finished goods. Whether each item produced is checked or a
random sample is conducted is a function of what is being produced, the cost,
and whether the item will be destroyed by the inspection process. For example,
if you are producing an expensive piece of machinery, it may be prudent to
subject each item to the inspection process, as the cost of inspection is more
than made up for in the price of the item. If, on the other hand, you are
producing a food product, once it is inspected it cannot be sold, so you can’t
afford to do more than a representative random sample of each batch.
Quality Circles
Quality circles are groups of employees who regularly work together on some
aspect of the production process. They meet several times a month with the
help of an outside facilitator to discuss problems and ideas related to their work
environment. They often come up with new solutions to problems that are then
put into effect, thus improving the efficiency and effectiveness of the manufac¬
turing process and the product as well. Using quality circles gives employees a
vested interest in what they are producing; consequently, they are more likely to
pay close attention to improving the way their task is completed.
Using the Human Resource for Quality Control

In reality, the real success or failure of the quality control effort is dependent on
the human element in the process: customers, employees, and management.
Quality begins with satisfying the needs of the customers, and that cannot be
accomplished unless those needs and requirements are communicated to
^Hopper, Kenneth. (1982). “Creating Japans New Industrial Management: The Americans as Teachers.”
Human Resource Management, p. 13-34.
management and employees. An entrepreneur with a new venture has a unique

opportunity to create a philosophy of quality from the very birth of the busi¬
ness, in the way the business is. run and in the employees hired. The entrepre¬
neur also has the advantage of creating new habits and patterns of behavior
instead of having to change old ones.
Using Customers for Quality Control. Recall the discussion of Quality

Function Deployment. At its core is the philosophy that a company produces
what the customer needs, when he or she needs it. How does this translate into
quality control? Customers, by their demands for reliability and performance in
a highly competitive market, establish the standards that must be met when the
product is designed and produced. If customers perceive that the product does
not meet their needs or does not meet them as well as another product could,
lost sales result.
Using Employees for Quality Control. If you want the employees to buy into
the notion of quality control at every level, they must be given the responsibility
and authority to make changes that will improve the process and product at
every level. If you are going to install new technology to improve the process,
the employees need to be trained not only in how to use it but how to look for
potential problems that would affect quality. The continual use of awareness
and training programs will help employees understand their importance in the
whole manufacturing process.
Using Management for Quality Control. For total quality management to

work, key management must be “on the floor,” learning every aspect of produc¬
tion and supporting the efforts of employees. It is their job to bring the require¬
ments of customers to the people who will satisfy those requirements. It is also
management’s job to establish company-wide, measurable quality goals. Too
often management focuses more on productivity goals than quality goals.
Ultimately it is quality, not productivity, that will sell product.
In an increasingly global market, it is not surprising that the need for inter¬
national quality standards would arise. ISO 9000, developed by the Interna¬
tional Organization for Standardization in Geneva, is a series of international
quality standards and certification that makes it easier for a product to enter the
export market. Approved by 95 countries, the standards apply to both manu¬
facturing and service businesses and certify quality control procedures.
PROFILE 11.3
The Baldrige Award Criteria

The Malcolm Baldrige National Quality Award is the United States’ highest quality
honor. Competition is tough and the selection process daunting, but the award
creates a standard to which small companies can compare themselves. The following
is a list of the Baldrige criteria:
1. Leadership. Demonstrate evidence that senior management promotes quality

values, and that those values influence day-to-day management.
2. Information and analysis. How effectively is the company using competitive
comparisons and does it support quality objectives through data analysis?
3. Strategic quality planning. Does the business plan incorporate quality require¬
ments?
4. Human resources development and management. What are the systems and
practices that involve employees in education, training, assessment and recogni¬
tion?
5. Management of process quality. Check for quality in product and service design,
process control, quality assessment and documentation, and assurance of the
quality of supplies.
6. Quality and operational results. Examine trends and levels in improvement of
products and services, business services, and suppliers’ quality.
7. Customer focus and satisfaction. Evaluate customer service standards,
customer satisfaction ratings, and the use of customer complaints and
suggestions.4
For a small, growing firm, however, it is a fairly costly process that includes,
among other things, writing a quality control manual. The cost of achieving the
standards is not as great as the cost of obtaining certification, which is subject
to audit semiannually and must be renewed annually. But these costs must be
weighed against the advantages. With certification, the companies with which
the entrepreneur does business don’t have to inspect to know the company’s
standards for quality, and it makes it much easier to enter the export market.
Two ways to reduce the costs involved include:
• Compare fees charged by ISO consultants to find the best rate.
4Adapted from Warren H. Schmidt and Jerome E Finnigan. (Feb. 1993). “The Race Without a Finish Line.”
in Small Business Reports, Vol 18 No. 2.
• Check with major customers to see if they will help subsidize the cost of
certification.
• Determine if you really need certification. Perhaps just meeting the standards
is sufficient in your business.
Product/Process Maintenance Requirements and Warranties

Maintenance in the manufacturing process refers both to the maintenance of
plant and equipment used to produce the product and the maintenance or
servicing of the product after it is sold.
Process Maintenance
At some point any machine will break down, which can mean lost sales and
costly repairs. To prevent unexpected breakdowns from disrupting the produc¬
tion process, one of three things can be done. The process can be organized so
when one machine is down, the work can be shifted to another. Another way is
to build up inventories at each stage of the production process so that machines
can keep working as long as the inventory lasts. (This method, however, will
probably not work in a company that has chosen a JIT system of inventory
management.) The third, and perhaps the best, approach is to regularly under¬
take preventative maintenance by checking and fixing the machines before they
break down. The advantage of this approach is that you control when the down
time occurs.
Product Maintenance
The entrepreneur who subscribes to total quality management will likely wish
to provide warranties with products to protect against potential liability and to
demonstrate that the company stands behind the product. Today product
warranties have also become a marketing tool to sell the product.
Some of the decisions to be made regarding warranties include:
• Length of warranty. This depends on industry standards.

• Covered components. Some components may come Irom other manufacturers
who have their own warranties. In this case, it is important to have your use
of that component on the product certified by the OEM (Original Equipment
Manufacturer) so you don’t invalidate the warranty. Then if a warranted
component from that manufacturer becomes defective, it can be sent back.
However, it is probably good business practice to have customers return the
product to you or your distributors for service, repair, or exchange under

your warranty, which covers the whole product.
• Product scope. Will the warranty cover one or all products in a line or will
there be separate warranties?
• Market scope. Will the same warranty apply in all markets? This will be a
function of state and foreign laws.
• Conditions of the warranty that the customer must fulfill. Is there anything the
customer must do to keep the warranty in force, such as servicing or
replacing disposable parts? These conditions should not include registering
the product via a postcard. Today a product is covered by warranty from the
moment it is purchased whether or not the purchaser returns a postcard
stating when and where it was purchased and answering a short, informa¬
tional questionnaire. What many companies do to get the postcard informa¬
tion is to offer update notification and potential discounts on future
products.
• Who executes the warranty? The entrepreneur must decide who will handle
warranty claims (manufacturer, dealers, distributors), recognizing that
customers do not like to mail products back to the manufacturer.
• How the public will be educated about the warranty.
• Policies for refunds and returns, and shipping and handling costs. This is a
function of the entrepreneurs philosophy about doing business. A customer-
oriented company would probably offer a generous return policy and pay for
the cost of returns.
Providing a warranty involves a cost to the manufacturer; however, that cost

must be weighed against the potential loss of business if no warranty is pro¬
vided. In the case of a new business with a new product, it is difficult to antici¬
pate the number of problems that might occur as the product gets into the
marketplace. Careful and adequate field testing of the product prior to market
entry will go a long way toward eliminating many potential problems and the
possibility of a recall, which is very costly for any firm, let alone a growing new
business.
Financial Requirements
Once the raw materials and parts list has been developed, and the manufac¬
turing or assembly process defined, including labor requirements, it is possible
to calculate the total investment required to start the business and the per unit
cost of manufacturing the product. To be sure, the initial units produced will
cost significantly more to manufacture and assemble because the volume will
usually not be sufficient to achieve industry discounts on raw materials and
parts, and the plant and equipment will not be used to full capacity.
Consequently, gross margins may be extremely small in the early stages until a
sufficient increase in volume allows an economy of scale that reduces the per
unit cost.
The calculation of the up-front investment in plant and equipment, coupled
with the high per unit cost of production, has resulted in many entrepreneurs
deciding to outsource manufacturing to an established manufacturing firm.
Some products that consist of off-the-shelf components from OEMs can give
the entrepreneur the option to set up an assembly operation, which is far less
costly than a manufacturing plant. In any case, the process of outlining all the
costs of setting up a product company is invaluable in making the final deci¬
sions about how the business will operate.
Including the Operational Plan in the Business Plan

Doing the work involved in presenting the technical and operational informa¬
tion in the business plan helps the entrepreneur decide the best alternative for
producing the product and gives the reader a good background on how the
production function of the new business will operate. The information gathered
helps the entrepreneur derive estimates of working capital requirements, start¬
up costs, and manufacturing costs, all of which will be needed when devel¬
oping the financial plan for the business.
The operational plan requires the collection of a significant amount of infor¬
mation about the business from a variety of sources. Some of these sources
include existing manufacturers (especially competitors), trade publications, trade
associations, and equipment suppliers. Once this information is collected, it can
be organized and placed in the business plan using the outline of the operational
plan section as shown in Figure 11.6 on p. 221. You should feel free to modify
this outline in any way to reflect the unique requirements of your business.
The business plan is not the place to provide pages and pages of technical
specifications and description in an effort to describe how the product or
process works. Remember that the reader, whether he or she is an investor,
lender, or potential management hire, is interested in how the business will
work, the benefits of the product/service, and who the entrepreneur is. The
exact specifications related to the new product or process are of less impor¬
tance. The question to keep in mind when organizing the operational section of
the business plan is:
Does the reader of the business plan need to know this piece of information to
understand the business?
The technical analysis may warrant the creation of two versions of the busi¬
ness plan. The highly technical version can be reserved for the founding team
and the technical staff and the less technical version for all other readers.
The Product
Several aspects of the product should be presented in the operational section of
the business plan.
The Purpose of the Product/Service. Let the reader know whether the product
solves a problem, recognizes an opportunity, satisfies a need, or is purely for
entertainment purposes.
The Unique Features of the Product/Service. The unique features can result in
a competitive advantage in the marketplace. They may include not only special
features or benefits of the product/service but also any proprietary rights you
own such as patents, trademarks, and copyrights. In the case of patents, be sure
to state where the product is in patent process. If licensing the product is an
option under consideration, the licensee will probably be looking to see that the
patent has been “issued,” or at the very least is “patent pending.” (Recall that
when the product is “patent pending” it has, for all practical purposes, been
conditionally approved by the PTO.) If your business involves licensing and/or
paying royalties to someone else, like an inventor, include that information as
well. Only the major points should be presented in this section with a copy of
any agreement or details in the appendix.
Include discussion of features such as the design, quality, capabilities, and
cost of the product. It is also important to incorporate any photographs or
drawings of the product. Again remember that the reader is primarily interested
in what the product functions are, not how it functions from an engineering point of
view.
Figure 11.6: Technical/Operational Plan
Product Specifications
Design and performance specifications
Level of quality
Service requirements
Status of development
Materials Requirements
Raw materials and parts required
Availability of raw materials and parts
Source of supply for raw materials and parts
Delivery lead time for suppliers
Inventory Requirements
Description of inventory system
Raw materials and purchased parts in inventory
Work in process inventory
Finished goods inventory
Production Requirements
Explanation of production process
Equipment needed, costs and alternatives
Output capacity from production
Materials handling equipment
Labor Requirements
Skills required
Availability of labor and cost
Support staff required
Maintenance Requirements
Plant equipment maintenance and repair
After sale service and warranties on product
Financial Requirements
Start-up investment in equipment and inventory
Manufacturing costs—raw materials, labor, equipment usage
21 New Venture Checklist

Have you
□ Developed a prototype of your product?
□ Field-tested the prototype?
□ Sourced the components of the prototype?
□ Outlined the production process?
□ Found suppliers for your material requirements?
□ Determined how inventory will be handled?
□ Developed quality control measures?
□ Determined the product/process maintenance requirements?
Clark, K & T. Fujimoto. (1991). Product Development Performance. Boston:

Harvard Business School Press.
Griffin, A. and Hauser, J.R. (1993). “The Voice of the Customer.” Marketing
Science, Vol. 12, No. 1. p. 1.
Hay, E.J. (1988). Thefust-in-Time Breakthrough. New York: John Wiley.
Hayes, R.H., Wheelwright, S.C. & Clark, K.B. (1988). Dynamic
Manufacturing. New York: The Free Press.
Hopper, K. (1982). “Creating Japans New Industrial Management: The
Americans as Teachers.” Human Resource Management, pp. 13-34.
What is the purpose of a technical analysis of the business concept?

Issues to
How can the product development process be shortened without affecting
Consider
quality?
4l What value does the philosophy that forms the foundation of the QFD,
team-based approach to product development have for entrepreneurs devel¬
oping new products?
What is the difference between product-focused and process-focused compa¬
nies?
What are three factors that should be taken into consideration when
choosing vendors to meet materials requirements?
How can PERT diagrams aid the entrepreneur in production scheduling?
In what ways can the human resources of the business help control quality in
all areas of the organization?
CHAPTER 12
The Marketing Plan
Overview
• The focus of entrepreneurial marketing in the 1990s
• Preparing a marketing plan
• Product, place, promotion, price in the marketing strategy
• Using the marketing plan as part of the business plan
Marketing in the 1990s

Marketing includes all the strategies, tactics, and techniques used to raise
customer awareness and to promote a product, service, or business. Tradi¬
tionally marketing has consisted of a push strategy, where a customer who has
not necessarily expressed a need for or interest in the product or service is
convinced to purchase it through selling techniques. In other words, the focus
was on the product, not the customer. In contrast, with world-class marketing
in the 1990s, the primary focus is on the customer. If the product or service is
designed with the customers needs in mind, much of the “selling” that would
otherwise have to be done has been taken care of by giving the customers what
they want. What is left then is to make them aware of its availability and how
and where they can purchase it.
In Chapter 6, the importance of researching the target market to determine if
there is a big enough market to warrant producing the product or service was
stressed. The demographics gathered during this research, as well as informa¬
tion about customers’ buying habits, will all be useful in putting together a
225
marketing plan for the new business. Market research is definitely a necessity
for operating in the 1990s and beyond. Knowing who your customer is and
how, why, and when they buy is the minimum required information any busi¬
ness must have.
Entrepreneurial Marketing
If you studied marketing in college or gained experience in marketing by
working for a large company, it is possible that you have seen only one side of
marketing. The kind of marketing done by Coca Cola, Burger King, K-Mart,
and the like is an entirely different game, calling for different strategies than
those entrepreneurs use for start-up ventures. Unfortunately, entrepreneurial
marketing is not often taught in business curricula because it isn’t as exciting or
competitive as brand name marketing in big companies. As a result, unsus¬
pecting entrepreneurs often attempt to employ the same techniques as more
established companies; however, since they usually don’t have the required
resources to market at the same level as the large corporations, the desired
results are rarely achieved.
Entrepreneurs must approach marketing from a distinctly different point of
view. While they may employ some of the same techniques as a large corporate
marketer, they will also take advantage of many other marketing opportunities
that the corporate marketer may ignore. In fact, some entrepreneurial strategies,
such as personalized customer service, are so successful that many large, estab¬
lished companies are now adopting similar programs. Levinson has called the
entrepreneurial marketing approach “Guerrilla Marketing,” which is an alterna¬
tive to traditional, expensive marketing tactics.1 Given that entrepreneurs don’t
have the time or money for elaborate, high-profile marketing strategies, they
essentially mimic what the “big boys” do, but do it for much less money and for
a shorter period of time.
This chapter presents some suggestions for creating an entrepreneurial
marketing plan that provides the best results for the least amount of money
possible. It begins by looking at the marketing plan in general and then consid¬
ering the traditional “4 P’s” of marketing—product, price, place, promotion—in
more detail and from an entrepreneurial point of view.
'Levinson, J.C. (1993). Guerrilla Marketing. Boston: Houghton Mifflin

Chapter 12 • The Marketing Plan 2.11
The Marketing Plan

Many people find the marketing plan section of the business plan the easiest to
work on and write. After all, how difficult can it be to conclude that TV, radio,
and the newspaper will be needed to advertise the product or service?
Unfortunately, it’s not that simple. Advertising is just one small component of a
total marketing strategy. Moreover, a poorly constructed marketing plan cannot
only give weak results in terms of sales, but can ruin a business financially.
A few steps taken before the actual writing of the marketing plan ensures
that the plan is on target and is one you can live with for a long time to come.
Saying you must live with the plan for a long time probably sounds inconsistent
with the need of the entrepreneur to remain flexible and adapt to change in the
marketplace. It is not. One of the biggest problems with most marketing plans
is that they are not followed long enough to achieve the desired results.
Typically, the business owner does not see immediate results from the
marketing effort and decides it must not be working. So he or she changes it
and starts the cycle all over again. Changing the plan precipitously is precisely
the wrong thing to do. It takes time to make customers aware of the product or
service. It takes time for a particular marketing strategy to take hold and build
confidence in the customer. From the first time a customer sees an ad, for
example, to the point at which the customer actually buys the product may be
weeks or even months. On average, the customer will see the ad 15 or 20 times
before the product is actually purchased. Therefore, just like a good stock
market investor, you must think of the marketing plan as an investment in the
future of the business, and any investment takes time to mature. Reaping the
benefits of a well-structured marketing plan requires persistence and unwa¬
vering dedication until the plan has an opportunity to perform.
There are several steps to take prior to writing a marketing plan.
1. Make a list of the options. To even begin to know which marketing options
should be considered, you need to talk to other business owners, customers,
and suppliers. Read some books and articles on marketing strategies for
entrepreneurs, like those suggested at the end of this chapter. This process
will produce a list of possibilities that may range from sponsoring a business
conference to advertising in a national trade publication. Determining which
strategies are the most effective, or even feasible, can be left for later.
2. Think like a customer. Imagine the business from the customer’s point of
view. What would entice you to enter that store, buy that product, take
advantage of that service?
3. Study the competition. Take a look at the businesses that will be competing
with yours and determine what makes them successful or unsuccessful.
What marketing strategies do they seem to employ, and are they effective?
How could you improve on what they are doing?
4. Analyze the options and rank them. Eliminate first those that either don’t
meet the needs of the target market or are simply not feasible at this time
(usually for budgetary reasons). Then rank the top ten choices. You are now
ready to begin writing the marketing plan.
The Marketing Plan in One Paragraph
Many experienced marketers suggest that the first step in creating the
marketing plan is to condense all the ideas about marketing strategy into a
single paragraph that says it all. Impossible? Not at all. A single, well-written
paragraph will force you to focus carefully on the central point of the overall
marketing strategy. The paragraph should include:
• The purpose of the marketing plan.

What will the marketing plan accomplish?
• The benefits of the product/service.
How will the product/service help the customer or satisfy a need?
• The target market.
Who is the primary buyer?
• The market niche.
Where do you fit in the industry or market? How do you differentiate yourself?
• The marketing tactics to be used.
What specific marketing tools will be employed?
• The company’s convictions, its identity.
How will the customers define the company?
• The percentage of sales the marketing budget will represent.
How much money will you be allocating to the marketing plan?
Here is an example of an effective one-paragraph statement of the marketing

plan for a product business.
The purpose of Gentech Corporation is to sell innovative, portable

power source equipment at the highest quality and the lowest possible
cost. Gentech will accomplish this by positioning itself as the leader in
providing reliable, dual power source products that reduce the number of
pieces of equipment a user must own. The target market is the construe-
Chapter 12 • The Marketing Plan 229
PROFILE 12.1
What’s in a Name?
Even the name of your business should be part of the overall marketing plan because
it’s the first point of identity you establish with the customer. It should be easily
remembered and should relate to what you are selling. A name like “Useful Products,”
the name of one California company, would not win any prizes for originality and
style, but “Higher Ground,” an Oregon coffee company, might.
tion industry, and more specifically, those who use power tools in areas
where no power is available. The niche Gentech will enter is that of
construction companies that own or lease power equipment. Initial
marketing tactics will include direct sales to equipment rental outlets,
advertisements in trade publications, and trade shows. Gentech’s
customers will see the company as service-oriented with a quick response
to customer needs both in service and product design. Twelve percent of
sales will be applied to the marketing strategy.
With your paragraph in hand and the focus established, a more detailed
marketing plan can now be created. Every marketing plan incorporates the four
Ps of marketing: product, price, place, and promotion. Once these aspects of
the plan have been dealt with, the creative aspects such as the advertising goals
can be addressed. You will also develop a media plan that details what media
will be used, when they will be used, and how much it will cost.
The Product
There are a number of considerations relative to the product or products that
must be addressed in the marketing plan. They include product features—iden¬
tity, branding, packaging and labeling—product positioning, and product mix.
Product Features
For marketing purposes, think of the product as a bundle of benefits to the
customer. These benefits include a wide variety of things: attractiveness,
distinctive characteristics, quality, options, warranties, service contracts,
delivery, and so forth. But more important to the customer, the product offers
intangible benefits like convenience, savings in time and money, or improved
PROFILE 12.2
Effective Niche Marketing:

The Bombay Company
Entrepreneur Robert Nourse began his career as a stereotypical college professor
with a doctorate from Harvard Business School. After teaching for nine years, he
joined a venture capital firm where he learned about what it takes to grow a business.
By 1979, when he was 40 years old, he decided it was time to run his own business.
The only problem was he didn’t know what that business should be.
As luck would have it, he met an old college friend who had invested in The
Bombay Co., a mail order company that sold replicas of 18th and 19th Century
English furniture. Shipped in boxes, they needed to be assembled by the customer.
The company was called The Bombay Co. after the jewel of the British Empire.
Nourse managed to meet the owner of the company, (Harper’s mail order, which at
that time was losing money) and saw an opportunity. Spelling out the deal on the
back of a napkin during lunch, Nourse bought the Canadian rights to Bombay for $1
and a 4% royalty.
The first thing Nourse decided was that mail order was not the best marketing
channel for the company. He saw shopping malls as the best outlet because of the
high foot traffic. He understood his target market to be the impulse buyer who saw
something and didn't want to wait six or eight weeks for delivery. With savings and a
loan from the bank, he opened his first store in 1980 with 2,000 square feet in the
Eaton Centre in Toronto, Canada’s premier shopping center. It was an immediate
success.
In 1981, Harper’s mail order business was acquired by Tandy Brands, Inc., a
holding company in Fort Worth, Texas, which then bought Nourse’s Canadian store,
giving him the rights to control it. By 1983, with the financial backing of Tandy, Nourse
was able to grow the business in Canada to 13 stores. The Bombay stores in the
United States, however, were losing money. Tandy decided it wanted to merge the
United States and Canadian operations and make Nourse the CEO of all of it. It was
an offer he couldn’t refuse. Within a year of taking over his new position at the helm
of Bombay, Nourse turned the company around. Bombay grew from 75 stores in
1986 to 272 in 1990, and eventually Tandy Brands sold off its other holdings,
changing its name to Bombay Co. Inc. In 1991, Nourse became president and CEO.
Today Bombay Co. has more than 385 stores and sales in excess of $235 million.
Their marketing niche is the scaled-down piece of furniture appropriate for a small
mall store. Their pricing strategy is to offer exclusive furniture and accessories at 30
to 60 percent below other furniture retailers. Keeping costs down has been achieved
by controlling the distribution channel from producer to retailer. Their furniture is mass
produced according to their trademarked specifications in Asia. The “ready-to-
assemble” technology, packaged in flat boxes, saves on shipping and handling.
Products can be shipped in standard 40-foot containers. The stores, therefore, main¬
tain only enough stock to meet demand, and excess stock is stored in regional ware¬
houses. They have, however, tested the concept of a superstore with larger,
functional pieces of furniture like sofas with great success and are now in the process
of converting many of their stores to superstores. Nourse is also introducing a new
concept, Alex & Ivy, a store that will feature American and French casual furniture.
health. This bundle of benefits is the information the customer must know
about the product/service in order to feel comfortable about buying it.
Merely offering these benefits is not enough, however. They must be offered
consistently. In other words, the benefits the customer derives from using the
product/service must be received time and time again. Often, for example, a
company will focus on a high level of quality without concerning itself with
minor fluctuations in that quality. The only way to build confidence in
customers and, hence, increase the chance of return customers, is to provide
consistency in all the product benefits.
Product Branding, Packaging, and Labeling

Product hype via mass marketing seems to be the strategy of the 1990s. It is
seen in everything from Coca-Cola versus Pepsi ads to the auto manufacturers
who tell us “It just feels right!” Creating an image through branding, packaging,
labeling, and advertising is pervasive because it works. While an ad featuring a
young, athletically slim, young woman drinking a “lite” beer seems to be an
oxymoron, subliminally it hits the mark. Drinking lite beer is sexy, healthy,
youthful, and low in calories. Whether it is true or not is irrelevant; the image
remains.
For companies that participate in the war of the images, the battle is every¬
thing. They will do anything to win. What is important is the brand name,
keeping it in the public eye. Most times we don’t even know what company is
promoting the brand. Often the name appears only briefly at the end of the ad.
This is the strategy of Calvin Klein and Nike. Image and reality are frequently
separated by an enormous gap. The belief is that if you repeat a slogan—for
example, “Were number one”—often enough, people (including the company)

will believe it, even if it’s not true. Eventually, however, the lie catches up and
customers begin to lose faith in the product (not necessarily in the company,
however, because its name was never used).
A counter movement, however, has begun to occur among world-class entre¬
preneurial ventures. A number of very successful businesses like the Body
Shop, Ben and Jerry’s, Smith and Hawkens, Apple Computer, and Starbucks
Coffee are resisting image positioning as the way to communicate their
message. Instead of promoting brand names, they choose to communicate the
philosophy of their business, which is at the core of all their products, and
which by its very nature differentiates these companies from others in
A number of the market. They do not go head to head with their competitors in a
very successful war of images; they create their own niche in marketing strategy by
businesses are seeking ways to increase pride and loyalty not only in their customers
resisting image but in their employees as well. They break with tradition to make
positioning as the themselves stand out.
way to communicate For example, Starbucks Coffee places great importance on its
their message. employees. In an industry that regularly experiences high employee
turnover and low wages, Starbucks sees the employees as its competi¬
tive advantage. The comprehensive compensation package, health care, and
stock options it offers all employees gives them a vested interest in the company
and a desire to see it succeed. This philosophy is communicated to customers
in a more personal manner than through mass marketing. It is communicated
in the way Starbucks’ employees treat their customers.
Anita Roddick, who with her husband Gordon founded the Body Shop,
opposed the traditional messages of the image-laden cosmetic industry by
offering her customers not just a “quick fix” but a “sense of well being.” Instead
of coming out in a massive ad campaign to say this, however, she chose to
demonstrate the philosophy of her business by using inexpensive, recyclable
containers (packaging), and products whose origins lie in nature.
The differences in products that these new marketing strategists promote are
real and can be measured. These real differences not only distinguish them
from the false reality of their competitors’ images, but expose those images for
what they are. Of course, developing a sound company philosophy or culture is
not an overnight achievement. It takes time, and while you are working at
building that philosophy, the image builders will probably receive the bulk of
the attention. Nevertheless, persistence will pay off when you are able to deliver
precisely what you said you would.
Packaging. The way a product is packaged reflects the philosophy of the busi¬
ness. If you are producing a consumer product, attractive packaging will grab
the consumer’s attention as it sits among many competing products on the
shelf. In global marketing packaging can often be as important as the product
itself. In Japan, for example, consumers value products that come in artistically
beautiful boxes and will pay more for such packaging.
In general, packaging should depict
• What the product is

• Its key product benefits
• The company philosophy
• The level of quality
When Jan Davidson of Davidson, Inc., a leading educational software manu¬

facturer, first studied the packaging of software back in 1979, she noted that
most of it was in plastic bags hanging on hooks in the stores. Since she was an
educator herself, she wanted her software to be more associated with books and
education, so to differentiate her product at the retail level, she packaged it in
binders that looked like colorful books on the shelf.
Labeling. Today many companies are promoting products they call environ¬
mentally friendly, but they often stretch the limits of that term. In an effort to
protect consumers, the Federal Trade Commission has issued guidelines for the
use of environmental terms in advertising and product labeling. For example, a
product can only be labeled recyclable if the entire product can be collected or
separated from solid waste and used in the manufacture of other products. A
product may be labeled recycled content if the recycled materials in the product
came from solid waste stream. You also have to distinguish between materials
recycled from manufacturing and those from consumer waste by weight. To use
the terms degradable, biodegradable, and photodegradable, there must be evidence
that the product will completely break down and return to nature in a relatively
short period of time. Otherwise you have to qualify just how degradable it
really is.
Product Positioning
Product positioning is the way customers view the product in relation to
competitors’ products. Is the product more luxurious, of higher quality, less
expensive, more attractive and so forth? In other words, product positioning
really defines the product by its benefits to the target customer. Consequently,
any product will probably be repositioned several times during the course of its
product life cycle as customer tastes and preferences change. And this is
precisely why a small company that is flexible and can move more quickly can
take on a giant in a market niche that the giant has not yet tackled.
It is also important to note that not only will you position the product, but
the company distribution channel, and technology as well. Savvy customers
today are concerned more and more about the reputation of the company they
are dealing with, so if a company, for example, associates with distributors
whose level of service is not up to its standards, it will ultimately reflect on the
company. Realistically a products position in the market will be a function of
the customers’ perception of where it should be. That is, you may have
designed your product to replace another established product, whereas the
customer sees it as a product they would like to have once they have already
bought the existing product. Precious marketing dollars will be wasted if you
don’t respond to the customers’ perceptions.
In positioning the new product, refer to the customer profile devel¬
Not only will you oped when you did your market research. However, be aware that you
position the product, must constantly receive feedback from customers to stay on top of
changes in tastes and preferences that may call for a repositioning of
but the company,
the product later on. Most products will have primary market segments
distribution channel,
and then sub-sets of those segments. Sub-sets are other markets or uses
and technology
for the product. Just as you studied the primary market, you must also
as well.
understand the sub-sets to correctly position the product in those
markets.
It is also important to carefully study your competitors to determine their
strengths and weaknesses and how they might respond to your entry into the
market. If a competitor is a publicly traded company, annual reports are avail¬
able. In the event they are not, talking to distributors, customers, and adver¬
tisers can provide valuable information to help plan a strategy. If you find out a
competitor holds the position you wish to occupy, you have three choices:
1) find another opportunity; 2) try to overtake the competitor in the position;
or 3) attempt to reposition the competitor. Overtaking the competitor is very
difficult to achieve and is rarely accomplished. If you have positioned the busi¬
ness in an emerging niche, there may be an opportunity to re-educate the
customer about the competitor’s product as well as introduce them to the
different benefits of yours.
Studying the market carefully can produce niches that may not have been
considered or vulnerabilities in competitors not previously apparent. It may
also result in positioning the product a little differently than originally planned.
Remember, however, to look not only for evidence to support a particular posi¬
tioning but also to refute it.
Once you have determined the position you wish to occupy and have
written the positioning statement, it needs to be tested in the marketplace.
There are several methods that can be used, and they vary in the time and cost
involved. In all cases, however, news of the product will be shared prior to
market entry, so have anyone who participates in the testing sign a Statement of
Nondisclosure.
• Peer Review. Ask anyone and everyone you know to give an opinion on the
positioning statement. Ask for their impressions and perceptions of how the
product will do in this position.
• Distribution Channel Review. Ask salespeople, distributors, and retailers
what they think of the position statement. These are people who understand
the industry and will have a pretty good sense of where you and your
product might fit in.
• Focus Groups. Bring together a representative sample of the customer base
and get their opinions.
• Test Marketing. This involves producing a limited amount of product and
selling it in a defined geographic region to determine if the product posi¬
tioning is correct. For most start-up companies, test marketing isn’t econom¬
ically feasible so the cost of this approach must be weighed against getting
out in the market as quickly as possible.
As discussed in Chapter 6, entrepreneurs need to consider the costs versus

benefits of expensive market research. With most markets far more volatile than
ever before, it usually pays to shorten the development and test time to get into
the market quickly, particularly where a company can gain a first-mover advan¬
tage. When you have a good positioning statement that will produce the
desired results, communicate this statement to everyone involved in the
production and distribution of the product so the company and everyone
involved with it will share a common philosophy and communicate a consis¬
tent message to the customer.
Product Mix
Product mix refers to all the products the business will produce and/or sell. If
the business will offer multiple products, you must consider how these products
relate to each other and if they all serve to communicate your company’s identity
and product positioning message. The products that comprise the product mix
will be determined by the markets to be served; for example, a more diversified
product mix may be needed when several markets are being served.
Catherine White, founder of Financial Architects, a financial services firm in
Lexington MA., offers social screening of potential investments as an additional
service in her “product mix.” Clients who wish to invest in companies that have
certain social goals can use her services as well as clients who invest based on
purely financial criteria. In this way, she is serving a larger market with a more
diverse product mix.
Price
Price is one of the most important features of a product. As a marketing tool,
price more than any other factor affects customer acceptance of the product, the
business’s cash flow, and in general the profitability. Price is determined by
many factors:
• The demand for the product is strong relative to the supply. Where demand
is greater than supply, a higher price may be commanded.
• The demand for the product is inelastic; that is, people will buy no matter
what the price because they need the product. This is typically true for
commodities with no viable substitute, like milk.
• Intense competition may force the price of the product down.
• Additional features may warrant a higher price.
• New technology may call for a higher price.
• Product positioning may be associated with a certain price level. For
example, positioning a product among luxury items commands a higher
price.
Strategies for Pricing

Pricing becomes a feature of the product when it is the central selling point. The
product that is considered a commodity or the product that faces intense
competition will often be marketed on the basis of lower price for the same
quality. How a product is priced is a function of a company’s goals. Is the goal to
• Increase sales? This may entail lowering prices to raise the volume sold.
• Increase market share? Again, by lowering prices, volume may increase, thus
increasing market share.
• Maximize cashflow? Increasing cash flow can be achieved several ways,

including raising prices and reducing direct costs and overhead.
• Maximize profit? Similar to maximizing cash flow, this can be accomplished
several ways, including raising prices, lowering prices and increasing
volume, or decreasing overhead.
• Set up entry barriers to competition? Lowering prices based on using efficient
production methods, achieving economies of scale, and keeping overhead
low can often set up entry barriers to companies that can’t compete on that
scale.
• Define an image? Setting a higher price based on higher perceived and/or
actual quality is one way of establishing a particular image in an industry.
• Control demand? Where a company does not have the resources to meet
demand, prices can be set at a level that discourages sales to a particular
degree.
Knowing what a pricing strategy is supposed to accomplish in advance of

setting a price will ensure compatibility with the company’s goals.
There are several components of a pricing strategy.
1. Cost-based pricing. This component adds the cost of producing the

product, the related costs of running the business, and a profit margin to
arrive at a market price.
2. Demand-based pricing. This component is based on finding out what
customers are willing to pay for the product, then pricing it accordingly. For
new products with no direct comparison, a combination of this approach
and cost-based pricing is often used to arrive at a satisfactory price. In
general, customers recognize several prices for any one product: the standard
price, which is the price normally paid for the item; the sale price, the price
paid for specials; and the relative price, which is the price of the item
compared to a substitute product. For some products, customers may have
to add to the normal cost of shipping, handling, or installation in their com¬
parison with other like products.
3. Competition-based pricing. Where the product has direct competition, the
entrepreneur can look at competitors’ pricing strategy and price the product
in line with theirs, higher if it is determined that the product has added
value, or lower if competing on price.
4. Psychological pricing. Using an odd-even strategy can suggest a pricing
position in the market, an odd number ($12.99) to suggest a bargain, an
even number ($40.00) to suggest quality, or higher than average pricing to

suggest exclusivity.
5. Distribution channel pricing. The channel of distribution through which
the entrepreneur chooses to move the product will affect the ultimate price
to the customer as allowance for each intermediary in the channel must be
made to make a certain percentage of profit.
6. Extrapolating from other industries. It is important to look at the pricing
strategies of businesses in other industries. Just because your industry does not
seem to employ that strategy does not mean it won’t work. Staying competitive
on price means always looking for new methods of pricing products.
Gross Margins
Gross margin percentage is a way to examine the productivity of the company as

well as aid in determining the price of a product. Be aware, however, that it is
not always an accurate measure of profitability because it is based on sales.
Gross margin is affected by manufacturing costs, distribution' costs, selling costs,
and inventory costs. Even where two businesses have equal gross margins, their
profitability levels may differ dramatically. That difference may be attributable to
higher or lower costs for handling, stocking, and marketing costs, which are
typically lumped into the category of administrative and selling expenses below
the gross margin line. Consequently, most businesses are not able to achieve an
accurate true unit cost for a product, especially for multi-product companies.
According to Walter J. Salmon of the Harvard Graduate School of Business, the
business is better served by tracking “Direct Product Profit” or DPP.2 DPP allows
a business to identify products that carry higher than normal variable costs such
as handling, so the entrepreneur can figure out ways to improve that aspect of
the operation. DPP tracks total cost per unit rather than just gross margin.
Place
The place strategy will dictate how products get to the customers. This is essen¬
tially the distribution strategy, which was discussed in detail in Chapter 7. In this
section, however, the scope of distribution and some issues related to transporta¬
tion are addressed. As in any aspect of marketing, consistency is important.
Naturally, the location of the business is a relatively stable feature so customers
2Parrott, M.D. (1988). “Margin for Error." Do It Yourself Retailing. Vol. 154, No. 6, p. 11.
always know where to find it. It is equally important to establish stable distribu¬
tion channels so customers don’t have to think about how to find your products.
Once a customer associates your product with a particular outlet, whether
wholesale or retail, a major change—such as moving to a mail order channel—
may cause frustration and lead the customer to seek a substitute product.
The distribution strategy dictates how broadly your products are distributed.
Choosing to distribute to all possible outlets involves using an intensive distrib¬
ution strategy. Limiting distribution to select outlets is a selective strategy. With
an exclusive distribution strategy, distribution is limited to one outlet per
geographic area.
Dealing with Multiple Channels of Distribution

More often than not, as a company grows and the diversity of its customer base
increases it develops more than one channel of distribution. It may, for example,
use direct sales to service the largest customers and intermediary channels of
resellers and manufacturer’s reps to bring in new customers. It is often not easy
to determine which channel is the most effective. Indirect channels are generally
associated with a lower level of marketing and sales expense because this task is
taken on by the reseller. However, indirect channels are also associated with
lower net margins because of the discounts given to resellers so they can make a
profit as well, hence the source of the oft-stated “the cost is in the middleman.”
What is rarely recognized, however, is that resellers often deal in competing
products or several products from one manufacturer and can therefore usually
achieve economies of scale, thus reducing their selling costs. Direct sellers, on
the other hand, are less able to compete on price with a variety of accounts and
typically incur the highest cost per sales call of the two methods. In addition,
they are not generally equipped to economically provide products to multiple
receiving points in the same way a distributor with regional warehouses can.
The advent of distribution computer software has encouraged the develop¬
ment of major distributors who can, more efficiently than a manufacturer,
handle orders, shipping, invoicing, inventory management, and receivables.
Today distributors are more than simply transfer agents or bulk breakers for
smaller companies; they actually add value through services provided to both
their suppliers and their customers.
Transportation is the Link in the Chain

Transportation is potentially the weakest link in the distribution chain because
it usually receives the least amount of attention from manufacturers. However,
when you consider that raw materials as well as finished goods spend a good
part of their time in transit or in inventory, incurring costs at both stages, any
savings in logistical functions brings more to the bottom line for everyone in
the chain. Even where price differentiation is not feasible, value can be added
through differentiation in logistical strategy. The goals of an effective logistics
system include:
• Increasing information
• Reducing inventories
• Increasing cycle times
• Reducing variable costs
• Improving customer service
Information is the key. The company that has a communications system that
lets it stay in touch with its distributors and sales force wherever they are will
be a more efficient and effective company. Some trucking companies, for
example, use two-way satellite communication and track shipments via
computer, so they are never out of touch. Thus, logistics is a significant aspect
of any marketing plan.
Promotion
A new business requires two promotional plans: one for opening the business
and making customers aware of its existence, and the other for growing the
business. The opening plan establishes the identity or philosophy of the busi¬
ness. Remember that identity and philosophy are quite different from image.
An image is what you may aspire to be, while your business character and
philosophy define who you are in reality. The marketing plan for growing the
business is the one you will implement and use consistently for the long term.
It is the plan you invest in to build a customer base. It will define the target
market and market share you wish to achieve, what people and resources it will
take to reach that share, and which services will be needed.
The promotion function of the marketing strategy is the creative one, for this
is where advertising, publicity, sales promotion, and personal selling tactics—in
short, your promotional mix—is decided. Not every business has the same
promotional mix; it is a function of the type of business, the target market, and,
of course, the budget. For entrepreneurs with new ventures, the last item—the
budget—usually dictates a creative approach.
Creativity begins with a clear understanding of the customer, the economy,

current trends, and even the daily news. You never know where a creative idea
will come from or what current event will trigger an idea for an ad campaign. In
the 1990s, for example, social responsibility is a big issue, hence the prolifera¬
tion of ads like those of The Body Shop that depict a company that cares about
people and natural resources. In fact, the ad may never mention the product
they are trying to sell. Tying a marketing strategy to current trends like social
responsibility means you must remain flexible and willing to change the
strategy should the current trend change. Customers are fickle, and no matter
how sound or beneficial a trend may be, they will eventually tire of it, and a
new tactic must be employed.
Advertising
Advertising media generally fall into two categories: print and broadcast. The
following sections examine the various types of media and their uses. It is not
the purpose of this book to provide all the information needed to use each
medium presented, only to create awareness of how and when each is used so a
decision can be made about which media will best serve the business.
Print Media—The Newspaper. The purpose of a newspaper is to distribute the

news in a direct, to-the-point fashion. Today that doesn’t just mean the town
gazette. Most cities have one or more major newspapers in addition to business
newspapers, shopper newspapers, ethnic newspapers, and national newspa¬
pers. How does an entrepreneur know which is most appropriate for the
product or service being sold? With businesses spending nearly one-third of
their advertising dollars on newspaper ads, this question becomes critical.
Newspaper advertising offers the advantages of:
• Broad coverage in a selected geographic area

• Flexibility and speed in bringing an ad to print and changing it along the
way
• Generating sales quickly
• Costing relatively little
Newspapers have disadvantages as well. Broad coverage means you are paying
to reach people who may not be part of the target market. Furthermore, since
newspapers carry hundreds of ads every day, it is not easy (short of taking out a
full page) to attract the attention of the reader. Then too, a newspaper has a very
short life. A person may read it with breakfast and throw it out before leaving for
work. Even an ad that was noticed may be forgotten by the end of the day.
Therefore, you may want to consider a specialized newspaper that will better
reach the customer you want. Here are some tips for using newspaper advertising.
• Determine which newspaper is best for your business by placing ads in all of
the ones in your target region the first time. Include in the ad a coupon or
800 number so the potential customer will either bring the coupon into your
place of business or call on a special line. In either case, ask them where they
heard about the business. The papers with the highest response rates should
be continued and all others dropped. Once this has been done in one or two
geographic regions, you can safely assume that a similar type newspaper in
another part of the country will give similar results.
• Be sure you or someone you have paid designs the ad so it doesn’t look like
every other one on the page. Often a distinctive border will make the ad
stand out.
• Create a basic design for advertising that reflects the philosophy of the busi¬
ness and use that design consistently in all advertising. Customers will even¬
tually recognize that the ad is for your company before they even read it.
• The best location for the ad is the right-hand page, above the fold of the
newspaper, but it is probably also the most costly.
• Keep track of the results of your ads, particularly if you are experimenting
with size and design.
• A national newspaper like USA Today offers a good opportunity to do
national advertising for less money and a broader reach than a magazine.
Magazines. A number of national magazines offer businesses the opportunity

to advertise to certain broad-based target markets. Magazines like People,
Newsweek, Business Week, and Time reach hundreds of thousands of people
every week. In addition, there are specialty magazines like Sports Illustrated,
AARP, Rolling Stone, and Road & Track that focus on specific interests. These
magazines are useful for businesses that are targeting a particular interest like
cars and car accessories or senior citizen issues. There are also a great number
of trade magazines that reflect the needs of specific trade organizations like
Advertising Age and Variety. Magazine advertising, however, is more costly and
the time lag for printing is generally 6-8 weeks, so it lacks the flexibility of
newspapers. These things must be weighed against the fact that you may be
doing a better job of reaching the target market.
Magazines also offer the entrepreneur one thing newspapers can’t: credibility.
According to Jay Levinson, “A properly produced magazine ad, preferably of
the full-page variety, gives a small business more credibility than any other mass
marketing medium.”3 Obviously, you would want to run the ad more than
once; but it is possible to run the ad one time and order reprints at a fraction of
the original cost to use in direct mail campaigns and in brochures.
Here are some tips for magazine advertising.
• If the magazine has a regional edition, run the ad in the region you are
targeting.
• Use a media buying service to gain real cost advantages.
• Ask the magazine if you can run a split-run ad, that is, run one headline in
half the magazines and another in the other half. Be sure to code them so
you can keep track of responses.
• Code all ads to reflect publication, date, run, and ad size.
• Use color effectively and take advantage of the fact that you can provide
more information in a magazine ad than in a newspaper ad because the
reader generally spends more time with it.
• Always give a phone number or mail-in coupon in the ad to encourage
people to contact you for a full brochure or a video.
• Check on “remnant space,” leftover space that must be filled before the
magazine goes to print. It will be a fraction of the original cost of an ad.
Database Marketing. Database Marketing (DBM) is a system to gather and use

information on customers and prospects with the goal of increasing profitability.
A well constructed database will contain names, addresses, and attributes of
people who are likely to purchase what the company has to offer. It will help
the entrepreneur define a trading area, reach new customers in the marketplace,
select specific target audiences, and survey current customers. DBM is not
merely a way to more easily contact customers by mail. Today retaining and
maintaining current customers is more important than spending money to find
new customers. It has been reported that 65 percent of a company’s business
comes from current customers. In fact, it costs five to 10 times more to go after
a new customer than it does to serve an existing one.4 With good customer
3Levinson, J.C. (1993). Guerrilla Marketing. Boston: Houghton-Mifflin.

4“Firms Now Spend More on Old, Not New, Customers,” Los Angeles Times, November 1, 1994
profiles, an entrepreneur can match demographic information on current

customers with demographic data in the geographic area of interest to find
prospects more effectively. Information contained in the database can be used in
advertising, sales promotion, public relations, direct mail, and personal selling.
The competitive advantages to DBM are many. It helps entrepreneurs
increase their response rates, aids in the development of new products, helps in
the forecasting of sales, and improves mass marketing decisions. Database
marketing also allows the company to personalize advertising, cross-
sell related products, and increase customer loyalty.
Direct mail has the
Database marketing is really an overall approach to doing business
highest response that requires the total commitment of everyone in the organization. The
rate of any type of payoff to this approach takes time—many frustrated entrepreneurs will
give up before seeing the results of the efforts. To successfully imple¬
advertising.
ment DBM, there must be measurement standards in place to ensure
that the efforts are producing the desired results.
Direct Marketing. Direct marketing includes direct mail, mail order, coupons,
telemarketing, door-to-door, and TV shopping networks. The essence of direct
marketing is that the entrepreneur attempts to close a sale at the moment the
advertising takes place. Direct marketing also permits coverage of a wide
geographic area while, at the same time, targeting specific customers; therefore,
more sales can be generated with fewer dollars. Much more information can be
provided in a direct-response brochure; in other words, it can answer all the
customer’s potential questions so they can make an immediate decision.
Consequently, direct mail has the highest response rate of any type of adver¬
tising, and the responses received from a purchased mailing list become the
business’s personal direct mailing list. Another way to create a personalized
mailing list is to have people who “walk in” to the place of business fill out a
database card and suggest other people who may be interested in the product
or service.
The average response rate for direct mail is two percent. That rate can be
increased 50 to 100 percent if you include an 800 number in the advertising,
which is easier than filling out an order form. That response rate can be
increased from 100 to 700 percent by following up the mailing with a phone
call—telemarketing—within 72 hours. As a small, growing company, it is
important to consider the staff resources you have and to control mailings to
the number you can reasonably follow up on within the 72 hours.
Telemarketing Law
Be sure you understand the Telephone Consumer Protection Act, which says you must maintain a
“do-not-call” list and bans unsolicited advertising via fax machines.
You can find out more about this law by writing for “Marketing by Telephone,” to the Direct
Marketing Association’s Ethics and Consumer Affairs Department, 1101 17th St. NW, Suite 705,
Washington, DC 20036-4704.
To get the highest response rate possible, you have to do several repeat
mailings. For catalogs, four times a year is typical. Also, since most customers
have a tendency to throw out direct, unsolicited mail before reading it, it is
important to put the central selling point on the envelope as well. Customers
must be enticed to open the envelope. A tag line that suggests that what is
contained in the envelope will bring the customer money, health, love, or
success will certainly encourage people to see what you have to offer.
More than half Be sure to continuously update the mailing list and refine it so the
of any success number of non-responses declines.

More than half of any success with direct mail is attributable to using
with direct mail is
a good mailing list, followed by offering something the customer wants,
attributable to using
and being creative in the marketing of the product or service. If you use
a good mailing list. a targeted mailing list, offer a real benefit to the customer, and send that
offer in a business envelope with no return address, the chances of
getting a response climb significantly. Not all products are suitable for direct
mail, however. Those that are not consumable (requiring repeat orders), short¬
lived as in a fad, too seasonal, not easily shipped, or too easily available in
stores are not good bets for direct mail advertising.
If you are dealing in a consumer item, you may also want to consider inter¬
active TV shopping shows or infomercials to sell the product. The interactive
version where the viewer can see the product and order it immediately is in
place in several test markets and will eventually be accessible by anyone who
wishes it. Interactive TV allows you access to the consumer you seek by sex,
age, special interests, occupation and so forth. It is estimated that 70 million
people watch Home Shopping Network; 28 million watch Cable Value
Network; and 18 million watch QVC. This is definitely a growing market for
direct market sales and as soon as interactive TV becomes a reality for anyone
who wants it, those numbers will increase. Computer online services like
Prodigy and CompuServe also provide an outlet for consumer products and will
be something to look at carefully in the future.
The Yellow Pages. Many businesses can benefit from placing ads in the Yellow
Pages of their telephone directory If you are in the retail business or offer a
service not considered a professional service (consultant, lawyer, accountant),
there is a good chance people will look for what you offer in the Yellow Pages.
However, remember that the Yellow Pages is fairly expensive advertising space
and only targets the local market for your product or service, so it should not
be considered a major source of advertising, particularly if you market nation¬
ally or globally.
Signs. Signs are a relatively inexpensive way to expose a lot of people to the
business. They also encourage impulse buying of consumer products. Naturally,
signs play the most important role in retail businesses where they become part
of the total advertising campaign. In other types of businesses, the sign is
merely a feature to help someone locate the business. Signs do, however,
outlive their usefulness fairly quickly. If a sale sign is left in a window too long,
people will tune it out; they will no longer see it, and it will have lost its value.
Broadcast Media—Radio. Radio is an excellent medium for local or regional

advertising as the audience can be targeted geographically and generally by age
group. Radio stations keep extensive records on the demographics of their
listening audience to help determine if this audience will be interested in any
product or service. It is useful to advertise on more than one station to saturate
your market. Recently many companies have been able to gain a national pres¬
ence by sponsoring a national radio program. This was the case with Snapple
Beverage Company, who bought time on the Rush Limbaugh radio talk show
and immediately gained access to 20 million listeners a week. Sales for the
company soared as a result.
When dealing in radio advertising it is important to understand that the ad
can’t be a one-shot ad. As radio listeners are fickle and tend to change channels
often, the ad needs to be played several times a day, several days a week to
achieve an impact. Keeping track of the responses received from the ad indi¬
cates where the greatest impact has been made. A general rule of thumb is that
prime radio time is during commuting hours in the morning and late after¬
noon. The cost will be higher at those times, but you will also reach the most
people. Be sure to provide finished recorded commercials to the station so you
can maintain quality and consistency in your advertising. Don’t rely on the
radio station personnel to give your ad the energy and professionalism it needs.
Here are a few more tips for radio advertising.
• Stick to shorter spots. You can usually achieve just as much in a well-
designed 30-second ad as you can in a one-minute ad.
• Use music and sound effects to set the tone for the commercial. Both can be
rented from most radio stations for a modest amount.
• Be sure to design the commercial to catch the listeners attention in the first
few seconds.
• Run your ads three weeks out of every four for good coverage at less cost.
Television. Many businesses spend one quarter of their advertising dollars on

television; consequently, it is the second-most-popular form of advertising after
newspapers for consumer products. With television, people can see as well as
hear about the product or service, and the audience can be targeted at the
national, regional, or even local level as well as by interest group by using cable
channels. However, television advertising is expensive, not only for the actual
on-air time but for the preparation and filming of the commercial.
Television time is based on the GRP (Gross Rating Point), which very simply
put means that you will pay per GRP, a rate that differs based on whether you
are in a small town or a large city. The range is about $5 to $500 per GRP. A
rule of thumb for deciding whether or not to use television as an advertising
medium is to calculate if you can purchase 150 GRPs per month for three
months. If this level of advertising is not within the budget, forget TV; you will
probably be wasting your money. When using television seek the help of a
media buying service. They are the equivalent of buying health insurance
through group pools, and they can get your media time much more cheaply
than you can because they buy millions of dollars’ worth every month.
While learning how to produce a television spot is a book by itself, here are
two pieces of advice: 1) Write the script yourself and let the television studio
provide the product equipment and expertise; and 2) do not appear in the
commercial yourself unless you are a professional actor.
Miscellaneous Advertising. Many simple advertising tactics have been very

successful for new and growing consumer products or service businesses.
Offering for sale (or as a give-away) T-shirts and baseball caps with the
company’s name emblazoned on them has been a very successful tactic. Using
248 Part 4 • The Operating Structure oj a New Venture
searchlights to attract people to your business site is an attention getter.

Couponing has certainly been an advertising staple, and there are many coupon
magazines in which you can buy space. These magazines are distributed to
households across the country and have been an excellent source of new
customers for businesses. Look for any and all opportunities to demonstrate the
product free to potential customers. One young entrepreneur who developed a
successful, easy-to-use cleaner for silk plants reports his sales always increase
when he does demonstrations in stores. Creating a video tape of the product in
action is another useful technique, especially where the product is not easily
transported. Many firms like PictureTel Corp. of Massachusetts incorporated
videos into free seminars. An outstanding 80 percent of people who attend
these seminars end up purchasing one of their products.
This section has provided just a few of the hundreds of tips and techniques
available to entrepreneurs who wish to advertise products or services in the
most efficient and effective ways while the new venture is growing. The series
of books on guerrilla marketing by Jay Conrad Levinson is highly recom¬
mended for its marketing suggestions geared specifically to young, growing
companies.
Publicity and Public Relations

Publicity is essentially free advertising for a product or business, through news¬
paper articles, radio and television stories, and talk shows. Public relations, on
the other hand, is the way a marketing campaign is structured so as to present
the desired perception to the public.
The key to publicity is having a unique or newsworthy product or business.
For example, your product may be environmentally friendly, where your
competitors is not. Or the way your business was founded may be an inter¬
esting story. If the business or product is newsworthy, there are several ways to
get some publicity. Write to a reporter or editor to tease them with an idea, and
follow up with a phone call. Issue a press release answering the who, what,
where, when, and why of the business and include a press kit containing the
press release, bios, and photos of the key people in the story, any necessary
background information, and copies of any other articles written about the
company. The key is to make it as easy as possible for the reporter to write or
tell the story. When an article is written about the business, use reprints in
future advertising and brochures to get even more value for the effort.
Whenever possible, get to know people in the media on a first-name basis,
even take them to lunch. This gives you instant clout when you need free
publicity. The media are always looking for news and appreciate the effort to
give them something newsworthy. An effective news release should contain the
following:
• The date, your name and phone number

• The release date (for immediate release, or after a certain date)
• An appropriate headline
• The release information typed double spaced with wide margins
• The who, what, where, when, and why
• A photo if appropriate
• A note explaining briefly why you sent the release
There are also several publishing services that can be used to distribute infor¬
mation on the business. The Contact Sheet, a monthly publication, prints news
releases written and paid for by companies. It is sent to over 1,800 editors and
reporters nationally who have free use of the material. Another publication is
the PR Newsletter, which is a membership electronic service that also assists the
company in writing a message targeted to a specific media audience.
Personal Selling
Traditional selling techniques just don’t meet the needs of todays customers.
Today, people expect a quality product at a fair price with good service. That’s a
given. If you start with this in mind, you will find that the way you sell your
products and your business is quite different from the traditional approach.
Today, a business distinguishes itself in the marketplace by identifying and
meeting specific customer needs. So even if you are “selling” a commodity, you
need to figure out some way to add value to the product.
A good example of this is a small manufacturer of molded plastic parts in
Massachusetts. Its largest account is a major acoustic speaker manufacturer, also
in Massachusetts. The speaker company asked the plastics company to assign a
full-time salesperson to their plant, which would help them eliminate some of
the costs of buyers and planners and, at the same time, let the plastics plant
concentrate on service rather than trying to acquire new accounts. As a result,
the plastic company’s sales have increased nearly 40 percent per year.
Becoming a value-added company, tailoring products to meet customers’
needs, requires that everyone in the company become service oriented, a time-
consuming task that necessitates training and educating employees. It also
demands an opportunity mindset, rather than a selling mindset. And as this type
of selling is usually accomplished at higher levels in an organization, it is a more
lengthy process; however, the returns are potentially greater. Working more
closely with customers can translate into reduced selling and marketing costs.
One of the most difficult issues an entrepreneur faces with regard to selling is
that of compensation—what and how to pay sales representatives. The possibil¬
ities are endless: Incentives can be tied to profit or gross margins, contract size,
the number of new accounts acquired, company goals, and so on. One of the
latest techniques is to pay sales people a salary plus a percentage of the profits.
Yet another issue is how to compensate those who provide service to customers.
Service is the key to customer retention, and the people who provide that
service are becoming increasingly more important to a firms success. Studying
the compensation practices in your industry as well as those of other industries
will help you decide which method is best for your business.
Trade Shows and Exhibits

For some entrepreneurs trade shows, fairs, and exhibits are a primary way to
expose their products.
Trade shows are a good way to find out who the competitors are and what
marketing techniques they are using. It is also the place to meet and negotiate
with sales reps and to get names for a mailing list. But the primary reason to
display your products at a trade show is to eventually sell more product. To
accomplish this, you should do the following:
1. Rent booth space. Hire a display designer to design and produce a quality
display booth that will attract attention. Visiting several trade shows prior to
doing your own will give you some ideas as to what works and what doesn’t.
You may also be able to work out a deal with a company that has compatible
products to share a booth and combine resources.
2. Hire a model to distribute an information sheet to as many people as possible
at the trade show that invites people to stop by the booth. Save the expensive
brochures to hand out at the booth to potential customers. Also be sure to ask
for business cards so you can follow up with people who took the brochure.
Trade Show Savvy
To learn about trade shows and conventions where you can display your products, check your
library for Tradeshow and Convention Guide, which can also be ordered from Budd Publications,
P.O. Box 7, New York, NY 10004.
3. Have enough knowledgeable, personable people in the booth so that poten¬

tial customers are not waiting to talk to someone. Stagger breaks to keep the
booth manned at all times.
4. Consider renting a hospitality suite in the hotel where the trade show is
located to entertain key people in your industry.
5. Offer something free at'your booth: a sample or a contest.
6. Follow up with letters to anyone whose business card was collected and
phone calls to all serious prospects.
Marketing to Industrial Customers

When the target market you are trying to reach is other businesses, the
marketing strategy is somewhat different in terms of advertising and promotion.
Consumer products and services require a lot of high-profile advertising and
promotion to entice customers away from the myriad of other choices they
have. With industrial products and services, the focus is on letting the targeted
businesses know the product or service is available and what it can do for the
business.
In general, industrial products and services do not use broadcast media or
most popular print media. Instead, they rely heavily on direct mail, personal
selling, trade shows, and articles and advertisements in trade journals. As most
industrial product manufacturers distribute their products through wholesalers,
it becomes the wholesalers’ job to market to and locate retail outlets. If you are
dealing with industrial customers, investigate how products and services are
marketed in your particular industry.
Online Market Research
With the addition of so many new electronic databases to the “information

superhighway,” it is now possible to do at least some of the needed market
research online. Electronic bulletin boards catering to special interests, U.S.
Census data, real-time stock quotes, financial and product information on
foreign companies, Dun & Bradstreet’s Financial Profiles and Company Reports,
demographics, active trademark listings, and analysts’ reports are but a few of
the information sources now available.
If there was ever too much of a good thing, it might be the information
superhighway. There are so many options and so much information that it
boggles the mind. Plus, the convenience of online information must be weighed
against the cost of retrieving it. Most database services charge either a monthly
Figure 12.1: Online Sources for Market Research
COMPUSERVE: Business Demographics, DIALOG: ABI/INFORM: Business

Iquest (gateway to more than 850 databases) publications
Magazine Database Plus: Full text articles Arthur D. Little/Online: Industry forecasts
Marketing/Management Research Center: Business Software Database
Full texts of major business magazines D&B Donnelley Demographics
Neighborhood Report: Demographics by zip D&B-Dun’s Electronic Business Directory
code Employee Benefits Inforsource
Moody’s Corporate Files
PTS Newsletter Database
DOW JONES NEWS RETRIEVAL: Compre¬ NEXIS: Analyst Research: Brokerage

hensive Company Reports Houses
Business Newswires Computers and Communications: full text
Text Library: Full text articles from over 500 sources
publications Company: Company & industry research
Dun & Bradstreet Financial Profiles & reports
Company Reports Consumer Goods: Trade publications
Japanese Business News: Same-day LEXPAT®: Full text of U.S. patents
coverage Marketing: Trade publications and general
Statistical Comparisons of Companies & sources on marketing information
Industries: PROMT/PLUS: Trends in markets and
Standard & Poor’s Profiles & Earnings technology
Estimates: Company reports
Top Business, Financial & Economic News
service fee, a per-search fee, an hourly rate, a print charge, or all of the above.
This can run into a considerable amount of money in a short time. Figure 12.1
presents a summary of some of the services available from the most common
database sources. Before signing up for any of these, arrange for a demonstra¬
tion of several at once so you can compare them for speed, ease of use, and
information provided.
Writing the Marketing Plan

While this chapter has covered a lot of material that will help you write your
marketing plan, it has barely scratched the surface of information available to
you in creating a unique plan that will work for you. Therefore, check some of
Figure 12.2: Marketing Plan Outline
• The purpose of the marketing plan. What are you trying to accomplish?
• The plan for achieving that purpose and the benefits that will accrue to the customer.
• The target market that the marketing plan will reach.
• The unique market niche that the business will occupy.
• The business's identity and how customers will perceive it.
• The distribution channels used to reach the customer.
• The marketing tools used to reach the target market (advertising, direct mail, trade shows, etc.).
• The media plan with the schedule of use and costs of each of the marketing tools.
• The total marketing plan budget as a percentage of sales.
the sources at the end of the chapter for more details on a specific topic that
may interest you. Including a marketing plan in your business plan is essential
as it helps ensure the business stay on track with its sales goals. It also lets
others who may read the plan (bankers, investors, potential employees) know
something about the company’s philosophy, identity, and goals. See Figure 12.2
for an outline of a marketing plan.
This plan, like the rest of the business plan, is a living document subject to
change based on new information. However, a marketing plan should not be
changed often. It takes time to implement an effective plan, and it takes time to
see the results. The plan you create should be the best one achievable, given the
resources available.
[7\ New Venture Checklist

Have you
□ Analyzed the marketing options and rank ordered them?
□ Written a clear, concise, one-paragraph statement of the marketing plan?
□ Written a position statement for the product/service?
□ Determined the distribution channels for the product/service?
□ Developed an advertising, publicity, and promotion strategy?

Advertising Age. 740 N. Rush St., Chicago, IL 60611.

Adweek. 5757 Wilshire Blvd., Los Angeles, CA 90036.
Albrecht, K. & Bradford, L. (1989). The Service Advantage: How to Identify and
Fulfill Customer Needs. New York: Dow Jones-lrwin.
Bangs, D.H. (1995). The Market Planning Guide, 4th ed. Dover, NH: Upstart
Publishing, Inc.
Benson, R.V (1987). Secrets of Successful Direct Mail. Savannah, GA: Benson
Organization.
Cohen, W.A. (1987). Develop a Winning Marketing Plan. New York: John
Wiley & Sons.
CompuServe. 800-848-8199.
Debelak, D. (1989). Total Marketing: Capturing Customers with Marketing Plans
that Work. New York: Irwin.
DIALOG. 800-334-2564.
Direct Marketing, Hoke Publications, 224 7th St., Garden City, NY 11535.
Dow Jones News Retrieval. 800-522-3567.
Levinson, J.C. (1993). Guerrilla Marketing. Boston: Houghton Mifflin.
Levinson, J.C. (1993). Guerrilla Marketing Excellence. Boston: Houghton
Mifflin.
NEXIS. 800-227-4908.
Reynolds, D. (1993). Crackerjack Positioning: Niche Marketing Strategy for the
Entrepreneur. Tulsa: Atwood Publishing.
Issues to 1. What is the difference between an entrepreneurial marketing strategy and a

large corporations market strategy?
Consider
2. Why is it important to stick with your marketing plan even if it isn’t
returning immediate results?
3. What does the marketing plan do for the business?
4. Why should an entrepreneurial venture not engage in image positioning like
large corporations?
5. How can a position statement be tested?
6. How is price for a product or service determined?
7. How does the promotion strategy for consumer-oriented businesses differ
from that of industrial businesses?
CHAPTER 13
The Management and

Organization Plan
Overview
• The entrepreneurial approach to organizational structure
• Ownership and compensation issues
• Hiring decisions
• The employee handbook
The Organizational Chart—Fact or Fiction

How to manage and organize the business is a fundamental decision every
entrepreneur must make, one that impacts all aspects of the business, from
product design to customer service. The way a business is organized and staffed
can also affect communications, morale, and performance in ways the entrepre¬
neur never expected. Entrepreneurs traditionally have resorted to the ubiqui¬
tous line and staff organizational charts as seen in Figure 13.1 to formulate a
structure for their businesses.
This chart depicts a company that is established, so it is more hierarchical
than a typical entrepreneurial venture. While the entrepreneur and the
founding team probably perform all these functions when the business is just
starting, they also have to think ahead to their requirements as they grow. The
organizational chart on p. 256 appears to spell out very clearly the relationships
among the staff, indicating lines of authority and responsibility. Because this
type of organizational structure focuses on functions, however, it often tends to
result in dependent relationships; therefore when a problem occurs, it is sent
up to the next management level for decision making.
255
Figure 13.1: Traditional Line and Staff Organizational Chart for a Simple
Manufacturing Plant
Personnel
Manager
Purchasing
Plant Manager J Sales Manager |
Manager
Buyer Buyer Sales Rep Sales Rep
What is not depicted by this traditional, hierarchical chart is the informal

organization or network of relationships that account for a significant portion of
the daily work. Informal networks of people consist of those who tend to gravi¬
tate toward each other in an effort to accomplish tasks in a more efficient and
effective manner than may be dictated by the chart. These networks form the
shadow organizational structure that brings the business through an unexpected
crisis, an impossible deadline, or a formidable impasse. They are social links that
form the real power base in the organization. Metaphorically speaking, the orga¬
nizational chart may be thought of as the skeleton of the body, while the informal
network constitutes the arteries and veins that push information and activity
throughout the organization—in other words, the lifeblood of the organization.
Research has found three types of informal networks: the advice network,
which includes those people who are the problem solvers in the organization;
the trust network where political information is shared; and the communication
network, which consists of employees who discuss work-related issues on a
frequent basis.1 Often the people in these networks come from various func¬
tional areas in the organization that don’t typically deal with each other on a
'Krackhardt, D. & Hanson, J.R. (1993). “Informal networks: The company behind the chart.” Harvard
Business Review, Vol. 71 (4), p. 105.
Chapter 13 • The Management and Organization Plan 257
daily basis. For example, the political/trust network might include the book¬
keeper, a sales rep, and a plant employee.
Entrepreneurs seem to have intuitively recognized the value of informal
networks in the organizational structure and often the most successful new
ventures adopt a team-based approach with a more flat structure. Figure 13.2
depicts the nature of this* structure. The lead entrepreneur is the driving force
for the entrepreneurial team, which normally consists of people with expertise
in at least one of the three functional areas of a new venture: marketing, opera¬
tions, and finance. The organization consists of interactive, integrative teams. In
the new venture, these are rarely “departments” in the traditional sense, but
rather functions, tasks, or activities. The statistics reflect this pattern. Fifty-one
percent of the growing companies that have made it to the Inc. 500 list do not
have a marketing director, while 61 percent have neither a COO nor a
personnel director. Thirty-two percent do not have a CFO, and an astounding
67 percent have no one to manage information systems in their companies.2
What is the explanation for this? For one thing, entrepreneurs are usually too
creative and flexible to be bound by the strictures of a formal organizational
structure. They are more comfortable bringing together resources and people as
a team and making decisions on the spot without having to go through layers of
management. Another reason is that growing new ventures must be able to
adapt quickly as they muscle their way into the market. Uncertainty and insta¬
bility are a way of life for young ventures, and a rigid, formalized, bureaucratic
structure would unduly burden a new venture both financially and operationally
Three components make up the entrepreneurial organizational structure:
formal processes, people, and culture. Formal processes include the planning
system, control mechanisms, compensation and reward policies, and other
processes that make the organization run more efficiently and effectively. These
processes are not independent units, but rather are linked to all functions of the
organization that require them. For example, quality control mechanisms are
Figure 13.2: Informal Networks in the Organizational Structure
2lnc. magazine, October 1993, p. 86.

not solely the purview of a single department, but flow from product develop¬
ment through manufacturing, to distribution, and throughout all of the support
functions needed to facilitate the process of getting the product to the customer.
People who work in market-oriented, entrepreneurial companies must not
only think of their individual tasks but of the product and company as a whole.
People required to make the business work need to have team building skills as
well as the ability to make decisions and implement them with very little input
from top management or the CEO. In new ventures those teams may consist of
independent contractors whose skills are being “rented” on an as-needed basis.
Informal networks create flexibility and speed up operations. They also have
the advantage of managing the personal issues not easily handled through poli¬
cies and structure.
The Entrepreneurial Approach to Organizational Structure

If entrepreneurs have always recognized the value of an integrative, team-based
approach (ITB) to management and organization, huge corporations—like
Xerox—are also attempting to mimic this entrepreneurial style. They have
learned that one of the greatest benefits of the entrepreneurial or market-oriented
style of management is that relationships with customers improve. Xerox, for
example, finds itself working with its customers to redesign the customers’ busi¬
ness processes instead of merely selling them copiers. They are focusing on what
the customer needs and then structuring their business accordingly.
What does this new market orientation look like? It begins with a purpose or
mission statement for the business that reflects the reason the business exists.
The mission then becomes the catalyst and driving force for everything the
business does. All strategies planned and decisions made derive from the core
mission of the business. The following is an example of a mission statement
from a market-oriented company:
DV Industries, Inc. will be recognized as a world-class provider of

finishing processes and services to the aerospace and other industries
requiring performance to demanding specifications.
We will maximize the economic well-being and quality of life of our
customers, employees, owners, suppliers, and neighbors by creating an
environment of continuous improvement and by our commitment to
excellence.
The purpose defines the opportunities, innovations, and parameters the busi¬
ness will pursue. DV Industries, for example, seeks to meet the specialized
materials finishing requirements of customers in the aerospace and related

industries. They do this by developing innovative processes customized to the
customers specifications.
The combination of purpose with innovation results in positioning the busi¬
ness in a unique market niche. DV Industries services customers whose needs
require the highest level of quality and service in very specialized tasks. Because
innovation and the development of new processes is time consuming, DV must
sense changes and trends in the market they serve before they occur so they can
stay ahead of their competitors. To succeed in the market niche, the business
has to use or develop collateral technologies that keep it on the leading edge
in the industry. DV Industries is continually developing innovative and
Organizing a busi¬
environmentally sound finishing processes that set it apart from other
ness in a way that
businesses in its market, based on discussions with its customers.
it is flexible, and
Entrepreneurs find that organizing a business in a way that it is
competitive in
flexible, quick to respond to market changes, and competitive in terms
terms of operational
costs requires an of operational costs requires an integrative, team-based approach.
integrative, team- Teams come in many varieties: self-directed work teams, problem¬
based approach. solving teams, quality teams, cross-functional teams. Essentially they
serve the same underlying purpose: “A team is a small number of
people with complementary skills who are committed to a common purpose,
set of performance goals, and approach for which they hold themselves
mutually accountable.3
What makes the entrepreneur’s situation unique is that, at least when the
venture is in the start-up or initial growing phases and capital resources are
limited, the team the entrepreneur develops will most likely consist of several
people outside the organization, namely, independent contractors. For example,
the entrepreneur may decide to sub-contract the manufacturing of a product to
an established company. This means he or she needs to understand how that
sub-contractor works and will, of necessity, become a part of that company’s
team in the production of the product. The entrepreneur’s marketing, sales,
operations, and finance people must also be able to work with the manufac¬
turing sub-contractor to ensure that the goals of the new venture are met with
the timeliness and level of quality desired. This requires skills on the part of the
team that are not normally learned in school, skills such as diplomacy in the
management of intra- and inter-team relationships, problem-solving skills, and
the ability to take responsibility for innovative changes on the spot, often
without the direct approval of the entrepreneur.
3Katzenbach, J.R. & Smith, D.K. (1993). The Wisdom of Teams. Boston: Harvard Business School Press.
PROFILE 13.1
A Market Orientation for Thermos

You are no doubt familiar with Thermos, the manufacturer of Thermos bottles and
lunch boxes. You may not have known, however, that they are also a major producer
of gas and electric cookout grills. These “barbecue” grills have become a commodity
in the marketplace—virtually everyone has one—and as a consequence, Thermos
was experiencing flagging growth in this segment of its market. Thermos had always
had a traditional, hierarchical structure organized by function, but this structure was
no longer working in a dynamic marketplace.
Thermos decided to take a big chance and pulled together a development team
consisting of managers from engineering, marketing, manufacturing, and finance.
The focus was to be on the market; the goal was to learn about the cookout needs of
their customers and then invent a brand new product to meet those needs.
Leadership of the team would vary depending on what stage of the process was
dominant at any point in time. Initially, marketing took the lead and everyone on the
team went out to find out everything they could about how people cook out-of-doors.
They used focus groups, visited people in their homes while they were barbecuing,
and ultimately learned that the product they were to develop should be attractive to
women (who were doing more of the barbecuing), not use charcoal (which is banned
in some cities), avoid gas (which is banned in some condos), and cook good food.
The solution was an electric grill that looked like a piece of furniture.
In the first phase of prototyping, the team took two rough models out to
consumers and retailers to gauge their reactions; while this was going on, engi¬
neering was developing an innovative way to raise the cooking temperature of the
electric heating rod using their core technology—the vacuum technology that keeps
liquids cold or hot. At the same time, the designers were looking at ways to differen¬
tiate the product in the stores with features that added value; and the manufacturing
segment, who had been involved from the beginning, was preparing for production.
Their first 100 grills went to employees to test and from that came some minimal
design changes. Then they were on the road to the trade shows to debut the new
product. The team approach was a success and increased revenues 13 percent in
the first year.
Building a team that works well together is a long process that involves
training the team in both interpersonal and job-related skills. In the beginning
of a new venture, that learning may come through trial and error, but later as
the budget allows, it may come through hiring a team facilitator or consultant
who can help fine-tune the teams efforts. Integrative team building demands
bringing in people who have a vested interest in the success of the business and
are not content to simply do their job but want increasing responsibility,
authority, and accountability. Entrepreneurs must be careful to make that
requirement very clear when bringing someone new into the team.
TQM—Panacea on Solution
Total Quality Management, or TQM, became the buzzword of the early 1980s.
As a management plan it requires businesses to become flexible and more
responsive to their internal and external environments. TQM is an integrated,
systematic, organization-wide management philosophy that helps to build
customer-driven businesses. It strives to improve product and service quality in
all aspects of the business by empowering employees to change processes. It
demands systematic changes in management practice, the redesign of tasks, and
the redefinition of managerial roles.4
Recently TQM has come under attack because despite its popularity, only 20
percent of those companies that institute TQM can identify significant improve¬
ment in their performance.5 Furthermore, it is a difficult concept to measure
without benchmarks as the traditional appraisal and reward systems do not
work with TQM. Some people suggest that TQM will be replaced by the
current buzzword, business process reengineering, which means constantly
questioning and re-evaluating whether or not current processes in the organiza¬
tion are working and make sense. In any case, the basic concept of total quality
throughout the organization is here to stay.
Ownership and Compensation in a Corporation

Two of the most perplexing management issues facing an entrepreneur with a
new corporation are how much of the company to sell to potential stockholders
and how much to pay key management. There is a tendency on the part of
small, privately held companies to use minority shares as an incentive to entice
investors and to pay key management, primarily because new companies do
not have the cash flow to provide attractive compensation packages. The
4Grant, RM., Shani, R; Krishnan, R. (1994). TQM’s challenge to management theory and practice. Sloan
Management Review, Vol. 35, Iss. 2, pp. 25-35.
5Fisher, Liz (1994). Total quality: Hit or myth? Accountancy, Vol. 113, Iss: 1208, p. 50.
prevailing wisdom is that providing stock in the new company will increase
commitment, cause management to be more cost conscious, reduce cash outlay
for salaries, and induce loyalty to the company in the long term. But recent
studies have found this is not always the case.6 More often than not the person
to whom you have given stock in good faith will ultimately leave the company,
taking the stock with him with the potential for future harm to the business.
In the initial growth stage of a new venture, it is difficult to determine with
any degree of accuracy what long-term role a particular person may play in the
organization. Often the entrepreneur, due to limited resources, is not able to
attract the best person to take the company beyond the start-up phase, so a
person with fewer qualifications will be hired for little salary plus a minority
ownership in the company. The entrepreneur is literally betting on the potential
contribution of this person, an eventuality that usually doesn’t pay off. Later
when the company can afford to hire the person it needs, the entrepreneur has
to deal with a minority shareholder who has developed territorial “rights.” When
minority ownership is an important issue to a potential employee, it is important
to make clear to that person what it means. There are few legal and managerial
rights associated with a minority position; thus, for all practical purposes,
minority ownership is simply the unmarketable right to appreciated stock value
that has no defined payoff period and certainly no guarantee of value.
Founder’s Stock
Founder’s stock (144 stock) is stock issued to the first shareholders of the
corporation or assigned to key management as part of a compensation package.
The payoff on this stock comes when the company goes public or is sold.
Assuming the company is successful, founder’s stock at issuance is probably
valued at the lowest level it will ever be relative to an investor’s stock value.
Consequently, one tax problem that arises as a result occurs when private
investors provide seed or working capital to the new venture. Often the value of
the stock the investors hold makes it very obvious that the founder’s stock was
a bargain and not the true value of the stock. According to IRC 83, the amount
of the difference between the founder’s price and the investor’s price would be
taxable as compensation income.
One way to avoid this problem is to issue common stock to founders and
key management, and convertible preferred stock to investors. The preference
6Osborne, R.L. (1992). "Minority ownership for key employees: Dividend or disaster?” Business Horizons,
Vol. 35(1), p. 76.
upon liquidation should be high enough to cover the book value of the corpo¬
ration so the common stockholders would receive nothing. This action would
effectively decrease the value of the common stock so it would no longer appear
to be a bargain for IRS purposes.
Founders stock is restricted, and the SEC rules (Rule 144) state that the
restriction refers to stock that has not been registered with the SEC (private
placement) and stock owned by the controlling officers and shareholders of
the company (those with at least 10% ownership). If a stockholder has owned
the stock for at least three years, and public information about the company
exists, Rule 144 can be avoided in the sale of the stock. If the stockholder has
held the stock for less than three years, the rules must be strictly complied
with. It is not the intent of this chapter to discuss the details of Rule 144.
Suffice it to say that the rule is complex and the appropriate attorney or tax
specialist should be consulted.
Compensating with Stock

Giving someone ownership rights in the company is a serious decision that
should be given very careful consideration. There are several things to con¬
template before taking on an equity partner, whether an investor or key
management.
1. Anyone brought in as an investor/shareholder or partner with the entrepre¬

neur does not have to be an equal partner. An investor can hold whatever
share of stock you have determined is warranted based on what that partner
will contribute to the business.
2. Never bring someone in as a partner/investor if you can hire that person to
provide the same service, no matter what you may feel the urgency of the
situation is. The most advantageous way to hire someone for a new venture
is to hire the person as an independent contractor.
3. Do not lock yourself into future compensation promises like stock options.
Use cash as bonuses whenever possible.
4. Establish the company as yours before taking on partners unless, of course,
you have founded the company as a team.
5. Consider having employees work for the company at least two years before
they are vested and given stock or stock options.
Issuing Stock When the Company is Capitalized. The number of shares you
authorize when you form the corporation is purely arbitrary. Suppose you
decide to authorize one million shares in the new venture. This means you have
one million shares available to be issued to potential stockholders. If you value
each share of stock at $1 and capitalize $100,000, you will have issued 100,000
shares; if each share is valued at $10, you will have issued 10,000 shares. The
value you place on each share is arbitrary; for psychological reasons you may
wish to value a share at $1, so a shareholder who contributes $10,000 to the
business can say that he or she owns 10,000 shares of stock as opposed to
1,000 shares at $ 10/share. In short, the number of shares issued depends on
the initial capitalization and the price per share.
Now suppose that you, the entrepreneur, will be initially contributing
$250,000 in cash and $300,000 in assets (equipment, furniture, etc.) to the
company. At $1 a share, you issue yourself 550,000 shares of stock
Holders of common and own a 100% interest in the company because you have only
stock share in issued 550,000 shares total. At a later date you issue 29,000 additional
shares at $5 a share to an investor. Your minority shareholder has
both the successes
therefore contributed $145,000 to the company and owns a five
and failures of the
percent interest in the company (29,000/579,000 issued stock). The
business and
investor will require that the current value or future additional income
benefit through
of the company be sufficient to justify the increase in price per share.
dividends and the
You can see that as additional shares are issued, the original stock¬
appreciating value
holder’s percentage ownership in the company declines. However, the
of the company. founders shares will not go below 55 percent (550,000/1 million)
unless the company authorizes additional shares and issues a portion
or all of those additional shares.
The type of stock you will be issuing is common stock, which is a basic
ownership interest in the company. This means that holders of common stock
share in both the successes and failures of the business and benefit through
dividends and the appreciating value of the company. Once common stock is
issued, a company can issue preferred stock, whose holders are paid first if the
company is liquidated. Preferred stockholders, however, must accept a fixed
dividend amount, no matter how much profit the company makes. If you form
a sub-chapter S corporation, you may only issue one type of stock.
One form of stock you may want to offer investors as an inducement is
called IRC Sec. 1244 stock, which permits a shareholder of a corporation with
capital and paid-in surplus of $ 1 million or less to treat a portion of any loss on
the disposition of the stock as an ordinary loss, rather than a capital loss. The
amount the shareholder can take as a loss is limited to the shareholders original
investment.
Buy-Sell Agreements. One of the real concerns entrepreneurs with privately

held corporations face is what to do when a stockholder wants to sell stock or
an employee with stock decides to leave the company to work for a competitor.
A buy-sell agreement spells out the terms and conditions for the sale of stock to
people outside the organization. It is a way to maintain control of the company.
Usually a buy-sell agreement provides for a right of first refusal to the company
to buy the stock before it is sold to someone else. To determine the value of the
stock at that point in time, it’s a good idea to call for an appraisal of the
company. Then the stock can be purchased using savings, insurance, or asset
sales. All investors, stockholder, and employment contracts involving stock
should contain buy-sell clauses.
Prenuptial Agreements. Entrepreneurs with family businesses face the addi¬

tional threat from divorce from their spouses or the divorces of their children
from spouses. One way entrepreneurs protect themselves from losing a signifi¬
cant ownership interest in the company to a divorcing spouse, whether theirs
or their children’s, is to have a prenuptial agreement. If the “prenup” is properly
structured, the couple would not be allowed to hold company stock jointly.
This is particularly important where a son or daughter who is a minority share¬
holder marries and subsequently divorces. The entrepreneur does not want to
have to deal with an ex-in-law. A prenuptial agreement, while not fool-proof,
will probably be upheld in a court of law if it is not vague and is reasonable in
its terms.
Trusts. An irrevocable trust offers the greatest protection for the ownership of
stock. For example, you may set up a trust for your child that contains his or
her stock in the family corporation. The trust will stipulate that creditors have
no rights to the trust. This also includes a potential spouse that your child
might divorce. The important thing to remember is that you, the entrepreneur,
must set up the trust using an attorney specializing in that area of the law.
Alternatives to Equity Incentives

There are other ways to compensate key management that will not require the
entrepreneur to give up equity in the company.
Deferred Compensation Plans. In a deferred compensation plan, the entrepre¬

neur can specify that awards and bonuses be linked to profits and performance
of both the individual and the company, with the lions share being on the indi-
vidual’s performance. The employee does not pay taxes on this award until it is
actually paid out at some specified date.
Bonus Plans. With a bonus plan, a series of goals are set by the company with
input from the employee, and as the employee reaches each goal, the bonus is
given. This method is often used with sales people and others who have a direct
impact on the profitability of the company. The key to success with bonus plans
is to specify measurable objectives.
Capital Appreciation Rights. This type of program gives employees the right to
participate in the profits of the company at a specified percentage, while not
being full shareholders with voting rights. Capital Appreciation Rights, or
“phantom stock,” provide for long-term compensation incentives whose value
is based on the increase in the value of the business. The phantom stock will
look, act, and reward like real stock, but will have no voting rights and will
limit the employee’s obligation should the business fail. Typically the employee
has to be with the company for a period of three to five years to be considered
vested, but otherwise they do not have to pay for these rights.
Profit-Sharing Plans. Profit-sharing plans are distinct from the previously

discussed plans in that they are subject to the ERISA rules for employee retire¬
ment programs. These plans must include all employees without regard to indi¬
vidual contribution to profit or performance. They are different from pensions
in that owners are not required to contribute in any year and employees are not
“entitled” to them.
Whatever plan you choose to compensate and reward key management,
understand that these rewards may not produce the desired performance. You
should carefully consider alternative plans before granting minority ownership
status, as you may be able to achieve the results you are looking for without
having to give up a portion of ownership.
Hiring—Job Descriptions and Specifications

One of the most important decisions made by any business is a hiring decision;
yet, more often than not, those who are doing the hiring don’t know what
they’re doing. They hire quickly, based on instinct, and then have to worry about
how to get rid of the person. Today, with more employees suing their bosses for
wrongful discharge, sexual harassment, and racial/gender/age discrimination, it
is increasingly important that the entrepreneur understand how to hire. Hiring,

however, is not a simple matter of placing a help wanted ad in the newspaper,
receiving resumes, and then holding interviews to select the best candidate. The
bulk of the work of hiring comes before the person is actually needed.
Job Profiles
Part of organizing the business is determining what positions are needed to do
the required tasks of the business. Naturally, in the start-up phase most entre¬
preneurs do the biggest share of the work themselves, but they know that at
some point they will have to hire employees, even if it’s only a receptionist or
administrative assistant. Preparing profiles and job descriptions for all the func¬
tions of the business ensures that you have them when you need them.
Typically when entrepreneurs (and managers) develop job descriptions, they
focus entirely on the duties and responsibilities of a particular job. While this is
important, it is equally important to develop behavioral profiles of these jobs; in
other words, what behavioral traits are typical of and vital to a particular posi¬
tion. An effective bookkeeper, for example, may require the following attrib¬
utes: detail orientation, focused, can work alone, is responsible and organized.
In addition to looking at the best behavioral traits for each position, the
entrepreneur must have a good sense of the business culture. While a job
candidate may have the education and experience required by the job descrip¬
tion and display some of the behavioral traits necessary for success in the posi¬
tion, the candidate’s chemistry may not fit in well with the culture of the
organization. This is an important distinction because education and experience
can be achieved, behaviors can in most cases be taught, but chemistry—fitting
in with the company culture—must already be present in the job candidate.
The Employee Search

The first and best place to look for an employee is your current employees, sub¬
contractors, or professional advisors. Referrals from people you know and trust
and who know the business have a greater likelihood of producing a successful
hire. That is why if you can induce a key management person to leave an orga¬
nization and join your business, that person will probably induce someone else
you need later on to come as well. Even during start-up, be constantly on the
lookout for good people who might come on board as the business grows.
The help-wanted ads is another source. An estimated 75 percent of those
who read the ads are actually employed with no intention of seeking another
job—unless they see an opportunity that interests them. Consequently, you

must make certain your ad stands out and presents an opportunity to a quali¬
fied person that they can’t pass up. You may also consider executive search
firms for key management positions.
Resumes
The most important thing to know about a resume is that it is a selling docu¬
ment. The person is attempting to convince you to give him or her an inter¬
view. Therefore, expect most resumes to exaggerate a person’s importance
somewhat. If a resume indicates a person has had a number of jobs in a rela¬
tively short period of time or a number of “very important” positions—vice
president of this company and president of that company—it may either mean
this person truly is in demand and has been wooed away from several compa¬
nies, or it may mean that this person can’t hold a job. Consequently, you need
to think of the resume as a screening tool to see if the candidate has the requi¬
site skills and experience. The more important information will be gained in
the interview.
Interviews
Most entrepreneurs dread interviewing job candidates, primarily because they
don’t know what to say and they don’t understand that they should ask ques¬
tions that get at the person’s personality, how they might react in certain situa¬
tions. This can be accomplished in part by asking open-ended questions,
questions that call for more than a yes or no answer. For example,
• What is your greatest strength? Weakness?

• How would you handle the following hypothetical situation?
While the person is answering the questions, be careful to note the non¬
verbal communication being sent through body language. Does the person
appear confident, at ease with what is being discussed? Does the person look at
you directly? Does the person sit with a very closed posture (arms crossed as if
to protect) or in a more open, relaxed manner. It is said that 90 percent of
communication is nonverbal, so if you don’t trust what a person is saying
verbally, check to see if the nonverbal signals match the verbal ones.
Entrepreneurs should know that certain questions may never be asked in an
interview situation because they are illegal and leave you open to potential
lawsuits. Under the laws administered by the EEOC (Equal Employment
Opportunity Commission) before the point of hire, you may not ask about a
persons:
• Religion or religious background

• Nation of origin
• Living arrangements or lifestyle choice
• Plans for pregnancy *
• Age (to avoid discrimination against people over 40 and under 21. You may
ask a young person who must be 21 to hold the job if proof of the required
age can be shown after hiring.)
• Criminal arrest record (You may only ask “Have you ever been convicted of a
crime?”)
• Military record
Screening Potential Employees

In an effort to screen potential employees for drugs, criminal records, false
information, and workers’ compensation history, some entrepreneurs are
resorting to hiring firms that do background checks. Whether or not you
need to run a background check is a function of the type of job for which you
are hiring. A receptionist position probably does not require more than
contacting previous employers to verify information on the resume. But
hiring a bookkeeper or Chief Financial Officer may call for checking for a
criminal record. Likewise, a truck driver position may require verifying a
clean driving record.
Some companies are requiring drug tests as well, and those jobs with phys¬
ical requirements may call for medical exams. In addition, many companies are
using integrity tests, which are psychological tests that measure whether a
candidate is more or less likely to steal, take drugs, or be violent. Still others use
personality assessment tests to see how a person matches a job profile or fits in
with the company culture. Since psychological tests can be wrong, however, it
is important to give them as only one part of a comprehensive interview and
hiring process. To avoid the possibility of a discrimination suit, all these tests
should be given only after a job offer has been made.
The recent surge in sexual harassment, wrongful termination, and discrimi¬
nation suits against employers has prompted a new form of business insurance
called employment-practices liability insurance. It came about after many busi¬
nesses found to their dismay that their standard business liability insurance did
not include, or specifically excluded, employment practices suits. These new
policies generally have limits from $50,000 to $10 million and are not inexpen¬
sive, averaging about $150 per employee annually.
Employee Contracts
Once you have decided to hire someone, it is crucial to put the terms of the
agreement in writing to avoid misunderstandings about salary, benefits, duties,
and responsibilities. What is not included in the agreement should be spelled
out clearly as well. Include in the contract a clause that calls for mandatory
arbitration in the event of a dispute and a non-compete clause to prevent
someone from leaving your business to start their own competing business with
your confidential information and customer/supplier lists.
The Employee Handbook

Every new business should have an employee handbook that spells out the
company policies and procedures, the mission, the expectations for
employees, and the company philosophy. It is at once a legal document that
protects both owners and employees and an enthusiastic rendition of the
company culture. The handbook serves as documentation of everything from
compensation and promotion to vacations and health care. It also lets
employees know under what circumstances their employment can be termi¬
nated and what that process is. If a dispute arises, you may find your state
court will bind you to the handbook as written, not intended; therefore state
all policies and procedures clearly without leaving room for ambiguity. Any
vague provisions will likely go in favor of the employee since the handbook
was written by you, the employer.
The Company History

Relating the story of how the company was founded should definitely be the
first entry in the handbook, because it sets the tone and gives the employees a
sense of history, of belonging to something potentially great. Tell the story
like a story, in other words, make it personal, entertaining, and readable (you
never know when this portion of your handbook will end up in some
magazine!). Remember that honesty about some of the troubles you faced
starting the business will make your employees feel that they are part of a
human effort rather than a serendipitous occurrence in an moment of extra¬
ordinary luck.
The Company Philosophy

Recall in the chapter on the Marketing Plan the discussion of identity versus
image. The company philosophy is essentially a statement of the identity of
your company—who you are and what you stand for. If the history section
describes the birth of the company’s culture, the philosophy section ingrains
that culture in the minds of the employees. After reading this section, the
employees should have a good sense of what you believe in, where the
company is going, and how they fit into the picture. If your philosophy is that
employees should be creative, assertive, productive, self-motivated problem-
solvers who aren’t afraid to be wrong, then let them know that up front.
Remember that the experiences of most employees with company cultures has
been quite the opposite. Shake them up a bit and help them to clearly see that
their experience with your company will be very different.
What Goes into the Handbook?

The best way to determine what to put into the handbook is to first consider
what your employees want to know about the business; then take a look at the
handbooks of other companies for comparison purposes to see what you like
and don’t like. In general, include the following information in the handbook:
• A section stating that the handbook is not a contract and is subject to

changes. This is important as business conditions may force work hours or
vacation times to change, and employees should be forewarned of this possi¬
bility. State also that the employment relationship may be terminated at any
time, for any reason, with or without cause or notice. Have the employee
sign a copy of this statement, acknowledging receipt of the handbook and
agreement with its terms.
• Employment policies on such things as opportunity, work hours, pay, perfor¬
mance reviews, vacations, sick leave, jury duty, and so forth.
• Benefits such as health, dental, insurance, disability, workers’ compensation,
and retirement. Include something on the Family and Medical Leave Act as
required by law.
• Guidelines for employee conduct, including a written sexual harassment
policy and dispute resolution procedures. State clearly that included are
merely examples of unacceptable conduct and not a comprehensive list.
• An organizational chart so the employees know who is who and where they
fit in the big picture.
• Phone numbers of key people.
• Table of contents, question/answer sections, and an index. The handbook

should not be too cumbersome, 20-30 pages is plenty for a young company.
It should be designed so information is easily accessed.
Other Policies
Besides policies relating to employees, create policies and procedures for the
routine tasks that are accomplished each day in the business. For example,
procedures for order taking, shipping, handling invoices, billing, and all of the
other administrative functions the business undertakes will be needed. One
way to figure out what procedures may be required is to take the business
through a hypothetical, typical day or week and list all the activities that occur
from the point an order is received to the point at which it is shipped, or from
the point a sale is solicited to the point at which the sale is closed. Activities
that take place over and over again require established procedures to promote
efficiency and effectiveness. Naturally, many of the procedures you develop
when you start the company will be modified as you bring on employees and
receive their input. But it’s still a good idea to start with something.
The Management/Onganizational Plan Section of the Business Plan

Most of what has been discussed in this chapter will become part of the
employee handbook, which is a supplement to the business plan and is not
normally given to potential investors and the like unless asked for. Basically, in
the management plan section of the business plan describe:
• The entrepreneurs general management philosophy (i.e. team-based, flat

structure, etc.) and company culture
• The legal structure and form of ownership of the company
• The formal organizational chart of the business to depict who the key players
are and their duties and responsibilities
• The compensation programs and incentives for key management
• The key policies on orders, billing customers, and paying suppliers
• Any major benefits offered to employees
The management plan is where the philosophy of business gets imple¬

mented. It should reflect the entrepreneurs beliefs about customers, suppliers,
and employees, and should give the reader a clear sense of the company
culture.

Have you
□ Determined the personnel required to run the business at start-up and over the
next three to five years?
□ Written a mission statement for the new venture?
□ Determined the ownership and compensation requirements of the business?
□ Created job profiles for positions in the business?
□ Formulated a plan to find the best candidates for positions in the company?
□ Established policies and procedures for the business?
□ Drafted an employee handbook?

Small Business Reports. (February, 1990). “Right employee, right job.”
Directory of Executive Compensation Consultants. Kennedy Publications, 17
Templeton Rd., Fitzwilliam, NH 03447, 603-585-6544.
Alexander Hamilton Institute. The Employee Handbook Audit. 201-587-7050.
Balkin, D.B. (1988). “Compensation strategy for firms in emerging and
rapidly growing industries.” Human Resource Planning, Vol. 11 (3), pp. 207-
213.
Bruce, S.D. (1993). How to Write Your Employee Handbook. Madison, CT:
Business & Legal Reports, 800-727-5257, extension 169.
Nobile, R.J. (1995). Guide to Employee Handbooks. Boston: Warren Gorham
Lamont, 800-950-1216.
Sack, S.M. (1990). The Hiring and Firing Book: A Complete Legal Guide for
Employers. New York: Facts on File, 800-255-2665.
Tibbetts, J.S. Jr. & Donovan, E.T. (1989). “Compensation and Benefits for
Start-Up Companies.” Harvard Business Review, January-February, pp. 140-
147.
1. In what ways can the new venture assume a market orientation?

Issues to
Consider 2. Why might the traditional line and staff organizational chart not be suitable
for a new entrepreneurial venture?
4x 3. What are the advantages and disadvantages of using stock as compensation

and incentives?
4. Compare and contrast common and preferred stock and the tax implications
of each.
5. Discuss three ways the entrepreneur can prevent stock from being sold to
outsiders?
6. List three alternatives to equity incentives for key management.
7. How can the entrepreneur improve the chances of choosing the best job
candidate?
8. What is the purpose and value of the employee handbook?
OHO (A)1
I n the summer of 1989, Sam Farber had persuaded Davin Stowell, owner of
Smart Design, to develop a line of kitchen gadgets (e.g. peeler, can opener,
pizza cutter, garlic press) that would be functional, comfortable, ergonomically
sound, attractive, and affordable. Stowell decided to accept the challenge for a
three percent royalty agreement and a small advance. Farber was expecting
Smart Design to have the kitchen gadgets prototyped and ready for manufac¬
ture so they could introduce the new line at the San Francisco Gourmet Show
in April 1990. Before Davin Stowell would begin the process of generating
prototypes, the Smart Design team needed to meet to reinforce or expand on
Sam Farbers initial product criteria and help set the design goals for these new
products.
The Seed of an Idea is Planted

Sam Farber had considerable experience in the housewares industry. He had
founded COPCO, a company that produced well-designed cookware and
related housewares items in 1960. COPCOs first products were enameled cast
iron cookware made in Denmark. The cookware was designed by an American,
Michael Lax. Up to that time, all enamel on cast iron cookware had been tradi¬
tional designs. COPCOs products were the first modern designs. The company
continued to expand its sales of well-designed products in enamel and plastics
and was especially known for its tea kettles. At COPCO the concentration was
on the shape and color of the products. The products were useful, but there
was little thought given to how products could be made more “user friendly.”
In 1983 Sam Farber sold COPCO, but he continued to head the company
under a management contract for the next five years, until he retired at age 65.
Sam and his wife, Betsey, had very strong interests in the field of outsider art,
1©1994, Corporate Design Foundation. This case was written by Professor William B. Gartner, San Francisco
State University School of Business, with the support of the Corporate Design Foundation as a basic for class
discussion rather than to illustrate either effective or ineffective handling of a business situation.
and they were looking forward to spending more time writing articles and
curating art shows. They had done both in the past, but only in a limited way
because of the demands of their work. They also loved to entertain and cook,
and they decided they would spend at least a few months each year in the
south of France, writing and cooking.
While they had never been happy with many of the tools they used in the
kitchen, they didn’t realize just how bad these tools actually were until they
began “marathon cooking” for all of their friends that just happened to be trav¬
eling through Provenge. It became apparent that most of the kitchen tools
didn’t seem to meet the basics of good design: aesthetics, function, and form.
Attractive products, when they found them, were a functional disaster. The bit
of arthritis affecting Betsey’s hands made it difficult for her to use the kitchen
tools. She is one of over 20 million Americans who currently suffer from
arthritis, so Sam and Betsey were particularly aware of how virtually none of the
products considered user comfort.
They kept asking, “Why was the kitchen environment at best indifferent and
at worst hostile to human use? Isn’t it possible to combine form with utility in
design, and combine them in such a way that it becomes accessible to the entire
population? And doesn’t it reason that such a design would have great
consumer appeal? Why can’t a kitchen tool be comfortable, easy to use, of good
quality, aesthetically pleasing, and easy to clean?” The seed was planted and
Sam Farber began to think about bringing this idea to market.
Market Research
Sam Farber devised a strategy to generate information on the market for
kitchen gadgets with as few interviews as possible. He decided to interview
buyers in different areas of distribution.
• Department stores—Bloomingdales, Macy’s

• Specialty store chains—Crate and Barrel, Williams and Sonoma
• Mass merchants—Target Stores
• Mail order catalogs—Chefs Catalog
These discussions centered primarily on best-selling items, price, design,

packaging, display, and service. Sam was surprised (and a little disturbed) to
find that buyers did not comment on the function of the product. When Sam
mentioned some of his preliminary product goals, the only criteria the buyers
seemed to respond to were dishwasher safe, good quality, and design. Most
buyers didn’t mention the latter two. Function and user comfort did not enter
into the discussion at all.
All the buyers suggested the same best-selling items: peeler, can opener,
garlic press, grater, pizza cutter, measuring spoons, and measuring cups. The
mail order catalog buyers preferred higher unit retails, and therefore wanted
sets that combined two or three items. All distribution areas were selling
kitchen gadgets in lower price ranges than the prices Sam Farber had contem¬
plated (e.g. peelers ranged from $.99 to $4.99). Sam was considering a peeler at
a price much higher than $4.99.
Sam Farber decided to confine his interviews with consumers to five or six
people he knew were good cooks. Some of these individuals were professional
chefs, but the majority were very good amateur cooks. Sam reasoned that they,
like he and his wife, would have thought a lot about the tools they use in the
kitchen. Their answers concentrated on quality, comfort, and function.
Design Partners
Concurrently with Sam Farber’s exploration of the market, he engaged the
design firm, Smart Design, to undertake the design process from concept to
product. Smart Design had done work for Sam previously at COPCO. Sam felt
Smart Design was forward-thinking, they had good technical expertise, and
they were willing to take chances. The firm also had a wide variety of experi¬
ence. Their client list included Corning Glass, Johnson & Johnson, Citibank,
Clairol, the University of Southern California, and JC Penney.
Sam knew Smart Design would make a good partner, and he wanted them to
be partners, not just hired hands. He worked out a three percent royalty agree¬
ment with Smart Design, plus a small advance. This way their success was
dependent on the success of the products. In addition, Sam wanted to keep
overhead costs (i.e. product design and development) minimal, as much as
possible, rather than start the company with little working capital.
The Design Process

The designers discussed the product goals Sam Farber had already outlined,
and most importantly, they attempted to identify the final customer. Was it a
product for people with arthritis? Yes. Was it a product for older infirm people
with weak hands? Yes. But it was really a product for everyone to use in the
kitchen. Shouldn’t everyone who cooks have comfortable tools? From a
marketing point of view, Sam wanted to appeal to the broadest possible market,
not just a very specific market for arthritics and the infirm. Sam wanted the
design of these products to be of transgenerational, or universal, design.
Universal design stresses the need to make the design of any product or
service fit the needs of as broad a spectrum of the populace as possible.
Products that make life more comfortable for everyone. Products that are easy
for everyone to use. Universal design acknowledges that people change over
time, that their needs vary with ordinary events like pregnancy, an armful of
groceries, carpel tunnel syndrome, skiing injuries, or the unavoidable changes
of aging. Universal design attempts to extend the useful life of both the object
and the user. Sam was hoping to push the boundaries dividing the able from
the encumbered. Transgenerational design considers all these variations in
strength and dexterity. It is a form of ecological thinking because it extends the
life of the product and its materials by anticipating the whole life experience of
the user. One of the designers put it this way: “We’d better design the stuff now
because we’ll need it when our abilities sag.” Sam’s comment was, “I think that’s
why I’m here.”
Sam and Davin Stowell of Smart Design decided to bring in Patricia Moore
as a project consultant. Moore was trained as a designer and had devoted
herself to design problems addressing the older generation. For example,
Procter and Gamble had asked her to help them redesign the Tide soap box to
make it easier to open. So she helped them develop the snap-top box. Smart
Design had collaborated with Moore on a number of universal design projects.
There were eager to demonstrate that designing for a general population that
included the elderly or those suffering from hand infirmities was not an excuse
to make “frumpy prosthetic devices,” but the opportunity to make products
that are better for everybody.
Design Research
The next step was to have the design team do their own research. Information
transmitted from the marketing managers to the designers can lose a lot in
translation. The design team went out into the market. They talked to
consumers. They examined all the competitive products. They interviewed
chefs and spent many hours with volunteers from the New York arthritis group
to learn the problems in hand movement. They used the products that were on
the market for weeks to pinpoint areas that needed improvement. This involve-
ment as the final user brought the designers close to the project and helped
them share Sam Farber’s passion and belief.
It was now time to sit down and determine the product goals.
1. What are the primary product goals for these kitchen tools in terms of
customer needs?
2. Once these product goals are determined, what should happen next in terms
of product development?
3. What problems in the areas of product development, quality control, and
pricing is this business likely to face before the introduction of these prod¬
ucts at the San Francisco Gourmet Products Show?
4. What does Sam Farber need to do before creating a marketing plan?
.
PART 5
The Financial Plan
Money is the seed of money, and the

first guinea is sometimes more difficult
to acquire than the second million.
-JEAN JACQUES ROUSSEAU
CHAPTER 14
Financing the New Venture
Overview
• Bootstrapping savvy
• Equity versus debt financing
• Venture capitalists and angels
Sources of Financing in the 1990s

Financing the start-up of a new venture in the 1990s is truly an exercise in
creativity and optimism. The period of tremendous growth and availability of
venture capital in the 1980s has been replaced by ultra conservative lending
practices on the part of banks and retrenchment on the part of investors.
Fueled by the savings and loan association crisis and the subsequent draconian
regulations imposed on banks, bankers are less likely to invest in a new venture
with no track record as their portfolios are continuously scrutinized by regula¬
tors. Similarly, the recession of the early 1990s, which sent the real estate
market into collapse and many businesses into bankruptcy, has made private
and professional investors alike nervous. As a result, they are cautiously
awaiting some indication of the long-term direction the economy will take in
light of new economic policy at the federal level. Therefore, it is very important
that the entrepreneur become aware of creative sources of start-up capital.
283
284 Part 5 • The Financial Plan
Bootstrapping
Creativity is one of the key watchwords for financing start-ups in the 1990s.
Techniques for creative financing are collectively known as “bootstrapping,”
which means getting by on as few resources as possible and using other
peoples’ resources whenever possible. Bootstrapping means begging, borrow¬
ing, or leasing everything needed to start the venture. It is the antithesis of the
“big money model” espoused by many when they talk about entrepreneurial
ventures.1 More often than not, bootstrapping is a model for starting a business
without money—or at least without any money beyond that provided by the
entrepreneur’s personal resources.
Entrepreneur Resources
Most entrepreneurs start their ventures with their own resources, at least
initially. These resources include savings, credit cards, and friends and family.
The Department of Commerce reports that 67 percent of all businesses were
started without borrowed money. Enita Nordick liquidated her stocks and
sold her home to contribute the required capital to start Unity Forest
Products, which re-manufactures lumber blanks into such things as siding
and paneling and sells them to retailers. Bill Gates and Paul Allen started the
software giant Microsoft in a cheap apartment in Albuquerque with virtually
no overhead, a borrowed computer, and very little capital. Ross Perot, one of
the great bootstrapping success stories, started EDS with $1,000. These entre¬
preneurs comprise the rule, not the exception; most new ventures are initially
funded through the resources of the entrepreneur. Gates, Perot, and Nordick
realized early on that no one except friends and family would consider
investing in the new venture until they had gotten it off the ground and had a
viable business.
Hire as Few Employees as Possible

Normally the greatest single expense a business has is its payroll (including
taxes and benefits). Subcontracting work to other firms, using temporary
help, or hiring independent contractors can help keep the number of
employees and their consequent costs down. This is the 'tactic taken by
'Bhide, A. (1992). "Bootstrapping Finance: The Art of Start-Ups.” Harvard Business Review, Vol. 70, No. 6,
pp. 109-117.
Chapter 14 • Financing the New Venture 285
Maritime Services, an internal outfitter of cruise ships founded in 1986 with

$1,000. As of 1991 it was doing $3.9 million in sales with only three
employees. Similarly, Marianne Szymanski founded Toy Tips Inc., a nationally
recognized, independent product testing and research firm in Milwaukee,
using student interns from Marquette University and bartering for office
space. The interns received university credit for working with her, and she
didn’t have to deal with payroll.
Lease, Share, or Barter Everything

Virtually all new ventures at some point need to acquire equipment, furnish¬
ings, and facilities. By leasing rather than purchasing major equipment and
facilities, precious capital is not tied up at a time when it is badly needed to
keep the new venture afloat. With a lease there is usually no down payment
and the payments are spread over time. A word of caution, however. Be
careful about leasing new and rapidly changing technology for long periods
of time or you may soon find yourself with obsolete equipment and a contin¬
uing obligation.
Some entrepreneurs have shared space with established companies not only
to save money on overhead but to give their fledgling ventures the aura of a
successful, established company. This was the strategy used by Michael
Kempner of Strategic Communications, Inc., a public relations firm. Kempner
moved in rent free to space in a friend’s elegant advertising offices with the
agreement that he would refer clients to his friends business in exchange for the
space. When Marianne Szymanski of Toy Tips, Inc. found she needed a profes¬
sional wardrobe for her media tour, she went to JH Collectibles and explained
her situation. As a young businesswoman with a start-up company, she didn’t
have much money to spend, but she wanted their clothes to wear on the tour.
JH Collectibles liked her idea and gave her a wardrobe of clothes she could
promote on the tour while also promoting her business.
Bartering is a well-established tradition among entrepreneurs with new
ventures. In fact, it is even used by large corporations going into global
markets. In Russia, for example, Pepsi Cola traded its surplus cola for vodka
which could be sold in the United States. Similarly, New Zealand had traded
dairy products for Russian coal. These barter arrangements are known as “one-
to-one trades.” There are also barter exchange groups where a member can earn
credits by providing products or services and then use those credits to “buy”
products or services from another company when needed.
Other People’s Money

Another key to bootstrapping success is getting customers to pay quickly and
suppliers to allow more time for payment. Entrepreneurs must be willing to
stay on top of receivables. Sometimes that means walking an invoice through
the channels of a major corporation in person (a favorite tactic of Talli Counsel
of Interfleet) or locating the person who can adjust the computer code that
determines when a government agency pays its bills.
Suppliers are an important asset of the business and should be taken care of.
If you establish a good relationship with your major suppliers, you may be able
to arrange favorable payment terms. After all, the supplier also has an interest in
seeing the new venture succeed. Use several suppliers to establish credit. Often
a young company can’t get sufficient credit from one supplier, so it helps to
seek smaller amounts of credit from several reputable suppliers. In this way
when you can qualify for a larger credit line, you will know which supplier is
the best source.
If possible, sell wholesale rather than retail. By dealing with wholesale
distributors, you make your life easier because they are the experts at working
with the customers. They have already set up the consumer and industrial
channels you may need to expand your market.
PROFILE 14.1
The Importance of Ethics

Scott Cook, founder of Intuit, the software developer known for its product Quicken,
reported in Inc. magazine that “being truthful is good business.”2 A common practice
in the software industry is to use promotional schemes to “load” the dealers with
excess product in the belief that the dealer will then push that product to get rid of it
before taking on a competitor’s product. The practice also involves overstating
demand.
Intuit refused to participate in this scheme and preferred to communicate their
expectations for sales honestly to the dealers. In this way the dealers were not
burdened with excess inventory, and Intuit kept its manufacturing facilities operating
at an even keel rather than in costly boom and bust cycles.
2Inc. magazine, September 1992, p. 87.

Bootstrapping Ethics. Whenever bootstrapping tactics are employed to allow a

new venture to survive long enough to use other sources of financing, the issue
of ethics arises. This is because when an entrepreneur bootstraps, by definition
he or she is making the new venture appear much more successful than it is to
gain some credibility in the market. But the entrepreneur must be careful,
because credibility, if it is-ill-gotten, comes at a tremendous price to the busi¬
ness. Lying to survive will return to haunt the business at some future time.
Intuit, a very successful software manufacturer, spent several start-up years
bootstrapping, during which they quickly learned that trust is an essential
element to long-term success.
Financing with Equity

One way to raise capital for the new venture is by having people invest their
money for an ownership share in the business. This ownership share is termed
equity. It is distinguished from debt in that the equity investor puts his or her
capital at risk; there is usually no guaranteed return, and no protection against
loss. For this reason, most entrepreneurs with start-up ventures seek invest¬
ment capital from people they know who believe in them. There are a variety of
sources of equity financing.
Personal Resources
As stated earlier, the number one source of start-up money is the entrepreneurs
personal resources: savings, credit cards, parents, and friends and family. The
reasons are many:
1. New ventures by definition have no track record, so all the estimates of sales
and profits are pure speculation.
2. An enormous number of new ventures fail, so the risk for an outside investor
is usually too high.
3. Many new ventures have no proprietary rights that would give them a
competitive advantage.
4. The founders often do not have a significant track record of success.
5. Too many new ventures are “me too” versions of something that already
exists, so they have no competitive advantages.
In addition to the personal resources already mentioned, entrepreneurs can

also tap the equity in their brokerage accounts. Margin is, in effect, another
Some Money Terms
Angel: Business jargon for a private investor who holds an equity interest in the venture.
Asset-Based Loan: A loan collateralized by accounts receivable, inventory, or other assets. If the
entrepreneur defaults on the loan, the lender can seize the assets.
Equity: An ownership interest in a company based on an investment of capital.
Factor: A lender who purchases a company’s accounts receivable and then advances cash at a
certain percentage of the value of the receivables.
Securities: The interest of a creditor or investor in the property or business of a debtor or owner,
pledged to secure repayment of the debt or investment.
Seed Money: Money needed to complete research and development prior to starting the
business.
Senior Debt: Usually a bank loan that has seniority over all other financial interest should the
business fail.
Subordinated Debt: Non-bank debt that is repaid after senior debt in the event of business
failure. Can often contain rights to convert to equity.
Venture Capital: Professional groups of individual investors whose purpose is to invest money in
new and growing businesses. They typically supply second-stage or buyout financing.
source of credit, and when interest rates fall below those of the typical credit
card, this source of funds becomes very attractive. With a margin loan, the
security in your brokerage account is pledged as collateral for the money
borrowed, just like pledging the equity in your home against a second mort¬
gage. You can still trade the collateralized security (buy or sell), but cannot take
possession of it until the loan is repaid.
Private Investors—Angels
The next source usually investigated for funding is private investors, typically
people the entrepreneur knows or has met through business acquaintances.
These investors who are part of the informal risk capital market—the largest
pool of risk capital in the United States, over $50 billion—are called angels.
They can’t be found in a phone book, and they don’t advertise. In fact, their
intentions as investors are often well-hidden until they decide to make them¬
selves known. They do, however, have several definable characteristics:
• They normally invest between $10,000 and $500,000 and usually focus on
first-stage financing, that is, start-up funding or funding of firms younger
than five years.
• They are well-educated, often entrepreneurs themselves, and tend to invest

within a relatively short distance from home, as they like to be involved in
their investment.
• They tend to prefer manufacturing, energy and resources, and service busi¬
nesses. Retail ventures are less desirable because of their inordinately high
rate of failure.
• They typically look to reap the rewards of their investment within three to
seven years. The risk/reward ratio is a function of the age of the firm at the
time of investment. They may want to earn as much as ten times their orig¬
inal investment, if the venture is a start-up, to five times their investment, if
the venture has been up and running for a couple years.
• They find their deals principally through referrals from business associates.
• They tend to make an investment decision more quickly than other capital
sources, and their requirements as to documentation, business plan, and due
diligence may be lower.
In general, angels are an excellent source of seed or start-up capital. The

secret to finding these elusive investors is networking—getting involved in the
business community—so you come into contact with sources of private capital
or people who know these sources—lawyers, bankers, accountants, and other
Stages of Financing for the New Venture
First Stage
(Seed Capital and Start-Up)
Personal Resources Angels
Small Business Investment Public Equity
Companies (SBICs) Second Stage
(Expansion Financing)
Public Equity State-Sponsored Venture
Venture Capital Capital Companies
Strategic Alliances Small Business Investment
Third Stage Companies (SBICs)
(Acquisition/Buyout)
Public Equity
Venture Capital Companies
business people. Developing these contacts takes time; you can’t wait until you
need the capital to look for it. Of course, taking on an investor means giving up
some of the ownership of the company. It is, therefore, probably wise to plan at
the outset for a way for the investor to exit. Including a buyout provision in the
investment contract with a no-fault separation agreement will ensure that the
entrepreneur doesn’t have to wait for a criminal act like fraud to end the rela¬
tionship. Structuring the buyout to be paid out of earnings over time will avoid
jeopardizing the financial health of the business. Above all, avoid using
personal assets as collateral to protect an angel’s investment.
Private Placement
Private placement is a formal vehicle for seeking funding from private
investors who are “sophisticated” in terms of the rules of private placement,
which are stated in Regulation D. Regulation D was designed to simplify the
private offering process and allow the entrepreneur to seek funding from
private investors as long as they met the requirements. Doing a private place¬
ment memorandum involves the completion of a business plan and a
prospectus detailing the risks of the investment. The rules for private place¬
ment must be carefully followed; they are discussed in detail in Chapter 17 on
financing growth.
As with any complex legal document, it is crucial to consult an attorney well
versed in the preparation of the private placement memorandum and disclosure
of information about the company and its principals. Problems don’t usually
arise if the business is successful; however, if the venture fails and the investors
uncover a security violation, you and other principal equity holders may lose
your protection under the corporate shield and become personally liable in the
event of a lawsuit. Security violations have been dealt with severely by the
courts, and there is no statute of limitations on the filing of such a suit.
Venture Capital
In general, venture capital companies are professional pools of managed funds
that often operate in the form of a limited partnership. Equity venture capital
funds are the most common type. While some venture capitalists invest in start¬
up companies, it is probably prudent not to attempt to seek venture capital
funding at this stage for several reasons. Venture capitalists recognize that start¬
up is the riskiest time for a business, and as there are many growing young
companies with a track record of performance (however short) available, their
funds are probably better placed with these companies. Venture capitalists
require substantial returns on their investments, generally in the 60 to 70
percent annual return range, and a significant ownership interest, which may
force the entrepreneur to give up controlling interest in the new venture before
the company gets off the ground.
In general funds are not as prolific as they were in the 1980s, and almost 60
percent of available venture capital funds are held by megafunds, usually insti¬
tutional investors who prefer to invest in increments of $2 million and up.
Consequently, most start-up ventures do not waste the time and money seeking
venture capital funding. Instead, they see it as a source of second stage or
growth funding. For this reason, venture capital funding is discussed in detail
in Chapter 17.
Strategic Alliances
A partnership—whether formal or informal—with another business is a
strategic alliance. Through strategic alliances, entrepreneurs can structure deals
with suppliers or customers that will help reduce expenditures for marketing,
raw materials, or R&D. By reducing expenditures, cash flow is increased,
providing capital that wouldn’t have otherwise been available.
Another type of strategic alliance is the R&D limited partnership. This vehicle
is useful for entrepreneurs starting hi-tech ventures that carry significant risk due
to the expense of research and development. The limited partnership contracts
with the new venture to provide the funding for the R&D to develop a market
technology that will ultimately be profitable for the partnership. This is advanta¬
geous for both the limited partner and the new venture. Limited partners are
able to deduct their investment in the R&D contract and enjoy the tax advan¬
tages of losses in the early years on their personal tax returns; they also share in
any future profits. In the R&D limited partnership, the new venture acts as a
general partner to develop the technology and then structures a license agree¬
ment with the R&D partner whereby the venture can use the technology to
develop other products. Often the limited partnerships interest becomes stock in
a new corporation formed to commercialize the new technology.
An alternative to this arrangement is an agreement to pay royalties to the
partnership. Yet another vehicle is the formation of a joint venture, which
allows the entrepreneur to purchase the joint venture interest after a specific
period of time or when the company reaches a certain volume in sales. As with
the private placement, strategic alliances should involve an attorney. The new
venture may incur significant costs in creating the partnership, a process that
could drag on for up to a year. In addition, giving up the ownership of the tech¬
nology may be too high a price if the partnership does not survive.
Small Business Investment Company (SBIC)

Small Business Investment Companies are actually venture capital firms
licensed by the Small Business Administration. They get financing through the
government to invest in small and growing businesses. Since their repayment
terms with the government are generous, they are able to invest over longer
periods of time. They can be found by contacting the SBA.
Venture Capital Institutes and Networks

Many areas of the country offer access to venture capital networks through
institutes established on the campuses of major universities. The university acts
as a conduit through which the entrepreneurs and investors are matched and
assumes no liability for or has no ownership interest in either the new venture
or the investor’s company. The entrepreneur typically pays a fee, in the $200 to
$500 range, and submits a business plan to the institute. The plan is then
matched to the needs of private investors in the database who subscribe to the
service. If an investor is interested in the business concept, he or she contacts
the entrepreneur. In general, venture capital networks are a way for entrepre¬
neurs to gain access to investors they may not be able to find through other
channels. Furthermore, the investors in the database are there voluntarily, so
they are actually looking for potential investments.
Financing with Debt

When an entrepreneur chooses a debt instrument to finance a portion of the
start-up expenses, he or she provides a business or personal asset as collateral
in exchange for a loan bearing a market rate of interest. The asset could be
equipment, inventory, real estate, or the entrepreneurs house or car. There are
several sources of debt financing.
Commercial Banks
In depressed economic climates, banks are not a readily available source of
either working capital or seed capital to fund a start-up venture. Today banks
are highly regulated; their loan portfolios are scrutinized carefully, and they are
told in no uncertain terms not to make loans that have any significant degree of
risk. Consequently, if established firms with good credit risks are being denied
loans and credit lines, it stands to reason that a new venture with no track
record would not be likely to get an unsecured loan from a commercial bank.
Generally, banks make loans based on what is termed “the five Cs”: character,
capacity, capital, collateral, and condition. In the case of the entrepreneur, the
first two—character and capacity—become the leading consideration because
the new business’s performance is based purely on forecasts. Therefore, the bank
will probably consider the entrepreneurs personal history carefully. It is impor¬
tant, however difficult, for the new venture to establish a lending relationship
with a bank. This may mean starting with a very small amount of money and
demonstrating the ability to repay in a timely fashion. Bankers also look more
favorably on ventures with hard assets that are readily convertible to cash.
Commercial Finance Companies

As banks have tightened their lending requirements, commercial finance
companies have stepped in to fill the gap. They are able to do this because they
are not as heavily regulated and they base their decisions on the quality of the
assets of the business. Thus, they are often termed asset-based lenders. They
do, however, charge more than banks by as much as five percent over prime.
Therefore, the entrepreneur must weigh the cost-benefit of taking on such an
expensive loan. Of course, if it means the difference between starting the busi¬
ness or not, or surviving in the short term, the cost may not seem so great.
Small Business Administration

When a commercial bank loan does not appear to be a viable option, the entre¬
preneur may want to consider an SBA guaranteed loan. Between 1980 and
1991, the SBA guaranteed $31 billion in loans, principally for start-up and
expansion. In 1993 alone, the SBA backed $6.4 billion in loans, which was a 40
percent increase since 1991. The SBA guarantees to repay up to 90 percent of
the loan to the commercial lender should the business default. A further incen¬
tive to banks is that SBA-funded ventures tend to be growth-oriented and have
a higher survival rate than other start-ups. In a study conducted by Price-
Waterhouse, SBA-funded businesses versus non-SBA businesses were compared
during the period between 1984 and 1989.3 The results were astounding.
3“SBA Loans Spur Start-Up Growth,” Inc. magazine, November 1992, p. 66.
SBA Funded Non-SBA Funded

Employee Growth 167% 0%
Revenue Growth 300% 37%
Survival after 4 years 75% <65%
Of course, since these loans are backed by the government, the documenta¬
tion and paperwork are extensive, and interest rates are usually no different
than with a conventional loan.
The Small Business Administration also has a new program, the micro loan,
that makes it easier for entrepreneurs with limited access to capital to borrow
small amounts (up to $25,000). Instead of using banks as in their guarantee
program, they use nonprofit community development corporations. The
Answer Desk at the SBA, 800-827-5722, can provide information on micro
lenders in a particular area of the country.
State-Funded Venture Capital

Many states now provide a range of services to help new and growing ventures.
From venture capital funds to tax incentives, states like Massachusetts, New
York, and Oregon are seeing the value of establishing business development
programs. They usually receive their funding from the state government, which
enables them to seek larger investment amounts from private sources. In states
where equity funding is not available, there is typically a loan program aimed at
new ventures. For example, in Massachusetts, favorable debt financing is often
exchanged for warrants to purchase stock in the new company. Pennsylvania
was the first to create a funding program aimed at minority-owned businesses.
Grants
The Small Business Innovation Development Act of 1982 requires that all
federal agencies with research and development budgets in excess of $100
million give a portion of their budgets to technology-based small businesses in
the form of grants. Small businesses find out about these grants by checking the
published solicitations by the agencies (see Figure 14.1) to see if they can
provide what the agency needs.
The grants have three levels:
1. Phase I is the concept stage, providing up to $50,000 for initial feasibility.

2. Phase II provides up to an additional $500,000 for projects that have the
most potential after completing Phase I.
3. Phase III brings in private sector funds to commercialize the new technology.
Figure 14.1: Small Business IR Agencies
• Department of Defense Nuclear Regulatory Commission
• Department of Energy Environmental Protection Agency
• Department of Transportation Health and Human Services
• Department of Interior National Science Foundation
• Department of Education U.S. Department of Agriculture
• National Aeronautics & Space Administration (NASA)
To qualify for an SBIR grant, the company must employ fewer than 500
people, be independently owned, and be technology-based.
The entrepreneur with a new venture has many options. Crafting a capital
structure for the new venture that works, however, depends in large part on the
creativity and persistence of the entrepreneur in securing the capital needed at
the right price to successfully launch the venture.

Have you
□ Considered how many personal resources you have to help fund the new
venture?
□ Determined ways to bootstrap the start-up of the new venture?
□ Networked to come in contact with potential “angels”?
□ Identified an attorney who can help structure a private placement agreement if

needed?
□ Investigated the sources of debt financing in the community?


The Best of Inc. Guide to Finding Capital. (1988). The Editors of Inc. Magazine,
New York: Prentice Hall Press.
Blechman, B. & J.C. Levinson (1991). Guerrilla Financing. Boston: Houghton
Mifflin.
Canadian Reciprocal Trade Association, Box 82008, Burnaby, BC V5C 5P2,
604-521-7911, FAX 604-521-7944.
Garner, D. (1991). The Ernst & Young Guide to Raising Capital. New York:
John Wiley & Sons.
Hicks, T.G. (1990). Business Capital Sources. Rockville Centre, NY:
International Wealth Success, Inc.
International Reciprocal Trade Association, 9513 Beach Mill Road, Great
Falls, VA 22066.
Latus, J. (1992). Cashing in on Free State Government Money. San Diego, CA:
Lion Publishing Col.
National Association of Trade Exchanges, 9790 Southwest Pembrook St.,
Portland, OR 97224.
O’Hara, RD. (1989). SBA Loans: A Step-by-Step Guide. New York: John Wiley
& Sons.
Wilmeth, J.R. (Ed.) Directory of Operating Small Business Investment
Companies. Washington, DC: Small Business Administration, Semiannual:
June and December.
1. What are some ways a new venture can bootstrap to conserve capital?
Issues to
2. What are some of the pitfalls of bootstrap financing?
Consider
3. What is the role of angels as a source of new venture funding?
ijl 4. At what stage of venture development do venture'capitalists typically become

involved and why?
5. What is the purpose of a private offering?
6. Why are commercial banks not usually a reliable source of new venture
financing?
7. What are three additional sources of debt financing?
CHAPTER 15
Preparing the
Financial Plan
Overview
• Projecting sales and capital expenditures
• Calculating how much start-up capital is needed
• Preparing the pro forma financial statements
• Preparing the financial plan
What Every Entrepreneur Should Know

No matter how many financial tools entrepreneurs use or how many complex
analyses are constructed, the bottom line for any new venture is cash. Income
statements and balance sheets can make a company look good—these are
accounting measures—but cash pays the bills and allows the company to grow.
Cash is the lifeblood of the business. The financial statements considered in this
chapter describe various aspects of the new venture and need to be included in
the business plan. However, significantly more attention is paid to the cash flow
statement because this is a working statement that tells the entrepreneur how
much start-up capital is needed and becomes a budget that guides the start-up
and growth of the business.
While this book has promoted creativity in all aspects of developing the
business concept, this creativity should not be reflected in the financial state¬
ments. Financial statements must follow “generally accepted accounting prin¬
ciples (GAAP)” so the reader of the business plan recognizes standard terms
and sees items in their normal order of presentation. This familiarity instills
297
confidence that the numbers are genuine. Furthermore, every assumption

made in constructing the statements must be justified with supporting
evidence, because with a new venture you are forecasting not based on histor¬
ical performance but on your belief as to how the new venture will perform.
Industry expertise, test marketing, and/or experience with a similar business
goes a long way toward imbuing the reader with a sense of trust. In addition,
having your accountant prepare and/or review the financials also adds
credibility.
Projecting Sales and Capital Expenditures

Certainly, one of the more critical issues for the entrepreneur is forecasting sales
and capital expenditures for the new business, but it is not an easy feat to
accomplish. The problem stems from the volatile nature of new ventures in
general—any effort to derive an accurate estimate is fraught with difficulty.
An example will make this dilemma clear. Gentech Corporation was a new
company manufacturing a technology-based industrial machine. It had to
purchase motors and other parts from its suppliers. In the start-up phase, the
company did not have enough sales to buy parts in sufficient volume to warrant
the maximum discount from the supplier, so initially material costs were high.
To compensate, the founders subcontracted some of the work, performed the
assembly themselves, and sold products with little or no gross margin. The
question then became: When would the business generate enough sales to buy
in adequate volume, thereby reducing costs and increasing profit? However,
once the volume was attained, the business would likely need to purchase addi¬
tional equipment, perhaps expand facilities, and add employees. At what point
should they do this, and how much should they spend?
This is the dilemma of the new venture. To answer these difficult questions,
the entrepreneur must gain a great deal of knowledge about the industry and
how similar businesses operate within it, and then extrapolate from that until
the business has been in operation for a while and has developed some patterns
of its own that better define it.
The information needed to complete the pro forma financial statements
includes demand, cost, and operating figures. The goal is to forecast the finan¬
cial condition of the new venture for the next three to five years based on the
information collected. These pro forma statements reflect the entrepreneurs
best estimate of how the company will perform and what the associated
expenses will be. The entrepreneur will also probably assume the ability to
Chapter 15 • Preparing the Financial Plan 299
acquire credit and take on debt at some time. It is important, then, to under¬
stand that as these pro forma statements are estimates, they are subject to
change based on the more accurate information gained when the business actu¬
ally begins operating. This is why entrepreneurs typically re-evaluate the finan¬
cial statements on a monthly basis for the first year.
The sales forecast should be calculated first because sales affects the other
expenditures of the business. The method for forecasting sales varies depending
on the general product or service category. For example, with a new product
that is a line extension or the next generation of an established product, the
entrepreneur can rely on historical data that will help ensure a more accurate
estimate. With a brand new or breakthrough product, however, the entrepre¬
neur is left to rely on market data, comparison of similar products, and the
opinions of market experts. Therefore, to improve the estimate, it is useful to
calculate best case, worst case, and most likely case scenarios that will cover
about 90 percent of all the possible sales results.
Forecasting Sales with Consumer Products and Services

If the product or service being offered does not currently exist in the market,
you must find a competing product or service that is similar or is a substitute
product to study. The information needed includes the volume of “sell-in” to
the retailer and the volume of “sell-through” to the customer—that is, the
amount of product that is sold by the manufacturer or distributor to the retailer
and the amount of that product that is ultimately sold to the customer.
Naturally, since a service business generally operates with direct channels of
distribution, it concerns itself only with the sell-through volume. In addition,
you want to determine if there is any seasonality in the market that would affect
the volume of sales during any particular period of time.
The mistake made by many companies who sell to retailers is focusing on
how much product they are selling to the retailer and structuring their produc¬
tion and/or inventory accordingly. They do not carefully monitor retail sales to
the customer. Consequently, when consumer buying slows and the retailer
cannot move sufficient product, the manufacturer or producer is left with
excess inventory. The entrepreneur with a new product or service, therefore,
should monitor retail sales of competing products to consumers in the same
category to arrive at an estimate of sales demand. Best case and worst case
scenarios should also be calculated.
One word of caution: when choosing competing companies for comparison
purposes, be aware that if the company is a publicly held company or a well-
established company, you as a new venture will probably not achieve the same
level of sales for some time. Therefore, the sales figures you gather serve merely
as an upper limit benchmark as you determine how much below that figure
your sales level will be. The percentage increase in your sales over a three- to
five-year period will depend on:
• Growth rates in the market segment of the product or service

• The innovations offered that will make your product/service more attractive
to the consumer, even at a higher price
• The technological innovations employed that permit you to produce the
product or service at a lower cost than your competitors, thus making it
more accessible and enticing to the consumer.
Forecasting Sales with Industrial Products

With industrial products, which are generally sold business to business, it is
important to understand the needs of the customer and the buying cycles of the
industry. Again, talking to experts (i.e. distributors) in the field, getting sales
figures from noncompeting product manufacturers in the same industry, and
generally determining the size of the market niches you intend to enter all help
in arriving at an estimate of sales demand. Like the consumer market, in the
industrial market it is vital to bracket the estimate with best case/worst case
benchmark figures so you are prepared for the most likely contingencies. The
rate at which sales increase is a function of the same three factors listed under
consumer products.
Forecasting Expenditures
In wholesale businesses, once the sales forecast has been determined, you can
apply the figures for inventory purchases as a percentage of sales and forecast
from that. So if inventory cost is 25 percent of sales, you can apply that
percentage to sales as they increase to forecast changes in the volume of inven¬
tory. In manufacturing businesses, it is a bit more complex because you must
first derive the Cost of Goods Sold (COGS), which usually consists of direct
labor, cost of materials, and factory overhead. Looking at the sales forecast in
terms of units produced to arrive at a dollar figure for COGS and then applying
costs of goods sold as a percentage of sales will probably suffice for purposes of
pro forma statements when the business is starting. Month-by-month analysis
of outcomes and use of a cost accounting model that considers raw materials
inventory, work-in-process inventory, finished-goods inventory, total inventory,
factory overhead, work-in-process flow in units, and weighted-average cost per

unit will give a more accurate estimate as the business grows.
In service businesses, the COGS is equivalent to the time expended for the
service. The rate at which you bill the service, say $100 an hour, is comprised
of the actual expenses incurred in providing the service, a contribution to over¬
head, and a reasonable profit. The actual expenses incurred is the cost of goods
sold equivalent.
General and administrative expenses—the expenses of running the busi¬
ness—are considered fixed but must be forecast separately in a detailed
breakout statement. This is because some of these items may vary over a
12-month period, while others remain stable. Therefore, do not use a
percentage of sales figure for G&A expenses. Only the totals of G&A expenses
for each month will be used in the financial statements, with a footnote
directing the reader to the G&A breakout statement. Selling expenses, which
include advertising, travel, sales salaries, commissions, and promotional
supplies, should be handled in the same manner, with a breakout statement,
and totals only in the financial statements. Sample lists of manufacturing or
construction expenses, distribution and warehouse expenses, and selling
expenses are shown in Figure 15.1 on p. 302.
The last item to forecast is taxes. While many businesses may be able to take
advantage of a tax-loss carry-forward for losses during R&D, ultimately the
business will have to account for state, federal, and possibly local taxes that are
paid at varying times of the year.
Preparing the Pro Forma Income Statement

The income statement, also known as a profit and loss statement, gives infor¬
mation regarding the profit or loss status of the business for a specified period
of time. It is normally calculated first so income tax liability can be determined.
The taxes owed based on the profit made by the company appear on the cash
flow statement when they are paid. As income taxes vary from state to state, the
financial statements presented here are not indicative of tax rates in every state.
Figure 15.2 on p. 303 displays an example of an income statement for a corpo¬
ration. Note that should the business be structured as a sole proprietorship or
partnership, the reference to taxes will be deleted as taxes are at the personal
tax rates of the owners.
The income statement should also contain footnotes for each item to refer
the reader to supporting material in the “Notes to Financial Statements.” Any
unusual major expenses like the cost of participating in a trade show, should be
footnoted separately and explained.
It is not uncommon for a new business to not show a profit in the first year
and it really is a function of the type of business and the cost of start-up. In
particular, high technology and manufacturing start-ups are capital intensive
and generally take longer to realize a profit than service businesses. In the
hypothetical example of NEW VENTURE INC., (see Figure 15.2) the company
ended the year with a net profit before taxes of $15,250 on which it must pay
taxes. For purposes of illustration, a 40 percent tax rate was used to include
federal and state income taxes.
Figure 15.1: Sample Lists
Sample Manufacturing or Construction Expenses List

Manager’s Salary Paid Employees Salaries
Payroll Taxes Vehicle Lease and Maintenance
Related Travel Packaging Costs
Supplies Depreciation on Owned Equipment
Sample Distribution and Warehouse Expenses List

Manager’s Salary Employees’ Salaries
Drivers’ Salaries Payroll Taxes
Vehicle Lease and Maintenance Warehouse Loading Vehicles
Lease/Maintenance Depreciation on Owned Equipment
Freight Expenses Supplies
Sample List of Selling Expenses

Sales Manager’s Salary Inside Sales Salaries
Inside Sales Commissions Telephone Sales Salaries
Telephone Sales Commissions Field Sales Salaries
Field Sales Commissions Payroll Taxes for Sales Employees
Sales Vehicles Lease and Maintenance Sales-Related Travel
Advertising and Promotion Depreciation on Owned Equipment
Sample List of General & Administrative Expenses

Advertising Rent
Salaries & Wages Utilities
Office Supplies Insurance
Office Equipment Business Taxes
Payroll Taxes
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How Much Start-Up Money is Needed?

Probably the key question to be answered when developing the financial plan
for the new business is how much money will be needed to start the business
and keep it operating until a positive cash flow is achieved. The first thing to
understand is that the best estimates of the start-up total are just that—esti¬
mates. There is no way to guarantee that you have figured correctly. You can,
however, achieve figures that prevent the business from dying before it has a
chance to succeed through the careful collection of information on both poten¬
tial revenues and expenses.
This section starts with a summary of pre-start-up costs, then moves to the
pro forma cash flow statement. At that point there will be enough information
to calculate the total start-up funds needed to keep the business running for a
year. From there the pro forma balance sheet and the sources and application of
funds statement for the new venture will be constructed.
Summary of Start-Up Costs

The bulk of expenses in the first year of a new business probably occur prior to
the business opening its doors for the first time. Purchasing furniture, equip¬
ment, start-up inventory, and supplies can quickly add up to a substantial
amount. Add to that deposits for leases and utilities, and you may have used up
the first years profits, assuming there would have been profits. See Figure 15.3
for typical expenses to start up the business.
Figure 15.3: Summary of Typical Pre-Start-Up and Start-Up Cost Categories
NEW VENTURE INC.
Office lease—deposit $ 2,000

Furniture and fixtures 25,000
Equipment (computer, plant equipment, etc.) 50,000
Business cards and brochures 2,500
Office supplies 1,000
Fees and licenses 500
Legal & accounting 2,000
Initial inventory 15,000
Employee training & wages 8,000
Pre-start-up marketing/promotion 10,000
Signage 1,000
Utility deposits and installation 3.000
$120,000
A manufacturing start-up might also include product development costs, a

plant lease deposit, and raw materials costs. Manufacturing start-ups with new
products typically accrue heavy, pre-start-up development costs that include
engineering, prototyping, and patent work. These are one-time expenses to get
the business started. For accounting purposes, some of these initial costs like
equipment must be depreciated over a period of time on the income statement;
others, such as organizational and formation expenses, must be amortized as
start-up costs. For determining start-up funding requirements, however, these
costs are treated as a lump sum. Your accountant can advise as to the correct
disposition of all start-up costs.
Forecasting Cash Flow

The cash flow statement is the most important financial statement to the entre¬
preneur because it depicts the cash position of the company at specified points
of time and lets the entrepreneur know when the company is expected to
generate a positive cash flow based on sales—in other words, the company’s
liquidity position. It is important to others (bankers and investors) because it
reflects the company’s ability to generate future positive cash flow, meet its
obligations, and pay dividends (assuming a corporate structure).
To begin to forecast cash flow in an effort to determine how much start-up
capital is needed, you must have a good estimate of potential sales. This is no
easy task. Certainly, the market research you conducted has given you a sense of
the demand for your product or service. That research probably included discus¬
sions with suppliers, competitors, and customers as well as studying industry
trends. As discussed previously, projecting sales is an educated guessing game at
best; therefore, entrepreneurs will normally forecast sales based on three
scenarios: best case, worst case, and a conservative, most likely case. For each
case the justification should be stated so the reader (investor, banker, and others)
can make his or her own judgments. Typically the entrepreneur forecasts five
years into the future (investors usually want a return of capital in five years),
monthly for years one and two, quarterly or yearly for years three to five.
Figure 15.4 on p. 307 gives an example of a cash flow statement for a busi¬
ness that has inventory to sell and is structured as a corporation. As with all
financial statements, each item on the statement should be footnoted in the
“Notes to Financial Statements” to explain what the assumptions were and how
the figures were derived.
The first section of the statement, cash inflows or receipts, records all the
sources of cash that come into the business when they are received. This is an
important point to remember about a cash flow statement: it records cash

inflows and outflows when they occur. Therefore, if a sale is made in March, for
example, but payment is not received until April, the sale is counted in April on
the statement. This explains the differences in figures on the income statement
and the cash flow statement.
The next section records operating cash outflows or disbursements. These
include such things as COGS, general and administrative expenses, selling
expenses, and other expenses of running the business. Recall that only the
totals of G&rA and selling expenses should be reported with a separate, detailed
breakout statement prepared to present the individual expenditures.
The next section reports priority outflows. Priority outflows are those obliga¬
tions that must be paid first, generally interest expense and debt repayment.
When the business has sufficient positive cash flow, it may also incur some
discretionary expenses, which might include capital expenditures, R&D, and
dividends. If the business is a partnership or sole proprietorship, the lines refer¬
ring to dividends as well as the line for taxes are deleted, since sole proprietors
and partnerships do not distribute dividends and pay taxes based on their
personal income level. In the case of NEW VENTURE, no debt was projected
for the first year.
The final section gives the crucial information to the entrepreneur: the net
change in cash flow—in other words, whether the business had a positive or
negative cash flow in that month. Note that in each month the net cash flow
reflects only the cash inflows and outflows for that month assuming no start-up
capital. With the net change computed for each month of Year One, it is now
possible to calculate how much total cash is needed to start the business. The
ending balance line provides the total of positive and negative cash flows for the
year plus the start-up expenses for a total capital requirement of $273,340 as
follows:
One-Time Start-Up Costs $120,000

Add Negative CF/Subtract Positive CF 153,340
Total Cash Required $273,340 (round up to $275,000)
By doing this analysis you learned that the business will probably not
generate a positive cash flow from sales until the 12th month, so, at a minimum,
there is a need to raise sufficient capital to not only cover the start-up costs but
the first 12 months of operation as well. Once the start-up capital is obtained, a
new cash flow statement can be generated to reflect the effect of the infusion of
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capital as can be seen in Figure 15.5. With an infusion of $275,000 in invest¬

ment capital, the company maintains a positive cash flow and finishes the first
year with an ending cash balance of $1,650, which will be recorded on the end-
of-year pro forma balance sheet as cash available. This is not sufficient cash with
which to begin the second year; the $275,000 must therefore be considered the
absolute minimum amount of capital to start given the current situation.
Use a spreadsheet program to set up the cash flow statement as well as the
other financial statements. When you make a change in one item, the computer
recalculates all the relevant figures to give you a new net cash flow figure.
Because it is relatively easy to produce very detailed analyses, however, there is
a tendency to overwhelm the potential reader with page after page of financial
statements. This will hurt more than help. Instead, be concise and to the point,
and be sure to understand and document how figures were calculated so you
can explain them if asked.
Spreadsheets make it easier to forecast best and worst case scenarios for your
financial statements. Doing these optimistic and pessimistic analyses is
extremely valuable because they provide a range of capital needs based on three
different economic scenarios. To attempt to reconcile the three cash amounts, it
is often suggested that you calculate a contingency factor.1 Take the annual cash
flow figures for the most optimistic and most pessimistic scenarios and calcu¬
late the difference between them and the conservative cash flow figure (most
likely). You will now have a range of values. The greatest negative difference
becomes the contingency factor. The calculations using hypothetical best and
worst case figures would be as follows:
Best case or most optimistic cash flow $ 50,000

Worst case or most pessimistic cash flow ($300,000)
Most likely or conservative cash flow ($153,000)
Pessimistic Optimistic
$(300,000) $ 50,000
-(153,000) -(153,000)
$(147,000) $ 203,000
In this example, the most optimistic case produces a positive cash flow of
$50,000, which means that $203,000 less capital would be needed to fund the
'Stancill, J.M. (1991). “How Much Money Does Your New Venture Need?” In Sahlman, WA. &r Stevenson,
H.H. (1992).The Entrepreneurial Venture. Boston: Harvard Business School Publications.
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start-up. In the most pessimistic case, however, $147,000 more capital is

required for start-up. This is the amount that should become the contingency
factor, bringing the total investment to $420,000 ($153,000 plus the contin¬
gency factor of $147,000—the greatest difference—plus the start-up capital
requirement of $120,000). Rather than investing the $275,000 as calculated
using simply the conservative cash flow statement, it is probably more prudent
to seek an investment of at least $420,000 so the probability of covering all
possible contingent situations is higher. Besides, the company ends the first
year with a positive cash balance of only $1,650, which is a very weak position,
leaving little room for error heading into the second year.
Using the Cash Flow Statement to determine the amount of capital needed
to start and run the business is certainly not its only use. Particularly during the
first year of operation, compare the monthly cash flow statement against actual
inflows and outflows of cash to the business to determine where estimates devi¬
ated. Making adjustments to the remaining projections avoids any surprises
later on. Essentially the cash flow statement becomes a budget for the business.
As the business grows, it is also a good idea to put someone in charge of moni¬
toring cash flow throughout all functions of the organization. That person
should be familiar with all the operations of the business; consequently, the
accountant is often not the best choice for someone to manage cash flow at the
operational level.
Preparing the Pro Forma Balance Sheet

The balance sheet shows the condition of the business in terms of its assets and
liabilities and the net worth of its owners at a specific point in time. Unlike the
cash flow and income statements, the balance sheet is usually prepared to
reflect the condition of the business at the end of each of the first five years of a
new business. Figure 15.6 on p. 311 displays a sample balance sheet for a new
business.
Forecasting Assets
The first section of the balance sheet is the assets, everything of value the busi¬
ness owns. Assets are valued in terms of actual cost for the item. Current assets
are those consumed in the operation of the business during the year, while
fixed assets are tangible assets used over the long term. Accounts receivable
must be forecasted based on the seasonality experienced by the business. If the
business experiences no pronounced seasonality, you may be able to assume a
certain percentage of sales that will not be paid in cash each month based on
industry averages or an accounts receivable turnover rate. Once the business is
established, however, it develops its own pattern of receivables and a more
accurate turnover rate can be calculated. To account for the fact that some
accounts receivable will not be collected, some entrepreneurs choose to
subtract from receivables an allowance for bad debt, a small percentage (two to
five percent) based on typical bad debt figures for the industry. Again, your
business will develop its own unique pattern over time and it will be easier to
predict more accurately what the bad debt rate will be. See Figure 15.6 for an
example of an end of first year pro forma balance sheet.
Figure 15.6: Pro Forma Balance Sheet: End of First Year
NEW VENTURE INC.

ASSETS
Current Assets
Cash $ 1,650
Accounts receivable 201,560
Inventory 23,000
Supplies 1.000
Total Current Assets 227,220

Fixed Assets
Equipment 75,000
Less depreciation 15.000
Total Fixed Assets 60,000
Total Assets 287,210
LIABILITIES AND OWNER’S EQUITY

Current Liabilities
Accounts payable $ 2,000
Current portion of long-term debt 0
Total Current Liabilities 2,000
Long-term Liabilities
Notes payable 0
Total Long-Term Liabilities $ 0
Owners’ Equity
G. Brown, capital $137,500
P. Smith, capital 137,500
Retained Earnings 10.210
Total Owner’s Equity $285,210
TOTAL LIABILITIES AND OWNERS’ EQUITY $287,210

Inventory turnover must also be forecasted. Again, if the business experi¬

ences seasonality, it is not feasible to employ a constant turnover rate based on
cost of goods sold. Inventory is a more complex issue for a manufacturing firm
than accounts receivable, because at any time a business may have raw mate¬
rials, work in process, and finished goods. In the beginning stages of the busi¬
ness, you will probably estimate the amount for each of these stages and then
use the total of the three for each month as the estimate for the year-end
balance sheet. As the business grows, however, using a cost accounting model
in which the three totals are shown separately on the balance sheet is a
preferred method.
Liabilities
Liabilities are everything the business owes to its creditors. Those that are due
within one period are called current liabilities. New ventures generally have to
pay for materials and inventory with cash until they have established a line of
credit with suppliers, so you need to show a separate schedule that depicts
when you expect to begin to use credit. Indicate only the total of materials and
inventory for the year on the balance sheet, however. If the business paid cash
for the entire year, which is not uncommon for a start-up, there will be no
accounts payable. The current portion of long-term debt is that portion owed in
the coming year.
Owner’s or Stockholder’s Equity

Owner’s equity, also known as stockholders equity in the corporate form, repre¬
sents the excess after liabilities have been subtracted from assets and is the net
worth of the business. Note that the individual investment contributions of the
owners are also stated in this section. Retained earnings is the profit (loss) from
the business that was not distributed as dividends.
When the balance sheet is completed, the total of the assets must equal the
sum of the liabilities plus owners equity. In other words, the balance sheet
must balance! Understand that should you decide to use venture capital,
private investors, or bank financing, the party involved may want a say in your
debt-to-equity ratio; therefore, as capital is raised, the balance sheet is subject
to adjustment.
Preparing the Pro Forma Sources and Applications of Funds Statement

To understand how net operating income and other sources of funds to the
business were used to increase assets or pay off debt and what effect this had on
working capital, the Sources and Applications of Funds Statement is created.
Figure 15.7 displays such a statement.
New Venture Inc. earned an after-tax profit of $10,850 during the year,
which becomes a source of funds for the business. Depreciation, which is not a
cash expense, is added back into the equation. Typical uses of funds include
paying dividends, increasing assets like equipment, paying off long-term debt,
and decreasing owner’s equity. The net increase in working capital is.the differ¬
ence between total funds received (sources) and total funds applied. Notice that
the statement must balance, with the balance item being working capital.
Break-Even Analysis
The break-even analysis is a useful tool the entrepreneur can use to calculate
when the business will make a profit in terms of either units sold or total sales
dollars. In order for a business to break even and begin to make a profit, it must
be able to generate a volume of sales that will cover both fixed and variable
costs of running the business.
Figure 15.7: Pro Forma Sources and Applications of Funds: End of First Year
ABC Company—New Venture Inc.

Sources of Funds
Personal funds (capitalization) $275,000
Net income from operations after taxes 10,850
Add depreciation 15.000
Total of Funding Sources $300,850
Applications of Funds
Purchase of equipment/furnishings $ 75,000
Inventory 23.000
Total Funds Applied 98,000
Net Increase in Working Capital 202,850
$300,850
Mathematically speaking, the break-even point is reached when total revenue

(TR) equals total costs (TC). Total revenue is comprised of the quantity of units
(Q) produced times the price (SP) per unit. Total costs are comprised of fixed
costs (FC) plus variable costs (VC) per unit times the quantity of units (Q).
Variable costs are associated with the production of the product such as mate¬
rials, selling expenses, and direct labor. The break-even formula is as follows:
TR = TC SP(Q) = FC + VC(Q)
Selling price = $ 50/unit Variable Cost = $30/unit
Fixed Costs = $278,740
$278,740
BE (Q) =-—- 13,937 units
SP/unit—VC/unit (marginal contribution) $50-$30
Whenever the unit selling price exceeds the unit variable cost, there will be
some contribution to cover fixed costs. When the excess is enough to cover all
fixed costs, break-even has been achieved. Using the continuing example of
New Venture Inc., it can be seen that the business has fixed costs of $278,740,
variable costs per unit of $30, and a selling price of $50 per unit. Therefore, the
break-even quantity is 13,937 units. This means that before New Venture can
begin to make a profit, it must sell 13,937 units.
Reporting the Financial Plan in the Business Plan

Preparing financial statements and a financial plan for the new venture is a
tedious and time-consuming process, but it is absolutely essential for two
reasons. Up to this point you have determined that your business concept has a
market and is operationally feasible. First, the financial plan lets you know if
you can turn this concept into a viable business that will be self-sustaining over
the long term. Second, it proves to others (investors, bankers, key manage¬
ment) that you have a credible concept with potential for growth.
As the financial plan can be a fairly complicated and intimidating section of
the business plan, include a brief summary of the highlights of the forecasted
performance of the business—namely, sales, earnings, and cash flow. The reader
can then selectively read the financials while still maintaining a sense of the
whole picture.
The financial plan should include all the elements in Figure 15.8.
Figure 15.8: The Financial Plan
Summary of Financial Plan Highlights

Sales
Earnings
Cash Flow
Pro Forma Cash Flow Statements
Years 1-5, monthly years 1-2
Notes to cash flow statements
Pro Forma Income Statements
Years 1-5, monthly years 1-2
Notes to cash flow statements
Pro Forma Balance Sheets
Years 1 -5
Notes to balance sheets
Pro Forma Sources and Applications of Funds Statements
Years 1 -5
Notes to sources and applications statements
21 l\lew Venture Checklist

Have you
□ Collected all the operating cost data needed to construct the financial state¬
ments?
□ Studied competitor products to learn about seasonality, sales volume, and

market share?
□ Calculated the amount of start-up capital required to start and operate the
business until a positive cash flow is achieved?
□ Forecasted best and worst case scenarios for the pro forma financial statements,
as well as the most likely case scenario?
□ Calculated a break-even analysis for the first year?
□ Completed a summary of the highlights of the financial plan?

Financial record keeping for small stores, SBA Small Business Management
Series, Stock No. 045-000-00142-3.
Andrews, E.L. (January 1986). “Running Out of Money.” Venture, pp. 32-25.
Frankston, F.M. (January 1981). “A Simplified Approach to Financial
Planning.” Journal of Small Business Management, pp. 7-15.
Stickney, C.P. (1990). Financial Statement Analysis: Theory. A Strategic
Perspective. New York: Harcourt Brace Jovanovich, pp. 275-90.
1. Why is the cash flow statement the most important statement for the entre¬
Issues to
preneur?
Consider
2. What kinds of information must be collected to complete the financial state¬
ments?
3. How is forecasting sales for consumer products different from forecasting
sales for industrial products?
4. What three factors affect the percentage increase in sales over a three-to-five
year period?
5. What are the distinct purposes of the income statement, the sources and
applications of funds statement, and the balance sheet?
Air Charter Worldwide:

Start-Up of an Air Charter Broker
Case #93-32 Flight Time: Start-Up of an Air Charter Broker (A) This case was written by Alberto
Bonacini, Candida Brush and Clifton Smith. Used with permission.
“Unfortunately, our request for the $300,000 loan has been rejected,” stated
Patricia Zinkowski to her two partners, Dara Zapata and Jane McBride, co¬
founders of Flight Time Corporation, a six-month-old air charter broker
company based in Chestnut Hill, Massachusetts. It was June 1985 and the three
partners were seated in the restaurant of the Suffolk Downs race track in East
Boston to discuss Flight Times first period of operations and future financial
needs. The business had not taken off the way they expected. Clients, and
consequently cash inflows, had not been enough to support the company
beyond six months and the relevant net loss had eroded the initial investment
of the three entrepreneurs. They had estimated that $300,000 was needed to
continue Flight Time’s operations, but their request for these funds to Shawmut
Bank had been turned down and their personal finances were not sufficient to
keep the company in business.
They all agreed their new company had potential and the possibility of
dissolving the corporation was not even considered. However, as Patti
observed, what had started as a desire for independence and challenge, “was
now becoming a much more serious game.”
Founder's Background
Dara A. Hoy Zapata

Dara Zapata had gained extensive experience in the airline business after gradu¬
ating from Cardinal Cushing College, an affiliate of Notre Dame, with a degree
in Business Administration in 1971. She began her career as a tour coordinator
with one of the first wholesale tour operators in Massachusetts. The firm
specialized in arranging vacations to Europe, particularly to Spain, for large

groups of retirees. Dara’s job was to organize the air charter flight and the hotel
sojourn for these tour groups.
In 1976 she left this company and worked for a short period of time as a
sales person, first for a Boston-based yacht brokerage company and then for a
local travel agency, selling air tickets and all-included vacation packages. In
1977, while working for this agency, Dara co-founded A.H. Zapata, Inc. with
her Chilean husband. The company offered bilingual translation and inter¬
preting services in Spanish and English, English as a Second Language
programs for foreign employees, and Spanish classes for U.S.
personnel of Boston metropolitan service-oriented companies,
such as Beth Israel Hospital, Mass General Hospital, Brigham
and Women’s Hospital, Mass Defenders, Boston Housing. Dara
worked alternately part-time and full-time setting up pro¬
grams, marketing services, hiring and training language
teachers. In 1983 Dara’s husband decided to accept a full
time position at the Brigham and Women’s Hospital and conse¬
quently the company ceased its operations in the same year.
In 1979, while working part-time for A.H. Zapata, she joined Braniff
International, a Texas-based airline, where she was employed as a manager of
Boeing 747 flight operations, responsible for organizing time schedules of inter¬
national pilots and crew. Dara subsequently became a manager of in-flight
services in charge of catering contracts for provisions and other supplies, until
she was dismissed by Braniff in 1982 due to a corporate-wide layoff.
Prior to starting Flight Time, Dara became an independent aviation consul¬
tant providing assistance to start-up airlines in meeting government regulatory
requirements. She was particularly involved with the short-term leasing of
aircraft and worked closely with Lusoair, a U.S. carrier that operated between
Boston and Ponta Delgada in the Azores. She helped them managing “wet
aircraft leasing,” where, along with the plane and crew, maintenance agreements
were included. It was the end of 1984 when Dara, observing the business oper¬
ations between this carrier and its clients—large international tour operators—
began to vaguely conceive the idea of an air charter clearinghouse.
Jane F. McBride
Jane McBride, Dara’s cousin, was 25 years old at the time of Flight Time’s incor¬
poration. Jane graduated from Wesleyan University in 1981 with a degree in
Cultural Anthropology and her first job was teaching English at A.H. Zapata,
Inc., Dara’s enterprise. Jane also had a passion for aviation and had obtained her
license as a private pilot, flying more than 200 hours on a Piper Dakota, her
fathers private plane.
The summer of 1982 she left Zapata, Inc. and went to work for International
Weekends, an American tour wholesaler operator which at the time moved the
largest number of passengers per year.1 Jane was a tour escort guiding tourists
to London, Amsterdam and Paris. Because her job at International Weekends
was seasonal, in 1983 she joined American Adventures, a U.S.-based travel
operator, as a tour leader. In this job, Jane led ten tours of foreign tourists
throughout the States, doing everything from driving the 20-seat van to coordi¬
nating the trip, arranging sightseeing and planning overnight accommodations.
A year later, Jane left American Adventures and went to work for Trans National
Travel (TNT), the travel-related wholesaler division of Trans National, a finan¬
cial services company based in Boston. As a tour director, her responsibilities
involved organizing trips and traveling to Asia, Europe, and the Caribbean.
Jane found her job “challenging and satisfying” and stayed with TNT until
the end of 1984. It was then that she had a conversation over dinner at Jane’s
sister’s wedding with her cousin Dara, who convinced her that joining their
business knowledge and skills to start a new company was a good idea.
Patricia A. Zinkowski
Patti Zinkowski, 27 years old, grew up in the Boston area and went to
University of Massachusetts at Amherst, planning to become a veterinarian.
Before graduation Patti switched her major to the Physics/Astronomy
Department and was especially interested in climatology and aviation weather.
However, due to the small number of climatology and meteorology courses,
she graduated with a degree in Physics and, according to her, “with no inten¬
tion of using it.”
After graduation in January 1980, she went to Europe backpacking with a
friend. She spent time in Switzerland, skiing and working as a ski instructor at
summer camps for kids. In November 1980, the head of a Philadelphia-based
company that sent American tourists overseas offered her a temporary six-
month position as tour guide at a hotel in Switzerland. “I had a lot of fun orga¬
nizing the stay of our clients and socializing with them. I had the best time,
made a few bucks and decided that I liked to travel.” After this assignment, she
came back to Boston for a visit, but ended up being hired in January 1982 by
the same company Jane was working for, International Weekends, at their U.K.
accounting office. Patti was appointed Accounts Supervisor and sent to
London, where she oversaw the bookkeeping activities of related tour agencies.
It was here she met Jane in 1982, who was working for International Weekends
as a tour escort.
In 1983, Patti left International Weekends to join Trans National Travel
(TNT), where she worked as Director of European Accounting, managing all
the financial aspects of tour operations in Switzerland, Italy, and Germany. In
the autumn of 1984, after discussing with Jane the possibility of starting their
own company, Patti decided to leave TNT in December of that year.
The Business Opportunity
The Idea
The idea for Flight Time was conceived by Dara during her consulting experi¬
ence, which involved the short-term leasing of aircraft for new airlines. The
leasing agreements typically required that the lessee guarantee a certain
number of flight hours2 to the owner of the airplane. Dara found that the more
flight hours the operator guaranteed, the more favorable the lease rate. As a
consultant, she tried to increase the number of guaranteed hours by making
some phone calls to tour operators whom she felt might need aircraft space for
tour groups. One of these contacts was a tour operator whose 80 clients had
been stranded in San Juan because of a last-minute flight cancellation.
Scheduled flights were fully booked and the tour operator had no ideas for
providing alternative air travel, so the angry tour group was unable to leave the
island. After a few more phone calls, Dara “discovered that there was quite a
demand for some type of a central clearinghouse, serving airlines operators,
who could let us know about aircraft availability, and the customer, who
needed airplanes.”
In September 1984, Dara, who desired to be “independent and to do things
in the [air travel] industry better than they were done”, approached her cousin
Jane at a wedding and over a glass of wine at the dinner party told her about
the business idea, already having selected the company’s name: “Flight Time.”
Dara wanted Jane to be involved because she “knew her cousin had the neces¬
sary background for the tour operator component needed by the envisioned
enterprise.” Dara believed Janes experience was a necessary complement to her
own expertise in aircraft operations and flight contract agreements. Jane was
extremely interested in the opportunity because of its “excitement, sense of
adventure. I [also] could not imagine working for anybody else.”
Dara was aware that “the third piece needed would have to be someone with
a solid background in computers, accounting and finance.” Jane remembered
Patti, who was now head of European accounting for TNT, and called her about
the Flight Time idea. Patti, who in her experiences had seen travel groups
getting stranded at various airports around the world, thought that the possi¬
bility of offering air charters to travel groups was very feasible and decided to
join Dara and Jane in the new venture.
Getting Started
The initial business concept was to operate in the air charter industry as a pure
charter broker.3 As Dara explained: “We thought of setting up an intermediary
company that would help aircraft owners to increase their utilization and assist
tour operators in finding an aircraft, whatever their needs might be.” From
September to November of 1984, Dara and Jane met several times to explore
the feasibility of the potential start-up company. Patti, who was abroad at the
time, joined them in December when she returned to Boston. During that
period, they called contacts in the travel business they had made over the years,
to see “if the idea was really off the wall or not.” Patti recalled the outcome of
those phone calls and meetings:
We asked them if we opened a business like this, ‘Would you use our
service?’ And it was an overwhelming response: ‘Are you in business now?
Do you know of any place [that provides this type of service]?’
We just couldn’t see that anything was so wrong with the idea. We just
thought it was a great idea since we also had personal experiences with
people needing planes.
In addition to talking to potential clients, they met with advisors from the
Service Corps of Retired Executives (SCORE)4, experienced in providing free
business and technical consulting to businesses and corporate start-ups. Even
though these counselors did not know very much about the industry or specific
business, they concluded if Dara, Jane, and Patti wanted to start this business, it
was feasible. The three entrepreneurs felt quite reassured with this advice. Jane
recollected later that excitement was growing because “at the time we did not
think there was any other company doing this.”
Enthusiastically they discussed the business idea with their families, but all
their parents expressed reservations and thought it was risky to start a new
company considering the young age of the three partners: “Why don’t you get a
real job?” was a recurrent suggestion. On the contrary, Jane felt “we did not
have anything to lose [because] we were between seasons with our tours” and
Patti thought that “if it was not going [to work], we could have gone back to
what we were doing before.”
In December, Dara, Jane, and Patti met several more times and decided their
bread and butter would be Part 1355 aircraft. Larger aircraft also were consid¬
ered but they decided to concentrate on the smaller aircraft first. They agreed to
target customers who traveled where scheduled service was
lacking or when times weren’t convenient. The following
description characterizes Flight Times target customer:
“If you went Boston to Atlanta no problem: you got eight
flights a day. But if you had to go from Biloxi, Mississippi, to
Daphne, Alabama, there was not good service. You had to go
back to Atlanta, change planes, go to Daphne, go back to
Atlanta, change planes, go back to Biloxi. It was this hub-and-
spoke. You just couldn’t get around the wheel. You always had to come to the
center where the airlines were.”
Tour operators’ small track programs, which involved prearranged periodical
flights to and from the same destination, were also targeted as a major source of
revenues. Other segments the three principals identified, in no specific order,
were the leisure market (defined as “vacationers”), corporate business travel, and
sports team travel. Dara stated their “target was to have a wider client base. If one
end did not pan out, the other part of the client base could pick up the slack.”
In the beginning, their main objective was to get the word out, to let people
know about the new service their business would provide. Jane and Dara
would concentrate on contacting potential clients and operators to find out
what type of aircraft they were operating and what type of utilization they
would have liked to have.
By chance, Dara met an administrator of the U.S. Military Travel
Management Command (MTMC), a federal military representation division.
This official explained to her how the Military Command arranged air charter
flights for its troops, how the contracts were filled out, and what kind of infor¬
mation was needed when dealing with air carriers. After this conversation, Dara
decided to adopt this framework for Flight Time’s operations.
A hired designer created a windrose high-tech logo, that represented the
three founders and an aircraft style design (see p. 317). Even though a formal
business plan had not been written, time had come to meet with the lawyer for
the official incorporation of the company.
Business Environment
Between 1976 and 1982, the commercial airline industry was characterized
worldwide by high fragmentation and intense competition. The top 15 airlines
flying between the United States and Europe, the most traveled international
route, had an overall passenger market share on that route of less than 70
percent in 1984. Pan Am,'TWA, and British Airways, the top three international
carriers, were separated only by one percentage point.6 U.S. carriers had the
largest share of world traffic in 1984 with 40 percent of the total Revenue
Passenger Miles (RPMs)7 flown, only a three percent increase from 1976.8
Commercial air carriers provide regularly scheduled and/or charter flights for
both passenger and cargo operations. Scheduled flights serve a specific route on
a regularly scheduled timetable (for instance, biweekly) and are sold to the
public. For charter flights, either public charters (i.e. typically a wholesale tour
operator resells the seats of the leased aircraft to the general public) or single
entities (i.e. a corporation charters a flight for its employees, without reselling
single seats), are purchasers of the services and negotiate their own routing and
timetables. A scheduled airline may provide both scheduled and charter air
service, while charter operators generally offer only the latter. Revenues from
charter flights varied greatly among single airlines, ranging from less than
$100,000 a year for the airline operating a single Part 135 aircraft, to nine-digit
figures for non-scheduled flights of major national scheduled carriers. In 1984,
scheduled air operations accounted for 89 percent of the total airline traffic
measured in Revenue Ton Miles (RTMs)9 and 90 percent of world RPMs (see
Exhibit 1). The Department of Transportation (DOT) estimated that in the
United States 5.5 million people—business travelers and vacationers—took air
charter flights in 1984.
Before the introduction of the Airline Deregulation Act (ADA) in 1978, the
competition among U.S. domestic airlines was regulated similar to public utili¬
ties by the Civil Aeronautics Boards (CAB’s) control of new entries, entries into
existing markets, routes, and pricing policies. Since 1978, when President
Jimmy Carter introduced the competitive aviation policy and the CAB was
dissolved, airlines were allowed to voluntarily modify their route networks and
marketing strategies. One of the most visible effects of the deregulation was the
accelerated growth of “hubbing.” Five years from the adoption of the ADA,
some airlines more than doubled their hub-and-spoke operations, with up to
10 percent increase of the load factor and a 15-20 percent increase of air trav¬
elers who flew a complete journey on a single airline.10 Major commercial
airlines began to cut regular services to and from locations considered not prof¬
itable enough, while small commuter, corporate jets, and charter operators
blossomed. According to the Financial Times, in the early 1980s “businessmen
are increasingly taking to the air in small, light transport aircraft either owned
by, or chartered on behalf of, their companies. This concept of ‘business avia¬
tion’-—as opposed to ‘business travel’ on scheduled airlines—has been winning
favor . . . [because of] . . . the greater convenience and time savings involved,
by comparison with the scheduled airlines, together with a significant saving in
cost.”11
In 1984 there were more than 12,000 airports in the U.S. but only 400 were
serviced by scheduled flights.12 Worldwide, there were 300 scheduled airlines,
of which fewer than 30 were the U.S. scheduled carriers,
accounting for more than $100 billion in revenues.13
Approximately 4,000 carriers operated air charter flights in the
U.S. accounting for $2.4 billion in sales, flying more than
14,000 aircraft. Revenues from vacationers (the so-called
“leisure travel”) comprised more than 60 percent of the $2.4
billion dollar sales, while 20 percent of the revenues came
from incentive houses14 and corporations. The remainder was
split among the U.S. government (i.e. troops movements), sports teams, and
entertainment.
The largest share of the air charter market was represented by public charter
flights, sold directly to the public or, more often, to tour operators. Most sched¬
uled and non-scheduled airlines marketed their charter flights through in-
house brokerage operations or through their own sales people. The rest was
managed by wholesale and retail tour operators and by a handful of regionally
dispersed and privately held independent brokers, whose revenues rarely
surpassed the one million dollars. Tour operators, corporate incentive planners,
government departments (such as the Defense Department), and sports teams
were, in order, the four main purchasers of the these brokerage services.
Few charter airplanes were large jet aircraft (such as DC-9, B737 and B757)
produced by major aircraft manufacturers, like Boeing and McDonnel-
Douglas.15 Instead, single-engine and two-engine piston planes, produced by
specialized smaller manufacturers, such as Fokker, and having fewer than 20
seats were most frequently chartered. The Part 135 aircraft made up 60 percent
of the 80 seats or less segment.16 Total shipments of general aviation aircraft to
scheduled and charter carriers were declining since 1979 (see Exhibit 2 on
p. 332) and in 1984 experts were forecasting a steady negative trend.
This downturn in the shipment of aircraft was mainly the result of the
airlines’ attempt to contain fixed costs and to strive for better use of the avail¬
able equipment, to be obtained partially by increasing the number of flight
hours. For airline operators, the average utilization of large equipment was 6 to
7 flight hours a day including scheduled flights, while for smaller airplanes
utilization barely reached.2 flight hours a day. Even though fixed costs such as
aircraft, maintenance, and personnel were steadily increasing, other variable
costs, such as jet fuel and oil prices, after a steady increase and a sharp rise in
1979, were declining beginning in 1981 (see Exhibit 2.)
The Start-Up
On January 2, 1985, Patti, Jane, and Dara went downtown to meet with their
lawyer for the first step of the legal incorporation of the business.
Initial Resources
Each of the three partners was able to withdraw ten thousand dollars from their
personal savings without involving family funds. Flight Time, Inc. was orga¬
nized so that the Dara, Patti and Jane had equal partnership in the business,
each owning one third of the three hundred shares issued at no par value. Dara
described the initial financing: “We figured that $30,000 would let us go on
forever. We would have enough income from our business to perpetuate the
business.” Then, they gave each other titles, a legal condition when an incorpo¬
ration occurred. Dara was named President because she had the original idea,
Patti was appointed Treasurer because she was doing the bookkeeping, and,
considering that the State of Massachusetts required someone to be clerk, Jane
was made Secretary by default.
They leased a one room office with no windows at a travel agency in
Chestnut Hill. To provide the new location with the necessary office supplies,
they went to friends’ basements and dug out old file cabinets, then to yard sales,
other companies, and offices to obtain second hand desks and appliances. On
the first day of business, their office furnishings consisted of a few telephones, a
couple of typewriters, an answering machine, a photocopier, a $4,700 Hewlett
Packard computer with dot matrix printer, and a coffee machine. They distrib¬
uted various Rolodex cards with the names and the addresses of all the contacts
that Dara, Jane, and Patti had made in the airline industry and the tour operator
business. Besides these contacts, they subscribed to Aviation Daily, Travel Weekly,
and other periodicals and newspapers, useful to keep updated aviation-related
news and to be used as possible sources for their first clients. Flight Time did
not have a firm commitment from anyone who prior to start-up had demon¬
strated interest in using the services of an air charter broker.
At Work
The first day of Flight Time’s operations, Jane, Dara and Patti went to work in
business attire promptly at 8:30. According to their new business cards, Jane
was Director of Operations, Dara was President and Director of Sales and
Marketing, and Patti was Director of Finance. After a few weeks at the office,
however, while it was clear that finance and accounting were Pattis main
responsibilities, most of the other functions were managed together. Decisions
other than those involving ordinary operations, had to be made unanimously.
Most of their time was spent jointly, searching for clients and
ivailable airplanes. Jane recalled that “how to get the word out
was our marketing plan.” Sitting in the same room facing each
other, they looked in the Boston Globe for companies that were
growing and called people they knew, from professional
contacts they had in the tour operator business, to friends
] and family, as well as friends of friends and referrals.
Through letters and follow-up calls, their efforts in convincing
potential Part 135 clients to consider chartering a small aircraft were based on
comparing charter planes to scheduled carriers: “Why change planes and why
stay overnight in a hotel, when you can fly with your own plane?”
With the goal of getting the word out and reaching potential clients, Flight
Time joined the National Business Aircraft Association (NBAA). Patti was able
to generate few descriptive articles about the company for the trade magazines
and local newspapers. Looking for new ideas, Patti went to a Public Relations
seminar, where she conceived the first press release of Flight Time. As she
mentioned, “it was necessary to have a lot of common sense. We did not have
a lot of money to spend in advertising, but we needed to get our name out
there.” Thus, the initial press coverage resulted in many phone inquiries that
were used to build up a list of possible clients. To expand this press coverage,
in April Flight Time also started a two-page newsletter that was sent to
prospective customers and air charter operators (see Exhibit 3 on p. 333).
Travel people began to identify them as “The Three Women in Boston.” In an
attempt to enhance Flight Times image and business network, Patti joined the
New England Women Business Owners (NEWBO) and Jane the National
Association of Female Executives (NAFE.) They were sure that being three
women in a “male” dominated industry would create a stronger awareness of

their service.
Operationally, when a potential customer called for a price estimate, a stan¬
dard client request sheet was completed and input into the computer.
Information included the desired time of departure, date, place of departure and
arrival, number of people- traveling, and special equipment carried along. Flight
Time then searched for the possible carriers in a computerized database they
created, in the World Aviation Directory, and in any other publications that could
provide a profile of different airlines and included information such as contact
names, types of the aircraft, and number of seats. In order to match the
customers request to an aircraft, Dara, Patti and Jane would call various carriers
and ask for a quote. Considering that the quoted price already included a 5
percent to 10 percent commission, they did not add any extra charge to the
client. When a client accepted the price and aircraft type, Flight Time linked the
customer and the charter airline, with only those two parties signing the final air
transportation contract. A database of available Part 135 and Part 121 aircraft
organized by state was set up on the computer, even though it was mostly used
for the newsletter and business correspondence to clients and airlines. Another
database, containing information about possible clients also was developed.
On March 31, after 3 months of operations, they had their first official board
meeting at the Emerson Place of Charles River Park. The three partners decided
to form an international executive committee to assist them in searching for
contacts and business advice, with no obligation or compensation for its
members. About at the same time, the three founders discovered that they were
not the only pioneers of the air charter brokerage industry; in fact another
company, Charter Services, had been operating in Albuquerque since 1979.
This discovery reinforced Flight Times moral: “if there is someone doing what
we are doing since 79, there must be a lot of business out there.”
First Clients
Dara recalled how many of Flight Times early contacts originated from the
consulting service she used to provide. “They were not a lot of contacts, but
certainly enough to get going. I knew the business well enough so that I could
call any airline, introduce ourselves and explain about our company.” In
February, the American Soy Bean Association travel planner called Flight Time
because some of the members had to inspect properties located in
Massachusetts and needed a Part 135 airplane for the tour. This was the first
deal for the newly born clearinghouse.
The second month of operation the phone rang again. A casino operator
wanted to fly 15-20 people daily from Boston and from Providence, Rhode
Island, to the casinos of Atlantic City, New Jersey.17 The three businesswomen
were speechless: it was a $1,000,000 yearly contract, one hundred thousand
dollars in brokerage fees. They located a start-up airline in New Hampshire
operating just the right size plane, a Dornier 228-201. The casino operator
signed the original contract. Because this track program was a long-term
commitment, he asked for a credit extension. As per Flight Times policy he
would pay for the first flight before the departure and then settle the other trips
a few days later. The plane flew smoothly for two weeks, then suddenly the
aircraft was not being filled, the casino operator stopped paying and the
contract failed. “But it was an eye-opener,” Patti recollected later, “we had this
one contract, but it got screwed up so fast. If there was one of these trips there
were more of these trips.”
A few weeks later, a former client of Dara, a hardware distributor from
Southeastern Massachusetts, was contacted by Flight Time. The owner of the
company was a pilot himself who easily understood the air,charter concept. He
decided that instead of picking up his clients at Boston’s Logan Airport, it
would be better to fly them directly to his factory. This $700 deal, paid a few
days prior to departure, generated a profit of $70 to Flight Time.
By June 1985, the five month old clearinghouse had generated $150,000 in
revenues, primarily from trips arranged at least 3-4 weeks in advance although
some flights were arranged on one-day notice. For every 10-12 price quote
requests, Flight Time was able close one deal, usually settled before the depar¬
ture and subject to a cancellation policy of 2 to 3 weeks in advance. Most of the
booked planes could carry between 10 and 50 passengers, with the 8 seater
Learjet being the most chartered aircraft. However, the time spent to shape a
deal on a Learjet with 8 people was the same as for a Boeing 727, a 100 seat jet.
At the end of the fifth month the names of several potential clients had been
entered into the database and it was clear to Jane that “the only limitation to
our success was creating awareness of our services.”
Second Financing?
During the first week of June, Patti inspected Flight Times financial position.
The business had less than $4,000 in cash. Most of the start-up money had
been used for office supplies, rent, utilities, promotional activities and salaries
to the principals. But Dara, Jane and Patti were not ready to give up.
“The track program we had set up was not going to sustain itself, which
was what the original plan was. We knew that the business we anticipated
was on the books. We were waiting for the big one to come along and get
us over, [but] the numbers decided for us that we needed a secondary
financing.”
After a quick analysis 'of the situation, they determined that $300,000 was
needed not only to keep the business running, but also to expand it. They
approached a local bank for the $300,000 loan. The bank requested that Flight
Time present a business plan and disclose relevant financial information.
Suggestions from SCORE helped them to construct the business plan (see
Exhibit 4 on p. 334) and a certified public accountant was hired to produce the
financial statements (see Exhibit 5 on p. 338). However, because of Flight
Time’s lack of track record and brief business history, the bank refused to lend
Flight Time the $300,000.
Watching the horses race, Dara, Patti, and Jane were wondering what kind of
future Flight Time could expect.
Footnotes
1 International Weekends was later bought by TWV, another U.S. wholesaler
tour operator.
2 Flight hours are measured block to block, only when the aircraft in moving.
3 An air charter broker is a fee-based business intermediary that links an airline
having aircraft space to rent, with another entity, usually a corporation or a tour
operator, needing to fly people or goods. A pure broker does not own or
personally lease aircraft, but acts only as an agent for the two parties.
4 SCORE, is an affiliate of the Small Business Administration (SBA).
5 In 1985, Part 135 referred to section of the U.S. Federal Aviation Regulation
(FAR) governing safety and operating procedures for aircraft having, among
other requirements and limitations, fewer than 20 seats and not more than a
12,500 pounds gross takeoff weight. Over these two limits, FAR Part 121 regu¬
lations applied. Aircraft operating under Part 135 and those operating under
Part 121 can be generically defined as “small airplanes” and “large airplanes"
respectively.
6 Source: International Air Transport Association (LATA), 1985.
7 Revenue Passenger Mile (RPM): As defined by the Federal Aviation
Administration (FAA,) “one revenue passenger transported one mile in revenue
service. Revenue passenger miles are computed by summation of the products

of the revenue aircraft miles flown during a flight stage, multiplied by the
number of revenue passengers carried on that flight stage.”
8 Source: US. Department of Transportation, 1985.
9 Revenue Ton Mile (RTM): As defined by the FAA, “one ton of revenue traffic
transported one mile.”
10 Source: U.S. Department oj Transportation, 1984.
11 Source: Financial Times, April 2, 1984.
12 Source: TravelAge East, May 12, 1986.
13 Source: International Civil Aviation Organization (ICAO), 1985.
14 Incentive Houses are service companies organizing the work incentive plans
(such as travel bonuses) for the employees of their corporate clients.
15 For a more detailed description of aircraft manufacturers in the 1970s and in
the 1980s, see Professor Sushil Vachani, “The Commercial Aircraft Industry In
1987,” (1990), Management Policy Department, Boston University.
16 Source: Federal Aviation Administration 1984 Forecast, Federal Aviation
Administration, 1985.
17 See Exhibit 3 on p. 333.
EXHIBIT 1
Flight Time
DISTRIBUTION OF WORLD AIRLINE TRAFFIC IN 1985
. International U.S. Total

Freight Services - Note A
Scheduled 84% 96% 90%
Charter 16 4 10
Passenger Services - Note B

Scheduled 81 97 89
Charter 19 3 11
Source: International Air Transport Association, Historical Data Report, 1985.

Note A: Measured in Revenue Ton Mile (RTM).
Note B: Measured in Revenue Passenger Mile (RPM).
SELECTED DATA FOR WORLD AIR TRANSPORT
1981 1982 1983 1984

Scheduled Airlines
Scheduled Services
Passengers Carried (millions) 752 767 798 845
Freight Tons Carried (millions) 11 12 12 13
Passenger-Miles Flown (billions) 703 717 745 798
Available Seat-Miles (billions) 1,109 1,132 1,166 1,236
Ton-Miles Performed (billions) 84 86 91 99
Available Ton-Miles (billions) 145 148 152 164
Charter Services
Ton-Miles Performed (billions) 3.9 3.6 3.5 3.7
Available Ton-Miles (billions) 6.1 5.7 5.5 5.8
Charter Airlines
All Services
Ton-Miles Performed (billions) 4.2 4.8 5.0 5.4
Available Ton-Miles (billions) 5.7 6.6 6.6 7.0

EXHIBIT 2
Flight Time
U.S. General Aviation Aircraft Shipments
Jet Fuel Prices

Real (FY—1982) Dollars
Year

EXHIBIT 3
Flight Time
Flight Time’s Newsletter
April/May 1985 Issue
FLIGHT LINE BY FLIGHT TIME April/May 1985

Congratulations, consider yourself an innovator in your company!
Every business needs individuals who think ahead, who are open to new ideas, and are not
afraid to try new products. By showing your interest in FLIGHT TIME you are supporting a
pioneer concept in the aviation industry.
This month FLIGHT TIME launches its first newsletter and introduces you to new opportuni¬
ties in air travel.
OPPORTUNITY No. 1—FLIGHT TIME

FLIGHT TIME is not a travel agency. We are not an airline nor a tour operator. What we are is a
resource, and information station, dedicated to securing cost-efficient and reliable private
charter air transportation for individuals, corporations, groups, and associations. FLIGHT TIME
fills requests for charter aircraft for groups of all sizes, whether it be for you or your entire
company.
Since you may have received some information on FLIGHT TIME prior to this newsletter,
here is a brief synopsis of the services offered by FLIGHT TIME.
FLIGHT TIME: 1. HELPS you decide if private charters are your best alternative in air travel.
2. LOCATES certified aircraft which best suit your needs.
3. PROVIDES quotes and options which include aircraft descriptions, per
hour costs, and technical data.
4. CONFIRMS and coordinates charter arrangements and itineraries.
Best of all, FLIGHT TIME offers these services FREE of charge.
OPPORTUNITY No. 2—PRECISION AIRLINES/ATLANTIC CITY HOLIDAYS

FLIGHT TIME is pleased to announce that Atlantic City is now accessible from Boston and
Providence via Precision Airlines.
Atlantic City Holidays, a New England based tour operator, is now offering daily departures
from Boston and Providence to Atlantic City, New Jersey. Round-trip air, complete overnight
packages including casino transfers shall be available starting April 5, 1985.
Precision Airlines puts into service its new DORNIER 228-201 for this program. The Dornier
is a new-generation commuter aircraft known for its speed, high passenger comfort, and STOL
capabilities.
Further information on price and schedule may be obtained by calling: (800) 442-1162
(Mass, only) or (800) 447-2250 (outside Mass.).
OPPORTUNITY No. 3
According to the National Business Aircraft Association, the average business trip involves 4.1
people traveling 338 miles with a four-hour turnaround.
Suppose you and your team of key salesmen want to blitz a customer in Syracuse. Instead
of dealing with complex schedules, two-hour layovers, and missed connections, you jump into
your private plane, make a three-hour presentation and fly back again. You get the job done
fast. Your plane waits for you rather than you waiting for the plane.
Many businesses do not even consider the possibility of chartering aircraft for their business
travel due to the myth that the cost is prohibitive. (Not all itineraries merit a chartered airplane.)
You could be pleasantly surprised to find that on many occasions a business trip would be
more cost-efficient if key employees traveled by private charter rather than scheduled carrier.
For more information call FLIGHT TIME at (617) 965-7060.
OPPORTUNITY No. 4—EASTERN CHARTER/NANTUCKET

Eastern Air Charter is planning to offer first class service to Nantucket Island from Norwood,
MA airport this upcoming summer season. Service is tentatively scheduled to begin May 15th.
The price of a ticket will include: First class comfort aboard executive aircraft (planes are
fully air conditioned), champagne, full liquor, and soft drinks, inflight snacks, free airport
parking, onboard telephone and entertainment systems.
The schedule is designed to accommodate weekend passengers with departures Friday
evenings and early Saturday mornings returning on Sunday evenings. The fare for this trip will
be $175.00-$180.00 per person round trip.
EXHIBIT 4
Flight Time
FLIGHT TIME’S BUSINESS PLAN
As Provided by Flight Time to Shawmut, for the Loan Request Application
STATEMENT OF PURPOSE
FLIGHT TIME is a service business dedicated solely to security charter air transportation for
individuals, groups, associations, and corporations. FLIGHT TIME specializes in screening and
locating Part 135 and Part 121 aircraft for this client base. FLIGHT TIME neither owns nor
operates any aircraft.
FLIGHT TIME acts as a charter clearinghouse. The company is in the business of distrib¬
uting information on aircraft prices and availability, negotiating terms of charter contracts and
coordinating details of charter flight operations. Upon authority by client, FLIGHT TIME acts as
agent for the client in security aircraft and arranging charter flight.
FLIGHT TIME charters aircraft (on behalf of clients) from carriers certified for charter. This
means that both commercially scheduled airliners and nonscheduled airliners may be used in
the selection process.
Note: FLIGHT TIME does not engage in activities such as the following, which are tradition¬
ally associated with retail travel agencies, i.e.:
• reserve and ticket airline seats on commercial or charter flights.

• arrange tours of any kind for individuals or groups.
• arrange “package deals” associated with tourism.
• reserve and confirm hotel accommodations or any other land arrangements.
• reserve or promote rental cars or ground transportation.
BUSINESS PLAN—MARKET SECTION

The market for FLIGHT TIME Corporation's charter air service may be subdivided into the
following segments, each with its own particular requirements.
CORPORATE
According to Travel Weekly, a trade journal, over 500 million business trips of one night or
more are made each year. The report concludes that because few corporation have any orga¬
nized business travel policy, millions of dollars are wasted annually.
FLIGHT TIME works, with corporations of all sizes, many of which are listed in the Fortune
1000. We recommend the following checklist to our clients as a yardstick to determine air
charter feasibility:
• When 3 or more people are charter feasibility • When the destination or point of origin is
• When key personnel travel business more than 45 minutes from a major airport.
or first class. • When a destination does not have
• When the limitations of scheduled airline non-stop or direct air service.
service mean unnecessary hotel
overnights with other added expenses.
Responses to FLIGHT TIME’S service have been extremely positive. Due to the wide array
of available aircraft, FLIGHT TIME has been able to accommodate requests for 15 passenger
turboprops, 5 passenger jets, and 80 passenger jets, just to name a few.
TOUR OPERATORS
There is a very high concentration of tour operators and wholesalers in the Northeast and for
many, the key to the success of a track program is contingent upon reliable and economical
chartered air space. In an industry where last minute changes and failed contracts are
commonplace, FLIGHT TIME assists tour operators in negotiating contracts with FAA certified
air carriers.
FLIGHT TIME recently negotiated a contract between a Boston based tour wholesaler and
regional air carrier for daily flights from Boston and Providence to Atlantic City.
TRAVEL AGENTS
Travel agents are prime targets for FLIGHT TIME'S services with their corporate, leisure, and
affinity markets already established. Since most travel agents, as well as the traveling public,
are unfamiliar with general aviation, FLIGHT TIME'S services complement those of retail and
corporate agents.
FLIGHT TIME has targeted reputable agents with upscale clientele who have expressed an
interest in private charter. Agents receive a percentage of FLIGHT TIME’S commission.
In addition to F.l.T.s, many agencies organize their own group tour programs and frequently
need larger aircraft. FLIGHT TIME has received requests from agents for groups of 15-100
passengers.
CASINOS
FLIGHT TIME, sponsored by Claridge’s Casino of Atlantic City, is awaiting confirmation of its
vendor registration number, a license to contract directly with New Jersey casinos. FLIGHT
TIME applied for the license in response to several queries from casino operators looking for
charter aircraft to transport VIP clients in from the greater Northeast region.
Casinos are constantly seeking ways in which to entice “high rollers” to their establishments:
flying them directly into Bader Field, located in downtown Atlantic City, is one such way. Bader
Field, however, has a very short runway—only 2950 feet, and few aircraft can land there.
FLIGHT TIME has located a number of high performance STOL aircraft capable of flying
directly into Bader, and is actively marketing these aircraft. Several casinos have expressed
interest in working with FLIGHT TIME once the vendor registration number has been assigned.
REFERRALS
Referrals from airlines constitute a major market segment, and these clients are usually already
qualified buyers. To date, we have received referrals for trips to Cincinnati, Minneapolis,
Bowling Green, Cleveland, and Atlanta.
Personal contacts and referrals have also generated considerable business.
HOTELS
Deluxe hotels are constantly seeking extra amenities to offer their clients. FLIGHT TIME has
contacted general managers of upscale hotels in MA to introduce our services. Executive
charter, like limousine service, is considered by many as a necessity rather than a luxury. Over¬
sized folded business cards, which include a brief description of FLIGHT TIME’S services and
are displayed in selected areas of a hotel, are an inexpensive yet effective way to reach the
discerning business or leisure traveler.
Travel and Meeting Planners, as well as Incentive Houses, are also good sources of poten¬
tial business.
LOCATION ANALYSIS FOR BUSINESS

FLIGHT TIME operates primarily via telephone, telex and written correspondence, therefore,
location is not a major factor. FLIGHT TIME is located in close proximity to the 128 belt, and is
convenient to Norwood airport.
COMPETITION ANALYSIS
As of this writing, there exists no other company operating exactly like FLIGHT TIME. The
existing competition consists of:
A. Direct Airway - New Jersey - Primary focus is corporations utilizing fleet based in Teterboro, NJ.
Charter Clearinghouse - Pennsylvania - Primary focus is on bringing clients from Pennsylvania

to Atlantic City.
Charter Services - New Mexico - Concentrates on Midwest sports teams.
Netair Int'l - Colorado - Organized 12 air taxi operators in the western U.S. under the Netair
name and uniform.
F. Miscellaneous Charter Operators - Charter operators who do not own or operate a particular
aircraft requested, but broker it out and charge hefty commissions.
PRICING PHILOSOPHY
The difference between FLIGHT TIME and its competition lies in our pricing philosophy.
FLIGHT TIME strives to offer its services free of charge to its clients. Because of the soft
general aviation market, aircraft owners and operators are extremely eager to maximize aircraft
utilization, and pay a sales commission to FLIGHT TIME. FLIGHT TIME receives a commission
based on the overall contract value:
- 10% on Part 135 operators—i.e. aircraft with fewer than 20 seats

- 5% on Part 121 operators—i.e. aircraft with more than 20 seats.
Unlike the competition, which levies 5-10% commission on both the operator and the client,
FLIGHT TIME’S prices are among the lowest in the industry. We believe that by keeping prices
low, we will be able to better demonstrate to our clients that private air charter can be cost-
effective and competitively priced.
CREDIT POLICY
FLIGHT TIME operates on a cash or credit card basis with the majority of sales prepaid. A 3%
bank charge will be assessed on credit card sales. (Once a client has established a favorable
credit history, FLIGHT TIME will extend credit on a net-10 basis, but only in situations where
FLIGHT TIME has at least the same terms with the carrier.)
EXHIBIT 5
Flight Time
BALANCE SHEET
as of May 31, 1985
(Note A)
ASSETS
Current assets
Cash $3,797
Supplies 866
Prepaid Expenses 229
Deferred Expenses - Note B_5,779
Total Current Assets 10,671
Property and Equipment
Computer 4,700
Equipment_1,853
Total Property and Equipment 6,553
Accumulated Depreciation - Note C_(175)
Total Net Property and Equipment 6,378
Other Assets
Deposits 575
Organization Expenses, Net of Amortization_596
Total Other Assets 1,171
Total Assets $18,220
LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities
Accounts Payable $978
Long-Term Debt
Loans Payable, Stockholders’ 26,000
Commitments - Note D
Stockholders' Equity
Common Stock - Note E 3,000
Retained Earnings_(11,758)
Total Stockholders’ Equity (8,758)
Total Liabilities and Stockholders’ Equity $18,220
Note A: Balance Sheet as Prepared by Robert M. Hurst & Company, Certified Public Accountants.
Note B: This Amount Represent Expenses Incurred Prior to the Date Operations Commenced and,
Accordingly, Are Being Amortized Over the First Twelve Years.
Note C: Property and Equipment Are Being Depreciated Using the Straight-Line Method of Depreciation
Over Their Estimated Useful Lives of the Assets for Book Purposes and the Accelerated Cost
Recovery System for Tax Purposes.
Note D: As of May 31, 1985, the Company Was Obligated Under a One-Year Lease Agreement Expires
December 31, 1985 Covering the Premises in Chestnut Hill, Massachusetts. The Terms of the
Lease Stipulate a Monthly Rental Payment of $300.
Note E: No Par Value; 15,000 Shares Authorized; 300 Shares Issued and Outstanding.
STATEMENT OF INCOME AND RETAINED EARNINGS

for the Period from January 2,1985 (Date of Inception) to May 31,1985
(Note A)
% to Sales
SALES - Note B $123,919 100 %
COST OF SALES - Note C 117,356 94.7
Gross Profit 6,563 5.3
SELLING, GENERAL AND ADMINISTRATIVE

EXPENSES - Note D 18,864 15.2
Net Profit (Loss) Before Other Income and (Expenses) (12,301) (9.9)
OTHER INCOME AND (EXPENSES)

Gain on Sale of Stock 687 0.6
Interest Income 85 0.1
Depreciation and Amortization (229) (0.2)
Net Profit (Loss) (11,758) (9.5)
Note A: Income Statement as Prepared by Robert M. Hurst & Company, Certified Public Accountants.
Note B: Dollar Amount as from Billing to Customers.
Note C: Dollar Amount as from Billing from Aircraft Carriers.
Note D: See SCHEDULE OF SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.
SCHEDULE OF SELLING, GENERAL AND

ADMINISTRATIVE EXPENSES
for the Period From January 2,1985 (Date of Inception) to May 31,1985
% to Sales
Office Supplies and Expenses $4,011 3.2 %
Promotion and Entertainment 3,801 3.1
Auto and Travel 3,405 2.7
Rent 1,567 1.3
Dues and Subscriptions 839 0.7
Equipment Rental 833 0.7
Telephone 715 0.6
Training 698 0.6
Postage 423 0.3
Maintenance and Repairs 418 0.3
Professional Fees 410 0.3
Insurance 383 0.3
Taxes, Other 228 0.2
Advertising 187 0.2
Organization Expense 131 0.1
Miscellaneous 815 0.7
$18,864 15.2
Note A: Schedule of Expenses as Prepared by Robert M. Hurst & Company, Certified Public Accountants.
STATEMENT OF CHANGES IN FINANCIAL POSITION

for the Period From January 2,1985 (Date of Inception) to May 31,1985
(Note A)
SOURCE OF FUNDS
To Operations
Net Income (Loss) ($11,758)
Add Back Non-Cash Expenses:
Depreciation and Amortization 229
Net to Operations (11,529)
Proceeds from Loans Payable, Stockholders’ 26,000

Proceeds from Issuance of Capital Stock 3,000
Total Source of Funds 17,471
APPLICATIONS OF FUNDS
Acquisition of Computer 4,700

Acquisition of Equipment 1,853
Increase in Deposits 575
Acquisition of Other Assets 650
Total Applications of Funds 7,778
INCREASE (DECREASE) IN WORKING CAPITAL $9,693
COMPONENTS OF WORKING CAPITAL
Increase (Decrease) in Current Assets

Cash $3,797
Deferred Expenses 5,779
Supplies 866
Prepaid Expenses 229
Total Increase (Decrease) in Current Assets 10,671
Decrease (Increase) in Current Liabilities

Accounts Payable (978)
INCREASE (DECREASE) IN WORKING CAPITAL $9,693
Note A: Cash Flow Statement as Prepared by Robert M. Hurst & Company, Certified Public Accountants.
1. What was the window .of opportunity, and what allowed these three entre¬
preneurs to take advantage of it?
2. How much did the three really know about the market and the economic
feasibility before start-up?
3. Was there any advantage (or disadvantage) to the three entrepreneurs being
female?
4. Should they continue operations?
A Plan for Growth
My candle burns at both ends.

It will not last the night.
But ah my foes, and oh, my friends,
It sheds a lovely light.
-EDNA ST. VINCENT MILLAY
CHAPTER 16
Growing the Business
Overview
• Positioning the new venture for growth
• Growth strategies within and outside the industry
• Preparing for globalization
• Issues to consider when exporting
Beyond Start-Up
Although some entrepreneurs, for a variety of personal reasons, may ultimately
choose not to grow their businesses, most founders of entrepreneurial ventures
are growth-oriented. Expansion is a natural by-product of a successful start-up.
It helps a new business secure or maintain its competitive advantage and estab¬
lish a firm foothold in the market. Contrary to popular opinion, the fastest
growing small companies come from a variety of industries; albeit, the ubiqui¬
tous computer software industry does dominate the high-growth companies.
When Business Week (May 23, 1994) listed the hottest growth companies in
America, included among the top 20 were:
• A fast-food pizza business

• A sports sandal company
• Five software companies
• A product marketing firm
• Three telecommunications companies
• A rehabilitation services business
345
346 Part 6 • A Plan for Growth
• Three casual clothing companies

• A saloon
• A slot machine manufacturer
• A magnetic ink character reader manufacturer
• A leather goods manufacturer
• A computer hardware manufacturer
What made these companies high-growth companies and set them apart
from others was that they displayed several of the following characteristics.
They were:
• First into the market

• Better at what they did
• Teaner in their operations
• Unique in what they offered
Being first in the market with a new product or service is one of the strongest
competitive advantages there is, as it presents the opportunity to establish
brand recognition so that customers immediately think of your company when
they think about a particular product or service. This was certainly the strategy
of Xerox in the copier industry and Microsoft in the operations and applications
software industry.
Many high-growth businesses have developed innovative processes that allow
them to do what they do better and to run leaner operations. For example, Papa
Johns Pizza, which topped the Business Week list, restricted its menu to pizza,
breadsticks, cheesesticks, and soft drinks, while offering a small tub of garlic
butter and two hot peppers with each pizza as a value-added item. They also
have three centralized commissaries that make all the sauce and dough for their
485 stores, which brings costs down substantially while also producing revenue.
A fourth way these companies have achieved high growth is by offering a
unique, innovative product or service. This is the strategy of Davidson &
Associates, the highly successful educational and entertainment software
company that has looked at software development from a child’s point of view
and has succeeded in bringing technology to education.
Factors that Affect Growth

The degree and rate at which a new venture grows are dependent on both the
market and the management strategy. Market factors that affect a firms ability to
grow include:
Chapter 16 • Growing the Business 347
The size, characteristics, and buying power of the target market. If the niche
market into which the company is entering is by nature small and relatively
stable as to growth, it will be more difficult to achieve the spectacular growth
and size of the fastest growing companies. On the other hand, if the product or
service can expand to a global market, growth and size are more likely to be
attained.
The nature of the competition. Entering a market dominated by large compa¬
nies is not in and of itself an automatic deterrent to growth. A small, well-orga¬
nized company is often able to produce its product or service at a very
competitive price while maintaining high quality standards because it doesn’t
have the enormous overhead and management salaries of the larger companies.
Moreover, if an industry is an old, established one, entering with an innovative
product in a niche market can produce rapid rates of growth.
The degree of product innovation in the market. In some industries like the
computer industry, innovation is a given, so merely offering an innovative
product is not in itself enough. In highly innovative industries, the key to rapid
growth is the ability to design and produce a product more quickly than
competitors. By contrast, in an industry that is stable and offers products and
services that could be considered commodities, entering with an innovative
product or process will provide a significant competitive advantage.
The status of intellectual property rights like patents, copyrights, trademarks, and
trade secrets. Intellectual property rights are also a competitive advantage to a
new venture as they permit a grace period in which to introduce the product or
service before anyone else can copy it. However, relying on proprietary rights
alone is not wise. It is important to have a comprehensive marketing plan that
allows the new business to secure a strong foothold in the market before
someone attempts to reproduce the product and compete with it. True, you have
the right to take someone who infringes on your proprietary rights to court, but
it is a time consuming and costly process, one which the small company can ill
afford to undertake at a time when it needs all its excess capital for growth.
The volatility of the industry. Some industries are by their very nature volatile;
that is, it is difficult to predict what will happen for any length of time and with
any degree of accuracy. The computer industry in the 1980s was such an
industry; it has lately become somewhat more predictable as the leading players
in the industry have emerged. The young and dynamic telecommunications
industry, however, is very volatile at this time. Consequently there are opportu¬
nities for extraordinary growth in new ventures and, at the same time, a higher
risk of failure. A new entry into such an industry needs to maintain a constant
awareness of potential government regulations, directions the industry is

taking, and emerging competitors.
The barriers to entry. Some industries, simply by their size and maturity, make
it difficult for a new venture to enter and achieve sufficient market share to
make a profit. Others by the cost of participating (plant and equipment or fees
and regulations) in the industry prohibit entry by new ventures. Yet, in the
right industry a new venture can erect barriers of its own to slow down the
entry of competing companies. Proprietary rights on products, designs, or
processes, for example, can effectively erect a temporary barrier to allow the
new venture a window of opportunity to gain market share.
Management factors that affect a firms ability to grow include:
The entrepreneur’s ability to move from controlling all aspects of the company to
delegating authority and responsibility for major functions. Rapid growth requires
different skills from start-up skills. In the beginning of a new venture, the entre¬
preneur has more time to take part in and even control all aspects of the busi¬
ness. But when rapid growth begins to occur, systems must be in place to
handle the increased demand without sacrificing quality and service. Unless the
entrepreneur is able to bring in key management who have experience in high-
growth companies, chances are the growth will falter, the window of opportu¬
nity will be lost, and the business may even fail needlessly. Many entrepreneurs
have found that at some point in the business’s growth, they must step down
and allow experienced management to take over.
The ability to encourage entrepreneurship in the entire venture team. Growing the
business does not have to mean that the entrepreneurial spirit is lost, but the
entrepreneur has to be very creative about how to maintain that sense of small¬
ness and flexibility while growing. Subcontracting some aspects of the business
is one way to keep the number of employees down and retain that team spirit.
Developing self-managing teams is another way.
Stages of Growth in a New Venture

Rates and stages of growth in a new venture vary by industry and business type;
however, there appear to be some common issues that arise at shared points in
time. The importance of knowing when these issues will surface cannot be
overstated, for they should become part of a well-orchestrated plan on the part
of the entrepreneur to anticipate events and requirements before they occur.
The stages of growth (see Figure 16.1) can be defined as four phases through
which the business must pass to move to the next level of activity.
Figure 16.1: Phases of Growth
Phases of Growth
Phase 1 Phase 2 Phase 3 Phase 4

Start-Up Initial High Stable Growth
Success Growth Growth & Maintenance
Start-Up Success. At the first level, the main concerns for the entrepreneur are
to ensure sufficient start-up capital, seek customers, and design a way to deliver
the product or service. At this point, the entrepreneur is a jack of all trades,
doing everything that needs to be done to get the business up and running.
This includes securing suppliers, distributors, facilities, equipment, and labor.
Initial Growth. If the new venture makes it through the first and most difficult
phase, it enters the second level of activity with a viable business that has
enough customers to keep it running. Now the concerns become more focused
on the issue of cash flow. Can the business generate sufficient cash flow to pay
all the expenses and support the growth of the company? At this point, the
business is usually relatively small with few employees and the entrepreneur
still playing an integral role. This is a crucial stage for the business, for it is here
that the business will either remain small or move to the next level, high
growth, which entails some significant changes in the organization and strategy
of the business. The owners need to decide if they are going to grow the busi¬
ness to a much larger revenue level or remain stable yet profitable.
High Growth. If the decision is to grow, all the resources of the business have
to be gathered together to finance the growth of the company. This is a very
risky stage as growth is expensive, and there are no guarantees the entrepreneur
will be successful at attempting to reach the next level. Planning and control
systems must be in place and professional management hired. The problems
faced in this stage center on maintaining control of rapid growth. This is
accomplished successfully by delegating control and accountability at various
levels and usually fails due to uncontrolled growth, running out of cash, and
not having the necessary management expertise to deal with the situation. If
growth is accomplished, it is in this stage that entrepreneurs often sell the
company at a substantial profit, assuming it will remain successful in its
growth. It is also at this stage that some entrepreneurs are displaced by their
boards of directors, investors, or creditors, so many entrepreneurial ventures
reach their pinnacle of growth with an entirely different management team than
the one that founded the company.
Stable Growth and Maintenance. Assuming the business has successfully

passed through the rapid growth phase and is able to effectively manage the
financial gains of growth, it will have reached Phase 4, stable growth and main¬
tenance of market share. Here the business, which is usually now large, can
remain in a fairly stable condition as long as it continues to be innovative,
competitive, and flexible. If it does not, sooner or later, it will begin to lose
market share and could ultimately fail or revert back to a much smaller busi¬
ness. Allowing decision making at the lowest levels in small operating units is
one way to permit the company to continue to grow without losing that entre¬
preneurial spirit and flexibility.
High-tech companies seem to be an exception to the traditional growth
patterns. Because they typically start with solid venture capital funding and a
strong management team (dictated by the venture capitalists), they move out of
Phases 1 and 2 very rapidly. During Phases 3 and 4, if the structure is effective,
they become hugely successful. If, on the other hand, the structure is weak,
they can fail rapidly.
Problems with Growth

New business growth, for the most part, is a very positive thing; however, it
does bring with it some issues for which the entrepreneur must be prepared.
For example, if the new venture is a retail business, and you expand by opening
additional stores, you need to decide whether or not to retain control of all
functions in one main st.ore, or delegate the day-to-day management and solely
control marketing, accounting, finance, and purchasing. It may be necessary to
establish a computer network to keep track of sales at all locations. For a manu¬
facturing firm, expansion may entail significant capital investment in additional
plant and equipment, or developing new strategic alliances to keep production
in line with demand. It may also mean locating additional distributors and even
new channels of distribution. For a service business, growth may mean taking
on additional associates or employees and investing in computer systems to
manage information.
This chapter looks at several strategies for growing the business:
• Intensive growth strategies, those that exploit opportunity in the current

market
• Integrative growth strategies, those that involve growth within the industry
as a whole
• Diversification strategies, those that exploit opportunities outside the
current market or industry
• Global strategies, those that take the business into the international arena
Intensive Growth Strategies: Growing within the Current Market

Intensive growth strategies focus on exploiting the current market fully, that is,
expanding the market share to the greatest extent possible. This is accom¬
plished by increasing the volume of sales to current customers and the number
of customers in the target market. There are generally three methods for imple¬
menting an intensive growth strategy: market penetration, market develop¬
ment, and product development.
Market Penetration
With market penetration, the entrepreneur attempts to increase sales using
more effective marketing strategies within the current target market. The
classic example of this strategy is the repositioning of Arm & Flammer Baking
Soda. The manufacturer began advertising and educating its customers about
additional uses for the product beyond cooking, such as a refrigerator deodor¬
izer, a toothpaste, and a cleaning agent. Having additional uses for the product
causes customers to buy more. Another way to employ market penetration is
to attract customers from your competitors by advertising product qualities,
service, or price that distinguishes your product from others. A third way is to
educate nonusers of product or service as to its benefits in an effort to increase
the customer base.
Market Development
Market development consists of taking the product or service to a broader
geographic area. For example, if you have been marketing on the East Coast,
you may decide to expand across the rest of the United States. One of the most
popular ways to expand a market geographically is to franchise because it is
generally less costly than setting up a national distribution system. Franchising
allows the business to grow quickly in several geographic markets at once. The
franchiser sells to the franchisee the right to do business under a particular
name; the right to a product, process, or service; training and assistance in
setting up the business as well as ongoing marketing and quality control
support once the business is established. The franchisee pays a fee and a royalty
on sales, typically three to eight percent. What the franchisee may get for the
fee, depending on the business, is:
• A product or service that has a proven market

• Trade names and/or trademarks
• A patented design, process, or formula
• An accounting and financial control system
• A marketing plan
• The benefit of volume purchasing and advertising
Franchises generally come in three types. Dealerships allow manufacturers to

distribute products without having to do the day-to-day work of retailing.
Dealers benefit from combined marketing strength, but are often required to
meet quotas. Service franchises provide customers with services such as tax
preparation, temporary employees, payroll preparation, and real estate services.
Often the business is already in operation before it applies to become a fran¬
chise member. The most popular type of franchise is one that offers a product, a
brand name, and an operating model. Some examples are Kentucky Fried
Chicken and Golf USA.
Franchising is not without its risks, however. It is virtually like creating a

whole new business, because the entrepreneur must carefully document all
processes and procedures in a manual that will be used to train the franchisees.
Potential franchisees need to be scrutinized to ensure they are qualified to
assume the responsibilities of a franchise. Moreover, the cost of preparing a
business to franchise is considerable and includes legal, accounting, consulting,
and training expenses. Then, too, it may take quite a long time to show a profit,
as many as three to five years.
Not all businesses are suitable for franchising as a growth strategy. A
successful franchise system will need to have the following characteristics:
• A successful prototype store (or preferably stores) with proven profitability

and a good reputation so the potential franchisee will begin with instant
recognition
• Registered trademarks and a consistent image and appearance for all outlets
• A business that can be systematized and easily replicated many times
• A product that can be sold in a variety of geographic regions
• Adequate funding, as establishing a successful franchise program can cost
upwards of $150,000
• A well-documented prospectus that spells out the rights, responsibilities, and
risks to the franchisee
• An operations manual that details every aspect of running the business
• A training and support system for franchisees both before they start the busi¬
ness and on-going after start-up
• Site selection criteria and architectural standards
Developing a franchise program requires the assistance of an attorney and

an accountant whose advice should be carefully considered before undertaking
the effort.
Product Development
The third way to exploit the current market is to develop new products and
services for existing customers or offer new versions of existing products. That
is the tactic of software companies, who are constantly updating software with
new versions their customers must buy if they want to enjoy all the latest
features. Savvy businesses get their best ideas for new products from their
customers. These new ideas usually come in two forms: incremental changes in
existing products or totally new products. Incremental products often come
about serendipitously when engineers, sales personnel, and management spend

time out in the marketplace with the customers learning more about their
needs. Bringing all these team members together on a weekly basis to discuss
ideas helps the business to quickly zero in on those incremental products that
are possible within the current operating structure and budget. The advantage
of incremental products is that since they are based on existing products, they
can usually be designed and manufactured fairly quickly.
New or breakthrough products, on the other hand, have a much longer
product development cycle and are therefore more costly to undertake.
Breakthrough products cannot be planned for; instead, they usually come about
through brainstorming, exercises in creativity, and problem-solving sessions. In
other words, if the entrepreneur creates a business environment that encourages
creative, “off-the-wall” thinking, the chances are greater that it will eventually
come up with breakthrough products. The breakthrough environment of neces¬
sity has no budget or time constraints and does not run on a schedule. A
combination of incremental and breakthrough products is probably the most
effective way to go. The speed and cost efficiency of the incremental products
keeps cash flowing into the business that helps fund the more costly break¬
through products.
Branding
The most successful entrepreneurs recognize the power of a brand name; there¬
fore, they strive to gain brand-name recognition for their products and services
as quickly as possible so they can use the recognition to create a family of
related products and services under that name. A company that is able to estab¬
lish brand recognition will find its marketing effort that much easier and its
costs reduced. A brand name that reflects quality, service, and value is an asset
that can ultimately generate huge profits for the business. One example of the
value of brand name recognition is the T-shirt industry. Companies like
Mossimo and Nike buy basic T-shirts from an apparel manufacturer and then
print their design and logo on the shirt. Customers will pay more for a T-shirt
with the Mossimo name on it than they will for the same T-shirt with an
unknown company name on it—that’s brand recognition.
To establish brand recognition:
• Know what you’re good at. In other words, list the strengths your company
and its products possess. For example, do you offer a higher quality product,
a wider range of accessories or models, or exciting new colors?
• Educate customers about your strengths. Once you have identified your core
strengths, communicate them over and over again in all your marketing
efforts, from brochures to signs to advertising. They should literally become
a mantra for the customer. The minute customers think of your product,
they should associate it with its strengths.
• Develop a set of rules for using the brand name. If you want your brand
name to only be associated with wholesome things, you probably would not
want to advertise during a television show that contained violence, for
example. How the brand name will be used also needs to be decided.
Gentech Corporation, for instance, wanted the trade name for their product,
PowerSource, always to be associated with the company name, so in all its
advertising and promotion, the product is referred to as the Gentech
PowerSource. In this way, when additional products are developed in the
future, the common thread will be the company name, Gentech.
• Get feedback on brand-name recognition. To make sure the brand name is
achieving the recognition level you are seeking, check periodically with the
target customer.
Once brand name recognition has been established, take advantage of it by

developing related products under the same brand name. This only works,
however, when you are offering new benefits to your target market or taking the
same benefits to a new market. If you take a new product to a new market, the
brand recognition will not necessarily follow.
Integrative Growth Strategies—Growing within the Industry

Traditionally when entrepreneurs have wanted to grow their businesses within
their industry, they have looked to vertical and horizontal integration strategies,
but with the mantra of the 1990s being “lean and mean,” entrepreneurs with
growing businesses are more often than not looking to a modular or network
strategy. This section examines all three strategies.
Vertical Integration Strategies

An entrepreneurial venture can grow by moving backward or forward within
the distribution channel. With a backward strategy the company either gains
control of some or all of its suppliers, or it becomes its own supplier by starting
another business from scratch or acquiring an existing supplier that has a
successful operation. This has been a common strategy for businesses that have
instituted a just-in-time inventory control system. By acquiring the core

supplier(s), the entrepreneur can streamline the production process and cut
costs. With a forward strategy, the company attempts to control the distribution
of its products by either selling directly to the customer (i.e. acquiring a retail
outlet) or acquiring the distributors of its products. This strategy gives the busi¬
ness more control over how its products are marketed.
Horizontal Integration Strategies

Another way to grow the business within the current industry is to buy up
competitors or start a competing business (i.e. sell the same product under
another label). For example, suppose you own a chain of sporting goods
outlets. You could purchase a business that has complementary products such
as a batting cage business so your customers can buy their bats, balls, helmets,
and so forth from the retail store and use them at the batting cage.
Another example of growing horizontally is to agree to manufacture your
product under a different label. New York designer Mark Eisen manufactures a
line of clothes for Spiegel Catalog under a different name in addition to his
designer label line. This strategy has been used frequently in the major appli¬
ance and grocery industries. Whirlpool, for example, produced Sears’ Kenmore
washers and dryers for years. Likewise, major food producers put their brand
name food items into packaging labeled with the name of a major grocery store.
Modular or Network Strategies

The latest way to grow within your own industry is to focus on what you do
best and let others do the rest. If the core activities of the business include
designing and developing new products for the consumer market, other
companies can make the parts, assemble the products, and market and deliver
them. In essence, your company with its core activities becomes the hub of the
wheel with the best suppliers and distributors as the spokes. By doing this, the
business can grow more rapidly, keep unit costs down, and turn out new prod¬
ucts more quickly. In addition, the capital saved by not having to invest in fixed
assets can be directed to those activities that provide a competitive advantage.
The electronics and apparel industries used this growth strategy long before it
became trendy. Today many other industries are beginning to see the advan¬
tages to a modular approach. Even service businesses can benefit from
outsourcing functions like accounting, payroll, and data processing, which
require costly labor. The key to success with a network strategy such as this is
to have a good relationship with suppliers and distributors so that as the busi¬
ness begins to grow rapidly, they are willing to ramp up to meet demand.
Diversification Growth Strategies—Growing Outside the Industry

When entrepreneurs expand their businesses by investing in or acquiring prod¬
ucts or businesses outside their core competencies and industry, they are
employing a diversification growth strategy. Usually, but not always, this
strategy is used when the entrepreneur has exhausted all growth strategies
within the current market and industry and now wants to make use of excess
capacity or spare resources, adapt to the needs of customers, or change the
direction of the company because of impending changes in the market or
economy. The latter is exemplified by the collapse of the Houston oil economy
in 1984. Many entrepreneurs who saw their oil ventures drying up found they
had to diversify into new product lines or services to survive and grow.
One way to diversify is to use a synergistic strategy where you attempt to
locate new products or businesses technologically complementary to your busi¬
ness. For example, a food processor may acquire a restaurant chain that can
serve as a showcase for the food. Another way to diversify is to employ a
strategy where you acquire products or services that are unrelated to your core
products or services. For example, a manufacturer of bicycle helmets may
acquire an apparel manufacturer to make clothing with the company logo on it
to sell to helmet customers. A final strategy for diversifying is called conglom¬
erate diversification and involves acquiring businesses that are not at all
related in any way to what you are currently doing. An entrepreneur might use
this strategy to gain control of a related function of doing business—for
example, purchasing the building in which the business is housed and then
leasing out excess space to other businesses to produce additional income and
gain a depreciable asset. Many entrepreneurs whose work causes them to travel
extensively find it advantageous to acquire a travel agency to reduce costs and
provide greater convenience.
A diversification strategy for growth is not something to undertake without
careful consideration of all the factors and potential outcomes, particularly
when it involves an acquisition. While it is true that the entrepreneur can find
consultants who are experts in mergers and acquisitions to help smooth the
path financially and operationally, what is difficult to predict with any degree of
certainty is how the cultures of the two businesses will merge. Acquisitions and
mergers cannot be successful based on financial and operational synergy alone.

Organizational styles and individual personalities of key management all come
into play when an acquisition or merger takes place. As a result, the human side
of the two businesses must be analyzed and a plan developed for merging two
potentially distinct cultures into one that can work effectively.
PROFILE 16.1
The Case of a Commercial Printer1

Quick Press is a commercial printer located in Connecticut. Its owner/entrepreneur,
Sam Quick, saw significant changes beginning to take place in the printing industry
toward the end of the 1980s. It was obvious that traditional printing methods were
being overtaken by desktop publishing via computers. Not wishing to become an
obsolete business, he hired a computer consultant to determine the best way to
computerize the company so it could continue to grow. The consultant informed
Quick that the cost would be high and the learning curve steep. It was then that Quick
decided it might be more cost efficient to acquire a company that already had the
capability he needed.
In 1991, Quick was able to buy such a company, Graphical Arts. On the surface
the deal appeared to have synergy. With the capabilities of the two companies, Quick
could offer their customers a wider variety of services and could also do some of the
work in-house that he had previously had to outsource, tasks like color-scanning.
However, many of Quick’s customers are large companies who have also gone to
doing much of their printing in-house. The marketplace is extremely competitive with
very tight margins.
The first thing Quick found out after the acquisition had taken place was that much
of the technological expertise for which he paid, although excellent, was still in the
R&D stage; this started things off on the wrong foot. The next problem was the clash
of cultures. There were significant differences in management style and workplace
attitude, with the Quick Press employees being a more laid-back group and the
Graphical Arts employees much more disciplined, professional, and serious. With no
preparation for the merger, it was no surprise that the two groups found it difficult to
adjust. The bottom line is that the acquisition definitely positioned the company for
future growth, but until the people issues were resolved, that growth remained stalled.
^he actual names of the parties in this case are not being used.
Many researchers have attempted to determine the most effective growth

strategy for a new venture. In general, it has been found that horizontal integra¬
tion, vertical integration, and synergistic diversification have been more
successful than unrelated diversification. This is true whether the entrepreneur
acquires an existing company or starts another company to achieve the goal.
This is not to say that unrelated diversification should never be chosen as a
growth strategy. If the potential gains are by comparison extraordinarily high,
the risk may be worth the taking. It is also generally true that an acquired busi¬
ness has a better chance of success than a start-up for the obvious reason that it
has usually already passed the crucial two stages of start-up and survival and is
more likely to be poised to grow.
Growing by Going Global

Today the question for a growth-oriented company is not should we go global,
but when should we go global? There are many reasons why entrepreneurial
ventures must consider the global market even as early as the development of
their original business plan. Today technology is not the sole province of the
United States. Gone are the days when the United States could ship its obsolete
technology to other countries to extend its market life. Other countries now
expect to receive the latest technology in the goods they purchase, and it may
not always come with a United States label on it. In fact, the United States,
while a huge market, represents less than half of the total global market.
Furthermore, due to rapidly changing technology, product lives are increas¬
ingly shorter and with R&D being so expensive, companies are forced to enter
several major markets at once to gain the maximum advantage from the
window of opportunity. Entrepreneurs who attend world trade shows know
their strongest competition may as easily come from a country in the Pacific
Rim as from the company next door. Entrepreneurs also know they may have to
rely on other countries for supplies, parts, and even fabrication to keep costs
down and remain competitive.
With increasing competition and saturated markets in some industries,
looking to global markets can add a new dimension to the entrepreneur’s busi¬
ness. Many entrepreneurs have found new applications for their products in
other countries or complementary products that help increase the sales of their
product domestically. Several events have made exporting United States prod¬
ucts to other countries more attractive than ever before.
• Relatively low United States interest rates have made it easier for businesses
to finance the exporting of their products.
• The North American Free Trade Agreement (NAFTA) eliminates trade
barriers among the United States, Mexico, and Canada, which makes
exporting to those countries more attractive.
• The decline of the U.S. dollar, while not good for U.S. travelers in other
countries, certainly makes U.S. goods more affordable for other countries.
• The opening up and growth of untapped markets like China and Vietnam
means more potential customers for U.S. products.
• The establishment of the first four Federal Export Assistance Centers give
businesses considering exporting a new source of help. The four centers are
located in Baltimore, Long Beach, Miami, and Chicago.
• The Uruguay Round of GATT (the General Agreement on Tariffs and Trade)
potentially will reduce or eliminate tariffs among 117 countries starting in
1995. It will also provide for improved patent and copyright protection,
which has been a problem for businesses exporting protected products to
other countries where proprietary rights may not be recognized or protected.
While you should include a global strategy in any business planning, you
will probably not be able to export until the business is somewhat established
and offering a high-quality product or service at a competitive price. Exporting
is a long-term commitment that may not pay off for some time. During that
period you may have to adapt the product or service somewhat to meet the
requirements of the importing country and develop good relationships with
agents in the country. If you are dealing in consumer products, target countries
that have disposable income and like American products. If, on the other hand,
you are dealing in basic or industrial products, look to developing countries
that need equipment and services for building infrastructures and systems. One
example is Mexico, which is taking on the enormous task of building bridges
and roads as it positions itself as a major player in the world market.
Finding the Best Global Market

Finding the best market for a product or service can be a daunting task, but
there are some sources and tactics that help make the job easier. Start with the
International Trade Statistics Yearbook of the United States, which is available in
any major library. Using the SITC (United Nations Standard Industrial Trade
Classification) codes found in this reference book, you can find information on
international demand for your product or service in specific countries. The
SITC system is a way of classifying commodities used in international trade.

You should also be familiar with the Harmonized System of classification,
which is a ten-digit system that puts the U.S. “in harmony” with most of the
world in terms of commodity tracking systems. If your international shipment
exceeds $2,500, you must know your HS number for documentation.
Demand for American products is usually reflected in three areas:
1. The dollar value of worldwide imports of a specific type of product to a

country
2. The level of growth of these imports as seen by import demand records over
time. Look for a country whose level of import demand exceeds worldwide
averages for a product or service.
3. The share of total import demand to a country that is enjoyed by U.S. prod¬
ucts. This figure should exceed five percent. A lower figure could indicate
that tariffs might be affecting growth.
Consult additional sources of information like the District Office or the

Washington DC office of the International Trade Administration, and the
Department of Commerce (DOC). The Commerce Department’s database links
all the DOC International Trade Administration offices and provides a wealth of
valuable research information.
The successful launch of a program of global growth should include a
marketing plan and budget directed toward that goal in the business plan. You
also need to bring someone onto the team who has international management
experience or export experience. Depending on your budget, you may choose
to hire a consultant who specializes in this area. It is also important to attend
foreign trade shows to learn how businesses in the countries in which you are
interested conduct business, who the major players are, and who the competi¬
tion is. Finally, this chapter cannot present all the detailed information needed
before beginning to export. Consulting a source dedicated to exporting, such as
Jack Wolfs Export Profits (Upstart Publishing), is a must.
Export Financing
To make a sale in the global market, the entrepreneur must have the funds to
purchase the raw materials or inventory to fill the order. Unfortunately, many
entrepreneurs assume that if they have a large enough order, getting financing
will be no problem. Nothing could be further from the truth. Export lenders,
like traditional lending sources, want to know that the entrepreneur has a
sound business plan and has the resources to fill the orders. Entrepreneurs
desiring to export can look for capital from several sources:
• Bank financing
• Internal cash flow from the business
• Venture capital or private investor capital
• Prepayment, down payment, or progress payments from the foreign
company making the order
A commercial bank is more interested in lending money to a small exporter

if the entrepreneur has secured a guarantee of payment from a governmental
agency such as the Import-Export Bank, which limits the risk undertaken by
the bank. Asking buyers to pay a deposit up front, enough to cover the
purchase of raw materials, can also be a real asset to a young company with
limited cash flow.
Foreign Agents, Distributors, and Trading Companies

Every country has a number of sales representatives, agents, and distributors
who specialize in importing American goods. It is possible to find one agent
who can handle an entire country or region, but if a country has several
economic centers, it may be more effective to have a different agent for each
center. Sales representatives work on commission; they do not buy and hold
products. Consequently, the entrepreneur is still left with the job of collecting
receivables which, particularly when you're dealing with a foreign country, can
be costly and time consuming.
Agents are a way to circumvent this problem. Agents purchase your product
at a discount (generally very large) off list and then sell it and handle collections
themselves. They solve the issue of cultural differences and the ensuing prob¬
lems inherent in these transactions. Of course, with an agent you lose control
over what happens to the product once it leaves your hands. You have no say
over what the agent actually charges customers in his or her own country. If the
agent charges too much in an effort to make more money for himself, you may
lose a customer. If you are just starting to export or if you are exporting to areas
not large enough to warrant an agent, consider putting an ad in American trade
journals that showcase American products internationally. If you are producing
a technical product, you may be able to find a manufacturer in the international
region you are targeting who will let you sell your products through their
company, thus giving you instant recognition in the foreign country. Ultimately,
they could also become a source of financing for your company.
Another option is to use. an Export Trading Company (ETC) that specializes

in certain countries or regions where they have established a network of sales
representatives. ETCs may also specialize in certain types of products. What
often happens is that a sales rep may report to the ETC that a particular country
is interested in a certain product. The ETC then locates a manufacturer, buys
the product, and sells it in the foreign country. Trading companies are a particu¬
larly popular vehicle when dealing with Japan.
Choosing an Intermediary
Before deciding on an intermediary to handle the exporting of your products:
1. Check their current listing of products to see if your company seems to fit in
with their expertise.
2. Understand with whom will you be competing; that is, does the interme¬
diary also handle your competitors?
3. Find out if the intermediary has enough representatives in the foreign
country to adequately handle the market.
4. Look at the sales volume of the intermediary. It should show a rather consis¬
tent level of growth.
5. Make sure the intermediary has sufficient warehouse space and up-to-date
communication systems.
6. Examine the marketing plan.
7. If needed, make sure the intermediary can handle servicing your product.
Once you have decided on the intermediary, draft an agreement detailing the
terms and conditions of the relationship. As it is very much like a partnership
agreement, consult an attorney specializing in overseas contracts. The most
important thing to remember about the contract is that it must be based on
performance so you do not tie yourself up for many years with someone who is
not moving enough product for you. Negotiate a one- or two-year contract with
an option to renew should performance goals be met. This will probably not
please the intermediary as most want a five- to ten-year contract. Be firm; it is
not in your best interests to do a longer contract until you know that the person
is loyal and can perform. Other issues that should be addressed in the agree¬
ment include:
• Your ability to use another distributor; in other words, negotiate for a non¬
exclusive contract so you have some flexibility and control over the situation.
• The specific products the agent or distributor will represent. This is impor¬
tant because as your company grows, you may add or develop additional
products and not want this agent to sell those products.
• The specific geographic territories for which the agent or distributor will be
responsible.
• The specific duties and responsibilities of the agent or distributor.
• A statement of agreed-upon sales quotas.
• A statement of the jurisdiction in which any dispute would be litigated.
This will protect you from having to go to a foreign country to handle a
dispute.
Choosing a Freight Forwarder

The freight forwarders job is to handle all aspects of delivering the product to
the customer. The method by which you ship a product has a significant impact
on the product’s cost or the price to the customer, depending on how the deal is
structured, so consider the choice of a freight forwarder carefully. The ability to
fill a shipping container to capacity is crucial to reducing costs. Freight
forwarders prepare the shipping documents, which include a bill of lading (the
contract between the shipper and the carrier) and an exporter declaration form
detailing the contents of the shipment, and they can present shipping docu¬
ments to your bank for collection. The entrepreneur, however, is responsible for
knowing if any items being shipped require special licenses or certificates, as in
the case of hazardous materials or certain food substances.
Additional Sources for Exporting
Directory of American Firms Major Companies of the Far East

Operating in Foreign Countries Moody's International Manual
Europa World Year Book Predicast's F&S International Index
European Directory of Marketing Information Sources Predicast’s F&S Index Europe
Exporters Encyclopedia U.S. Importers and Exporters Directory
Guide to Canadian Manufacturers United Nations Statistical Yearbook
International Marketing Handbook Worldcasts
Japan Trade Directory
Global Franchising
The first franchisors on the global scene were primarily the large food franchises
such as MacDonalds, Kentucky Fried Chicken, and Burger King. Today even
smaller franchisors are going global. Franchisors are generally welcomed by
foreign governments because they bring not only a product to the country but a
way of doing business, which provides jobs for the citizens of the country.
Those who have chosen to try their luck in developing countries or the old
Eastern Block countries have consistently found the cost of doing business there
much higher. In addition, they are likely to have to deal with unstable govern¬
ments, volatile currencies, and a general lack of understanding of competitive
market systems. Many international franchisors have discovered that having a
local partner is one of the keys to a successful global effort because it allows
them to acquire an understanding of the business and consumer culture in the
country. They also tend to look to establish master franchise agreements, which
gives the franchisee the rights to the entire country or region.
One of the challenges facing international franchisors is achieving the same
level of productivity and service they experience in the United States. In some
countries low productivity is simply a way of life, and changing old habits can
require hours of training. One source of help for potential international fran¬
chisors is the International Franchise Association (IFA) located in Washington,
DC. This organization has established a Code of Ethics and, through its
Franchisee Advisory Council, provides dispute resolution for both franchisees
and franchisors.
PROFILE 16.2
Domino’s Goes Global

Domino’s went into Japan literally against all odds. Other pizza companies had failed,
suggesting that the Japanese simply didn’t like pizza. Moreover, free delivery, which
was the way Domino’s had differentiated itself in the domestic market, was an
expected service in the Japanese market. Still, after extensive research, Domino's
decided to move ahead and successfully captured the Japanese market by reducing
the size of their pizzas to accommodate the smaller appetites of the Japanese
customer, using scooters to maneuver the crowded streets, and creating exciting
packaging and brochures, which the Japanese appreciate. Today Domino’s stores in
Japan do twice the volume of those in the United States.
To Grow or Not to Grow...

Some entrepreneurs make a conscious choice to control growth even in the face
of extraordinary market demand. This is not to say growth is slowed to single
digits. Instead the entrepreneur may choose to maintain a stable growth rate of
35 to 45 percent per year rather than subject the young venture to a roller
coaster ride in the triple digits. In general, entrepreneurs who restrain growth
do so because they are in the business for the long term, so they don’t advertise
heavily or aggressively seek new customers beyond their capabilities. Instead,
they diversify their product or service line from the beginning to make them¬
selves independent of problems that may face their customers or their indus¬
tries.
It is intoxicating for a new venture to realize potential demand is great and
that the company could virtually fly off the scales in terms of industry averages.
But “speed of light” growth has destroyed many companies that did not have
the capacity, skills, or systems in place to meet demand. The growth phase of a
new business can be one of the most exciting times for an entrepreneur. But if
the entrepreneur has not prepared for growth with a coherent plan and budget
to match, it can be instead a disastrous time for an otherwise successful start¬
up. The keys to successful growth are to be the best at what you do, be the first
in the market where possible, operate lean and mean, offer something unique,
and have a plan.
[7| New Venture Checklist

Have you
□ Identified market factors that may affect the growth of the business?
□ Determined which growth strategy is most appropriate?
D Identified potential international markets for the product or service?
D Developed a plan for globalization of the company at some point in the future?
Commerce Department, “Flash Facts,” a 24-hour free fax line for information
on specific international regions. Eastern Europe, 202-482-5745; Mexico,
202-482-4464; Pacific Basin, 202-482-3875; Africa, Near East, and South
Asia, 202-482-1064.
Commerce Department—District Offices. The Export Yellow Pages, includes
U.S. export companies, intermediaries, and freight forwarders.
Export-Import Bank, Washington, D.C. 202-566-4490, for a list of lenders
who handle international transactions.
Export-Import Bank’s City/State Program, 800-424-5201.
Rager, L. (June 1989). “How to Expand by Franchising.” Nation’s Business.
Roberts, M.L. & Berger, P.D. (1989). Direct Marketing Management.
Englewood Cliffs, NJ: Prentice-Hall, Inc.
Trade Information Center, 800-USA-TRADE (800-872-8723). Ask for an
industry desk officer who specializes in your industry.
U.S. Small Business Administration, Bankable Deals, a book on export
finance, 202-205-6720. Also has lists of trade events.
Wolf, J.S. (1992). Export Profits. Dover, NH: Upstart Publishing Company,
Inc.
1. What are four characteristics of high-growth companies?

Issues to
2. How can both market and management factors affect the growth of a new
Consider
venture?
4x 3. What questions should you ask at each level of the new venture’s growth?
4. What advantages do intensive strategies have over integrative and diversifica¬
tion strategies?
5. Why is it important to start a growth-oriented business with a plan for glob¬
alization from the beginning?
6. What are the differences among foreign agents, distributors, and export
trading companies in terms of the services they provide?
CHAPTER 17
Financing Growth
Overview
• The nature oj the venture capital industry
• How to obtain venture capital
• Using the Private Placement Memorandum to raise growth capital
• Going public
• Using strategic alliances as a growth vehicle
• Valuing the growing venture
Finding Growth Capital

Seed capital is the money the entrepreneur raised or used to develop and start
the business. Growth capital, or second round financing, refers to those funds
needed to take the venture out of the start-up phase and move it toward becom¬
ing a contender in the global marketplace. To the extent that the entrepreneur
has met the sales and earnings targets estimated in the start-up business plan,
the choices available increase substantially when growth financing is sought. The
fact that more choices are available is important because the amount of money
needed to grow the business is normally significantly larger than that required to
start the business. One exception is high-tech companies that incur considerable
R&D costs prior to start-up. These types of companies may spend millions of
dollars and accrue several years of negative income before their first sale.
Most venture capital today is still going to the biotechnology, software, and
computer ventures, but, in general, the best companies in any industry have the
369
easiest time finding capital. To become one of the “best” companies requires an
excellent track record (however short), a sound management team, and potential
for high growth. Often the bottom line criterion for securing a bank loan is to be
a company that doesn’t really need the money. The same can be said for
suppliers of growth capital. They typically will not go into a situation where their
“new money” is paying off “old debt,” or where a company has poor cash flow.
They want to know that the infrastructure is in place, sales are increasing, and
the growing venture needs capital only to take that next leap up the sales ladder.
Make no mistake about it, raising growth capital is a time-consuming and
costly process. Many entrepreneurs opt instead for growing slowly, depending
exclusively on internal cash flow to fund growth. They have a basic fear of debt
and giving up any control of the company to investors. This attitude is
The first thing to fine if it works, but new ventures that begin with obvious high-growth
understand about potential will find themselves hamstrung and frustrated by a level of
raising growth
growth that prohibits them from meeting demand. Plan for growth from
capital is that it will
the very beginning so you will be prepared for the expense and the
invariably take at
demands on your time when they come.
least twice as long
The first thing to understand about raising growth capital (or any
as you thought.
capital for that matter) is that it will invariably take at least twice as
long as you thought to actually have the money in the company’s bank account.
If you are attempting to raise a substantial amount of money, several million
dollars for instance, you can expect it to take possibly several months to find
the financing, several more months for the potential investor or lender to do
due diligence and say yes, and then up to six months more to receive the
money. In other words, don’t wait to look for funding until you need it; it will
be too late, which—if you’re not prepared with a backup source—could spell
disaster for the business. Moreover, as this search for capital can take the entre¬
preneur away from the business when he or she is needed most, it is helpful to
use financial advisors who have experience raising money, and to have a good
management team in place so you don’t have to worry about the business while
you’re out seeking money.
The second thing to understand about raising growth capital is to never rely
on the person you have identified as the financial source to actually come
through for you. Keep looking for additional investors, if only as backups,
because you may ultimately determine that the terms of the first investor are not
compatible with your goals. Often second round financiers request a buy-out of
the first round funding sources, who could be friends or family, because they
feel the first round has nothing more to contribute to the business and they no
Chapter 17 • Financing Growth 371
longer want to deal with them. This can be a very awkward situation, as the
second round funder has nothing to lose by demanding the buy-out. They can
certainly walk away from the deal; there are thousands more out there.
In figuring out how much capital the venture needs to grow, many entrepre¬
neurs concentrate on the cost of the capital in terms of interest rate or return on
investment and fail to ipclude the cost of seeking the capital, which can be
substantial. The costs incurred before the money is received must be paid up
front by the entrepreneur, while the costs of maintaining the capital can often
be paid from the proceeds of the loan, or in the case of investment capital, from
the proceeds of a sale or internally generated cash flow.
If the business plan and financials have been kept up-to-date after the start of
the business, you have taken the first step in preparing the company for presen¬
tation to a funding source and saved some money in the process. If you are
seeking capital in the millions, however, growth capital funding sources prefer
that your financials have the imprimatur of a financial consultant or investment
banker, someone who regularly works with investors. This person is expert in
preparing loan and investment packages that are attractive to potential funding
sources. Your CPA will prepare the business’s financial statements and work
closely with the financial consultant. All of these activities result in costs to the
entrepreneur. In addition, if you are seeking equity capital, you need a
prospectus or offering document, which requires legal expertise and often has
significant printing costs. Then there are the costs to market the offering; such
things as advertising, travel, and brochures can become quite costly.
In addition to the up-front costs of seeking growth capital, there are “back¬
end” costs when the entrepreneur seeks capital by selling securities (shares of
stock in the corporation). These can include investment banking fees, legal fees,
marketing costs, brokerage fees, and various other fees charged by state and
federal authorities. The total cost of raising equity capital can go as high as 25
percent of the total amount of money sought. Add that to the interest or return
on investment paid to the funding source(s) and you can see why it definitely
costs money to raise money.
The Venture Capital Market

Private venture capital companies have been the bedrock of many high-growth
ventures, particularly in the computer, software, biotechnology, and telecom¬
munications industries. As venture capitalists rarely invest in start-up ventures
outside the high-tech arena, the growth stage of a new venture is where most
entrepreneurs consider approaching them. Waiting until this stage is advanta¬

geous to the entrepreneur because using venture capital in the start-up phase
can mean giving up significant control. Private venture capital is, quite simply, a
pool of money managed by professionals. These professionals usually assume
the role of general partner and are paid a management fee plus a percentage of
the gain from the investment by their investors. The venture capital firm takes
an equity position through ownership of stock in the company. It also normally
requires a seat on the board of directors and brings its professional management
skills to the new venture in an advisory capacity.
In the 1980s the number of private venture capital firms grew by 199
percent, while the average amount of money under professional management
grew from $2.9 billion in 1979 to over $49.5 billion in 1989. It was an easy
time for entrepreneurs seeking this type of capital. However the growth in
venture capital firm formation peaked in 1987 and has been on the decline ever
since. One reason is the relative demise of the junk bond market, and with it
the leveraged buy-out and mergers and acquisitions market. Another reason is
that most of the new opportunities lie with smaller, innovative companies that
have not held the interest of the venture capitalists. A third reason is the poor
performance of many venture capital funds, due in large part to a weak
economy. Two experts on venture capital markets, Bill Bygrave and Jeff
Timmons, believe the venture capital system is at a “crossroads” with the need
for a new vision.1 Others agree, calling venture capital the “incredibly shrinking
venture capital industry.”2 On the other hand, the possibility of global venture
capital is now very attractive. Europe, for example, has 342 million inhabitants,
making it arguably the richest market in the world.
The Venture Capital Sequence of Events

To determine if venture capital is the right type of funding for the growing
venture, the entrepreneur must understand the goals and motivations of
venture capitalists, for they dictate the potential success or failure of the
attempt. The venture capital company invests in a growing business through
the use of debt and equity instruments to gain long-term appreciation on the
investment within a specified period of time, typically five years. By definition,
this goal is often different from that of the entrepreneur, who usually looks at
the business from a much longer frame of reference. The venture capitalist (VC)
'Bygrave, W.D. & Timmons, J.A. (1992) Venture Capital at the Crossroads. Boston: Harvard Business School
Press.
2Venture Capital Journal, Special Report, April 1990, p. 1.
also seeks varying rates of return depending on the risk involved. An early-stage
investment, for example, characteristically demands a higher rate of return, as
much as 50 percent or more, while a later-stage investment demands a lower
rate of return, perhaps 30 percent. Very simply, as the level of risk increases, so
does the demand for a higher rate of return as depicted in Figure 17.1. This
relationship is certainly not surprising. Older, more established companies have
a longer track record on which to make predictions about the future, so normal
business cycles and sales patterns have been identified, and the company is
usually in a better position to respond through experience to a dynamic envi¬
ronment. Consequently investing in a mature firm does not command the high
rate of return that investing in a high-growth start-up does.
Usually the first thing venture capitalists look at when scrutinizing a potential
investment candidate is the management team to see if experienced people with a
good track record are in place and able to take the company to the next level of
growth. In addition to experience, they are looking for commitment to the
company and to growth because they recognize that growing a company requires
an enormous amount of time and effort on the part of the management team.
Once they have determined that the management team is solid, they look at the
product and the market to see if the opportunity is substantial and if the product
holds a unique or innovative position in the marketplace. Product uniqueness,
especially if protected through intellectual property rights, helps create entry
barriers in the market, commands higher prices, and adds value to the business.
Figure 17,1: Risk vs. Rate of Return
Rate of
Return
The other major factor is the potential for significant growth and the amount
of growth possible, because it is from the consequent appreciation in the value
of the business that the venture capitalist will derive the required return on
investment. The venture capitalist weighs that potential for growth against the
risk of failure and the cost to achieve the growth projected. Therefore, when
negotiating with venture capitalists, the entrepreneur should have a good sense
of the value of the business, a topic discussed at the end of this chapter.
Armed with an understanding of what venture capitalists are looking for, the
entrepreneur is prepared to begin the search for the company that meets his or
her needs. As the venture capital community is fairly close knit, at least
The best way to
within regions of the country, it is wise not to “shop” the business
approach a venture
around looking for the best deal. Do some research on the venture
capitalist is through
capital firms in your state first to see if any specialize in your particular
a referral from
industry or type of business. Get recommendations from attorneys and
someone who
knows them. accountants who regularly deal with business investments. In fact, the
best way to approach a venture capitalist is through a referral from
someone who knows them. Once a venture capital company has been chosen,
it is preferable to stay with that company until you are certain the deal will not
work. Under no circumstances should you be talking to two companies at once.
The venture capital company will no doubt ask for a copy of the business
plan with an executive summary. The executive summary is a screening
device—if it can't be immediately determined that the entrepreneurial teams
qualifications are outstanding, the product concept innovative, and the projec¬
tions of growth and return on investment realistic, they will not bother to read
the entire business plan.
If, on the other hand, after studying the plan they like what they see, they
will probably call for a meeting to determine if the entrepreneurial team can
deliver what they project. This may or may not call for a formal presentation of
the business by the entrepreneur. During this meeting, the initial terms of an
agreement may also be discussed; however, the entrepreneur should not be too
eager to discuss issues like owner compensation until the venture capitalist
indicates a deal is imminent. It is also very important that the entrepreneur not
hype the business concept or make claims that cannot be substantiated. Venture
capitalists have literally seen it all and readily recognize when an entrepreneur
is puffing. The entrepreneur should, however, disclose any potential negative
aspects to the business and ways to deal with them.
If the meeting goes well, the next step is due diligence—that is, the venture
capital firm has their own team of experts check out the entrepreneurial team
and the business thoroughly. If they are still sold on the business, they draw up
legal documents to detail the nature and terms of the investment and declare that
“the check’s in the mail.” Don’t spend the money, however, as it may take some
time to receive it. Some venture capitalists wait until they know they have a satis¬
factory investment before putting together a partnership to actually fund the
investment. Others just have a lengthy process for releasing money from the firm.
You should not be surprised if the money is released in stages based on
meeting agreed-upon goals. Also realize that the venture capital firm will
continue to monitor the progress of the new venture and probably want a seat
on the board of directors to have a say in the direction the new venture takes.
Capital Structure
It may seem that the entrepreneur is totally at the mercy of the venture capi¬
talist. That, unfortunately, is true if the entrepreneur enters the negotiation from
a weak position, desperately needing the money to keep the business alive. A
better approach is to go into the negotiation from a position of strength. True,
venture capitalists have hundreds of deals presented to them on a regular basis,
but most of those deals are not big hits; in other words, the return on the
investment is not worth their effort. They are always looking for that one busi¬
ness that will achieve high growth and return them enough gain on their invest¬
ment to make up for all the average or mediocre-performing investments in
their portfolio. If the entrepreneur enters the negotiation with a business that
has a solid record of growth and performance, he or she is in a good position to
call many of the shots.
Any investment deal has four components:
• The amount of money to be invested

• The timing and use of the investment moneys
• The return on investment to investors
• The level of risk involved
How these components are defined will affect the venture for a long time,
not only in constructing its growth strategy but in formulating an exit strategy.
Venture capitalists often want both equity and debt—equity because it gives
them an ownership interest in the business, and debt because they will be paid
back more quickly. Consequently, they tend to want redeemable preferred stock
or debentures so that if the company does well, they can convert to common
stock, and if the company does poorly or fails, they will be the first to be repaid
their investment because they have preferred stock. If you have entered the
negotiation from a position of strength, you will more likely be able to convince
them to take common stock, which makes things much easier for you. In
another scenario, the venture capitalists may want a combination of debentures
(debt) and warrants, which allows them to purchase common stock at a
nominal rate later on. If this strategy is carried out correctly they can conceiv¬
ably receive their entire investment back when the debt portion is repaid and
still enjoy the appreciation in the value of the business as a stockholder.
There are several other provisions venture capitalists often ask for to protect
their investment. One is an antidilution provision, which ensures that the
selling of stock at a later date will not decrease the economic value of the
venture capitalists investment. In other words, the price of stock sold at a later
date should be equal to or greater than the price at which the venture capitalist
could buy the common stock on a conversion. One way to ensure that dilution
does not occur is to have a full ratchet clause that allows the venture capitalist
to buy common stock at the lowest rate at which it has been sold. For example
if the lowest price at which the stock has been sold to this point is $ 1, then that
is the conversion rate for the VC. However, if subsequently the stock is
Venture capital is sold at $.50, then all the VC’s convertible shares can be purchased at
only one source, the new lowest rate. Where their $1 million investment would have
and with the advice bought 1 million shares at $ 1/share, they now can buy 2 million shares
of experts, the at $.50 a share, effectively reducing the equity holding of the founders.
entrepreneur should A better method from the entrepreneurs point of view is to use a
consider all other weighted ratchet approach, which uses the weighted price per share of
possible avenues. all the stock issued after the founder’s stock and before the lowest stock
price that will cause dilution. This is certainly fairer to the founders and
prevents them from losing control of the company should the value of the stock
decrease substantially.
In addition, the VC may often request a forfeiture provision, which means that
if the company does not achieve its projected performance goals, the founders
may be required to give up some of their stock as a penalty to the VC to guard
against their having paid too much for their interest in the company. This
forfeited stock increases the VC’s equity in the company and may even be given
to new management that the VC brings on board to steer the company in a new
direction. One way to mitigate this situation is for the entrepreneur to request
stock bonuses as a reward for meeting or exceeding performance projections.
Using venture capital is certainly an important source for the entrepreneur
with a high-growth venture. It is, however, only one source, and with the
advice of experts, the entrepreneur should consider all other possible avenues.
The best choice is one that gives the new venture the chance to reach its poten¬
tial and the investors or financial backers an excellent return on investment.
Private Placement
Private placement is a way of raising capital from private investors by selling
securities in a private corporation or partnership. Securities are common and
preferred stock, notes, bonds, debentures, voting-trust certificates, certificates
of deposit, warrants, options, subscription rights, limited partnership shares,
and undivided oil or gas interests. It is a less costly, less time-consuming
process than a public offering, and many states now offer standardized, easy-to-
fill-out disclosure statements and offering documents.
The advantages of a private offering are many. The growing venture does not
have to have a lot of assets or credit references, which they would need for bank
financing, or a lengthy track record. They also don’t have to file with the
Securities and Exchange Commission (SEC). They do, however, have to qualify
under the rules of Federal Regulation D. Not all states recognize the exemptions
under Regulation D in their “Blue Sky” laws, so the issuer of a private placement
memorandum may have to register with the state. Essentially, Regulation D says:
• The entrepreneur must file five copies of Form D with the SEC within 15
days after the first sale of securities, then every six months thereafter, and 30
days after the final sale.
• The entrepreneur must follow the rules for notices of sale and payment of
commissions.
• Rule 504 permits the entrepreneur to sell up to $1 million worth of securi¬
ties to any number of investors, whether they are sophisticated or not during
a 12-month period. Sophisticated in this context refers to people who invest
on a regular basis and have a net worth of at least $1 million.
• Rule 505 allows the founders to sell $5 million of unregistered securities in a
12-month period to up to 35 investors of any type in addition to an unlimited
number of accredited investors. Accredited investors include institutional
investors such as banks and insurance companies, investors who purchase at
least $150,000 of securities in the entrepreneur’s venture, investors with a net
worth over $1 million or annual income of over $200,000 in the previous two
years, and directors and officers of the company.
• Rule 506 allows the founders to sell an unlimited number of securities to 35
investors and unlimited accredited investors and relatives of the founders but
without general solicitation through advertising. An issuer under this rule

can sell securities to accredited investors without any disclosures whatsoever.
An example might be selling securities to someone with whom you have an
ongoing business relationship and who qualifies as an accredited investor.
The burden is on the issuer to document that the exemption from registra¬
tion requirements have been met. Therefore, the “sophistication” of all offerees
should be examined closely and the reasons why they qualify carefully docu¬
mented. The issuer should also number each private placement memorandum
and keep a record of who has looked at the memorandum or discussed the
offering with the issuer. The memorandum should have a qualifying statement
on it that the contents must not be copied or disclosed to anyone other
Within the structure
than the offeree. If an offeree becomes an investor, the issuer should
of the corporate
document when and where the offeree examined the books and records
private placement,
of the company. When the offering is complete, the issuer should place
the entrepreneur
a memo in the offering log stating that only those persons listed in the
can sell preferred
log have been approached regarding the offering.
and common stock,
convertible Even if the offering qualifies as exempt from registration, it is still
debentures, and subject to the antifraud and civil liability provisions of federal securities
debt securities laws and state Blue Sky securities laws. Many states have adopted the
with warrants. Small Corporate Offering Registration Form, also called SCOR U-7,
which makes the registration process much simpler by providing 50
fill-in-the-blank questions that ask for the basic financial, management, and
marketing information for the company. Your lawyer should be consulted as
some of the adopting states restrict who can use Form U-7.
Within the structure of the corporate private placement, the entrepreneur
can sell preferred and common stock, convertible debentures, and debt securi¬
ties with warrants. Recall that preferred stock has dividend and liquidation
preference over common stock in addition to antidilution protection and other
rights as may be specified in a stockholder agreement. Common stock, on the
other hand, carries with it voting rights and preserves the right of the corpora¬
tion to elect S-Corporation status. Convertible debentures are secured or unse¬
cured debt instruments that can be converted to equity at a later date as
specified in the agreement. In its debenture form, however, it provides for a
fixed rate of return (interest), which can be deducted by the corporation. Debt
securities with warrants give the holder the right to purchase stock at a fixed
price for a specified term. Purchasing common stock under this instrument
does not invalidate the preferred position of the debt holder as creditor.
PROFILE 17.1
The Private Placement Process

As an example of what the private placement process is like, consider the following
situation of a company that wanted to raise $1 million to grow. These are the steps
it took.
1. Using a SCOR software program provided by the state securities agency, the
entrepreneur, Tom Lauder, wrote a prospectus detailing the terms, conditions, risks,
and rewards of the offering.
2. Lauder refined the document with the aid of his attorney. The 60-page docu¬
ment took about three weeks to complete at a total cost of about $50,000.
3. He hired a nationally known accounting firm to audit the corporation’s most
recent financial statements. This cost was approximately $15,000.
4. Comparing his company with others in the industry, he was able to arrive at a
value for the company of three times present earnings or $15 million.
5. He registered the corporation in ten states where the SCOR filing was
permitted, with filing fees ranging from $50 to over $2,000.
6. He then had to decide to whom he should present the offering. A logical choice
was his major customers and suppliers. To these people he sent an announcement of
the offering. From the announcement he received requests from 3,000 people for a
prospectus and from that group he received enough commitments to be fully
subscribed within the year.
The Initial Public Offering (IPO)

The initial public offering, or “going public,” has an aura of prestige and repre¬
sents an exciting time in the life of a high-growth business. However, the deci¬
sion whether or not to do a public offering is difficult at best because once the
decision has been made to go ahead with the offering, a series of events is set in
motion that will change the business and the relationship of the entrepreneur to
the business forever. Moreover, returning to private status once the company
has been a public company is an almost insurmountable task.
An initial public offering is simply a more complex version of a private
offering, in which the founders and equity shareholders of the company agree
to sell a portion of the company (via previously unissued stocks and bonds) to
the public by filing with the Securities and Exchange Commission and listing
their stock on one of the stock exchanges. All the proceeds of the IPO go to the
company in a primary offering. If the owners of the company subsequently sell
their shares of stock, the proceeds go to the owners in what is termed a
secondary distribution. Often there is a combination of the two events;
however, an offering is far less attractive when a large percentage of the
proceeds are destined for the owners, as it clearly signals a lack of commitment
on the part of the owners to the future success of the business.
More and more smaller corporations are using the IPO vehicle to raise
growth capital; in fact, well over half of all IPOs are companies with an asset
value under $500,000. This trend has been helped by SEC Form S-18, which
applies to offerings of less than $7.5 million and simplifies and reduces the
disclosure and reporting requirements. There is no “rule of thumb” for when to
go public; but, in general, many companies consider it as an option when their
need for growth capital has exceeded their debt capacity. On average, the
company should have an attractive rate of annual growth, at least $10 million
in annual sales and $1 million in earnings, and a history of audited returns.
Advantages and Disadvantages of Going Public

The principal advantage of a public offering is that it provides the offering
company with a tremendous source of interest-free capital for growth and
expansion, paying off debt, or product development. With the IPO comes the
future option of additional offerings once the company is well-known and has a
positive track record.
A public company has more prestige and clout in the marketplace so it
becomes easier to form alliances and negotiate deals with suppliers, customers,
and creditors. It is also easier for the founders to harvest the rewards of their
efforts by selling off a portion of their stock as needed or borrowing against it.
In addition, public stock and stock options can be used to attract new
employees and reward existing employees.
There are, however, some serious disadvantages to the public offering. Of the
3,186 firms that went public in the 1980s, only 58 percent are still listed on
one of the three major exchanges. Moreover, the stock of only one third of these
firms was selling above its issue price.3 It is a very expensive process. Where a
private offering can cost about $100,000, a public offering can run well over
$300,000, a figure that does not include a seven to ten percent commission to
3Zeune, Gary D. (Febmary 1993). “Ducks in a Row: Orchestrating the Flawless Stock Offering.” Corporate
Cashflow.
the underwriter, which compensates the investment bank that sells the securi¬
ties. One way to prevent a financial disaster should the offering fail is to ask for
stop-loss statements from lawyers, accountants, consultants, and investment
bankers. The stop-loss statement is essentially a promise not to charge the full
fee if the offering fails.
Going public is an enoirnously time-consuming process. Entrepreneurs report
that they spend the better part of every week on issues related to the offering
over a four- to six-month period. Part of this time is devoted to educating the
entrepreneur about the process, which is much more complex than this chapter
can express. One way many entrepreneurs deal with the knowledge gap is to
spend the year prior to the offering preparing for it by talking to others who
have gone through the process, reading, and putting together the team that will
see the company through it. Another way to speed up the process is to start
running the private corporation like a public corporation from the beginning,
that is, doing audited financial statements and keeping good records.
A public offering means that everything that the company does or has
becomes public information subject to the scrutiny of anyone interested in the
company. The CEO of a public company is now, above all, responsible to the
shareholders and only secondarily to anyone else. The entrepreneur, who
before the offering probably owned the lion’s share of the stock, may no longer
have the controlling stock (if the entrepreneur agreed to an offering that
resulted in the loss of control), and the stock that he or she does own can lose
value if the company’s value on the stock exchange drops, an event that can
occur through no fault of the company’s performance. World events and
domestic economic policy can adversely (or positively) affect a company’s stock
regardless of what the company does.
A public company faces intense pressure to perform in the short term. Where
an entrepreneur in a wholly owned corporation can afford the luxury of long¬
term goals and controlled growth, the CEO of a public company is pressured by
stockholders to show almost immediate gains in revenues and earnings which
will translate into higher stock prices and dividends to the stockholders. Last,
but not least of the disadvantages, the SEC reporting requirements for public
companies are very strict, time-consuming, and, therefore, costly.
The Public Offering Process

The first step in the public offering process is to choose an underwriter, or
investment banker. This is the firm that sells the securities and guides the
corporation through the IPO process. Some of the most prestigious investment
banking firms only handle well-established companies because they feel smaller
companies will not attract sufficient attention among major institutional
investors. Consequently, the entrepreneur should contact anyone he or she
knows who has either gone public or has a connection with an investment
bank to gain entry.
The importance of investigating the reputation and track record of any under¬
writer cannot be stressed enough, as investment banking has become a very com¬
petitive industry with the lure of large fees from IPOs attracting some firms of
questionable character. The entrepreneur should also examine the investment
mix of the bank. Some underwriters focus solely on institutional investors, others
on retail customers or private investors. It is often useful to have a mix of share¬
holders, as private investors tend to be less fickle and more stable than insti¬
tutional investors. The investment bank should also be able to provide the IPO
support after the offering by way of financial advice, buying and selling stock,
and helping to create and maintain interest in the stock over the long term.
Once chosen, the underwriter draws up a letter of intent, which
The importance of outlines the terms and conditions of the agreement between the under¬
investigating the writer and the entrepreneur/selling stockholder. It normally specifies a
reputation and track price range for the stock, which is a tricky issue at best. Typically,
record of any under¬ underwriters estimate the price at which the stock will be sold by using
writer cannot be a price/earnings multiple that is common for companies within the
stressed enough. same industry as the IPO. That multiple is then applied to the IPO’s
earnings per share. It should be emphasized that this is only a rough
estimate. The actual going out price will not be determined until the night
before the offering. If the entrepreneur is unhappy with the final price, the only
choice is to cancel the offering, something that is highly unpalatable after
months of work and expense.
A registration statement must be filed with the SEC. This document is known
as a “red herring,” or prospectus, because it discusses all the potential risks of
investing in the IPO. This prospectus is given to anyone interested in investing
in the IPO. Following the registration statement, an advertisement, called a
“tombstone,” in the financial press announces the offering. The prospectus is
valid for nine months; after that the information becomes outdated and cannot
be used except by officially amending the registration statement.
Another major decision to make is which exchange to list the offering on. In
the past, smaller IPOs automatically listed on the American Stock Exchange
(AMEX) or National Association of Securities Dealers Automated Quotation
(NASDAQ) only because they couldn’t meet the qualifications of the New York
Stock Exchange (NYSE). Today, however, the NASDAQ, with companies like
Microsoft and Apple, is the fastest growing exchange in the nation.
There is a difference between the way NASDAQ and the other exchanges
operate. The NYSE and AMEX are auction markets with securities traded on the
floor of the exchange, enabling investors to trade directly with one another. The
NASDAQ, on the other hand, is a floorless exchange that trades on the National
Market System through a system of broker-dealers from respected securities
firms who compete for orders. In addition to these three, there are also regional
exchanges like the Pacific and Boston stock exchanges that are less costly alter¬
natives for a small, growing company.
The high point of the IPO process is the road show, a two-week, whirlwind
tour of all the major institutional investors by the entrepreneur and the IPO
team to market the offering. This is done so that once the registration statement
has met all of the SEC requirements and the stock is priced, the offering can
virtually be sold in a day. The coming out price determines the amount of
proceeds to the IPO company, but those holding stock prior to the IPO often
see the value of their stock increase substantially immediately after the IPO.
Strategic Alliances
Chapter 16 talked about how to use strategic alliances to create the virtual
company or grow the business. Strategic alliances with larger companies are also
an excellent source of growth capital for young companies. Sometimes the part¬
nership results in major financial and equity investments in the growing venture.
Such was the case of United Parcel Service of America, which acquired a 9.5
percent ownership interest in Mail Boxes Etc. for $11.3 million. This gave Mail
Boxes Etc. capital to grow and UPS additional pickup and drop-off outlets.
Growing companies that link with established companies can usually get a better
deal than they would have gotten from a venture capitalist. In addition, they
derive some associated benefits that give them more credibility in the market¬
place. The large, investing partner is, at a minimum, looking for a return of the
cost of capital, but in general a return of at least ten percent on the investment.
Strategic alliances are every bit as tricky as partnerships, so the entrepreneur
must evaluate the potential partner carefully as well as do “due diligence” on
the company. It is also crucial not to focus on one partner but consider several
before making a final decision. For the partnership to really work, the benefits
should flow in both directions; that is, both partners should derive cost savings
and/or revenue enhancement from the relationship. It is probably best not to
form a partnership that requires one of the partners (usually the smaller
company) to be too heavily dependent on the other for a substantial portion of
their revenue-generating capability. It is a dangerous position to be in should
the partnership dissolve for any reason.
Valuing the Business

A key component of any growth strategy is determining the value of the
company, as a realistic value figure is needed no matter which financial strategy
is undertaken to raise growth capital. However, understand at the outset that
value is a subjective term with a myriad of meanings. In fact, at least six different
definitions of value are in common usage. Summarized, they are as follows:
• Fair Market Value. This is the price at which a willing seller would sell and
a willing buyer would buy in an arm’s length transaction. By this definition,
every sale would ultimately constitute a fair market value sale.
• Intrinsic Value. This is perceived value arrived at by interpreting balance
sheet and income statements through the use of ratios, discounting cash flow
projections, and calculating liquidated asset value.
• Investment Value. This is the worth of the business to an investor and is
based on the individual requirements of the investor as to risk, return, tax
benefits, and so forth.
• Going Concern Value. This is the current status of the business as measured
by financial statements, debt load, and economic environmental factors such
as government regulation that may affect the long-term continuation of the
business.
• Liquidation Value. This value assumes the selling off of all assets and calcu¬
lating the amount that could be recovered from doing so.
• Book Value. This is an accounting measure of value and refers to the differ¬
ence between total assets and total liability. It is essentially equivalent to
shareholder’s or owner’s equity.
Accountants tend to value a business by using earnings and multiplying a

year’s worth of earnings by some multiple. However, the variation in ways that a
company can calculate earnings makes this a dubious measure at best for
purposes of valuation. Similarly, financial analysts use a price/eamings ratio from
which to figure a multiple; however, this approach only makes sense for valuing
publicly traded companies. The point is that neither of these approaches
considers what the investor will receive for his or her investment. If valuing the
business as a whole is the goal, the most common measure and the one that
gives more accurate results is future cash flows, because only cash or cash equiv¬
alents are used in the calculations. The method is called discounted cash flow
analysis or capitalization of future cash flows to the present value. What this
means is simply calculating how much an investor would pay today to have a
cash flow stream of X dollars for Y number of years into the future.
For this analysis, the entrepreneur uses pro forma cash flow statements for the
business and determines a forecast period. To do this, the length and nature of
business cycles in the industry must be understood so a forecast period that goes
either from trough to trough or peak to peak in a cycle is chosen. In other
words, you need to have at least one complete business cycle within the forecast
penod to give a fair representation of the effect on cash flow. (See Figure 17.2)
The forecast period is also affected by macroeconomic cycles, particularly if
the business is in the consumer products area. A study of leading, lagging, and
coincidental indicators can provide information on macroeconomic cycles that
may affect the future cash flow of the business in some industries. For example,
leading indicators such as Manufacturers’ New Orders for Consumer Goods or
Orders for Plant and Equipment have typically declined for nine months prior to
the beginning of a recession. One way to mitigate the problems associated with
business and macroeconomic cycles is to calculate a weighted average of three
cash flow projections: worst case, best case, and most likely case. The entrepre-
Figure 17.2: Business Cycles and the Forecast Period
Product Demand
1 2 3 4 5 6 Year
neur should assign a subjective probability to each case based on best estimates
of the chances for that case occurring, given certain economic conditions.
Once the forecast period has been defined and the cash flow projections
prepared (See Chapter 15 for a discussion of pro forma cash flow statements), a
discount rate must be chosen. This is not a purely arbitrary exercise. The deci¬
sion should be based on two factors:
1. The rate achievable in a risk-free investment such as U.S. Treasury notes over
a comparable time period. For example, for a five-year forecast, the current
rate on a five-year note is appropriate.
2. A risk factor based on the type of business and industry should be added to
the interest rate in #1. Several precedents for determining what these factors
are have been established over years of study. The most recent, widely
accepted standards are offered by Schilt4 and Pratt.5 in the form of five cate¬
gories of business. Note that even within each category there is room for
degrees of risk.
a. Category 1: Established businesses with good market share, excellent
management, and a stable history of earnings: 6-10%
b. Category 2: Established businesses in more competitive industries, still
with good market share, excellent management, and a stable earnings
history: 11-15%
c. Category 3: Growing businesses in very competitive industries, little
capital investment, average management team, and a stable earnings
history: 16-20%
d. Category 4: Small businesses dependent on the entrepreneur or larger
businesses in very volatile industries, and the lack of a predictable earn¬
ings picture: 21-25%
e. Category 5: Small service businesses operating as sole proprietorships:
26-30%
The following example illustrates this valuation method:
Assume: 6% risk-free rate

14% risk factor (Category 2 business)
20% discount rate
4Schilt, James H. (1982). “A Rational Approach to Capitalization Rates for Discounting the Future Income
Stream of Closely Held Companies.” The Financial Planner.
5Pratt, Shannon P. (1989).Valuing a Business, 2nd Edition, Homewood, IL: Business One Irwin.
End of Year Cash Flow ($000) Factor (20%) Present Value

1 200 .8333 166.7
2 250 .6944 173.6
3 300 .5787 173.6
4 375 .4823 180.9
5 450 .4019 180.9
Totals •1,575 874.7
Assuming the current rate on a ten-year treasury note is 6 percent and you
are dealing with a Category 2 business at a 14 percent risk factor, the adjusted
discount rate becomes 20 percent. Using a calculator or a present value table,
the present value of the five-year cash flow stream can be calculated. What this
example shows is that this hypothetical business will throw off $1,575,000 of
positive cash flow over five years. Hence, a buyer would be willing to pay
$875,000 today for that business, given the discount rate.
In addition to the discount rate and risk factor, a business may have an
ability to generate cash virtually into perpetuity, assuming a strong position in
the marketplace and an excellent management team. Tuller and others have
advanced similar proposals to deal with what they call “continuing value” of the
business.6 It involves choosing a period of time subsequent to the forecast
period of at least 50 years so the final years will have little or no impact on the
cash flow stream being discounted and applying the last years cash flow figure
from the forecast period as if it would go on unchanged for the next 50 or more
years. In other words, multiply the last years cash flow figure by 50 (or 75 or
100 depending on the period chosen). Discount that product using a discount
factor of double the original factor (or triple depending on subjective assess¬
ment of risk) to account for the unknown probability that the business will
continue for that period of time and produce that amount of cash flow. The
total for the discounted continuing period can then be added to the discounted
cash flow from the forecast period to arrive at an estimate of value. If you have
prepared three scenarios—best, worst, and most likely cases—you will end up
with three values for the business. At this point the “real” value for the business
is determined through negotiation with investors, lenders, or the underwriters
who are helping to take the company public. However, doing the calculations
just discussed provides an excellent jumping off point for the negotiations.
As careful as this procedure is, it still has a significant “crystal ball” aspect to it
because at several crucial points in the process subjective decisions are made by
6Tuller, Lawrence W (1994). Small Business Valuation Book. Holbrook, MA: Bob Adams, Inc.
the entrepreneur. There is really no way to avoid this dilemma; it is the nature of
the beast. The entrepreneur, nevertheless, must recognize that everyone inter¬
prets value differently and must be prepared to discuss and defend the assump¬
tions used to estimate value. Another point needs to be made. While the
entrepreneur is attempting to place a value on the business as a whole, the
potential investor/owner is looking at the business in terms of what the business
will return to the investor/owner. This is a very specific type of return and includes
three categories of items: cash flow returns, appreciation, and tax benefits.
• Cash Flow Returns. The investor/owner can receive the benefits of cash flow
through “perks” such as expense accounts and company cars, the repayment
of debt which is a tax-free transaction, interest, salary, and dividends. Each of
these has personal advantages and disadvantages to the investor/owner.
• Appreciation. The investor/owner can sell off a portion of his or her interest in
the company and enjoy a tax-free event up to the amount of his or her cost
basis.
• Tax Benefits. The investor/owner may be able to receive pass-through losses
that generally occur in the early years of a venture, if the business has elected
an S-corporation status.
This chapter has focused on one accepted method for valuing a young, grow¬
ing business. Valuation is by its very nature an incremental process that involves
bringing together key pieces of information that will, hopefully, give some
insight into the health and future of the business. In all discussions of value, the
entrepreneur should be clear on whose definition of value is being used.
Final Thoughts on Growth Capital

Recall from Chapter 1 that entrepreneurs work with a vision of where they see
their company going and what it will look like when they get there. That vision
sustains them through the ups and downs of start-up and the breathless speed of
growth when the company finally takes off. It also supports them in the difficult
search for capital to feed that growth and ensure that the business remains
successful. The growth period of a world-class venture can be an extraordinarily
exciting time for everyone if the entrepreneurial team has prepared for growth by:
• Networking, researching, and lining up potential capital sources well in

advance of need
• Determining at least three years in advance if the company will go public at
the most appropriate window of opportunity. This is so the company can
begin, if it hasn’t already, to regularly prepare audited financial statements

using a nationally recognized accounting firm and put in place the financial
and control systems required of a public company.
• Updating the comprehensive business plan

Have you
□ Determined how much growth capital will be needed?
□ Developed a strategy for seeking growth capital?
□ Established a value for the business?
Bygrave, W.D. & Timmons, J.A. (1992). Venture Capital at the Crossroads.
Cambridge: Harvard Business School Press.
Gladstone, D. (1988). Venture Capital Handbook. Englewood Cliffs, NJ:
Prentice Hall.
Tuller, L.W. (1994). Small Business Valuation Book. Holbrook, MA: Bob
Adams, Inc.
1. Why should a private offering be used as a capital-raising vehicle before a

Issues to
public offering is used?
Consider
2. For what kind of business would private venture capital be a logical financial
strategy for growth? Why?
3. How can strategic alliances be used to help grow the business?
4. What are some things that should be done to prepare for a public offering
before the year of “going public”?
5. In approaching a venture capitalist, how can the entrepreneurial team deal
from a position of strength?
6. What are the key components in valuing a new or growing venture?
M Case StudyT^
I n the summer of 1989, Sam Farber and a design team lead by Davin Stowell
from Smart Design, were involved in the development of a line of kitchen
gadgets (e.g., peeler, can opener, pizza cutter, garlic press) that would be func¬
tional, comfortable, ergonomically sound, attractive, and affordable. Farber
expected the Smart Design team to have the kitchen gadgets prototyped and
ready for manufacture so they could introduce the new line at the San
Francisco Gourmet Show in April 1990. A number of design, marketing, and
manufacturing challenges would need to be solved in the next nine months.
Determining the Product Goals

When OXO and Smart Design conducted a consumer survey about kitchen
gadgets, they found users complained about: rusting metal, cracking plastic,
dull peeler blades, and can openers that didn’t cut. Users wanted nonslip
handles, easy-to-read measurements on all devices, simple directions, easy-to-
clean tools, dishwasher-safe tools, a self-cleaning garlic press, and comfortable
handles, especially for scissors.
The design team decided to spend most of the investigative time looking at
the range of manual limitations, from serious permanent disabilities to the
limited mobility and declining strength associated with aging. The team
believed that by making tools that most of this group could use comfortably,
they could satisfy the needs of all users.
The designers divided motions into twist (used to scoop, stir, and peel),
push/pull (graters and knives), and squeeze (used to work scissors, garlic
press, and can opener). The design team made hundreds of models and tried
them all. They discovered that it was necessary to use a combination of
motions to work most tools. The project would narrow down to three
■©1994, Corporate Design Foundation. This case was written by Professor William B. Gartner, San Francisco
State University School of Business, with the support of the Corporate Design Foundation as a basic for class
discussion rather than to illustrate either effective or ineffective handling of a business situation.
Chapter 17 * Financing Growth 391
functional groups: gadgets and utensils with a general multipurpose handle,

squeeze tools, and measuring devices.
A general handle was to be used for the twist and push/pull motions. The
handle would be large to increase leverage and oval to keep it from rotating in
the hand. The short round end would fit comfortably into the palm and evenly
distribute the pressure in motion.
When the group sat down to determine the product goals, they generated
the following criteria:
Comfort: This was the key goal. A new product has to be able to differentiate
itself from all the ones on the market. Almost every tool they held was the wrong
shape or so hard that it hurt the hands. They also experienced hand and wrist
fatigue after using many of them. All the scissors on the market were a disaster.
Sore fingers were a common complaint. It was actually in the conversation with
one of their consumer cooks that the word “soft” appeared. They all agreed that
a soft handle would be a comfortable handle and that it should be a key goal.
Easy to Use: They decided to stick to simple hand tools—ones that served
one purpose and did it well.
Good Quality: This was a key recommendation from most of the consumer
cooks. They complained about the inferior quality of the kitchen tools on the
market. They rusted. Peeler blades became dull (or started out dull). Plastic
cracked. Consumer cooks were willing to pay more for a longer-lasting tool.
Aesthetically Pleasing: There was a consensus that all the tools on the
market were ugly or old-fashioned. Many people left their kitchen tools out in
jugs on the counter and wanted them to be attractive.
Dishwasher Safe: A lot of people were afraid to put their kitchen tools in
the dishwasher. Their previous experiences were disastrous: rusting, cracked
handles. All agreed they would like tools they could just throw into the dish¬
washer. This was important in their search for the right soft materials for
handles and led to their choice of Santoprene.
From Prototype ol Product

In order to develop the general handle to be used for the different gadgets,
hundreds of prototypes were constructed. Besides determining the shape of the
handle, the design team also needed to specify a material to make the handle
from. The design team wanted the material for the handle to be soft and flex¬
ible. However, the material had to be easy to mold and dishwasher safe. The
team chose “Santoprene,” a material from Monsanto. Santoprene is composed
of polypropylene plastic and rubber. This material has a warm non-slip feel to
it. Since Santoprene is used for dishwasher gaskets, there was no doubt that it
was dishwasher safe. By using Santoprene it was also possible for the designers
to incorporate another feature of the handle, “fingerprints softspots,” which are
flexible fin sections. These resilient fins help the handle to bend to an indi¬
vidual finger grip, thereby giving the user more cushion and control, even
when hands are wet or soapy. The flexible fin feature was subsequently
patented. The “fingerprints softspots” were added to the handle
because Sam Farber saw a need to make an innovative feature
of the general handle (soft spots) visible.
In conducting their research on the usability of different
handle prototypes, the Smart Design team had identified the
need for “soft spots,” a portion of the handle that was softer
than the rest of the handle in order to make the handle easier
to grip and maneuver. The Smart Design team had originally
designed in many of the prototypes for the soft spots to be “invisible,” that is, the
handle looked the same from tip to end, but when grasped, a portion of the
handle where the finger gripped the tool, gave more, and therefore provided a
better grip. Sam Farber felt that this feature needed to be visible to the customer:
“the handle should invite involvement.” By creating flexible fin sections for the
soft spots on the handle, the handle had a distinctive and visually descriptive
design. Much like an elegant sneaker built for the hands, the flexible fins on the
handle were a sign to prospective customers that this was not another “me too”
product.
In order to achieve the necessary rigid inner structure in the handle to
support the tool end of a particular gadget as well as provide a base for the soft
flexible outer handle, the metal part of the tool was molded to an inner core of
inexpensive ABS plastic. The injection-molded Santoprene handle was then
slipped over the ABS core.
The squeeze tools were designed with wide flat handles, so that in the
clenching motion of the whole fist, the pressure on the hand was evenly distrib¬
uted to alleviate sore spots and finger cramps. In designing the scissors they
added a hidden spring in the hinge that opens the blades automatically. The
user does not have to use the tender backside of the thumb to pull the blades
apart. The scissors were designed to use the strength of the whole hand for
cutting. They were designed so that the bottom of the handle was flat, so that a
user could press the scissors down on a table or countertop and, therefore, put
the weight of one’s shoulder into cutting through tough items like poultry joints
or tree branches. The scissors were also designed to be used in either the right
or left hands. A pair also latches shut for safe storage in a drawer or on a hook.
The measuring cups and measuring spoons were designed with wide handles
for extra control and big easy-to-read size markings that were color coded. This
feature helps the eye perform better, as well as the hand. Finally big holes on the
gadgets, and big rings for the measuring items enhance their ease in hanging.
Manufacturing
The key group of items that would be Sam Farber’s focus of attention when
selecting a factory for production involved the peeler group of gadgets. Peelers
are the biggest selling item in a line of kitchen gadgets. A factory was required
that could manufacture a high quality peeler and OXO peelers would require a
factory that had expertise in both metal parts production and plastic production.
Because of Sam Farber’s prior experience at COPCO in manufacturing kitchen
products abroad and in selling kitchen wares in the United States market, he
knew that OXO’s products would have to be made in the Far East to be price
competitive. Sam knew that the cost of tooling in the Far East would be lower
and that he could get factories to share in the costs of making the tooling. Yet,
Sam did attempt to coax American manufacturers to bid. When Sam approached
a factory in the United States that was making bicycle grips with a material
similar to Santoprene, the factory manager looked at the Santoprene/ABS
composite prototype handle and said, “It can’t be done.” When Sam visited a
Japanese factory, the factory manager looked at the prototype handle and said.
“Very interesting—why not?” Sam selected a Japanese factory to make the
peelers. He had used this factory before to make knives for COPCO.
Sam turned to other factories in the Far East to manufacture the scissors,
garlic press, measuring cups and spoons. He researched many factories in
Taiwan and found three quality producers offering competitive prices. For
manufacturing the large stainless steel tools, such as spoons and turners, Sam
sought out factories in China. These large tools require a great deal of hand
labor for a polished finish, and labor for this type of work is cheaper in China.
Sam worked with a Hong Kong company that would ensure quality control in
China. Sam sought companies that had experience selling to the German
market. German consumers demanded higher quality than American
consumers. The Hong Kong company was producing products for a number of
quality German importers.
In summary, all of the factories that Sam Farber choose met the following
criteria:
1. They were producing similar products, so that they were familiar with the
production problems that could arise and could consult effectively with the
designers during the final stages of design.
2. They were quality conscious.
3. They understood the process of exporting to the U.S. market.
4. They were willing to help pay for the cost of tooling as well as accept low
minimum quantities on the original order.
Developing a lime Table

After selecting the factories to produce the products, Sam Farber established a
time schedule with each factory, laying out a time frame from the day final
drawings would be received to the shipping date of the gadgets. When he
returned to the U.S. from this trip, Sam Farber met with the design team to
map out a design and production schedule. Sam planned to show the line at
the Gourmet Products Show in San Francisco in April 1990. Working back
from this date, the following activities would have to be accomplished:
1. The preliminary conceptual designs would be ready on October 15. A design

direction would be chosen. If none of the designs were accepted, the design
team would try again.
2. The final designs would be presented for approval on November 15.
3. Prototypes would be made by Smart Design or their model maker on
December 15.
4. Final drawings and prototypes would be sent to the factories on January 1,
1990.
5. The lead designer and Sam Farber would visit the factories and finalize all
designs and give approval to start the tooling.
6. In order to show something at the Gourmet Show by April, temporary molds
of the gadgets made at the Japanese factory would be made, and prototypes
of the items made at the Taiwanese and Chinese factories would be shown.
7. Stock would be in the warehouse by July 1 for shipment.
While this schedule was ambitious, Sam felt it could be achieved. In bringing
the kitchen gadgets into production. Sam never went to the Far East without
someone from the design team. He believed that the designer needed to be
familiar with the factories and their production capabilities, what a factory can
and cannot do. Sam felt that “factory guys” are notonous for saying “it can’t be
done.” Sam found that the design team couldn’t just work in the studio, but had
to be actively involved in the early marketing studies and in the production tech¬
niques and manufacturing. “You can’t accomplish design innovation in a vacuum.
All the players have to participate and feel they are partners all along the way”
Other Considerations
All of the distribution areas (e.g., department stores, specialty kitchen shops,
mail order catalogs, discount retailers) suggested the same best selling items:
peeler, can opener, garlic press, grater, pizza cutter, measuring spoons, and
measuring cups. The mail order catalogs preferred higher unit retails and were
therefore interested in selling sets that combined two or three items.
All distribution areas were used to selling kitchen gadgets in lower price
ranges than OXO had contemplated, e.g., most peelers were selling from $.99
to $4.99 while the 0X0 peeler would be sold from $5.99 to $7.99. The mass
market companies were interested in the lower end of the price range. This was
an important factor in the decision to produce a second line for this distribu¬
tion area that would be lower priced. This line, labeled “Prima,” would sell
peelers for $3.99, which is at the higher end for mass merchants. In order to
manufacture gadgets at this lower price, tradeoffs in the quality of the product
would have to be made. While the handle would be “user friendly,” it would be
made of hard plastic and in one piece, rather than made from Santoprene, and
in two pieces. Farber also decided he was willing to take a lower gross margin
on the Prima line in order to sell the product for a lower price.
Department stores and mass merchants wanted items packaged on cards in a
traditional manner. Farber and the design team realized that their “story” was in
the handle, so they designed cards so that the handle swung free. Customers
could actually grab the handle and feel it. 0X0 also realized that many
specialty stores didn’t like cards, so gadgets were also sold uncarded, or with
small counter top displays. The demands from the mail order catalogues were
mixed. Some wanted cards for customer information and some didn’t.
The accepted display technique in all stores was to hang the items on the
“gadget wall.” The team’s marketing observations were that these walls were
unsightly—it was difficult to find a product and none of the lines were
presented together as one package. Since 0X0 had a story to tell, they wanted
to keep their line separate from the others. The department stores and specialty
stores were receptive to the idea of a free-standing display. The mass merchants
only used the wall. The design team created a large display at first and subse¬
quently created a smaller revolving display, and finally, a display that holds six
items that could be placed near the cash register.
Most department stores wanted service, either complete service such as
inventory counting and display maintenance, or display maintenance. Some
mass merchants were not interested in service because they had sophisticated
scanning devices for quick reordering through EDI setups as well as trained
stocking people in the stores. Other retailers wanted merchandise sold to a
distributor who would handle the stocking and service. For example, they
found that Target stores wanted merchandise sold directly to them, while
Caldor wanted merchandise to be sold to Federal Wholesale, who maintains
their inventories and displays.
Because the handle was the key to the whole line, they realized that they
needed to have a name for the gadgets that told the customer what was special
about the product. “Good Grips” proved to be a perfect name. This name
communicated the major advantage of the line to the customer quickly: these
products were comfortable kitchen tools.
Expanding the Team

While Sam Farber had invested his own money in the venture during these
initial stages of development, he realized that as the company began manufac¬
turing the product, he would likely need more capital for inventory expansion
and working capital. He approached a few of his friends, explained his idea,
and received assurances from them that they would like to participate as
investors. When Sam talked to his son John, a vice president at Prudential
Bache in mergers and acquisitions, about OXO, John agreed to become Sam’s
business partner, but not actually work full-time for the company However, a
few months later, John changed his mind and decided to become an active
participant. Sam and John decided to form 0X0 as a limited partnership with
four of Sams friends as the other partners. Through the assistance of Sam’s
accountant, the partners arranged for a line of credit with Chemical Bank.
Surprisingly, because of strong initial sales and inventory purchases on a just-
in-time basis, 0X0 had a healthy positive cash flow and never did borrow any
money from the bank.
Sam’s wife Betsey had shared the same passionate beliefs about the products
from the very beginning. Her experience in the kitchen and her arthritis were
key factors in the original concept. She decided to join the company rather than
return to the practice of architecture. She came to be in charge of all publicity,
trade shows, brochures, copywriting, and in-house graphic design.
Though Sam had many contacts with buyers, he knew he needed to focus
his own efforts on developing new products. OXO would need a sales force and
someone to manage this sales force. One of his former sales vice-presidents
from COPCO, Ed Beren, was presently working as a sales consultant to two or
three companies in the housewares field. When Sam explained the idea of
“Good Grips” to Ed and showed him some of the initial models, Sam had
another passionate believer. Ed agreed to work as OXO’s sales manager and as a
consultant to the company for a percentage of the sales and a small advance.
Though 0X0 would not get all of Eds time, they would only have to share in
paying for his expenses, thereby turning what is often a fixed overhead expense
into a variable cost.
The meeting with Ed took place in February. They agreed that Ed would find
a sales force of manufacturers’ representatives and bring them together for the
first time at a sales meeting during the San Francisco Gourmet Show in April.
The manufacturers’ representatives would all work on commission.
A three-year marketing plan was developed. The initial line of kitchen
gadgets would be sold to upscale distribution outlets to establish the concept
and the name. They targeted January 1992 as the time to introduce a second
line of kitchen gadgets geared to mass merchants, like Wal-mart, K-Mart and
Target. By the end of 1993 they would produce a third line aimed at the super¬
markets and lower-priced kitchen stores. Although the lines would be different
from each other, they would adhere to the same basic principles of universal
design: all of the tools would be easier to hold and use.
Last Minute Details

Right before the San Francisco Gourmet Show, Sam and Betsey contacted many
of the trade magazines about the story of 0X0 and Good Grips. Trade maga¬
zines are looking for news of new products. The editors of these magazines
jumped at the opportunity to write feature stories on the company and the
concept. Magazine editors and writers were introduced to the Smart Design
office. The entire design process was explained. Sam wanted them to become
believers too. They did. A number of articles were written that celebrated the
revolutionary qualities of the new designs for these kitchen gadgets.
In building a display booth for the Gourmet Show, the team realized they
didn’t have much product to display, and the products, themselves, were small.
In order to catch the buyer’s eye quickly and communicate the features of these
unique products, the booth was constructed of photo murals of the products.
A week before the Gourmet Show the Japanese factory sent the initial
samples for the show. But the grade of material chosen for the handles was
noticeably harder than what the design team had wanted. The Japanese worked
around the clock and through the weekend to produce another set of samples
in time for the show. Sam’s view of this burst of cooperation was:
They too had become believers. They felt involved as partners. Making
the supplier a part of the team in the early stages is one of the keys to
success of a project. In any innovative design project, you’re probably
pushing way beyond the boundaries of present products and present tech¬
niques—and in many cases present technology too. Those land mines
hide all over the road. It is hard to imagine this statement in relation to a
fairly prosaic item like the potato peeler. But we were using a material
unfamiliar to our factories, and one never before used in kitchen tools. We
were asking them to mold very thin uniform sections in the material. We
were convinced it could be done and Monsanto felt it could be done.
Naysayers are a serious impediment in the process of design innova¬
tion. They can be outside suppliers, technical people, or people within
your own company who always follow the safe path. Safety and self-doubt
don’t flourish along the pathway of the entrepreneur. It’s not the way of
someone trying to push through a revolutionary design project. That’s
why it is so important to have the suppliers involved. When they believe,
they will continually try to help you prove that it can be done.
The Good Grips line was an instant success when it was presented at the San
Francisco Gourmet Show in April 1990. Everyone wanted the merchandise.
While the product had been promised for delivery in July, shipments did not
begin until September. OXO was able to place the products in all the major
department stores and specialty stores. Sales did meet initial projections.
Expansion and Growth

In Spring 1991 0X0 introduced a line of knives using the Santoprene handle.
The handle has a slightly different shape, since knives are held differently than
other kitchen gadgets. In July 1991 0X0 introduced the “Prima” line for mass
merchants in the 500-store western chain, Target. The Prima line has the same
finger grip, but uses less of the Santoprene, which is an expensive material.
Other products that were introduced include a hand-held jar opener which
easily twists off stubborn jar lids and bottle caps. A “flying nun” corkscrew, that
has a large easy-to-turn knob, .and wide wings contoured to the curve of the
hand to facilitate the downward push which lifts out the cork. The screw is
coated with zylon, a non-stick material that enables it to glide easily into the
cork without tearing it. •
OXO has also introduced a line of tools designed for the garden. The handle
uses a soft material similar to the Santoprene. It has the patented fingerprint
fins, but the shape of the handle has been altered slightly to conform to the
different ways the hand moves when using a garden tool. 0X0 signed a
licensing agreement with the Sierra Club to market the tools as “Good Grips
Sierra Club Garden Tools.” Part of the proceeds from the sale of these tools goes
to the Sierra Club to help preserve and protect the environment.
The company is developing nonskid mixing bowls. They are also conducting
extensive studies on arm and wrist movements when lifting a pot filled with
food in order to design a line of cookware using a version of the patented
handle. In terms of the future, Sam commented:
We think there is still much more we can do in designing innovative

items for the kitchen and related home areas. We also realize that our
patented handle and our work in promoting universal design has poten¬
tial even beyond that. At the present time we are licensing our knife
handle to a major medical supply company. They are using it to produce
a set of tableware—rocker knife, fork, and various spoons—for use by
people who have physical difficulty holding ordinary silverware. Our
factories manufacture the implements exclusively for them and we
receive a royalty. We are also in the process of discussing licensing the
patented handle to a paint tool company and to a hair brush company.
Our scissors are about to be introduced in a number of poultry
processing plants where relief of hand and wrist fatigue in repetitive
motion is very important. We feel that we are just at the beginning, both
in developing our own new products and in licensing our handles in
other markets.
In the four years since the first showing, these products have won a number
of design awards:
• International Design Magazine Annual Design Review, 1991. Selection for

consumer products category out of 1,300 submissions.
• Industrial Design Excellence Awards. Gold Medal, 1992. A contest

conducted by the Industrial Designers Society of American and sponsored by
Business Week.
• Design Leadership Award for Growing Companies, 1993. Winner for
product design. A context sponsored by Inc. magazine and the Corporate
Design Foundation.
On October 20, 1992, General Housewares Corporation (GHW) announced

the acquisition of OXO International L. P In making the announcement, Paul
A. Saxton, Chairman, President and CEO of General Housewares, said,
The acquisition of OXO and its exceptional portfolio of distinctive

products strengthens General Housewares’ position as the leading
domestic supplier to the highly involved, discriminating kitchen
consumer. We are especially pleased to become associated with Sam
Farber and John Farber, the principals of OXO. Sam and John will be
joining the GHC executive team, continuing their direct management
roles in 0X0. They will also play a key contributory role in our sourcing
and new product development programs. With the addition of kitchen
tools, we provide to our customers a more comprehensive product assort¬
ment, as well as create for GHC new and exciting cross-merchandising
opportunities building upon our existing products.
0X0 is an acquisition that fits very well with GHC’s strategy. As with
the Chicago Cutlery acquisition, 0X0 embodies a truly superior product
line and an emerging brand franchise that we believe will add important
value to GHC in the years to come.
Sam Farber commented,
We are extremely excited about the combination with General

Housewares. As our business continues to grow dramatically, we have
become increasingly aware of the need to bring top-quality service as well
as products to our customers. General Housewares is known in the
industry for the superior quality of its marketing and customer service
and I believe those capabilities, combined with our product development
work, create a unique force in the housewares industry. Finally, we have
been very impressed by the character and depth of the General
Housewares management team and believe that our compatibility with
them will ensure a very successful future.
Plans (or the Future

With 0X0 now a part of a company with substantial resources for product
development and marketing, Sam Farber felt that 0X0 needed to direct its
energies to new opportunities. But, in order to do that Sam needed to deter¬
mine the company’s direction:
What should we do next? Are we a kitchen company or are we

a company developing comfortable universal design products for any
place in the home or office or outside the home? I have posed this ques¬
tion to everyone at 0X0 and to our designers. We are in the middle of
discussions.
1. How was OXO’s philosophy and mission used to develop the product line?
2. Was it necessary for 0X0 to join forces with General Housewares
Corporation to grow and why?
3. Is 0X0 a kitchen company or are they a company developing comfortable
universal design products for any place in the home, office, or outside the
home? Why is it important for Sam to answer this question?
PART 7
Contemplating
the Future
We know not yet what we have done,

still less what we are doing. Wait till evening
and other parts of our day’s work will shine
than we had thought at noon, and we shall
discover the real purport of our toil.
-HENRY D. THOREAU
CHAPTER 18
—■!— IlimI mill IW ■! I' —I I in ■ I ■ —
Planning lor Change
Overview
• The purpose and uses of a contingency plan
• The purpose and uses of an exit plan
• Issues related to the selling of a business as an exit strategy
• Mechanisms for cashing out of the business while still maintaining a
degree of control
• Bankruptcy as an escape plan or an entrepreneurial tool
• Presenting the contingency plan in the business plan
The Contingency Plan

There is no crystal ball that will tell an entrepreneur what the future holds for
the new venture. Many entrepreneurs have started a business with a plan in
mind for where that business would go, but along the way things changed.
Forces beyond the control of the entrepreneur forced the venture into new
directions and a new set of plans had to be constructed. This was the case with
Talli Counsel of Interfleet, who found that the rewards for consulting and
providing education to the major auto makers and others were much greater
and provided less liability and fewer problems than the physical part of his
business—servicing the fleet vehicles of the Fortune 500 companies worldwide.
Consequently he is now changing the primary focus of the business to reflect
changes in the environment as well as his personal goals.
405
406 Part 7 • Contemplating the Future
It is a sad fact that most entrepreneurs with growing ventures do not have
time for contingency planning; they are just too busy keeping the business
alive. But planning is essential. In the absence of planning, the business puts
itself in a reactionary mode, virtually at the whim of the environment in which
it operates. Instead of dealing from a position of strength, entrepreneurs may
find themselves reacting in panic and without information to situations for
which they are not prepared. As a result, the quality of decision making is
reduced and the business suffers.
By forcing entrepreneurs to consider multiple outcomes and possibilities,
contingency plans help a growing business deal with the ubiquitous downturns
and upturns in the economy, new regulations, changes in customer
In the absence of
tastes and preferences, and many other events that regularly, and often
planning, the busi¬
without much warning, disrupt the equilibrium of the business. For
ness puts itself in a
example, the reason many businesses fail in a recession is that they
reactionary mode,
haven’t prepared for it by forecasting the potential impact on demand
virtually at the whim
of the environment. when signs of a recession appear and calculating how they can adjust
and still maintain a positive cash position.
Recessions do not happen overnight. There are signs, even within specific
industries, that signal a slowdown. Since the government began compiling
indices on the economy after World War II, some consistent trends have
appeared. For example, the leading index, which consists of such items as the
Producer Price Index, the Consumer Confidence Index, and the Manufacturers’
Orders for Durable Goods, declines for nine months prior to the onset of a
recession. The coincident/lagging index, which is a ratio of the coincident index
(employment, personal income, industrial production) to the lagging index
(Consumer Price Index, interest rates, unemployment), declines for 13 months
prior to the onset of a recession.
Being able to recognize the signs of recession before they impact the business
gives the entrepreneur the chance to prepare in many ways, including maintain¬
ing a higher degree of liquidity. In recessionary times it is more difficult to raise
capital from either bankers or private sources, so being liquid allows the entrepre¬
neur to take advantage of opportunities that become available only during reces¬
sions. For example, the entrepreneur may be able to purchase a building that in
good economic times was beyond reach, or he or she may be able to negotiate
more favorable terms from suppliers just to keep the business moving forward.
Growing entrepreneurial ventures need to engage in both short- and long-
range planning. Short-range planning involves setting quantitative goals for the
coming year and developing a plan for achieving them. If a business does any
Chapter 18 • Planning for Change 407
planning, it is usually short-range. Long-range plans, by contrast, are based on

the business’s mission and focus on the direction the business will take,
accounting for potential changes in the environment in which the business
operates. It is certainly not possible to account for all contingencies, but there
are some key crisis issues that seem to occur for all high-growth ventures.
Taxes and Regulations

Government regulations and regulatory paperwork are severe problems for
growing ventures, and the cost of compliance is rising to the point that entre¬
preneurs are looking for a way to avoid coming under the purview of some of
the regulations. The Family Leave Act now has a threshold of 50 employees, so
many small businesses fight to stay below that number, because the lengthy loss
of an employee in a small, growing company can impact operations severely.
The cost of hiring an employee is becoming so prohibitive that many compa¬
nies are solving the problem by subcontracting work and leasing employees.
Take, for example, a growing manufacturing company with fewer than 50
employees. On an hourly basis, per employee base pay is $11; health coverage
costs about $3 an hour; Social Security, Medicare, and unemployment insurance
is about $1.50; and workers’ compensation is $1, for a total hourly cost of
$16.50. If you then factor in profit sharing, bonuses, and retirement plans, you
can easily reach $20 an hour as the actual cost of hiring that employee. However,
the government is cracking down on businesses that categorize people as inde¬
pendent contractors, so the IRS rules must be carefully followed. (See Chapter 4.)
Changes in the tax laws can place a significant burden on the business and
the entrepreneur as well. The $135,000 ceiling on income subject to Medicare
Tax has been eliminated, which could add several thousand dollars to the busi¬
ness’s tax liability and to that of the entrepreneur in an S corporation. Growth
in state and local taxes in some states makes it more important than ever to
search for states that place a smaller burden on business. Changes in the tax
law, however, can also provide a benefit to the entrepreneur; for example, the
recent break for investors in businesses with less than $50 million in assets
allows them to reduce their taxable gain by 50 percent if they have held the
stock for more than five years.
Product Liability
The chances are fairly good that if you manufacture a product, your company
will at some point face a product liability suit. The Administrative Office of
the U.S. Courts in Washington, DC reports that in 1989 alone, 14,339

product liability claims were filed. The states with the most industry naturally
had the highest claims, with Pennsylvania, Ohio, Texas, and New York leading
the list. More and more the risk of product-related injuries has been shifted to
manufacturers, creating a legal minefield that could prove disastrous to a
growing company.
The problem stems from the fact that even if the company carefully designs
and manufactures a product, and covers it with warnings and detailed instruc¬
tions, it is still vulnerable to the misuse of and consequent injury from the
product. For a company to be legally liable, the product must be defec¬
tive and an injury must have occurred. But in a litigious society, those
A growing company
requirements don’t stop people from suing. Most product liability
must plan for poten¬
insurance covers the costs of defense, personal injury, or property
tial litigation from the damage, but does not cover lost sales and the cost of product redesign.
very inception of the Moreover, if your insurance company must pay on a claim, your
premiums will, no doubt, increase.
business.
A growing company must plan for potential litigation from the very
inception of the business. One proven method is to establish a formal
safety panel that includes people from all the major functional areas of the busi¬
ness. During the start-up phase, that panel may only consist of the entrepreneur
and one or two outside advisors with experience in the area. It is the job of the
safety panel to review safety requirements on a regular basis, establish new ones
when necessary, and document any injuries or claims made against the product.
Prior to product introduction in the marketplace, the panel should see that
careful records of all decisions regarding final product design, testing, and eval¬
uation procedures are maintained. Any advertising regarding the product
should not contain exaggerated claims or implied promises that may give
customers the impression that you are claiming more safety features than the
product actually has. Implied promises can be used against you in a court of
law. Instruction manuals should be easy to follow and should point out poten¬
tial hazards. They should also include guidelines for when and how to service
the product, which components made by other manufacturers are not covered
by your warranty (unless pass-through warranties have been negotiated), and
statements that the warranty is invalidated by misuse, misassembly, or modifi¬
cation, and is only valid if the specified maintenance procedures are followed.
Of course, the best insurance is to keep in contact with your customers so that
if a problem occurs, you will be given the opportunity to fix it before legal
action is taken.
Early on in the operation of the business, identify a qualified attorney

familiar with your industry to handle any potential product liability claims.
This attorney should handle the first case with which the business is faced.
Thereafter, if other suits arise in various parts of the country, you can save
money by hiring a “local attorney” in the jurisdiction of the claim. Then let the
primary attorney brief the* “local attorney” on the precedent-setting cases related
to the claim and assist while the local attorney carries the case to court. In this
way, you do not have to send your primary attorney on the road, incurring
significant travel and time expenses.
Loss of Key Employees

Today more than ever before, no one can count on having the same manage¬
ment team over the life of the business—or even past the start-up phase. The
demand for top-notch management personnel, particularly in some industries
like high-tech, means that other companies will constantly be trying to woo
away the best people from the best firms. Moreover, with more CEOs traveling,
the chance for a fatal accident is greater. Then too, disease and heart attack
often claim the lives of high-powered executives. This type of contingency plan¬
ning is often called succession planning and involves identifying people who
can take over key company positions in an emergency. Ideally that person will
come from within the company, but in the case of a growing entrepreneurial
company that has been operating in a “lean and mean” mode, that may not be
possible, so outsiders must be found. To prepare for the eventuality that a key
employee will be lost, the entrepreneur must have shared his or her vision for
the company with others both inside and outside the company.
Bringing in a consultant to guide the management team in succession plan¬
ning is a valuable exercise for any growing venture. Often consultants are even
hired temporarily to take over a vacant position for a specified period of time
during which they train a permanent successor. Another solution is to cross-
train people in key positions so that someone can step in, at least for the short
term, in the event of an emergency. Cross training is generally an integral part of
a team-based approach to organizational management.
In the case of entrepreneurs who head family-owned companies there are
special problems because they tend to look to a son or daughter to succeed them.
Unfortunately, often that child will have no interest in doing so but will not have
said anything to that effect to the parent/entrepreneur. One solution is to insist
that the potential “successor” work for another company for several years to gain
some business savvy and learn if they want to take over the family business.
Decline in Sales
When sales decline and positive cash flow starts looking like a memory, entre¬
preneurs often go into a period of denial. They start paying their suppliers more
slowly to preserve cash; they lay off people; they stop answering the phone and
insulate themselves against the demands of their creditors. Their panic often
causes them to make poor decisions about how to spend the precious cash they
have. They figure that if they can just hold on long enough, things will turn
around. Unfortunately, this attitude only makes the problem worse, effectively
propelling the business toward its ultimate demise. How can an entrepreneur
lose touch with the business and the market so much that he or she puts the
business at risk? What often happens is that entrepreneurs get so tied up with
the day-to-day operations of the business that they don’t have time to contem¬
plate the “big picture” or stay in tune with their customers. Consequently, many
times they don’t see a potential crisis coming until it’s too late.
When sales decline, the solution isn’t necessarily to lower prices. If you have
educated your customers about the value of your product or service, they will
be confused by the sudden discounting. When there is a decline in sales it is
especially important to look at all possible sources, not just the economy. You
may have been lax about checking the credit status of customers and distribu¬
tors, or the inventory turnover rate may have changed. You may have failed to
notice an emerging competitor offering a product or service more in line with
current tastes and preferences.
When a growing business first notices a dip in sales, it is time to find the
cause and make the necessary changes. This will be easier if the business has a
contingency plan in place. If, however, those changes cannot be made in time
to forestall a cash flow problem, it is time to consult a debt negotiation
company, a crisis management consultant, or a bankruptcy attorney who is
willing to work through the problem outside of court. These experts can help
the entrepreneur work with creditors until the problem is resolved. To make
the best effort at avoiding a cash flow crisis, the entrepreneur must be continu¬
ally committed to:
• Producing exceptional quality products

• Controlling the cost of overhead, particularly where that overhead does not
contribute directly to revenue generation (i.e. expensive cars, travel, exces¬
sive commissions)
• Controlling production costs through subcontracting and being frugal about
facilities
• Making liquidity and positive cash flow the prime directive, so that the
company can ride out temporary periods of declining demand
• Having a contingency plan in place
The Exit Plan

Many entrepreneurs have questioned the need for an exit plan when they are
more concerned with launching the business and making it a success. They
find it difficult to think about how to get out of the business when they have
barely gotten into it. While some entrepreneurs stay with their start-up for the
rest of their lives or the business’s, whichever comes first, the majority of entre¬
preneurs enjoy the challenge of start-up, the excitement of growth, and abhor
with a passion the custodial role of manager of a stable, mature company.
Exiting the business does not necessarily mean exiting the role of entrepreneur.
It may in fact mean taking the financial rewards of having grown a successful
business and investing them in a new venture.
There are entrepreneurs who do that very thing over and over again
throughout their lives. Other entrepreneurs find that when the venture reaches
a certain level, the business needs professional management skills that the
entrepreneur often does not possess. In fact, the entrepreneur may actually be
holding the company back without realizing it. At some point the board of
directors will relegate the entrepreneur to R&D, public relations, or they may
actually push the entrepreneur out of the company, as Apple Computer did
with Steve Jobs. In any case, whether or not you intend to exit the business,
you should have a plan for harvesting the rewards of having started the busi¬
ness in the first place.
Selling the Business

Selling the business outright to another company or an individual may be the
goal if the entrepreneur is ready to move on to something else and wants to be
free financially and mentally to do so. Unfortunately, however, selling a busi¬
ness is a life-changing event. For several years the entrepreneur has probably
devoted the majority of his or her time and attention to growing the business,
and it played an important role in structuring the entrepreneurs life. When the
business is sold, the entrepreneur often experiences a sense of loss, much like
the death of a loved one. If the entrepreneur has not prepared for this change in
his or her life, serious emotional problems could be the consequence. There are
several alternatives to selling the business outright that will be discussed in the
next section. For now suffice it to say that before selling the business, the entre¬
preneur should plan for what will happen after the business is no longer part of
his or her life.
The best way to sell a business is to know almost from the beginning that
selling is what you want to do. This is so that you will make decisions for the
business that will place it in the best position for a sale several years later. For
one thing you will maintain audited financial statements that give the forecasts
more credibility. The tax strategy will not be to minimize taxes by showing low
profits but to show actual profits and pay the taxes on them because you will
probably more than make up for the expense at the time of sale. Higher
recorded profits will likely help the business be worth more. You will keep the
business expenses and activity totally separate from the personal expenses and
ensure that the business has value without you by preparing a successor. You
will also plan for the time it will take to sell the business and wait to sell until
the window of opportunity has opened.
Smaller businesses often use the services of business brokers to sell the
business; however, a high-growth venture will more likely employ the services
of an investment banking firm that has experience with the industry.
Investment banks normally want a retainer to ensure the seriousness of your
commitment, but that retainer will be applied against the final fee on the sale,
which averages five percent of the purchase price. It is recommended,
however, that a third party with no vested interest in the sale be employed to
judge the fair market value of the business. This “appraiser” can also prepare
financial projections based on the history of the company and their indepen¬
dent market research.
When a business is sold, the entrepreneur does not have to sell all the assets.
For example, the building could be held out of the sale and leased back to the
Selling Your Name
If you have used your name as the name of the business, it becomes a negotiable asset in the
sale. To sell the business you may have to give up the right to use your name in any future
venture or in any advertising you do after the sale. Remember it has probably taken several years
to establish your business’s name in the marketplace. A purchaser will probably not want to
change that name and confuse customers. You may, however, be able to pay for the right to use
your name in a non-competing business, perhaps in a different industry. This is a serious issue
that should be discussed with an attorney.
business purchaser, with the original owner staying on as landlord. While the
potential purchaser is conducting due diligence on the entrepreneur and the
business, the entrepreneur needs to do the same with the purchaser. The
purchasing firm or individual should be thoroughly checked out against a list of
criteria the entrepreneur has developed. The purchaser should have the
resources necessary to continue the growth of the business, be familiar with the
industry and the type of business being purchased, have a good reputation in
the industry, and offer synergies that will ensure that the business continues in a
positive direction. It is often helpful to make a complete list of criteria and then
weight them by importance to fairly compare one potential buyer with another.
Cashing Out But Staying In

Sometimes entrepreneurs reach the point where they would like to take the bulk
of their investment and gain out of the business but are not yet ready to cut the
cord entirely. They may want to continue to run the business or at least retain a
minority interest. There are several mechanisms by which this can occur.
Selling Stock. If the company is still privately owned, the remaining share¬
holders may want to purchase your stock at current market rates so control
doesn’t end up in other hands. In fact, the shareholder’s agreement that was
drafted when you set up the corporation may have specified that you must first
offer the stock to the company before offering it to anyone else. If the company
is publicly traded, the task is much simpler; however, if you own a substantial
portion of the issued stock, you must follow strict guidelines set out by the SEC
in the liquidation of your interests. If the company had a successful IPO, the
entrepreneur’s founders stock will have increased substantially in value, which
presents a tax liability the entrepreneur should not ignore. That is why many
entrepreneurs in such situations cash out only what they need to support what¬
ever goals they have. This, of course, is based on the presumption that the
company stock will continue its upward trend for the foreseeable future.
Restructuring. Entrepreneurs who want to cash out a significant portion of

their investment and turn over the reins of business to a son or daughter can do
so by splitting the business into two firms, with the entrepreneur owning the
firm that has all of the assets (plant, equipment, vehicles) and the child owning
the operating aspect of the business while leasing the assets from the parents
company See Figure 18.1 onp. 414.
Figure 18.1: Restructuring a Business
A Phased Sale. Some entrepreneurs want to soften the emotional blow of

selling the business, not to mention the tax consequences, by agreeing with
the buyer—an individual or another firm—to sell the business in two phases.
During the first phase the entrepreneur sells a percentage of the company but
remains in control of operations and can continue to grow the company to the
point at which the buyer has agreed to complete the purchase. This approach
gives the entrepreneur the ability to cash out a portion of his or her invest¬
ment and still manage the business for an agreed-upon time, during which the
new owner will likely be learning the business and phasing in. At the second
phase, the business is sold at a price that is prearranged, usually as a multiple
of earnings.
This approach is fairly complex and should always involve an attorney expe¬
rienced with acquisitions and buy-sell agreements. The buy-sell agreement,
which spells out the terms of the purchase, specifies the amount of control the
new owner can exert over the business before the sale is completed and the
amount of proprietary information that will be shared with the buyer between
Phases 1 and 2.
Using an ESOP. If the business has more than 25 employees, one option for
the entrepreneur is to cash out via an Employee Stock Ownership Plan (ESOP),
but still maintain control for as long as desired. ESOPs, which are tax-qualified
pension plans or defined-contribution plans governed by ERISA and IRS regu¬
lations, have long been considered viable devices for succession planning but
work only where certain ingredients are present. The potential ESOP company
should have revenues of at least $3 million and an annual payroll of at least

$500,000, because the costs of setting up the plan can be substantial, around
$100,000 for legal, bank, and accounting fees. The business also needs to have
assets—inventory, accounts receivable, equipment—that can be used as collat¬
eral if a bank loan is required. Finally, the company should have excellent cash
flow to repay the ESOP .debt and buy back the stock of any employees who
might leave the company over time.
The company sets up an ESOP trust fund into which it puts new or existing
shares of stock. Another option is for the ESOP trust to take out a bank loan to
buy stock and a minority interest in the company, at least 30 percent to trigger
the capital gains exclusion. The shares in the trust are then allocated to indi¬
vidual employee accounts. The capital gains exclusion provides that the cash
the owners receive from the ESOP is not taxed if it is reinvested in U.S. stocks
or bonds. The banks too have an incentive to provide these ESOP loans because
half of the interest the company pays to the bank is tax deductible to the bank
if the ESOP owns 50 percent of the voting stock of the company. This can effec¬
tively raise the return on an eight percent loan to 12 percent.
The ESOP company makes tax-deductible contributions of up to 25 percent
of the participant payroll to the ESOP to repay the bank debt. The cash-out
price for the entrepreneur is based on the company’s value at the time and
results from a negotiation process with the trustee for the ESOP The ESOP
procedure is not something that can be completed quickly. Normally the entre¬
preneur prepares for the exit several years in advance, usually the length of time
to repay the bank loan. See Figure 18.2.
There are several advantages to ESOPs:
• The entrepreneur can reinvest the proceeds of the sale in other securities
within 12 months of the stock sale and thereby defer the gain until the new
securities are sold. This assumes that the entrepreneur has owned the stock
Figure 18.2: ESOP Financing
Loan
1 ■ Contributions^ I Payments
CORPORATION Stock ESOP Stock as
BANK |
OWNERS TRUST Collateral
Loan Funds 1 Loan Funds

for more than three years. If the securities remain in the entrepreneur’s estate
at death, the heirs avoid having to pay a capital gains tax.
• The ESOP creates a ready market for any remaining owner shares in the
entrepreneur’s estate upon death. The heirs can sell those shares to the ESOP
• ESOP loan interest rates are much lower than normal borrowing rates
because banks can deduct 50 percent of the interest income when an ESOP
owns 50 percent of the company’s voting stock.
• Assuming the ESOP owns 50 percent of the stock, it can deduct interest and
principal payments on the loan, which benefits cash flow enormously.
• ESOPs can also fund retirement plans and health care coverage.
• Employees participating in the ESOP can accumulate significant amounts of
money over time, once they are vested.
• Employee shareholders have no voting rights but are represented by the
trustee.
There are also several disadvantages the entrepreneur should be aware of:
• A company with an ESOP cannot elect a sub-chapter S corporation election,
partnership, or professional corporation.
• ESOPs are expensive to set up and maintain, with annual expenses running
about $10,000-$15,000.
• Private companies are required to repurchase the shares of employees who
leave the company.
• New shares issued dilute the value of existing shares of stock.
• An ESOP creates a much more open environment in terms of information
that must be shared with the ESOP participants than many entrepreneurs are
accustomed to.
Entrepreneurs often find that with an ESOP in place, employees have a

vested interest in the success of the business and tend to perform accordingly
In fact, the ESOP Association reports that about 71 percent of ESOP companies
surveyed experienced higher performance after the ESOP. The employees will,
however, also expect to be treated as partners in the venture and will want to be
privy to full information on the operations of the company.
Bankruptcy: Entrepreneurial Tool or Escape Plan?

It is an unfortunate fact of life that some entrepreneurs must exit their busi¬
nesses through liquidation. For whatever reasons, the business was unable to
pay its obligations and unable to secure capital to float the business until it
could. Certainly no entrepreneur starts a high-growth venture with liquidation
in mind as the exit strategy; but sometimes the forces working against the busi¬
ness are so great that the entrepreneur must have an exit vehicle so he or she
can move on to do something else. What forces a corporation into bankruptcy
is difficult to pinpoint. The immediately precipitating cause is the failure to pay
debt; however, a myriad of other events led up to that cause. They include
economic and business, cycles, excessive debt, surplus overhead, shifts in
demand, excessive expenses, poor dividend policies, union problems, supplier
problems, and poor financial management. Of course, the common denomi¬
nator for all of these factors is poor management.
The title of this section referred to bankruptcy as a “tool,” suggesting a
vehicle by which the entrepreneur can accomplish something. The use of bank¬
ruptcy law as a tool stems from the fact that once any bankruptcy action is
filed, all lawsuits and creditors’ calls stop. This was certainly important to
Manville Corporation, who filed for bankruptcy protection in 1982 based on an
anticipated 32,000 lawsuits related to injury from asbestos products. Manville,
which was a healthy corporation at the time, determined it could not stay in
business and pay the lawsuits. Some firms have used Chapter 11 to nullify a
union contract and force a change. At this point it should be noted that not all
businesses can file for bankruptcy protection. Those that are exempt include
savings and loans, banks, insurance companies, and foreign companies.
Furthermore, a bankruptcy filing cannot occur where the intent is to defraud,
and a company may file only once every six years.
Bankruptcy is normally a voluntary event; however, a company can be forced
into bankruptcy by its creditors if they are:
• One or more creditors whose claims amount to $5,000 over the value of any
assets if there are fewer than 12 claims, or
• Three or more creditors under the same above conditions where there are
more than 12 claims, or
• Any number fewer than all the general partners in a limited partnership.
Involuntary bankruptcies are not common because the courts deal harshly
with creditors that force a business into bankruptcy in bad faith.
The Bankruptcy Reform Act of 1978 and Public Taw 95-958 provide for
more than just liquidation of the business. Therefore, a clear understanding of
the bankruptcy mechanisms available to the entrepreneur is essential in consid¬
ering the options when a venture is faced with financial adversity.
• Chapter 7 discusses liquidation

• Chapter 9 deals with municipal debts

• Chapter 11 handles reorganization of businesses
• Chapter 13 deals with the debts of an individual with a regular income.
The two chapters that are pertinent to the entrepreneur are Chapter 11 and
Chapter 7.
Chapter 11. Chapter 11 under the bankruptcy code is really not a bankruptcy
in the commonly used sense of the word. It is simply a reorganization of the
finances of the business so it can continue to operate and begin to pay its debts.
Only in the case where the creditors believe the management is unable to carry
out the terms of the reorganization plan will a trustee be appointed to run the
company until the debt has been repaid. Otherwise, the entrepreneur remains
in control of the business while in a Chapter 11 position. After filing for reorga¬
nization, the entrepreneur and the creditors must meet within 30 days to
discuss the status and organization of the business. The court then appoints a
committee, which usually consists of the seven largest unsecured creditors, to
develop a plan for the business with the entrepreneur. That plan must be
submitted within 120 days and acceptance of the plan must come within 60
days of submittal. Of the total number of creditors affected by the plan, repre¬
senting at least two-thirds of the total dollar amount, at least one half must
accept the plan. Once the reorganization plan is approved by the court, the
entrepreneur is discharged from any debts with the exception of those specified
in the plan.
Chapter 7. Chapter 7 of the Bankruptcy Code is essentially the liquidation of

the assets of the business and the discharging of most types of debt. This
vehicle is usually chosen when the business does not have sufficient resources
to pay creditors while continuing to operate. The filing of a petition under
Chapter 7 constitutes an Order for Relief. A trustee is then appointed to manage
the disposition of the business, the goal of which is to reduce it to cash and
distribute the cash to the creditors where authorized. After exemptions, the
moneys derived from liquidation go first to secured creditors and then to
priority claimants. Priority claimants include in order:
• Administrative expenses related to the bankruptcy

• Wages, salaries, or commissions
• Vacation, severance, and sick leave pay up to $2,000 per person if earned
within 90 days of filing or the date of cessation of the business, whichever
came first
Chapter 18 * Planning for Change 419
• Contributions to employee benefit plans up to $2,000 per person earned

within 180 days of filing or cessation
• Individual claims up to $900 each for services not rendered or products not
received but paid for
• Taxes and customs duties
• General unsecured creditors
• Punitive penalties
• Accrued interest during the bankruptcy
Any surplus funds remaining after this distribution go to the entrepreneur.

Prior to distribution, the entrepreneur has the right to certain exempt property.
If the business is a corporation, those exemptions are minimal:
• Interest in any accrued dividends up to $4,000

• The right to Social Security benefits, unemployment compensation, public
assistance, veterans’ benefits, and disability benefits
• The right to stock bonuses, pensions, profit sharing or similar plan
If the legal form of the business is a partnership, the entrepreneur is entitled

to exempt those properties specifically allowed for individuals filing bankruptcy
petitions.
Lest it seem as though the entrepreneur is at the mercy of the creditors in a
bankruptcy situation, it should be made clear that the entrepreneur in either
type of bankruptcy petition, Chapter 7 or 11, has a great deal of power and
control over the process. This power comes from the natural desire of the credi¬
tors for a quick and equitable resolution to the problem, and the protections
inherent in the bankruptcy law. Often the creditors are better served by negoti¬
ating a restructuring of debt while the company is still operating and prior to a
Chapter 7 liquidation where they are not likely to receive as great a portion of
what is owed them. There are, however, certain things the entrepreneur will not
be permitted to do within a certain period of time before the filing of a bank¬
ruptcy petition:
• Hide assets or liabilities

• Give preferential treatment to certain creditors 90 days prior to filing the
petitions
• Make any potentially fraudulent conveyances up to one year prior to the
filing of the petition
Any of the above conveyances may be recouped by the court during the
bankruptcy proceedings.
Recently a new vehicle under Chapter 11 has emerged. Known as a “prepack¬

aged bankruptcy,” it can take from four to nine months to complete rather than
the typical nine months to two years. The entrepreneur presents the creditors
and equity owners with a reorganization plan before the bankruptcy filing actu¬
ally goes to court. If the entrepreneur can achieve the required number of votes
to agree to the plan (more than half the total creditors and two-thirds within
each class of creditors), then the prepackaged plan can go forward expeditiously.
There is an obvious advantage to the entrepreneur using this approach.
Under the traditional Chapter 11 approach, the creditors and everyone else
learn of the company’s problems at the filing. With a prepackaged plan,
by contrast, an approved plan is in place at the point at which the
A new vehicle
public becomes aware of the problem, and the creditors thus may
under Chapter 11
experience a greater sense of confidence in the entrepreneur. Moreover,
is the prepackaged
the prepackaged plan results in far less time in legal processes. For this
bankruptcy. approach to succeed, however, the statement of disclosure for the cred¬
itors about the positive and negative aspects of the business must be
carefully constructed to give the creditors all the information they need to
consider the plan and protect their interests.
Before considering bankruptcy as an option to either exit a troubled business
or restructure the business in an effort to survive, you should seek advice from
your attorney and/or a specialist in turnarounds in the industry. With the aid of
an accountant, you need to audit your assets and liabilities to see if the business
can qualify for and benefit from a Chapter 11 reorganization. Often seeking
help before filing a bankruptcy petition can lead to alternative, less difficult
solutions that are more beneficial to the entrepreneur and creditors alike.
Presenting the Contingency Plan in the Business Plan. The contingency plan
is normally a small section of the business plan. It represents the entrepreneurs
effort to demonstrate that the new venture has considered future contingencies
that may affect the business’s ability to perform as projected in the pro forma
Strategies for Avoiding Bankruptcy
• Avoid relying on one major customer or industry for revenue generation

• Keep overhead costs to essentials that directly contribute to support the generation of
revenues
• Maintain a degree of liquidity equal to about several months of overhead expense
• Maintain current and honest relationships with bankers, creditors, and suppliers
financial statements. Those contingencies typically include such events as

changes in the economic climate, changes in demand for the product, loss of
key employees, and the potential for changes in laws and regulations affecting
the business. Certainly no one expects the entrepreneur to account for all
contingencies that may impact the business; only those that may significantly
impact the business and have a real probability of occurring need be addressed.

Have you
□ Identified the issues that could potentially affect the business at various points
in the future?
D Developed a contingency plan for various scenarios that may impact the busi¬
ness at some future date?
D Determined your goals for the business relative to an exit strategy?
ESOP Association, Washington, DC, 202-293-2971.

Friedman, Robert. (1993). Small Business Legal Guide. Chicago: Dearborn
Financial Publishing, Inc.
Freiermuth, Edmund P. (1988). Life After Debt. Homewood, IF: Dow Jones
Irwin.
National Center for Employee Ownership, Oakland, CA, 510-272-9461.
Issues to 1. What is the benefit to the entrepreneur of contingency planning?
Consider 2. How can the entrepreneur prepare for potential product liability litigation
both to minimize the chance of occurrence and to give the company the best
4l chance of prevailing against a product liability claim?

3. How can the entrepreneur prepare for a potential decline in sales?
4. Which mechanisms are available to the entrepreneur when the goal is to
cash out of the business but maintain some degree of involvement with the
business?
5. How can bankruptcy law be a tool for the entrepreneur?
CHAPTER 19
Packaging and Presenting

the Business Plan
Overview
• The focus of the business plan
• The content of the business plan
• Oral presentation of the business plan
Preparing the Business Plan

This book has focused primarily on launching a new venture and secondarily
on growing the venture. In both instances, a business plan can be enormously
helpful if not absolutely essential. The business plan is a living guide to the
business that lets the reader understand the culture, mission, goals, and objec¬
tives of the new venture at various points in its life. Prior to start-up, the busi¬
ness plan helps the entrepreneur understand completely the nature of the
venture being undertaken, and to that extent, it assists the entrepreneur in
deciding if the business is viable or if new directions or new concepts should be
developed. Too often entrepreneurs “fall in love” with their business concepts
and charge ahead with no plan, only to discover after much time and money
have been expended that there is no market for it. Doing a feasibility study can
go a long way toward preventing these kinds of costly errors. Once the business
concept has been judged feasible, the business plan establishes the direction the
new venture will take in its effort to grow, and the means and methods by
which it will get there. It is also a vital source of information for others as the
entrepreneur seeks investment capital, a loan or credit line, or equity members
for the management team.
423
You have no doubt noticed that this book was designed to carry you through
the business planning process in a “logical” progression. Following this progres¬
sion may be the ideal way to go about preparing a business plan, but, frankly, it
doesn’t often happen in such an orderly fashion. Typically, information for all
parts of the business plan is gathered at various points in time, usually at the
convenience of the entrepreneur. The entrepreneur may talk to a distributor in
the industry seeking a sense of market demand for the proposed product and
wind up getting, in addition, an understanding of typical gross margins in the
industry, information that will not be needed until after it has been
Preparing a busi¬ determined that there is a market for the product. From talking to
suppliers during market research, the entrepreneur may become
ness plan doesn’t
concerned that the cost to produce the product is too great, so he or
often happen in an
she will quickly calculate the cost to produce and the probable selling
orderly fashion.
price based on preliminary information to see if there will be enough
money left over to pay overhead and eventually make a profit. If it
looks as though there isn’t enough profit in it to make the effort worthwhile, the
entrepreneur may decide to abandon the concept even before finishing the
market research.
As you can see, business planning is a fluid and dynamic process. One way
to gain a measure of control of the information gathered over time is to set up
files for each of the major sections of the business plan. As each piece of infor¬
mation is collected, it is filed in the appropriate folder. When it’s time to analyze
and prepare that section of the business plan, all the information needed to do
it will be there.
You will find people who will proudly proclaim that they never had a busi¬
ness plan and yet were successful. That may be true—there are always excep¬
tions to every rule—but more often than not, these entrepreneurs started small
businesses rather than high-growth, world-class ventures, or perhaps never had
to seek capital from outside sources. Also many of the more famous companies
that were started without plans—Pizza Hut, Crate and Barrel, Microsoft, and
Reebok—were started in the 1970s and early 1980s in a less global, less tech¬
nologically complex business environment. Moreover, most of these companies
eventually had to write business plans when expansion required taking on
investors, going public, or being acquired by a major corporation. Then, too,
you can’t dismiss the luck aspect. Being in the right place at the right time has
played a telling role in the early success of many ventures.
No one will deny that writing a business plan is a chore, but if you organize
the information in advance and plan for the time it takes to actually do the
Chapter 19 • Packaging and Presenting the Business Plan 425
writing, it can be accomplished with a minimum of pain and frustration. Be

realistic. This is not a job that can be completed in a marathon weekend, but is
a job that you as the lead entrepreneur and the key members of your founding
team must tackle seriously if you are to ensure the best chance for achieving the
goals of the business.
Writing with a Focus

Too often entrepreneurs approach the writing of the business plan with a “what
do I need to know” approach without considering the reader’s interests. It is
important to know prior to writing the plan that different readers have different
needs which must be addressed. How is it possible to write one business plan
for several different audiences? It’s not. You may need to have more than one
version of the plan to appropriately address the specific needs and requirements
of various audiences. For example, a business plan written with venture capital¬
ists in mind would focus on growth and high return on investment, but might
be considered too risky by a banker, who is more interested in how the bank’s
loan will be repaid. Likewise, a plan written to meet the needs of the banker
will not capture the attention of a venture capitalist, because generally it is too
conservative in its projections.
There are several audiences for the business plan. This section focuses on
those typically encountered by entrepreneurs starting high-growth ventures:
investors and venture capitalists, bankers or lenders, strategic alliances,
customers and suppliers, and key management.
Focusing on Investors and Venture Capitalists

Anyone investing in the new venture has four principal concerns: rate of
growth, return on investment, degree of risk, and protection. Investors are
generally betting on the value of their ownership interest in the business
increasing over time at a rate greater than that which could be gained in
another type of investment or in a bank account. They want to know how fast
the business is projected to grow, when that growth will take place, and what
will ensure that the growth actually occurs as predicted. They expect that
predictions will be based on solid evidence in the marketplace and a thorough
knowledge of the target market. Investors are naturally concerned about when
and how the principal portion of their investment will be repaid and how much
gam on that investment will accrue over the time they are invested in the
company. The answers to these concerns are largely a function ot the structure
of the investment deal, whether that be a limited or general partnership, or

preferred or common stock, and so forth. Consequently, investors want to
understand what the entrepreneur intends as far as deal structure, knowing full
well that the investor will at some point have some input into how the deal is
ultimately structured.
Investors want to thoroughly understand the risks they face in investing in the
new venture, principally, how their original equity will be protected. They expect
the entrepreneur to present the potential dangers facing the new venture and a
plan for mitigating or dealing with them to protect the investors against loss.
Finally, investors want to know how their equity will be protected if the business
fails and how the business will protect its assets from seizure by creditors.
There are some typical errors that entrepreneurs frequently make when
writing the business plan for investors or venture capitalists:
• Projecting rapid growth beyond the capabilities of the founding team. This is a
common problem. The new venture shows potential for rapidly increasing
demand, sales doubling or tripling on an annual basis in the first few years.
The entrepreneur believes this will be very attractive to investors. What he or
she doesn’t realize is that there is no evidence in the business plan to prove
that the founding team can manage and control this type of growth, and this
is a cause for great concern on the part of the investors. Too often they have
seen a business fail during rapid growth because management didn’t have
the systems in place to deal with it. The entrepreneur should be careful to
project controlled growth and have a plan for bringing on the necessary
personnel at the point at which the company is ready for more rapid growth.
The other danger in projecting too high a level of success is that you increase
the chances you will not be able to achieve it. It is better to project a little
more conservatively and try to exceed those projections.
• The three-ring circus with only one ringleader. Many entrepreneurs pride them¬
selves on being a “jack of all trades.” They claim to have expertise in all the
functional areas of the new venture. What they really have is general knowl¬
edge of all the functional areas and maybe a real expertise in only one.
Investors are very nervous about relying on solo entrepreneurs to lead
world-class ventures. They much prefer a team of founders with at least one
person specializing in each of the functional areas.
• Performance in some or all areas that exceeds industry averages. While it is
possible for a new venture to exceed industry averages in a particular area, it
is not likely. Most averages, such as those for receivables turnover and bad
debt losses, have come1 about as a result of economies of scale, which the
new venture is not likely to achieve for some time. It is better for the busi¬
ness plan to initially indicate performance measures at or slightly below
industry averages with a plan for how to exceed those averages at some point
in the future.
• Underestimating the need for capital. Investors need to know that the business
plan projects sufficient capital infusion to grow the company until internal
cash flows can carry the load and then provide a plan for an additional infu¬
sion of capital when the company is ready for rapid expansion. If the entre¬
preneur underestimates the amount of capital needed, most savvy investors
will recognize it and attribute the error to naivete on the part of the entrepre¬
neur, or, conversely, they will rely on the figures presented in the plan and
ultimately suffer the potential loss of their investment as a result. Every esti¬
mate for capital should contain an additional amount for contingencies.
• Confusing strategy with tactics. It is much easier to develop tactics than strate¬
gies. Strategies define the overall focus of the business, while tactics are the
methods by which those strategies will be achieved. When an investor asks
what the entrepreneur’s strategy is for achieving a projected market share by
year three and the entrepreneur responds with “attending trade shows and
advertising in trade journals,” the entrepreneur has lost the confidence of the
investor by responding with tactics. This mistake is often made, as many entre¬
preneurs focus too much attention on tactics, often to the exclusion of identi¬
fying the overall strategy those tactics will support. The strategy for achieving
the market share may be to become the first mover in a market niche.
• Focusing on price as a market strategy for a product or service. This is similar to
projecting performance above industry averages. It is rarely possible for a
new venture with a product or service that currently exists in the market¬
place to enter based on a lower price than competitors. Established compa¬
nies have achieved economies of scale that the new venture is usually unable
to do and will no doubt easily match the price set by a new entrant into the
market. Furthermore, this strategy does not impress investors. They are more
interested in how the new venture will differentiate itself in terms of product,
process, distribution, or service.
• The entrepreneur’s investment in the business. Investors are more comfortable
investing in a new venture where the entrepreneur has contributed a
substantial amount of the start-up capital. That signals to the investors a level
of commitment necessary to achieve the goals of the company.
Focusing on Bankers or Lenders

Like investors, bankers or lenders want to know they are going to get their
money back. When considering a business plan and an entrepreneur for a loan,
lenders have several concerns:
• The amount of money the entrepreneur needs. Lenders are looking for a specific
amount that can be justified with accurate calculations and data.
• What positive impact the loan will have on the business. Lenders would like to
know that the money they are lending is not going to pay off old debt or pay
salaries, but rather improve the business’s financial position, particularly with
regard to cash flow.
• What kind of assets the business has for collateral. Not all assets are created
equal. Some assets have no value outside the business because they are
custom-made or specific to that business and therefore cannot be sold on the
open market. They prefer to see industry-standard equipment and facilities
that can easily be converted to another use.
• How the business will repay the loan. Lenders are interested in the earnings
potential of the business over the life of the loan, but more important, they
want to know that the business generates sufficient cash flow to service the
debt. While fixed expenses are fairly easy to predict, variable expenses—
those related to the production of the product or service—present a more
difficult problem. That is why lenders are also interested in the market
research section of the business plan, which tells them what the demand for
the product/service is, and the marketing plan, which tells them how the
entrepreneur plans to reach the customer.
• How the bank will be protected if the business doesn’t meet its projections. Lenders
want to know that the entrepreneur has a contingency plan for situations
where major assumptions prove to be wrong. They want to ensure they are
paid out of cash flow, not by liquidating the assets of the business.
• The entrepreneur’s stake in the business. Like investors, lenders feel more confi¬
dent about lending to a business where the entrepreneur has a substantial
monetary investment in the business. That way the entrepreneur is less likely
to walk away, leaving the lender stranded.
Focusing on Strategic Alliances

Strategic alliances may involve formal partnership agreements with major
corporations or simply an informal agreement through a large purchase
contract. In either case, the larger company that is allying itself with the new
venture is usually looking for new products, processes, or technology that
complement its current line of products or services. Accordingly, it will search

for a new venture management team that has some large corporate experience
so the relationship will be smoother. They are also interested in strategic issues
like the marketing and growth strategies of the new venture.
Focusing on Major Customers and Suppliers

Major customers and suppliers are concerned with the new ventures perfor¬
mance record since the company was founded. As it takes some time to establish
a stable performance record, these third-party readers of the business plan will
probably not be interested in seeing the plan until the business is up and running
and beginning to demonstrate that its predictions for sales are fairly accurate.
Focusing on Key Management

Key management that the founding team wishes to attract during the growth
phase of the new venture will also be concerned about how precisely and accu¬
rately the entrepreneur has forecasted demand for the product or service. Many
of these targeted key management people will leave other jobs to join the new
venture so they will want to feel confident that the business will not fail and has
strong potential for growth. More than any other group mentioned, potential
key management will be more interested in the details of the operations of the
company.
At the beginning of this section, it was suggested that various versions of the
plan be developed depending on the audience. The longest and most detailed
. version will probably be for internal use and for attracting key personnel.
Investors, strategic alliances, and lenders in particular will probably prefer a
more concise—perhaps 40-page—version of the plan, focusing on the specific
areas of interest they have. It’s a good idea to read other companies’ business
plans to get a sense of what works and what doesn’t in terms of impressing the
reader. If the style and organization of a particular plan makes the business
concept seem more appealing, consider adapting the style to your business
plan. But make sure the content is written in your own unique style—other¬
wise, it may sound like a “canned” or professionally prepared business plan and
will win no points with a potential funder.
What to Include in the Business Plan

While there are no hard and fast rules about all the items to include in a busi¬
ness plan and where to put them, most business plans contain the sections
discussed below. The major sections of the business that have already been
discussed and outlined in detail in various chapters of the book will only be
listed here.
The Cover Page for the Bound Document

Like any document designed to sell something, the business plan is attempting
to convince various third parties—and the entrepreneur—of the viability of the
new venture. Therefore, the cover page should convey in an attractive, profes¬
sional manner the confidence and creativity of the entrepreneur. In the case of
venture capitalists and lenders, most have dozens of business plans cross their
desks every day, so it is important to make your plan stand out. Appearance
may be only skin deep, but positive first impressions go a long way toward
attracting the attention of a potential financial source. The typical information
to have on the cover page is:
• The name of the company

• The words “Business Plan”
• The name of the contact person for the new venture and the address and
phone number of the business
Some ways to make the business plan stand out are to use color on the cover,
the business’s logo with the name, or a design that reflects the personality of the
business.
The Executive Summary

The executive summary is a two-page (maximum three-page) summary of the
key points in the business plan. Often entrepreneurs use an executive summary
to gauge interest in the business before handing out the complete business
plan. It is also used to query venture capitalists as to their curiosity and desire
to know more about the business. If first impressions count, the executive
summary is one of the most crucial sections of the business plan, and probably
the most difficult to write. It is not easy to condense the major sections of the
business plan into a paragraph each, but it is an excellent exercise that forces
the entrepreneur to truly understand the key elements of the business and state
them in such a way that they entice the reader to want to know more.
Accordingly, the executive summary is first and foremost a selling document
whose purpose is to get the reader to look at the complete business plan. Most
venture capitalists and investors—as well as lenders—see so many plans that all
they ever read in the first pass is the executive summary. If they aren’t excited after
reading that, they’ll never look at the complete plan. So the first paragraph, even
the first sentence, is critical. It must convey the excitement and personality of the
business without using such time-worn, over puffed phrases as “There is nothing
like this in the market today” Statements like that are sure to turn an investor off,
because they know immediately that it isn’t true; very few new ventures are based
on concepts that are entirely new and nonexistent, and investors know this.
The first paragraph should also clearly show how the product or service
being represented differentiates itself in the marketplace. One way to do this is
to use the approach Gentech Corporation employed in its executive summary
(See Figure 19.1, for a portion of that summary). They briefly described a.prob¬
lem in their industry and how they were going to solve it. This approach lets
the investor know right away that the company is customer-oriented and has
differentiated itself in the marketplace.
Another important thing to remember about the executive summary is that it
should be a stand-alone document—that is, you should be able to hand it out
independent of the business plan.
Figure 19.1; A Portion of an Executive Summary
GENTECH CORPORATION
EXECUTIVE SUMMARY
Businesses and individuals who use both power and pneumatic tools have always had to deal
with using two distinct power units—a generator and a compressor—and leaving those units
running continuously for extended periods of time. This inefficiency results in:
• Increased operating costs of using two units
• Increased fuel consumption
• Increased costly maintenance and repairs
• Increased nuisance level of noise associated with gasoline engine-powered generators and
compressors running continuously
• Increased environmental pollution
GENTECH CORPORATION’S PowerSource™ alleviates these problems by providing:
• A combination air compressor and generator unit driven by a single gasoline engine and
providing both AC electric power and air power from one portable unit
• A patented start/stop system to control the engine remotely and automatically based on
demand, which reduces fuel consumption, costly maintenance repairs and is less polluting to
the environment as the engine only runs during tool usage or to replenish tank pressure
• Patented electronic switching between the generator and compressor to monitor AC and air
power requirements to ensure maximum power output on demand
• A variable timer delay system which avoids numerous engine shutdowns if tools are being used
frequently
• Portability through the use of one lightweight engine to power both functions
The executive summary goes on to describe how Gentech Corporation will

compete in the marketplace and summarizes the other major sections of the
business plan.
The Cover Page for the Business Plan

Between the executive summary and the table of contents for the business plan,
it is useful to put another cover page containing the name of the business and
the words “Business Plan.”
The Table of Contents

The table of contents should display the major sections of the business plan and
the key subheadings for each section.
The Body of the Business Plan

The body of the business plan contains all the major sections of information
that were discussed throughout the book.
• The purpose and description of the business

• The management team
• The industry
• The target market
• Operations
• Marketing plan
• Financial plan
• Contingency plan
• Deal structure (if appropriate for the reader)
• List of references if footnotes were not used
Business plans contain a lot of private information, some of which you may
not want to share with everyone who reads the plan. Again, that is the reason for
several versions. A section like “Deal Structure,” for example, should probably not
be included when giving a plan to a lender or potential management employee,
but is usually needed when dealing with investors or venture capitalists.
Be sure that the body of the business plan answers the basic questions:
1. Who are you?

2. What is the company?
3. What do you sell?
4. Who will buy?
5. Why will they buy?

6. How is your financial health?
Supporting Documents—The Appendices

Many items that might be important to the reader but would clog up the body
of the business plan and make it more difficult to read quickly can be placed in
appendices after the body of the plan. Some items that typically go in an
appendix include:
• Resumes of the founding team

• Job descriptions
• Lease agreements
• License agreements
• Contracts
• Letters of intent
• Incorporation agreements or partnership agreements
• Evidence of patents
• Designs, architectural or product
• Personal financial statement (only where required, typically by a lender or
investor)
Visual Presentation of the Business Plan

By now you know that the appearance of the business plan is the first step in
getting the plan read. The trick, however, is to have the plan look professional
without being too slick by making it a hard-bound, full-color, textbook-style
business plan. Besides, a hard-bound plan suggests it’s not subject to change
any time soon, which is not an impression you want to convey. Here are some
suggestions for ways to make the business plan stand out from the crowd.
• The plan should be bound in such a way that it lies flat when you read it. A
spiral type binding or binder works well.
• Use index tabs to separate major sections and make it easier for the reader to
find something.
• Use 12- or 13-point type fonts and an easily read font style like Times
Roman for readability.
• Use bolded subheadings and bullets generously, again to facilitate finding
information. (See Figure 19.2 on p. 434 for an example of one style of head¬
ings and sub-headings.)
• If you have a logo, use it at the top of every page.
Figure 19.2: Sample Formatting for a Business Plan
GENTECH CORPORATION
PRODUCT PLAN
Purpose Gentech Corporation, a privately held California corporation, was established to
manufacture and distribute portable power equipment incorporating patented, state-of-
the-art technology and satisfying a need for efficient, energy-saving and environmen¬
tally friendly power equipment. Gentech Corporation has been actively involved
since 1989 in the research and development of a portable dual-purpose power source
_ for power and pneumatic tools.
Product PowerSource ™, the first product to be offered by Gentech Corporation, is a combi¬
nation air compressor and generator unit mounted on a typical twin-tank, wheel¬
barrow-style frame. Driven by a single gasoline engine, the dual purpose
PowerSource ™ provides both AC electric power and air power from one portable,
lightweight unit. When operating as a generator, it supplies electrical power to 110 volt
outlets. When an electrical tool is in use, an electronic switching device automatically
sends a signal to open a valve to vent the compressor piston to the atmosphere, thus
significantly reducing the demand on the engine. As long as there is air stored in the
tanks, air tools and power tools can be used simultaneously. A powerful AC generator
and a high-output air compressor, the PowerSource ™ eliminates the need to trans¬
port both a generator and compressor to the work site.
PowerSource ™ features a state-of-the-art, start/stop system which controls the
engine remotely and automatically based on demand. This innovative system starts
the engine immediately upon demand from a power tool or when the pressure in the
air tank reaches the lower limit. The engine stops automatically when power tools are
not in use and the pressure in the air tank reaches the upper limit. No special tools,
electric cords, or air hoses are required. This system is considered to be fuel efficient
and less polluting since the engine is only running while an electrical tool is being
used or tank pressure is being replenished. To avoid numerous shutdowns if tools are
used frequently, a variable timer delay mechanism can be activated to allow the gas
engine to idle down for a set period prior to shutting down altogether. In addition, an
override switch allows the option of operating the engine continuously when a
constant power source is preferred.
• Make sure your writing is focused and concise. Prune excess words with a
vengeance.
• Make sure all claims are supported by solid evidence.
• Ask several people to edit the plan.
• Do not use fill-in-the-blanks computer programs to write the plan. The

result will not reflect the personality of your business.
• Revise and rewrite several times.
• Number each copy of the business plan and include with it a Statement of
Confidentiality that the reader should sign. Keep track of who has which plan.
• Place a statement on the cover page prohibiting copying of the plan.
Oral Presentation of the Business Plan

It is not uncommon, particularly if the plan is being used to seek capital, for the
entrepreneur to be asked to do a presentation of the business concept, high¬
lighting the key points of the business plan. Usually this occurs after the poten¬
tial funders have read the executive summary and perhaps done a cursory
reading of the complete business plan. In any case, they feel it is worth their
time to hear from the entrepreneur and the founding team to see if they measure
up to their expectations. While this presentation should not be confused with a
formal speech, it does share with a speech many common elements.
• Answer the fundamental questions as discussed in the preceding section on the

body of the business plan.
• Keep the presentation under a half hour. That is plenty of time to present the key
elements. Questions and discussion will probably follow the presentation.
• Be sure to catch the audience’s attention in the first 60 seconds. Tet them know
you’re happy to be there and immediately get them involved in the presenta¬
tion by showing concern, for example, for whether or not they can easily see
the presentation slides.
• Stand without using a podium. It will give you better command of the situation
and make it easier to use gestures and visual aids.
• Move around but don’t pace. It is deadly to stand constantly in one place, but it
is equally annoying to pace back and forth with no purpose. Moving helps
reduce stress and livens up the presentation.
• Maintain eye contact with everyone. Talk to the audience, not over their heads.
• Use visual aids. Color slides or overheads help keep the presentation on track
and focused on key points. Be careful not to dazzle the audience with too
many overheads, however, as the audience may find themselves more inter¬
ested in the rhythm of the motions you subconsciously develop as you flip
through the slides than in what you have to say. Keep the slides simple—no
more than five lines per slide—and professional looking.
• Make sure the key members of the founding team are involved in the presentation.
• Do a demonstration of the product or service where possible. It helps generate

excitement for the concept.
• Practice the presentation in advance for a small group of friends or colleagues
who will critique it, or videotape the practice session so the founding team
can critique themselves.
• Anticipate questions that may be asked by funders and determine how they
should be answered.
If the founding team has successfully made it through the presentation, they
have cleared the first hurdle. The second hurdle, however, is the hardest:
answering questions from the funders. One thing to learn about funders is that
they generally like to ask questions for which they already know the answers;
this is a test to see if the founding team knows what they’re talking about.
Furthermore, they will ask questions that either require an impossibly precise
answer or are so broad as to make the entrepreneur wonder what the questioner
is looking for.
Another type of question typically asked is “What are the implications of...?”
With this question they are looking for an answer that addresses their needs
and concerns relative to the request for capital. Finally, the type of question that
poses the most problems for the founding team is the inordinately complex
question that contains several underlying assumptions. For example, “If I were
to analyze your new venture in terms of its market share before and after this
potential investment, how would the market strategy have changed and how
much of the budget should be allotted to changing that strategy?”
The first thing the entrepreneur should do when faced with such a compli¬
cated question is to ask that it be repeated to ensure nothing has been missed
that might cause the entrepreneur to make an incorrect assumption. Alterna¬
tively, you can restate the question and confirm that it has been understood
correctly. Another suggestion is to ask for a few minutes to formulate your
answer. With this type of question, you may only feel comfortable answering
part of it, for example, you may have evidence to support a change in market
share as a result of the capital infusion which you could present. On the other
hand, you probably don’t want to commit to any course of action or any budget
amount without having had time to consider it further and gather more facts.
Saying this in response to the question will no doubt gain you a measure of
respect, for you will have demonstrated you don’t make important decisions
precipitously without considering all the facts.
If you are asked a factual question for which you do not know the answer
(usually these are tangential to the business plan and asked to see how you will
respond), admit that you don’t have that answer off the top of your head but
will be happy to find it after the meeting is completed and get back to them. If
the presentation or anything the team has proposed is criticized (a likely possi¬
bility), be careful not to be defensive or turn the criticism in any way on the
audience. If you do so, you will have lost your chance with them immediately
and may never regain it-. Remember, you are playing in their ballpark. They
make the rules. If it appears they will be difficult people to deal with as
investors or lenders, you don’t have to use them. Chalk up the presentation to
practice and go on to the next one.
Preparing and presenting the business plan is the culmination of months of
work. The business plan represents the heart and soul of the new venture and,
if it was researched and written well, it can enhance the chances of starting a
successful, high-growth venture.
Publishing Company, Inc.

Detz, Joan. (1984). How to Write and Give a Speech. New York: St. Martin’s
Press.
Gumpert, D.E. (1990). How to Really Create a Successful Business Plan. Boston:
Inc. Publishing.
Hoff, Ron (1992). I Can See You Naked. Kansas City: Andrew and McMeel.
Mancuso, Joseph (1985). How to Write a Winning Business Plan. New York:
Simon & Schuster.
Issues to 1. Why is the business planning process an excellent exercise for any entrepre¬
Consider neur contemplating the start-up of a new venture?
ih 2. How might the business plan change if the reader were an investor versus a
potential management hire?
3. What are the key components of the business plan?
4. When might you need to include a personal financial statement in the
appendix?
5. What are three key elements of a successful business plan presentation?
I n July 1985, a California corporation called Simtek, Inc. was founded to

produce and market patented consumer products. The company was initially
capitalized in November 1986 by selling 60 percent of its stock to two private
investors. Seed capital of $500,000 was raised to develop two products—the
Tapemate electric Scotch tape dispenser, and the Tapemate box sealer. Simtek,
Inc. initially chose to begin development and operations with the Scotch tape
dispenser, a concept that the founder, Steven Johnson1, had been developing
since 1982.
The Product
Tapemate®, a registered trademark of Simtek, Inc., is an AC electric tape
dispenser that dispenses and cuts any desired length of tape by pressing a
button. The TM-100 is designed to be quick and efficient and incorporates a
patented disposable tape cartridge containing Scotch brand tape. The original
Scotch brand tape did not sell well when it was introduced as there was no easy
way to remove the tape from the roll. The first tape dispensers invented are
those still in common usage today. They all contain a means for holding a roll of
tape and a serrated blade for tearing a desired length of tape. 3M, the manufac¬
turer of Scotch brand tape, produces an excellent adhesive product, but diffi¬
culties continue to arise when customers attempt to remove the desired length
from a tape roll even with the use of a traditional dispenser. Invariably, the tape
has unwanted finger prints, smudges, jagged edges, and so forth. The TM-100
solves this problem by pulling tape off the roll at a smooth three inches per
second without finger prints or smudges and also cutting the dispensed length
of tape cleanly without serrations or jagged edges.
To further ensure the quality of the Tapemate dispenser and its intended
functions, Simtek also designed a disposable tape cartridge, much like a type-
^teven Johnson is not the real name of the entrepreneur/inventor who founded Simtek.
writer ribbon cartridge. The cartridge helps keep the dispenser clean while
ensuring that the correct type of tape is being used in the dispenser. The
cartridge is easy to load into the dispenser and comes in several types of tape in
a variety of widths, lengths, adhesives, thicknesses, and overall quality. Simtek
felt it was important to control the type of tape used in the dispenser to guar¬
antee the highest quality. It also planned to price the product at a price point
similar to the electric pencil sharpener so it would sell well in major office
supply outlets. A retail price point of $79.95 was determined.
Simtek applied for and was granted a United States Patent, #4,638,696, for
the electric tape dispenser. Research found that previous similar inventions
suffered from a number of difficulties, including the jamming of the operative
mechanisms due to the adhesive surfaces contacting the operative mechanism
of the dispensing device. Another chronic problem was the propensity for slack
to form in the lead portion of the material within the device that would then
become entangled in the operative mechanism, thereby jamming the dispenser.
It was based on this research that Simtek believed that a need existed for its
Tapemate product.
The Company Philosophy

Johnson planned to begin operations with a very small staff of multiskilled indi¬
viduals, subcontract for manufacturing, and use independent sales reps for a
sales team. The goal was to be a “highly service-oriented company with a firm
belief in quality and customer satisfaction.” It would strive to maintain a very
low product defect ratio to promote customer loyalty. Furthermore, Simtek
would not be a one-product company. It would continually search for new
consumer products that were innovative and competitively priced.
The History ot the TM-100

Johnson approached a prestigious design firm located in Palo Alto, California to
engineer the product and complete the assembly drawings, and contracted with
a well-known Southern California design firm to handle the packaging design.
The cost of design and development was exceptionally high. It included about
$60-70,000 for injection molding tools, $30-40,000 for engineering, and
$25,000 for patents. Johnson then took the drawings to a model builder to
develop a prototype. At this point a total of about $150,000 had been spent in
R&rD. It was decided to produce the Tapemate m Korea to keep manufacturing

costs down, and limited production was begun.
The initial feedback was positive; it appeared that the market for the electric
tape dispenser was very large. However it was quickly learned that the product
was more price sensitive than first anticipated and, in addition, manufacturing
costs were coming in higher than estimated, due in large part to over-design of
the product. In other words, the product had too many advanced features that
resulted in excessive manufacturing costs.
Johnson decided to save money by acting as his own manufacturers rep,
initiating sales first in the United States and then in Europe through a contact
he had made in Switzerland. He attended trade shows and demonstrated the
product in major department stores like Bloommgdales and Macys. Demon¬
strating the product resulted in greater sales, in large part because of the design
of the box in which the Tapemate was packaged. While very attractive (it won
several design awards), it did not, however, show what was in
the box beyond saying Simtek Tapemate®. There was no picture
of the dispenser on the box, so potential customers didn’t
recognize the product for what it was when they saw it on the
shelf. Still, Johnsons efforts produced sales of approximately
7,000 units domestically and 5,000 in Europe. In 1988 gross
sales totaled $16,345 with a COGS of $10,945. In 1989,
gross sales totaled $28,062 with a COGS of $21,092.
At this point, the product had been in the market for
three years. Simtek did additional market research and
concluded that some key changes had to be made in the product—specifically,
a DC battery-operated version so the product would not be geographically
sensitive, and some minor design flaws had to be adjusted. For example, it was
found that if a customer touched the start button too quickly and didn’t hold it
quite long enough, the dispensing mechanism would jam after several repeti¬
tions. Furthermore, there was the problem of the price point. Johnson’s market
research indicated that customers perceived the electric tape dispenser as an
equivalent of an electric pencil sharpener rather than an electric stapler. This
was a crucial distinction, as electric pencil sharpeners could be bought in the
$15-$20 range, while the price on electric staplers was much closer to the price
on the tape dispenser. At $79.95, the tape dispenser did well in gift stores
because its design was very stylized and it worked well in demonstrations.
However, it was not competitive in the office supply market where margins are
very small.
Back to the Drawing Boards

Having determined that the original design was probably not the most market¬
able, Simtek approached two major California product design firms for estimates
on the development costs for the battery-operated tape dispenser. The goal of re¬
design was to reduce the cost of manufacturing through component optimization,
part reduction, and mechanism development. The design goals included:
• A battery-powered product with an optional AC adapter for extended

operation
• An improved user interface via a switch separated from the tape dispensing
area to eliminate accidental switch activation
• Easy access to internal components in the event of mechanism failure
• Control of the minimum length of tape dispensed to avoid mechanism failure
• Elimination of custom cartridges. Access to the internal feeding mechanism
would be provided to facilitate the tape-loading process.
• Replacement of the solenoid-driven cutting mechanism with a mechanically
equivalent solution to reduce the overall power consumption and compo¬
nent cost
• Cost of Goods Sold held to between $5 and $6
• Exploration of alternative motor and drive assemblies to optimize perfor¬
mance and minimize cost
• Reduction in the number of labor-intensive processes such as electrical assem¬
bly and soldering, and provide for unidirectional assembly of all components
It was estimated that to be competitive, the new unit must sell at a retail price
of approximately $15. This translated to a manufacturing cost of $3-$4.50 per
unit. The estimates from the product design firms came in at $74,000-$91,000
for concept design, breadboard design (the first stage of a design using models),
documentation, prototyping, and pre-production. The entire process would take
from 28 to 33 weeks to complete, with the deliverable being a production-quality
prototype.
Estimate of Sales After Redesign

Cost to Unit Sales Year 1 Year 2 Year 3 Year 4
Redesign Cost Price Sales Sales Sales Sales
Tapemate $150,000 $6.00 $12.00 25,000 units 75,000 units 125,000 units 150,000 units
$300,000 $900,000 $1,500,000 $1,800,000
The Beginning of the End

With the design proposal and a revised financial project in hand, Johnson went
in search of additional funds for redesigning and to buy out his original
investors who, by 1990, were becoming frustrated. Tired of waiting any longer,
though, the original stockholders finally forced a dissolution of the company
and wrote off the investment on their taxes in 1991.
SIMTEK, INC.
Pro Forma Income Statement
(Year 1 after redesign)
Revenues Monthly Annual

Sales - Tapemate 25,000 300,000
Sales - Box Sealer* 100.000 1.200.000
Gross Revenues 125,000 1,500,000
Less: Cost of Goods Sold 62.500 750.000
Gross Profit 62,500 750,000
Expenses
1. Promotion and Advertising 250
2. Entertainment and Travel 500
3. Meals 100
4. Wages 12,083
5. Payroll Tax 483
6. Medical/Workers’ Comp 725
7. Telephone 400
8. Supplies 250
9. Rent 1,500
10. Freight 300
11. Model Making R&D 1,000
12. Drafting R&D 2,500
13. Materials R&D 1,000
14. Tooling 11,000
15. Legal 750
Total Expenses 32,841 394.092

355,908
Commissions 75.000
Net Profit Before Taxes 280,908
* Based on adding Box Sealer product to mix
1. Contract PR efforts 6. 6% of payroll 11. Appearance and check models

2. Trade show travel/buyer visits 7. Average including fax 12. ME drafting to work up ideas
3. Employee travel/meals 8. Office supplies and equipment 13. Stuff
4. Staff salaries 9, Office/warehouse space 14. Tapemate • $50K; Box Sealer -
5. 4% of payroll 10. UPS/Fed Ex/US Mail 15. Patent work
1. With regard to Simteks product development process, what were the key
problems with the process and how could they have made it more efficient
and less costly?
2. What were the advantages and disadvantages of taking on venture partners
during the product development phase?
3. With consideration to Johnsons pro forma statement for what he expects to
happen after redesign, what should Steve Johnson do now that the partners
have dissolved the company?
A World-Class
Venture
The quality of your work, in the long run,

is the deciding factor on how much your
services are valued by the world.
-OG MANDINO
CHAPTER 20
Achieving World-Class Status
On Becoming World Class

This chapter culminates a long process that started with an opportunity and an
idea in the mind of the entrepreneur. Whether or not the reader is an entrepre¬
neur, by this point it should be clear that the entrepreneurial mindset—the
entrepreneurial vision, if you will—is the antithesis of the bureaucratic mindset
found in so many large organizations today. It is also distinctly different from
the mindset of the small-business owner. Unfortunately, in much of what is
written about entrepreneurs (and the term is often used loosely) these distinc¬
tions are blurred, so the reader never comes away with a clear sense of why
some ventures become the Microsofts of the world and others never go beyond
providing a modest income for the owner.
This book has attempted to make that distinction clear by focusing on entre¬
preneurs as founders of high-growth, world-class ventures. It should also be
apparent from the book that the birth of a Silicon Graphics or a Staples Office
Supply begins in the mind of the entrepreneur with world-class intentions. The
decisions made, even in the pre-start-up phase, reflect the global mindset of
these entrepreneurs.
The defining factor for world-class ventures is no longer size; in fact, size
may actually be a deterrent to world-class status in the 1990s. Certainly, there
can be no doubt it is much easier to start a venture with world-class intentions
than it is to change the habits of years in a large organization. A new venture
with world-class intentions can set up the infrastructure and hire people who
have the same mindset. It can measure all of its actions against the criteria for
world-class companies. A monolithic, bureaucratic organization, by contrast,
struggles constantly against resistance to change among its people and organiza¬
tional structures that seem to be as firm as concrete. While the bureaucratic
447
448 Part 8 • A World-Class Venture
company may have the financial resources and clout to become world-class,
they may be outdistanced by the scrappy entrepreneurial venture that under¬
stands how to be world class from the very beginning. In the 1990s, make no
mistake about it, being world class is a distinct competitive advantage.
How do you know when you have achieved world-class status? While there
certainly are exceptions, there seem to be eight characteristics common to
world-class ventures:
• A global vision
• An established network of strategic alliances
• Innovative, proprietary technology
• A market-driven strategy
• A globally experienced management team
• An integrative, organizational team philosophy
• Absolute integrity
• A passion for excellence
A Global Vision
World-class ventures are born with a global view. From sourcing materials and
parts, to distributing product, selling product, and setting goals for the future,
these ventures know no geographic boundaries. It has often been said that new
ventures should wait to go global until they are well established and have
achieved a certain level of sales. If Water Ventures, Inc., a resort watersports
equipment and services company in California, had listened to that advice, it
might not be in business today. Water Ventures found that the best markets for
its products lay overseas, in particular the Middle East. Consequently, the
domestic market is a relatively small portion of its total sales.
Having a global vision is not just a world-class attribute—it is a matter of
survival. An entrepreneur has two choices: take the leap into the international
arena or retreat within the boundaries of the U.S. and watch its market share
being eaten up by international competitors. Of course, “taking the leap” does
not necessarily mean establishing a physical presence in another country via a
manufacturing or other facility. It may mean establishing a strategic alliance with
a foreign company or simply exporting products internationally to gain a pres¬
ence in a region before investing large amounts of capital in something more
permanent. If you are an original equipment manufacturer (OEM), it may mean
responding to a customer that has gone global by locating a distribution center
in the region where the customer is selling product. In fact, in some countries,
Chapter 20 • Achieving World-Class Status 449
the only way to do business is through a joint venture or contract with a local
company. The U.S. venture maintains control of its R<SrD, finance, manufac¬
turing, and quality control, but uses locals for marketing and service functions.
Having a global vision is much more than merely recognizing an opportunity
in another country, however. It entails understanding the way business is
conducted in that country, learning the rules and regulations of trade, and
having an awareness of global monetary markets.
An International Network of Strategic Alliances

Maintaining a global vision requires resources beyond any one company’s
ability to acquire or manage. The future of business lies in establishing
successful relationships with other companies and sharing resources to the
benefit of all. The so-called information superhighway is a global phenomenon
still in its infancy, but it presents a wealth of opportunity not seen since the
invention of the personal computer. It is touted to change completely how tech¬
nology is used, to the extent that no one technological source (i.e. the PC) will
dominate or be required. For the information superhighway to be a success,
however, will take cooperation among the hundreds of new and established
ventures seeking to grab a piece of the action.
Going into global markets also requires partnerships with experts in partic¬
ular countries. Nowhere has this been more evident than in the former eastern
block countries, including Russia. With capitalism and a market-driven
economy still new concepts to the people of these countries, the local expertise
that a U.S. venture intending to do business there will seek is expertise in
government policy, monetary policy and exchange, and general “street smarts.”
Developing a relationship with a local business, no matter how small, will
smooth the way into the business environment of the country.
Innovative and Proprietary Technology

For a company with a global vision, it is not enough to simply have a patent on
a product and expect to maintain a competitive advantage on a global level. For
one thing the global markets have not yet come to complete agreement on how
to protect intellectual property rights outside the boundaries of the country in
which they were executed. In some countries a patent application by a U.S.
company is held in the “applied for stage” as long as eight years before a patent
is issued. During that time it is not uncommon for a local company to “reverse
engineer” the product and bring it into the market to compete with the propri-
etary company. Moreover, even if a company has secured patent rights in a

country, it may be inordinately costly and time consuming to protect them
against local infringers.
The problem that U.S. companies have long faced is the loss of technological
preeminence and with it a competitive advantage in terms of proprietary tech¬
nology. Relying heavily on foreign technology, by 1986 American companies
had lost the lead to Japan in seven major areas that were key to future develop¬
ments in electronics and optics.1 The principal reason advanced for this decline
in technological strength was a lack of sufficient investment in R&D and basic
research. By 1985, almost 45 percent of all patents granted went to foreign
applicants.2 Moreover, American businesses were increasingly getting their high-
tech components from foreign manufacturers.
But the solution to this problem is not to retreat within the political and
economic boundaries of the United States, but to seek ways to regain techno¬
logical preeminence while still dealing in the global marketplace. If innovation
and proprietary technology are to be key components of a world-class venture,
they must be interwoven so tightly in terms of product and process that
“reverse engineering” becomes an exercise in futility. Businesses need to follow
the lead of those industries that continue to pay attention to basic research:
chemical, electrical equipment, and food products industries. Innovation in
products in these industries has always necessitated innovation in process as,
more often than not, companies have had to invent equipment and processes to
produce their products. In doing so, they have gained a proprietary advantage
both in their products and in the equipment used to produce them—a difficult
barrier to overcome for those who would attempt to compete by infringement.
Innovation can often provide a competitive advantage even where legal
protections are not available. An innovative marketing strategy or a unique
distribution strategy, even using products or services not in and of themselves
innovative, can give a new venture a niche advantage in the market. Innovation
is not just about technology, or products, or processes. It is about looking at
every aspect of the organization to see how things could be done better.
Innovation... “is the specific tool of entrepreneurs, the means by which they
exploit change as an opportunity...”3 It’s about what Drucker called, “creative
Advanced Processing of Electronic Materials in the United States and Japan; A State-of-the-Art Review Conducted
by the Panel on Materials Science of the National Research Council. (1986). Washington, DC: National Academy
Press.
2Hayes, R.H., Wheelwright, S.C. & Clark, K.B. (1988). Dynamic Manufacturing: Creating the Learning
Organization. New York: The Free Press.
3Drucker, Peter F (1985). Innovation and Entrepreneurship. New York: Harper & Row.
imitation,” waiting for something new to be developed and then jumping in

and making it better. That is what IBM did after Apple introduced its successful
personal computer. It designed a computer based on customer needs that
became the standard in the industry, the PC. The idea was not IBM’s; IBM
simply exploited the success of Apple through creative imitation.
The world-class entrepreneurial venture of the 1990s must make innovation
an ongoing process in every function of the business—not innovation for inno¬
vations sake, but innovation that is market-driven, that will give customers
what they want. New ventures have a distinct advantage over large businesses
because they are used to thinking small, and it is many small experimental
starts that ultimately lead to innovation. Paul Hawkin, in his book The Next
Economy, observes that “...it is one thing to start a business that becomes large
and entirely another to start things on a large scale. You should imitate nature,
where meaningful beginnings are almost always unnoticeable.”4 The fact that
most new ventures have little capital can also be an asset because the project
stays small and simple and the pressure to succeed is much greater. Innovation
in a world-class venture involves:
• Including customers at all stages from idea to design to prototype

• Using a team-based approach
• Testing the idea early and quickly
• Getting physical with a prototype quickly
Innovation is action-oriented; it happens quickly and usually without the

formality of committees, boards of directors, and strategy sessions. Innovation
welcomes failure, in fact, demands it, but quick failures that help the company
change direction and move toward success. Innovation means breaking the old
rules and creating new ones. In short, innovation is the new venture constantly
renewing itself.
A Market-Driven Strategy
The world-class venture of the 1990s lives for its customers. Customers will
decide what is produced, when and how it is produced, how much is
produced, how much it will cost, and where it can be purchased and serviced.
To paraphrase Ross Perot, the customers are the owners of the company.
Keeping the customers happy is essential to the survival and success of the
business. In a market-driven business, it is not just the sales personnel who
4Hawkin, Paul. (1983). The Next Economy. New York: Holt, Rinehart & Winston., pp. 172-3.
deal with the customer. Everyone from the engineers to the plant workers to
the office staff knows the customers. This means that those responsible for
product development spend time with customers assessing needs; those who
handle billing and invoicing spend time with customers to assure that the
service they provide is meeting its mark; and senior line management spends at
least a third of the time with customers so they don’t lose touch with the
company’s greatest asset. In short, all actions taken by the organization are first
assessed based on their impact on the customer and secondarily on their impact
on the business. Without the customers, there is no business.
In a world-class business, the customer is an integral part of the organization
and is encouraged to participate in the company through letters, newsletters,
visits to the company facilities, and attendance at special meetings. Customers
are given numerous opportunities to express their feelings, give their sugges¬
tions, and are regularly sampled for their degree of satisfaction with the
company and its products or services. When a world-class business makes
promises to a customer, those promises are kept no matter what the cost to the
business to do so. The customer is always right.
An Internationally Experienced Management Team

The new venture with a global vision must be led by people who understand
the economy and the marketplace beyond their native country. That knowledge
may have come from reading, vacations abroad, and television, but everyone in
a world-class organization must have or acquire at least a basic understanding
of other cultures and economies. Naturally, a start-up venture normally does
not have the resources to hire international experts in management positions
for some time, but the founding team can rely on international consultants and
foreign agents to guide them through the process of internationalization until
they can hire the expertise to become part of the team.
So much is now being written about how business is conducted in other
parts of the world that it will not be difficult for any entrepreneur to start
becoming internationally educated. Universities, corporations, and individuals
regularly give seminars on global issues related to business. If the entrepreneur
has targeted a certain region of the world for market introduction, it is always
wise for key management to spend some time there in advance of introducing
the product and the company. It can never be assumed that customers are the
same everywhere or that suppliers or distributors operate by the same set of
rules. Management should also acquire a working knowledge of international
trade rules and agreements, such as the General Agreement on Tariffs and
Trade, the North American Free Trade Agreement, the European Community,
and the Association of South East Asian Nations.
An Integrative, Organizational Team Philosophy

This book has stressed the team approach to entrepreneurship because it is
believed that no one person has the expertise, experience, or energy to do every¬
thing or take control of every activity of a rapidly growing venture. The classical
entrepreneurial leadership style is to do all of the crucial tasks yourself, hire
others to do the secondary tasks, and direct and monitor everything yourself.
This is, for the most part, how the majority of new ventures start out. The clas¬
sical style works fine for a while, until the business outgrows the entrepreneur’s
ability to stay on top of everything. The classical entrepreneur, finding it
Complex new difficult to delegate responsibility and authority, may hire management
ventures require an personnel to help, but will still stay directly involved in all major deci¬
sions. This approach does not work well when you’re trying to build a
Integrative, team-
world-class venture; in fact it more often than not inhibits the growth of
based approach to
the business and makes it difficult to achieve excellence.
management. Another approach is for the entrepreneur to act as the ringmaster in a
three-ring circus. The entrepreneur outsources all the tasks he or she
doesn’t want to do and essentially coordinates all the efforts—the ultimate virtual
corporation. It is possible to build a very large business this way; however,
whether or not you can achieve world-class status is arguable. What many
virtual corporations find is that it is often difficult to control the quality, service,
and delivery timing of other companies’ resources. That lack of control is no
more apparent than when a member of the virtual channel suffers a loss such as
fire that can cause a chain reaction throughout the entire channel of distribution
with potentially devastating consequences for the entrepreneur’s business. To
build a world-class organization under this scenario requires the complete coop¬
eration of all members of the virtual team, a difficult achievement at best.
Complex new ventures require an integrative, team-based approach to
management. Some examples of complex organizations are manufacturing,
service organizations that provide a variety of services, and retail operations
with multiple locations. These types of ventures demand that the entrepreneur
delegate authority in specific areas of the business to specific people and then
let those people make their own decisions. Of course, the entrepreneur retains
the right to terminate the employee if he or she feels those decisions are not
appropriate to the goals or philosophy of the company. An integrative, team-
based approach (ITB) means that key management in all the functional areas of
the organization participate fully in the design, development, production, and

distribution of the products or services that the business offers. This does not
necessarily suggest that all members of the team are employees of the entrepre¬
neur. They may, in fact, be virtual members of the organization, independent
contractors who carry out specific functions of the entrepreneur’s business
within their own companies.
The advantage of the team-based approach is that it promotes skill, discipline,
motivation, and learning—essential attributes of a world-class organization. It is
not an approach that can be achieved overnight, however. That is where a new
venture has an advantage over an established firm that is attempting to convert
to a team-based approach to management. The new venture can begin with a
team-based philosophy, infrastructure, and personnel prepared to take on the
responsibilities inherent in this approach.
In a team-based approach, employees work in teams of perhaps six to seven
people with a supervisor who really acts as a facilitator. The team in essence has
a problem-solving mandate; consequently members of the team are
The advantage of paid based on their skill level rather than on the job they perform. This
the team-based is a critical distinction, because in the ITB approach, problem-solving
approach is that it and people skills are rated as important, if not more important, than
promotes skill, disci¬ physical or task skills. All teams are charged with the responsibility of
pline, motivation, finding ways to improve all aspects of the product, process, and
and learning — service. A particular job is measured by the number of physical opera¬
essential attributes tions involved in completing a task and the number of managerial or
of a world-class problem-solving skills involved. This means that no longer are there
organization. assembly-line jobs that can be done without thinking. Technical and
managerial competence is required of all jobs; accordingly, the people
who are hired to work in a world-class business must have both skills or at least
be motivated to acquire them.
It is certainly much easier to form an organization with ITB in mind than it is
to decide to convert later on after employees with a more traditional mindset have
been hired. Nevertheless, even the entrepreneur with a new venture cannot
simply announce to potential employees that they will have to think about their
work and ways to improve it and expect it to happen automatically. Entrepre¬
neurs dedicated to ITB must be willing to train employees in problem-solving
skills and provide incentives for continual learning. They must also be willing to
educate their employees on where they fit into the big picture of the organization.
Another advantage of ITB is that less information is required to coordinate
the activities of all the functions of the business because control is much further
down in the organization. In the case of a manufacturing firm, however, more

information is typically needed on the plant floor because of the need to coordi¬
nate the efforts of the various teams to ensure the timely and efficient
processing of the product. This information requirement can be met by the use
of computer-integrated manufacturing technology (CIM), which allows those
involved in the production process to manage quality control, production plan¬
ning, machine setup, and problem diagnosis and resolution in real time and by
interacting with staff via computer where necessary.
To balance the greater demand for information, teams are given the authority
to respond to various situations as they occur. In this way valuable production
time is not lost attempting to get approval from a higher level of authority. Of
course, for teams to be able to make decisions on the spot, they must have a
clear understanding of the entire production process and the impact any deci¬
sion they make might have, hence, the importance of integration and contin¬
uing education. The best type of ITB is one in which all teams are cross-trained
so no one aspect of production is dependent on a single team.
Furthermore, all production teams work directly with engineering teams,
marketing teams, sales teams, and finance teams, with everyone rewarded based
on the performance of the business. With an integrated, team-based approach,
no one team and no one person is more important than any other. Management
sends a clear message that the person who solders the wires is every bit as
important to the company as the person who manages the finances, or the sales
person who promotes the product. Accordingly, in an ITB organization, you
will not see executive dining rooms, special parking places for certain people,
or barriers of any kind to the free and open flow of communication and trust.
Of course, integrated, team-based management and process control must go
hand in hand as well. It is only by streamlining materials flew and minimizing
work-m-process inventory that problems and bottlenecks in the system readily
surface so they can be detected and solved, not in a piecemeal fashion, but so
the entire production process can continue unimpeded.
Absolute Integrity
To accomplish the successful networks of strategic alliances necessary to
operate in a global economy requires integrity. The old adversarial mindset that
business has traditionally held no longer works when you are striving to
become a world-class venture. The environment for entrepreneurial ventures
has always been volatile and uncertain. Add to that the global dimension and
there aren’t too many things that can be relied upon to remain constant. Hence,
the one constant that must be present is the security that relationships are
based on integrity, ethics, and trust. Often, in an effort to be competitive,
companies promise what they can’t deliver or change the terms of an agreement
at the last minute when the other party is at its most vulnerable. These tactics
may be successful in achieving certain ends in the short term, but the cost in
loss of customers and reputation will be devastating in the long term.
Integrity is consistency in what the company says, does, and stands for. It is
fair and uncompromising treatment of every supplier, every distributor, every
customer, and every employee. If you are going to expect the best from these
people and ask them to assume some of the risk with you, they must feel confi¬
dent you will do what you promise. Integrity is confidence that the company is
who they say they are. It means knowing that you will not be short-changed on
a payment, or on a quantity order, that products will meet the level of quality
advertised, and that service will be provided as promised.
In a global economy the issue of business ethics often displays its formidable
presence. It is common knowledge that not all countries operate under the
same rules of ethics as the United States. Is it OK for an American business to
accept a bribe in another country or pay a government official under the table
to speed up a process? For a world-class venture the question is moot. Absolute
integrity means maintaining high ethical standards in all business dealings no
matter where they take place. How can an entrepreneur expect employees to
act fairly and honestly toward the business if the business is not doing the
same? Honesty is still the best policy.
A Passion for Excellence

In their best-selling book, A Passion for Excellence, Peters and Austin said, “a
passion for excellence means thinking big and starting small: excellence
happens when high purpose and intense pragmatism meet.” But they caution,
“the adventure of excellence is not for the faint of heart.”5 Ten years later that
message is probably even more relevant than it was when the authors wrote it.
Like being a world-class venture, achieving excellence is not a stage in the life
of business,' but rather an ongoing process of improvement that never ends.
Hayes, Wheelwright, and Clark call it “continual learning.”6 They assert that
wherever U.S. manufacturers have lost competitive advantage, the source can
be traced to problems with cost, quality, and innovation.
5Peiers, Tom & Austin, Nancy. (1985). A Passion for Excellence. New York: Warner Books.
6Hayes, R.H., Wheelwright, S.C. &r Clark, K.B. (1988). Dynamic Manufacturing. New York: The Free Press.
For companies dealing in a global market, cost is a function of productivity

and the exchange rate. If U.S. companies do not keep pace with other countries
in terms of their investment in plant and equipment, any productivity gains
may be lost. Moreover, while American companies strive to dispel the percep¬
tion of low quality, foreign companies are also moving ahead in that arena,
making it difficult for-American companies to catch up. Finally, with U.S.
investment in R&rD at low levels compared to other countries and with the
majority of federal government money for research going to defense and aero¬
space rather than commercial development or basic research, it is difficult for
American companies to regain technological preeminence with breakthrough
products and technology. But it is not impossible. Waiting for the government
to change its focus or for megacorporations to reinvent themselves is not the
short-term solution. The short-term answer lies with new ventures and the
entrepreneurs who start them. These entrepreneurs must:
• Hire the very best people and work hard to keep them
• Become experts in integrating product/process design
• Be flexible and fast
• Maintain a state-of-the-art philosophy in every area of the organization
• Manage on the leading edge
• Use an integrated, team-based approach
• Have a customer focus
• Take a return-on-quality approach to excellence
• Engage in lifelong learning
• Maintain a state of perpetual self discovery
One of the more recent buzzwords to hit the business world is “return on
quality” (ROQ). ROQ is really a reaction to the frustration faced by those compa¬
nies that took up the mantra of Total Quality Management in the 1980s and did
not achieve the results they were seeking. TQM pushed for quality in all func¬
tional areas of the organization, a worthy goal, but it now appears that no one
ever really considered the cost/benefit side of TQM; in other words, what was
the return on the investment in TQM? Many companies leaped into TQM with
total dedication, applying a good share of their resources to that end. Some, like
Wallace Co., an oil equipment company, won the Malcolm Baldrige National
Quality Award (1990). Unfortunately, Wallace filed for Chapter 11 two years
later, due in large part to falling oil prices and mounting quality program costs.7
7Business Week, August 8, 1994, p.54.

Today, more and more companies are taking a bottom-line approach to quality
control and measuring each quality improvement effort against its costs to judge
the ultimate value. And the bottom line is whether or not a particular quality
improvement makes good economic and business sense.
How does ROQ correlate with a customer focus? It is interesting that some¬
times businesses think they really know their customers’ needs when they don’t
because they haven’t been asking the right questions. UPS, for example, always
figured that on-time delivery was the number one concern of their customers,
so that was their focus. They had delivery times down to a science. The reason
they thought that on-time delivery was the most important thing to the
customers was that all of their customer surveys had only asked about that
particular issue. When they recently began asking more broad questions like
how can UPS improve its service, they found to their surprise that what
customers most wanted was greater interaction with the drivers. They actually
wanted to get to know their drivers better. Accordingly, UPS, while it still
emphasizes on-time delivery, encourages its drivers to spend more time with
the customer. The ROQ for this new effort is increased sales—the bottom line.
Focusing on the return on quality forces everyone in the organization to
think more about what they are doing. A common complaint about TQM in its
later incarnations was that it had become mechanistic. True, costs were cut,
defects were reduced, and cycle times were shortened, but along the way the
customer was lost from the equation. Quality for quality’s sake was the result.
ROQ attempts to correct that situation by getting customers involved in the
quality process from the beginning. It is not about short-changing the customer
on quality just to make the bottom line look better. It is about finding out what
is really important to the customer and getting the customer involved in
bringing it about.
On Becoming Successful
A business’s success is easily measured by total revenues, earnings, return on
investment and so forth, but entrepreneurs don’t typically measure success in
these terms. Entrepreneurs seem to take a much more personal view of what
constitutes success; consequently, the definition varies from entrepreneur to
entrepreneur. Wally Amos of Uncle Noname Cookies believes that success is
“turning lemons into lemonade.” For Sue Szymczak of Safeway Sling in
Milwaukee, success is “being happy with what you’re doing and feeling as
though you’re accomplishing something.” One group of entrepreneurs decided
that measuring their success in terms of the financial performance of the busi¬
ness did not reflect their definition of success, even at the company level. These
are the entrepreneurs who started many of the so-called “socially responsible”
businesses, most of which came into being in the 1980s. Ben and Jerry’s, The
Body Shop, and Patagonia are just a few of these new-age businesses that set
out to make a difference in the world by establishing very ambitious social goals
that were virtually impossible to reach.
Consequently, success in their terms can never really be achieved. For
example, one of The Body Shops goals was to end Third World poverty. No one
would dispute that this is a lofty and worthwhile goal. But realistically, can one
corporation do what nations have been unable to accomplish? The Body Shop
was setting itself up for failure. It should be noted that The Body Shop has since
modified its goal to changing the lives of hundreds of poor people and has seen
success in that effort.8
The unfortunate thing for these companies is that they have used
Entrepreneurs who their social goals as the focus of all their advertising and promotion, so
aspire to socially every day they are reminded by the ever-vigilant media of how they
responsible success have not succeeded. They are also held to impossibly high standards by
must understand their employees, who expect working conditions to be substantially
that unless the busi¬ better than those at traditional, nonsocially responsible companies—
ness of the business and often they are not. Entrepreneurs who aspire to socially responsible
is conducted well, success must understand that unless the business of the business is
there will be no busi¬ conducted well, there will be no business from which to achieve the
ness from which to goal of social responsibility.
achieve the goal of No matter what your definition of success, there seem to be some
social responsibility. constants that comprise the very essence of what is success. One of
those constants is purpose. To feel successful, entrepreneurs need to
know that what they are doing is taking them in the direction of a goal they
wish to achieve. True success is a journey, not a destination—even the achieve¬
ment of a goal will just be a step on the way to the achievement of yet another
goal. Success attained serendipitously, without purpose, is usually fleeting.
Entrepreneurs purposefully avoid the path of least resistance to success. An
electric current will follow the line of least resistance; a light bulb will only glow
8As of this writing The Body Shop is embroiled in a controversy over assertions that it has been misleading
customers in its claims. For example, one allegation is that the Body Shop uses non-renewable petrochemi¬
cals as ingredients in its products while it advertises them as all natural. In response, The Body Shop has
hired an ethicist from Stanford University to look into the claims.
when there is resistance. Entrepreneurs striving to build world-class ventures

will leave the path of least resistance to those who are seeking the quick
successes that usually don’t endure.
The second constant is that life has its ups and downs. Failure is the other half
of success, and most entrepreneurs have experienced several failures of one sort
or another along the way. But entrepreneurs do not fear failure, because they
know intuitively that those who obsessively avoid failure are doomed to medi¬
ocrity. To avoid failing one has to virtually retreat from life, to never try
anything that has any risk attached to it. Most entrepreneurs strive for a high
batting average, in other words, more successes than failures. To ensure this
high batting average they make sure that every time they come to bat they give
it their best, and then win or lose, they strive to learn from the experience and
go on. Entrepreneurs are generally optimists with great expectations.
The third constant is a sense of satisfaction with what they’re doing. The most
successful entrepreneurs are doing what they love, so the satisfaction level is
usually very high. Does satisfaction with the work result in success or does
success bring satisfaction? Probably both are true in many instances; however,
being content with how things are progressing will not always bring a
successful outcome, nor will success always bring with it lasting satisfaction.
For the most part, though, entrepreneurs do achieve a certain level of
satisfaction when they consider themselves successful because they
Failure is the other usually have predetermined what success means to them, so the ulti¬
half of success. mate achievement of that success is even sweeter.
The fourth constant of success is that there is no free lunch. Success
rarely comes without work. Entrepreneurs do not have the luxury of a
nine-to-five work day where at five o’clock the entrepreneur goes home, leaving
thoughts of the business behind. Entrepreneurs are married to their businesses
24 hours a day. Recently Bill Gates of Microsoft got married and proudly
proclaimed that he now leaves work at midnight instead of in the middle of the
night as he has done since he founded the company. It is not just the number of
hours of work that distinguishes entrepreneurs but how they use their time.
Entrepreneurs make productive use of odd moments in their day—while
they’re driving, on hold on the telephone, in the shower, walking to a meeting.
They make the best use of the time they have.
Success has another kind of price, however. Napoleon said that “the most
dangerous moment comes with victory.” Paraphrasing that statement, it can be
said that the most dangerous moment comes with success. This is because
people who forget that success is transitory tend to relax in their success and
stop moving forward. Many entrepreneurs have suffered physical and

emotional problems, divorces, financial problems, and a whole host of other
maladies simply because they, didn’t know how to handle success. Many have
seen their hugely successful venture crumble into dust because, buoyed by
their success, they didn’t keep striving for continued excellence. Many have
subconsciously set themselves up for failure because they weren’t prepared for
success. There is a tendency on the part of many to focus on how to deal with
failure, but equally important is how to deal with success, for if entrepreneurs
are truly striving to raise their success/failure ratio, they will potentially have
more opportunities to encounter success than failure over the long term and
must therefore be equipped for that eventuality.
The best way to illustrate how success can turn into failure is to recall a
meeting that took place in 1929 at the Edgewater Beach Hotel in Chicago.
Attending the meeting were eight of the world’s most successful and important
financiers: the presidents of the largest steel, utility, and gas companies; the
president of the New York Stock Exchange; a presidential cabinet member; the
most successful Wall Street investor; the chairman of the world’s largest
monopoly; and the president of the Bank for International Settlements. Twenty-
five years later, all of them faced ruin. Charles Schwab died bankrupt; Samuel
Insull was a fugitive from justice; Howard Hopson became insane; Richard
Whitney served in prison, as did Albert Fall, who was eventually pardoned so
he could die at home; and Jesse Livermore, Ivan Krueger, and Leon Fraser all
committed suicide.9
It is not within the scope of this book to fully treat the issue of the entrepre¬
neur’s inability to cope with success—that will be left for a later study—but
suffice it to say that those entrepreneurs who seem to have found the formula
for coping with success maintain a constant state of self renewal, a constant
striving to be better at what they do and better at who they are as human
beings—a constant pursuit of excellence in every aspect of their lives. Only the
best is good enough for world-class entrepreneurs, these intrepid people who
not only say “I can,” but “I will”—and who envision their success long before it
is achieved.
9Mandino, O. (1982). University of Success. New York: Bantam Books.

Index
A Aspartame, 44
A & M Records, 152 Assets: asset-based lenders, 293; asset-based loans,
AARP, 242 288; forecasting, 310-312
ABS plastic, 392 Association of South East Asian Nations, 453
Accessibility, customer, 183 Attorneys, 64; for product liability claims, 409
Accountants, 65, 384 Austin, Nancy, 456
Accredited investors, 377 Aviation Daily, 325
Achievement, entrepreneurs need for, 6 B
Ackerman, Alan, 24 Baby boom generation, 19
Acquisitions and mergers, 357-358 “Back-end” costs, 371
Advertising: media, 241-244; “tombstone,” 382; truth Bankers/lenders, 36, 65-66; business plan focus
in, 162 towards, 428
Advertising Age, 242 Bankruptcy, 416-420
Advice network, 256 Bankruptcy Reform Act of 1978, 417
Advisory boards, 69 Banks, commercial, 292-293, 362
Agents: foreign, 362; and manufacturers’ representa¬ Barbecue grills, 260
tives, 118-119 Bargaining power, buyers,’ 87
A.H. Zapata, Inc., 318, 319 Barrios Technologies, 20
Airline Deregulation Act (ADA), 323 Bartering, 285
Alex & Ivy, 231 Beaver, Don, 44, 45, 56
Allen, John, 126-127, 128-129 Ben and Jerry’s, 232, 459
Allen, Paul, 284 Beren, Ed, 397
Allott, Jeff, 176 “Best suited,” 179
Ambiguity, entrepreneurs tolerance for, 8 Biodegradable products, 233
American Adventures, 319 Blind testing, 108
American companies, and foreign competition, 15-16 Blue Sky securities laws, 377, 378
American Distribution Systems, Inc., 210 Board of directors, 67-69
American Stock Exchange (AMEX), 382, 383 The Body Shop, 5; business philosophy of, 232;
Americans with Disabilities Act, 158-159 business regulations, 150; business success of, 30;
Amos, Wally, 7, 458 emphasis on social responsibility, 18, 241, 459
Angels, private investors, 288-290 Bombay Company, 230-231
Anti-dilution protection, 376 Bond protection, 66-67
Apparel industry, 356 Bonus plans, 266
Apple Computer, 5, 15, 192, 232, 451; Apple II Book value, 384
computer, 16; trademark for, 51 Bookkeeping, 65
Appreciation, 388 Bootstrapping, 70, 168, 284-287
Arm & Hammer Baking Soda, 351-352 Boston Globe, 326
463
464 Index
Boston stock exchange, 383 Caldor, 396

Brainstorming, 29 Calvin Klein, 231
Brand loyalty, 86 Calyx & Corolla, 8, 120
Brand-name recognition, 354-335 Campbell-Hausfeld, 130
Braniff International, 318 Candy & Kids Shoes, 169
Break-even analysis, 313-314 Capital appreciation rights, 266
Broadcast media, 246-247 Capital expenditures, 298-302
Brokerage accounts, 287-288 Capitalization of future cash flows to the present value,
Building codes, 153 385
Building the facility, 191 Career flexibility, 19
Burger King, 365 Carpel tunnel syndrome, 157
Business brokers, 412 Carrying capacity, 84
Business concept: copyrights, 52; description of the, Carter, Jimmy, 323
55-58; patents, 45-50; protecting the, 43-44; Cash flow: capitalization of future cash flows to the
starting vs. buying a business, 53-55; trade secrets, present value, 385; discounted cash flow analysis,
51-52; trademarks, 51 385; forecasting, 305-310; returns, 388
Business income taxes, 164 Caveat emptor, 161
Business incubators, 181-182 Celestial Seasonings, 55, 179
Business name, 229; selling your name, 413 Certificate of Incorporation, 139
Business plan, 34-35; bankers/lenders, 36; contingency Certificate of Occupancy, 191
plan in the, 40, 420-421; deal structure section, 40; Chambers of Commerce, 105
distribution channel information in the, 123; execu¬ Change, concept of, 3-4
tive summary, 374, 430- 432; financial plan in the, Chapter 7, 418-419
40, 314-315; industry data in the, 96; investors, 36; Chapter 11, 417, 418, 420, 457
management team section of the, 75; Cities in Schools, 7
management/organizational plan section of the, 272; Civil Aeronautics Board (CAB), 323
market analysis in the, 111; operational analysis Civil Rights Act (1964), 159
section, 37, 40; operational plan in the, 219-221; Clark, K. B„ 456
oral presentation of the, 435-437; outline, 38-39; Clayton Act of 1914, 159
potential management, 36; preparing the, 423-425; Clinical studies, 108
product/service plan, 56; strategic partners, 36-37; Closely held corporations, 139
visual presentation of the, 433-435; what to include Cocooning, 20
in the, 429-437; writing the, 425-429
Coincident index, 406
Business process reengineering, 261
Collaboration, 61-62
Business site: choosing a, 152-154, 178-183; choosing a
Collateral technologies, 259
retail site, 182; choosing the manufacturing site,
Combined inventory systems, 209
184-186; choosing the service/wholesale site, 183-
Commercial banks, 292-293, 362
184; home-based businesses, 192; lease-buy-build
Commercial finance companies, 293
decision, 186-192
Commercial printing industry, 358
Business Week, 242; list of high-growth companies,
Common stock, 264, 378
345-346
Communication network, 256-257
Buy-sell agreements, 265, 414
Compaq Computers, 63
Buyers bargaining power, threat from, 87
Competition: competition-based pricing, 237;
Buying a building, 190-191
identifying the, 101-102; international, 196; nature
Buying a business, starting vs., 53-55
of, 347; within the trade area, 182-183
Bygrave, Bill, 372
Competitive advantage, 102, 197
Competitive analysis, industrial, 90-91
C corporations, 139-141; and Limited Liability Complexity, industrial, 84-85
Corporations (LLC), 144, 146; and S-corporations, CompuServe, 246, 252
143-144 Computer-integrated manufacturing technology (CIM),
Cable Value Network, 245 455
Index 465
Computers: computer creativity, 24; high-growth soft¬ Customer: accessibility, 183; business plan focus towards
ware industry, 345; information availability, 19-20; major customers, 429; customers from fragmented
microprocessors, 16; on-line services, 245-246; markets, 196-197; describing the target customer,
online market research, 251-252; patent protection 100-101; marketing to industrial customers, 251;
for computer programs, 47; start-up ventures, 63, perceptions of performance, 203- 204; primary, 57;
178 product development and customer needs, 202-203;
satisfying customer needs, 102; using customers for
Concept investigation, product development and, 199
quality control, 215
Conglomerate diversification, 357
Constructing a building, 191 0
Consultants, 73, 409 Database marketing, 243-244
Davidson & Associates, 346
Consumer channels of distribution, 116-119
Davidson, Inc., 233
Consumer Confidence Index, 406
Davidson, Jan, 233
Consumer credit, 161-162
Dealerships, 352
Consumer Price Index, 406 Debentures, convertible, 378
Consumer Product Safety Commission, 16, 160 Debt: debt capacity, 380; debt securities, 378; debt-to-
Consumer products and services, forecasting sales with, equity ratio, 312; financing with debt, 292-295;
299-300 subordinated debt, 288
Consumer protection, 160 Deferred compensation plans, 265-266
Contact Sheet, 249 Degradable products, 233

Delaware, incorporating in, 142-143
Contingency plan, 40, 405-407; decline in sales, 410-
Demand-based pricing, 237
411; loss of key employees, 409; product liability,
Demographics: and population base, 181; of the target
407-409; taxes and regulations, 407
market, 104-105
Continual learning, 456
Department of Commerce, U.S., 74, 284, 361
Continuing value, 387 Department of Defense, U.S., 324
Contracts: and agreements, 151-152; employee, 270 Department of Justice, U.S., 158
Convenience sample, 107 Department of Labor, U.S., Fair Labor Standards Act, 156
Convertible debentures, 378 Department of Transportation (DOT), U.S., 323
Cook, Scott, 286 Depreciation, 313

Design patents, 47
COPCO, 275, 277, 393, 397
Design preparation, product development and, 199
Copyrights, 52; computer programs and, 47; intellectual
DIALOG, 252
property rights, 347
Differentiation, 89
Corporations, 139-143; C corporations, 139-141, 144,
Direct channel of distribution, 116
146; downsizing of major, 18; Limited Liability Direct competitors, 101
Corporations (LLC), 144-146; non-profit corpora¬ Direct marketing, 244-246
tion, 146-147; ownership and compensation in a Direct Product Profit (DPP), 238
corporation, 261-266; S corporations, 143-146, 378; Direct selling, 116-117
virtual, 71, 72, 174-178, 206 Directors and officers (D & O) liability insurance, 69
Cost of Goods Sold (COGS), 300-301, 306 Disclosure document, patent, 49
Cost superiority, 89 Discount rate, 387
Cost-based pricing, 237 Discounted cash flow analysis, 385
Distribution channels: access to, 86; choosing, 115-116;
Counsel, Talli, 8-9, 74-75, 286, 405
consumer channels of distribution, 116-119; distrib¬
Couponing, 248
ution channel review, 235; graphing, 120-122;
Crate and Barrel, 37, 424
industrial channels of distribution, 119; multiple
“Creative imitation,” 450-451 channels of distribution, 239; presentation in the
Creativity, 23, 241; enhancing your creative skills, 24-25; feasibility study/business plan, 123; pricing, 238
sources of new venture ideas and, 25-29 Distributors: foreign agents, trading companies and,
Current liabilities, 312 362-363; and wholesalers, 117-118
466 Index
Diversification growth strategies, 357-359 Environmental focus, 18

Doing Business As (DBA), 137, 138 Environmental impact, 58
Domino’s, 365 Environmental Protection Agency (EPA), U.S., 16, 154
Dow Jones News Retrieval, 252 Environmental regulations, 153-154
Downsizing, 17; of major corporations, 18 Equal Credit Opportunity Act (ECOA), 161
Drucker, Peter F., 17, 450-451 Equal Employment Opportunity Commission (EEOC),
Dun & Bradstreet, 251 154,155, 159, 268-269
DuPont De Nemours E. I. & Company, Inc., 58 Equity: financing with, 287-292; owner’s or stock¬
DV Industries, Inc., 258-259 holder’s, 312
Dynamism, 84 Equity incentives, alternatives to, 265-266
Erie Bolt Company, 175
E
ERISA, 266, 414
Economic base, of a region or community, 180
European community, 453
Economic disequilibrium, 4
Evolution, industrial, 91
Economies of scale, 85-86
Executive summary, business plan, 374, 430-432
Edgewater Beach Hotel, Chicago, IL, 461
Exhibits, trade shows and, 250-251
Education, entrepreneurship courses, 17
Existing building, on a potential site, 186-187
Eisen, Mark, 356
Exit plan: bankruptcy, 416-420; cashing out but staying
Electric grill industry, 260
in, 413- 416; selling the business, 411-412; selling
Electric tape dispenser, 439-443
your name, 413
Electronic bulletin boards, 251
Expanding the business. See Growing the business
Electronic Data Systems (EDS), 31, 284
Expenditures, forecasting, 300-302
Electronic highway, 3
Export Profits (Wolf), 361
Electronic point-of-sale (POS) system, 209, 213
Export Trading Company (ETC), 363
Electronics industry, 356
Exporting. See Global marketplace
Emerging competitors, 102
Emerging industries, 88-89 F
Emerson Electric Co., 129 Factor, 288
Emglo, 130 Failures: business, 460; success and failure, 30-31
Employee Stock Ownership Plan (ESOP), 414-416 Fair Credit Billing Act (FCBA), 162
Employees: employee contracts, 270; employee hand¬ Fair Credit Reporting Act (FCRA), 162
book, 270-272; employee search, 267-268; Fair Labor Standards Act, 156
Employee Stock Ownership Plan (ESOP), 414-416; Fair market value of the business, getting the, 384, 412
hiring, 154-159, 407; interviews, 268-269; job Fair Packaging and Labeling Act, 160
descriptions, 267; leasing, 407; loss of key, 409; Fall, Albert, 461
resumes, 155-156, 268; screening potential, 269- Family Leave Act, 407
270; using employees for quality control, 215 Family-owned companies, 409
End-users and intermediaries, 109 Famous Amos Cookies, 7
Engineers, and model builders, 200 Farber, Betsey, 275-276, 396-397
Enterprise zones, 180-181, 184 Farber, John, 396
Entrepreneur Partnership Program, 182 Farber, Sam, 275-279, 390-401
Entrepreneurial act, 8 Farrow, Paul, 176
Entrepreneurial marketing, 226 Feasibility study: distribution channel information in
Entrepreneurship, world-class, 3-5; entrepreneur the, 123; industry data in the, 96; management team
defined, 5-8; entrepreneur myths, 10-11; entrepre¬ section, 34, 75; market analysis section, 34, 111;
neurial venture, 11-14; role of the entrepreneur in outline, 33; product/service plan, 32, 56
the marketplace, 15-17; trends for the 1990s and Federal Census Bureau data, 104
beyond, 18-21; why do entrepreneurs start busi¬ Federal Export Assistance Centers, 360
nesses?, 8-10 Federal Express, 13, 120
Entry, barriers to, 348 Federal Reserve, 15
Environmental Business Resources Assistance Centers, Federal Trade Commission, 159, 162, 233
154 Federal Unemployment Tax Act (FUTA), 163
Index 467
Federal Wholesale, 396 Freight forwarders, 364

FICA, social security tax, 162-163 Friedman, Milton, 4
Fictitious business name statement, 137 Fry, Arthur, 29
Field testing, and prototype building, 199-201 Full ratchet clause, 376
Finance companies, commercial, 293
G
Financial Architects, 236
Gannt charts, 211
Financial incentives, community, 180-181
Garden tools, designs for, 399
Financial plan: financial statements, 297-298; preparing
Gardeners’ Eden, 8, 120
the pro forma balance sheet, 310-312; preparing the
Gardeners’ Supply, 18
pro forma sources and applications of funds state¬
Gas and air compressor companies, 130
ment, 313-314; preparing the pro forma statement,
Gates, Bill, 5, 284, 460
302-303; projecting sales and capital expenditures,
Geffen, David, 152
298-302; reporting in the business plan, 40, 314-
Generac, 130
315; start-up money, 304-310
General Agreement on Tariffs and Trade (GATT), 360,
Financial Times, 324
452
Financing costs, inventories and, 208
General and administrative (G&rA) expenses, 301-302,
Financing growth: finding growth capital, 369-371; initial
306
public offering (IPO), 379-383; private placement,
General contractors, 191
377-379; strategic alliances, 383-384; valuing the
General Electric, 129, 130
business, 384-388; venture capital market, 371-377
General Housewares Corporation (GHW), 400
Financing the new venture: bootstrapping, 284-287;
General Motors, 15, 18
financing with debt, 292-295; financing with equity,
General partnership, 139
287-292; sources of financing in the 1990s, 283
Generally Accepted Accounting Principles (GAAP), 65,
First in the market, with new product or service, 346
297-298
First round funding sources, 370 Gentech Corporation: brand recognition, 355; business
Fitness and health industry, 19 plan executive summary, 431-432; carrying capacity
Fixed costs (FC), 314 strategy, 84; case study, 126-132; marketing plan,
Flight Time Corporation, 317-341 228-229; PowerSource, 90, 127-128, 129, 131, 355,
Focus groups, 107-108, 235 431; sales and capital expenditures, 298; as a virtual
Food and Drug Administration (FDA), U.S., 160 enterprise, 174-175; visual presentation of the busi¬
Foot and car traffic counts, 183 ness plan, 433, 434
Ford Motor Company, 201 Global marketplace, 74, 359-360; bartering in the, 285;
Forecast period, business cycles and, 385-386 choosing a freight forwarder, 364; choosing an inter¬
Foreign agents, 362 mediary, 363-364; competing on a global level, 90;
“Foreign” corporation, 142 export financing, 361-362; exporting products and
Forfeited stock provision, 376 services, 19; finding the best global market, 360-361;
Form S-18, 380 foreign agents, distributors, and trading companies,
Form U-7, 378 362-363; global franchising, 365; global orientation,
Formal test market, doing a, 109-110 19; price of money in the, 3; sources for exporting,
Fortune 500, 20, 405 364; world-class ventures and global vision, 448-449
Forward integrate, 87 Godfrey, Joline, 20
Founder’s stock, 262-263, 413 Going concern value, 384
Founding team, 63; accountants, 65; advisory board, 69; “Going public”. See Initial Public Offerings (IPO)
attorneys, 64; bankers, 65-66; board of directors, Golf USA, 352
67-69; independent contractors, 70-75; insurance Gooch, Sandy, 10, 78-80, 100
agents, 66-67; management team section of the Government: as source of new venture ideas, 29; govern¬
feasibility study/business plan, 75; mistakes to avoid, mental agencies, 74-75; regulations, 86
69-70; solo entrepreneur vs. the, 61-63 Grants, 294-295
Fragmented markets, customers from, 196-197 Gross lease, 188
Franchising, 352-353; global, 365 Gross margins, 238
Fraser, Leon, 461 Gross Rating Point (GRP), 247
468 Index
Growing the business, 345-346; diversification growth Industry: analysis, 91-95; competitive strategies, 89-91;
strategies, 357-359; factors that affect growth, 346- data in the feasibility study and business plan, 96;
348; growing by going global, 359-365; integrative defining the, 83-85; forecasting sales with industrial
growth strategies, 355-357; intensive growth strate¬ products, 300; industrial channels of distribution,
gies, 351-355; problems with growth, 351; stages of 119; marketing to industrial customers, 251; pricing
growth in a new venture, 348-350. See also strategies, 238; structure, 85-89; volatility of the,
Financing growth 347-348
Growth capital, 369-371, 380 Informal networks, 256-257
Guerrilla Marketing (Levinson), 226, 248 Information availability, 19-20; sources of industrial
Gutenberg, Johann, 29 information, 92-93
Information needs, assessing, 103-104
H
Ingersol-Rand, 130
Hardigg Industries, 176 Initial Public Offerings (IPOs), 68, 139, 379-380, 413;
Harmonized System (HS) of commodities classification, advantages and disadvantages of going public, 380-
361 381; public offering process, 381-383
Hatlen, Roe, 19 Innovative, and proprietary technology, 449-451
Hawkin, Paul, 451 Inspection process, quality control and the, 214
Hayes, R. H., 456 Insull, Samuel, 461
HDI Engineering, 169 Insurance: agents, 66-67; costs, 208; Directors and offi¬
High technology start-ups, 61-62 cers (D & O) liability insurance, 69; workers’
High-tech companies, 5; growth capital, 369; growth compensation insurance, 156-157, 185
patterns of, 350 Integrative growth strategies, 355-357
Historical analogy, using substitute products or, 109 Integrative team based approach (ITB), 258, 453-455
Home Shopping Network, 13, 245 Integrity, absolute, 455-456
Home, staying, 20 Intel, 16

Intellectual property rights, 347
Home-based businesses, 191-192
Intensive growth strategies, 351-355
Honda, 130
Interfleet, Inc., 9, 74-75, 286, 405
Hopson, Howard, 461
Intermediaries: choosing a global intermediary, 363-364;
Horizontal integration strategies, 356
interviewing prospective end-users and, 109
Hostility, industry, 86-87
Internal locus of control, 7
Human resource, for quality control, 214-217
Internal Revenue Service (IRS): forming a non-profit
I corporation and the, 147; taxes and the, 164; 20-
Ibuka, Masaru, 10 point test for independent contractors, 71-72
Ideas: and opportunities, 25; keeping an idea file or International Business Machines (IBM), 88, 451
notebook, 27; sources of new venture ideas, 25-29; International competition, 196
testing your business idea, 31-32 International Franchise Association (IFA), 365
Image, 240 International Jensen, 102

International Organization for Standardization (ISO),
Image Designs, 57, 58
215
Import-Export Bank, 362
International Toy Fair, 110
Inc. 500 list, 257
International Trade Administration, 361
Inc. magazine, 286
International Trade Statistics Yearbook of the United States,
Incremental products, 353-354
360
Incubators, business, 181-182
International Weekends, 319, 320
Independence, entrepreneurs sense of, 6-7 Internet, 3
Independent contractors, 70-72, 284-285; shadow team, Interviews: hiring employees, 155, 268-269; inter¬
73-75 viewing prospective end-users and intermediaries,
Indirect channel of distribution, 116 109; target market, 106-107
Indirect competitors, 101-102 Intrinsic value, 384
Industrial parks, 184 Intuit, 286
Index 469
Inventors: and entrepreneurs, 44; patents, 45, 47-50, Limbaugh, Rush, 246
449-450 Limited Liability Corporation (LLC), 144-146
Inventory requirements, 207; inventory costs, 208; Limited partnerships, 139, 291
inventory turnover, 208, 312; Just-in-Time (JIT) Limited production, going into, 109
system, 209-211; tracking inventory, 208-209 Liquidation. See Bankruptcy
Investment banking firms, 381-382, 412 Liquidation value, 384
Investment value, 384 Litigation, product liability and, 408
Investors, 36; business plan focus towards, 425-42*9 Livermore, Jesse, 461
Involuntary bankruptcies, 417 Loans: asset-based loans, 288; margin loans, 287-288;
IRC Sec. 1244 stock, 264 securing a bank loan, 370
ISO 9000, 215-217 “Local attorney”, hiring a, 409
Location of the business. See Business site
J
Locus of control, 7
Jefferson, Thomas, 45
Logistics firms, 118
JH Collectables, 168, 285
Long-range planning, 407
Job shop, 14
Lunsford, Bruce, 19
Jobs, Steven, 5, 15
Joint ventures, 190-191, 291 M
“Jointing a check,” 191 McBride, Jane E, 317-329
Just-in-Time (JIT) inventory control system, 209-211, McDonalds, 169, 365
356 Magazine advertising, 242-243
Mail Boxes Etc., 383
K
Mail surveys, 105-106
K-Mart, 397
Major corporations: downsizing of, 18; virtual enterprise
Kearns, Bob, 46
concept, 177-178
Keiretsu, 206
Malcolm Baldrige National Quality Award, 216, 457
Kempner, Michael, 285
Mall of America, Bloomington, MN, 182
Kentucky Fried Chicken, 352, 365
Management: business plan focus towards key, 429;
Keynes, John Maynard, 4
internationally experienced management team, 452-
Kitchen gadgets industry, 275-279, 390-401
453; management team section of the feasibility
Kohler, 130
study/business plan, 34, 75; using management for
Krueger, Ivan, 461
quality control, 215-217
L Management and organization plan: employee hand¬
Labeling, product, 233 book, 270-272; entrepreneurial approach to organi¬
Labor, cost of, 185 zational structure, 258- 261; hiring, job descriptions
Lagging index, 406 and specifications, 266-270; organizational chart,
Lauder, Tom, 379 255-258; other policies, 272; ownership and
Lauer, Daniel, 110 compensation in a corporation, 261-266; section of
Lax, Michael, 275 the business plan, 272; Total Quality Management
Leading index, 406 (TQM), 261
Leasing: a building, 187-190; employees, 407; equip¬ Manufacturer’s Orders for Durable Goods, 406
ment, 285 Manufacturers’ representatives, agents and, 118-119
Lee Apparel Company, 213 Manufacturing Industrial Classifications, 92
Legal structure: corporation, 139-143; Limited Liability Manufacturing process, maintenance in the, 217-218
Corporation (LLC), 144-146; of the new venture, Manufacturing site, choosing the, 184-186
135-136; nonprofit corporation, 146-147; partner¬ Manufacturing start-ups, 305
ship, 138-139; S corporation, 143-144; sole propri¬ Manufacturing support, 73
etorship, 137-138 Manville Corporation, 417
“Let the buyer beware,” 161 Margin loans, 287-288
Liabilities, 312 Maritime Services, 285
Life forms patent, 47 Market analysis, feasibility study and, 34
Life-long learning, 20 Market development, 352-353
470 Index
Market niche, 100 New England Women Business Owners (NEWBO), 326
Market penetration, 351-352 New entrants, threat of, 85-87
Market research. See Target market New Pig Corporation, 44, 45, 56, 57-58, 100
Market-driven strategy, 451-452 New product development, 196-197
Marketing plan, 227-229; marketing in the 1990s, 225- New venture process, 11-14; sources of new venture
226; online market research, 251-252; place strategy, ideas, 25- 29; stages of growth in a new venture,
238-240; price, 236-238; the product, 229, 231- 348-350. See also Legal structure
236; promotion, 240-251; writing the, 252-253 New York: high product liability claims in, 408; state-
Massachusetts Metalforming Network, 175 funded venture capital programs in, 294
Massachusetts, state-funded venture capital programs in, New York Stock Exchange (NYSE), 139, 382-383
294 Newspaper advertising, 241-242
Mats, Yoshiro Naka, 26 Newsweek, 242
Mattel Toy Company, 19, 185 NEXIS, 252
Mergers and acquisitions, 357-358 The Next Economy (Hawkin), 451
Micro loans, 294 Niche strategy, 89-90
Micro Planner X-Pert, 212 Niche, the market, 100, 347
Microbits Peripheral Products Inc., 24 Nike, 231, 354
Microprocessors, 16 1990 Census Basics, 104
Microsoft, 5, 284, 346, 424, 460; Windows, 86, 88 Nirvana (musical group), 152
Microsoft Project, 212 Nonprofit corporations, 146-147
Mid-Atlantic Packaging, Inc., 157 Nordick, Enita, 284
Miscellaneous advertising, 247-248 North American Free Trade Agreement (NAFTA), 360,
Mission statement, 258 453
Mitsubishi, 201 Nourse, Robert, 230, 231
Model builders, 200 Nutrasweet, 44
Modular growth strategies, 356-357
0
“Mom and Pop” businesses, 13-14
Obsolescence, 208
Monsanto, 391
Occupation health and safety, 156-158
Moore, Patricia, 278
Occupational Safety and Health Act of 1970, 157
Mossimo, 354
Occupational Safety and Health Administration (OSHA),
Motors and generators industry, 129-130
U.S., 16, 29, 154, 157-158
Mrs. Gooch’s Natural Foods Market, 10, 78-80, 100
Odysseum, Inc., 20
N Office of Health and Emergency Planning, 154
Nader, Ralph, 161 Ohio, high product liability claims in, 408
Name: selling your name, 413; of your business, 229 Oil ventures, 357
Napoleon 1, 460 Old Country Buffet, 19
National Aeronautics and Space Administration “One-to-one trades,” 285
(NASA), 20 Operational plan: designing an, 195-196; financial
National Association Female Executives (NAFE), 326 requirements, 218-219; inventory requirements,
National Association of Manufacturers, 105 207-211; materials requirements, 206-207; new
National Association of Securities Dealers Automated product development, 196-197; product develop¬
Quotation (NASDAQ), 382-383 ment and the entrepreneur, 197-204; product manu¬
National Business Aircraft Association (NBAA), 326 facturing cycle, 205-206; product/process
National Market System, 383 maintenance requirements and warranties, 217-218;
National Staff Leasing Association, 74 production requirements, 211-213; quality control,
National Toy Information Hotline, 166 213-217
Need for achievement, entrepreneurs, 6 Opportunity: cost, 208; enhancing your creative skills,
Nelson, Bill, 126-127, 128 24-25; recognition and product development, 199;
Net lease, 188-189 recognizing, 23-24, 199; sources of new venture
Network growth strategies, 356-357 ideas, 25-29; success and failure, 30-31; testing your
Networking, 27; and business alliances, 175 business idea, 31-32
Index 471
Order for Relief, 418 Poneman, Jonathan, 152

Oregon, state-funded venture capital programs in, 294 Popcorn, Faith, 20
Organization of Petroleum Exporting Countries (OPEC), Population: aging, 19; demographics, 104-105, 181
15 Porter, Michael, 85, 90
Organization plan. See Management and organization PR Newsletter, 249
plan Pratt, Shannon R, 386
Original equipment manufacturer (OEM), 217, 448 Preferred stock, 378
Outlets, manufacturers, 116-117 Prenuptial agreements, 265
Outsourcing, 70, 74 Prepackaged bankruptcy plan, 420
Owades, Ruth, 8, 120 Price discrimination, 159-160
Owner’s equity, 312 Pricing strategies, 236-238
OXO, Good Grips, case studies, 275-279, 390-401 Primary customer, 57
P Primary data: collecting, 105; importance of, 93-94
Pacific stock exchange, 383 Primary market, 99
Packaging, product, 233 Print media, 241-243

Papa John’s Pizza, 346 Printing industry, 358
Parking accessibility, 183 Private investors, angels, 288-290
Partnership, 138-139; business income taxes, 164 Private placement, 290, 377-379
A Passion for Excellence (Peters and Austin), 456 Private placement memorandum, 378
Patagonia, 459 Privately owned corporations, directors of, 67
Patents, 45, 47, 449-450; appeals process, 50; disclosure Pro forma financial statements, 298-299, 385; preparing,
document, 49; intellectual property rights, 347; 301-302; preparing the pro forma balance sheet,
oath, 49; patent application, 49; patent infringe¬ 310-312; preparing the pro forma sources and appli¬
ment, 46; “patent pending” stage, 50; patent process, cation of funds statement, 313-314
48-50; “patent-applied for” stage, 50, 449; Process maintenance, 217
patentability of the invention, 47-48 Process-focused organizations, 205
Pavitt, Bruce, 152 Proctor and Gamble, 110, 278
Payroll taxes, 162-163 Prodigy, 246
Peer review, 235 Producer Price Index, 406
Pennsylvania, high product liability claims in, 408 Product: branding, packaging, and labeling, 231-233;
People, 242 . features, 229, 231; mix, 235-236; place strategy,
Pepsi-Cola Co., 285 238-240; positioning, 233-235; price, 236-238
Percentage lease, 189 Product development, 197-204, 353-354; new, 196-197
Perot, Ross, 31, 284, 451 Product innovation, 346, 347
Perpetual inventory systems, 209 Product liability insurance, 67
Personal resources, financing with, 287-288 Product liability issues, 161, 407-409
Personal selling, 249-250 Product maintenance, 217-218
PERT (Program Evaluation and Review Technique) Product manufacturing cycle, 205-206
diagrams, 211-212 Product market introduction and ramp-up, 201
Peters, Tom, 4, 456 Product warranties, 217-218
Phantom stock, 266 Product-focused organizations, 205
Phases, selling a business in, 414 Product/service plan, 56
Phone surveys, 106 Production run: going into limited production, 109;
Photodegradable products, 233 product development and the initial, 201
Physical count inventory system, 209 Profit-sharing plans, 266
PictureTel Corp., 248 Promotion, 240-241; advertising, 241-244
Pizza Hut, 37, 424 Property liens, 191
Place strategy, product, 238-240 Proprietary issues, 44; innovative and proprietary tech¬
Planning for change: contingency plan, 405-411; exit nology, 449-451; intellectual property rights, 347;
plan, 411-421 proprietary factors and barriers, 86; proprietary
Point-of-sale system (POS), electronic, 209, 213 rights, 46, 57, 347, 348
472 Index
Prospectus, investment, 382 Robinson, Emyre, 20

Prototypes, 109, 110; prototype building and field Robinson-Patman Act of 1936, 159
testing, 199- 201 Roddick, Anita, 5, 18, 30, 232
Psychological pricing, 237-238 Roddick, Gordon, 150, 232
PTO Form 1478, 51 Rol-Air, 130
Public Law 95-958, 417 Rolling Stone, 242
Publicity and public relations, 248-249 Russia, corporate bartering in, 285
Publicly owned corporations, directors of, 67
S
Publicly traded companies, directors of, 67
S corporations, 143-144, 378; and Limited Liability
Push strategy, 225
Corporations (LLC), 144-146
Q Safeway Sling, 458
Quality circles, 214 Sale-leasebacks, 190
Quality control, 213-217, 457-458; Total Quality Sales: capital expenditures and projecting, 298-302;
Management (TQM), 261, 457 decline in, 410-411; and use taxes, 163-164
Quality Function Deployment (QFD), 201-204 Sales representatives, 362
Questionnaires: mail surveys and questionnaire design, Sales support, 73-74
105; phone surveys and questionnaire design, 106; Salmon, Walter J., 238
“Should You Start Your Own Business,” 9, 21-22 Sampling, the target market, 107
Quicken, 286 San Francisco Gourmet Show, 275, 390, 394, 397, 398
QVC, 245 Santoprene, 391-392, 398
Satisfaction, business, 460
R Saxton, Paul A., 400
Radio advertising, 246-247
Schilt, James H., 386
Ramp-up, 201 Schumpeter, Joseph, 4
Random sample, 107 Schwab, Charles, 461
Rapid growth, 348 SCOR U-7, 378
“Rapid prototyping,” 200 Sears Roebuck and Co., Kenmore appliances for, 356
Ray o vac, 169 Second round financing, 369, 370-371
Ream, Michael D., 129 Secondary distribution, 380
Recession, recognizing signs of, 385, 406 Secondary market, 99
Recyclable packaging, labeling and, 233 Securities, 288
Reebok, 37, 424 Securities and Exchange Commission (SEC), 263, 377,
Regulation D, 290, 377-378 379,381,383,413
Regulation Z, 161 Seed money/capital, 288, 369
Regulations affecting new businesses: choosing a busi¬ Self-managing teams, 348
ness site, 152-154; from idea to start-up, 151-152; Selling the business, 411-412
hiring employees, 154-159; regulation as a way of Selling your name, 412
life, 149-150; trade issues, 159-164 Senior debt, 288
Renting, and leasing a building, 187 Service agencies, 74
Repetitive motion injuries, 157 Service businesses, 356
Research and development (R&rD), 175, 197; limited Service Corps of Retired Executives (SCORE), 321
partnership, 291 Service franchises, 352
Restructuring and reorganizing, 17, 413-414; reorganiza¬ Service jobs/firms, 17
tion plan, 418 Service organizations, 94
Resumes, 155-156, 268 Service/wholesale site, choosing the, 183-184
Retailers, 117; choosing a retail site, 182 Sexual harassment, 159
Return on quality (ROC), 457-458 Shadow team, 73-75
Reverse engineering, 449-450 Sharing space, 285
Risk-taking, in entrepreneurs, 6 Shaw, Robert, 102
Rivalry, industrial, 88 Short-range planning, 406-407
Road & Track, 242 Short-term leasing, 187-190
Index 473
Shrinkage costs, 208 Strategic Communications, Inc., 285

Siegel, Mo, 55, 179 Strategic partners, 36-37
Sierra Club, 399 Stress-related disabilities, 157
Signs, 246 Sub Pop, 152
Sims, Judy, 31 Sub-contracting work, 74, 284, 348, 407
Simtek, Inc., 439-444 Sub-contractors, building, 191
Small Business Administration (SBA), 15, 74, 105, 293- Sub-sets, market, 234
294; on workers’ compensation insurance, 156 Subordinated debt, 288
Small Business Development Centers (SBDCs), 105 Substitute products: threat from, 87; using, 109
Small Business Innovation Development Act of 1982, 294 Suppliers: access to, 185; business plan focus towards,
Small Business Investment Companies (SBIC), 292 429; relationship with, 286; threat from suppliers’
Small businesses, vs. entrepreneurial ventures, 13-14 bargaining power, 87
Small Corporate Offering Registration Form, 378 Supply-side economists, 4
Smart Design, 275, 277, 278, 390, 392 Supra, 24
Smith and Hawkens, 232 Surveys, mail and phone, 105-106
Snapple Beverage Company, 246 Synergistic strategy, 357
Social security tax (FICA), 162-163 Szymanski, Marianne, 166-170, 285
Socially responsible businesses, 18, 241, 459 Szymczak, Sue, 458
Sole proprietorship, 137-138; business income taxes, 164 T
Sony Corporation, 10 Tandy Brands, Inc., 230
Soundgarden (musical group), 152 Tapemate, 439-443
Sources and Applications of Funds Statement, 313-314 Target market: cost/benefit of market research, 110-111;
Spiegal Catalog, 356 defining the, 99-101; forecasting new product/service
Spin-offs, 32, 57-58 demand, 108-110; identifying the competition,
Sports Illustrated, 242 101-102; market analysis in the feasibility study or
Spreadsheets, 308 business plan. 111; researching the, 103-108
Standard Industrial Classification (SIC) codes, 92 Target stores, 396, 397
Standard Industrial Trade Classification (SITC) codes, Tax Code (1993), 144
360-361 Tax Reform Act (1986), 144
Standard Metropolitan Statistical Areas (SMSA), 181 Tax-deferred exchange, 190
Stapelfeld, Ben, 44, 45, 56 Taxes, 162; business income tax, 164; payroll, 162-163;
Starbucks Coffee, 232 and regulations, 407; sales and use, 163-164; tax
Start-up money, 304-310 benefits, 388
Start-ups, entrepreneurial, 4, 5; high technology Technology, and prototype building, 200
start-ups, 61-62 Technology-based industries, 197
Starting, vs. buying a business, 53-55 Telemarketing law, 245
State-funded venture capital, 294 Telephone Consumer Protection Act, 245
Statement of Non-Disclosure, 235 Telephone surveys, 106
Stockholder’s equity, 312 Television advertising, 247
Stocks: anti-dilution provision, 376; common stock, Test marketing, 235
264, 378; compensating with stock, 263-265; forfei¬ Texas, high product liability claims in, 408
ture provision, 376; founder’s stock, 262-263, 413; Texas Instruments, 63
full ratchet clause, 376; IRC Sec. 1244 stock, 264; Thermos, 260
phantom stock, 266; preferred stock, 378; selling Thomas Industries Inc., 130
stock, 413; weighted ratchet approach, 376 Thompson, Charles, 28-29
Stop-loss statements, 381 3M Company, 29, 202, 439
Storage costs, 208 Thriving on Chaos (Peters), 4
Stowell, Davin, 275, 278, 390 Time, 242
Strategic alliances, 291-292, 383-384; business plan Timmons, Jeff, 372
focus towards, 428-429; international network of, TM-100, electric tape dispenser, 439-443
449 Total Quality Management (TQM), 261, 457*
474 Index
Total revenue (TR)/total costs (TC), 314 W

Toy Manufacturers of America, 167 Wage and hour laws, 155-156
Toy Tips Inc., 166-170, 285 Wal-Mart, 206, 397
Trade area, 182 Walden Paddlers, 176
Trade magazines, 93, 397 Wall Street Journal, 55
Trade secrets, 51-52, 347 Wallace Co., 457
Trade shows, 94; and exhibits, 250-251 Warranties, product, 217-218
Trademarks, 51, 347 Water Ventures, Inc., 448
Trading companies, 363 WaterBabies, 110
Traffic counts, 183 Weighted ratchet approach, 376
Trans National Travel (TNT), 319, 320 Wheelwright, S. C., 456
Transportation: access to, 185; in the distribution chain, Whirlpool, 356
239-240; parking accessibility, 183 White, Catherine, 236
Travel Weekly, 325 Whitney, Richard, 461
Triple net, 188-189 Wholesale/service site, choosing the, 183-184
Trust network, 256 Wholesalers/distributors, 117-118
Trusts, 265 Wiley, John, 24
Truth in advertising, 162 Winco, 130
Truth-in-Lending Act, 161 Windshield wipers, intermittent, 46
Tuller, Lawrence W, 387 Wolf, Jack, 361
Women, in business, 20
U
Workers’compensation insurance, 156-157, 185
The Uncle Noname Cookie Co., 7, 458
World Aviation Directory, 327
Underwriters, 381-382
World-class status, achieving: on becoming successful,
Uniform Commercial Code (UCC), 160-161
458-461; on becoming world-class, 447-458. See
Uniform Partnership Act, 138
also Entrepreneurship, world-class
United Parcel Service of America, 383, 458
World-class ventures, 5, 448
Unity Forest Products, 284
Wozniak, Steven, 5, 15
Universal Product Code (UPC), 213
U.S. Military Travel Management Command (MTMC), X
322 Xerox, 201, 258, 346
U.S. Treasury notes, 386, 387
Y
JJSA Today, 242
Yellow Pages advertising, 246
Use tax, 163-164
Utilities, cost of, 186 Z
Utility patents, 47 Zapata, Dara A., 317-329
Zinkowski, Patricia A., 317-329
V
Zoning laws, 152-153
Variable costs (VC), 314
Variety, 242
Velcro, 26
Vencor, Inc., 19
Vendors, locating, 206-207
Venture capital, 290-291, 371-372; business plan focus
towards, 425-429; capital structure, 375-377;
defined, 288; finding, 369-370; institutes and
networks, 292; sequence of events, 372-375; state-
funded, 294
Vertical integration, 174; strategies, 355-356
Vietnam War, 15
Virtual enterprise, 71, 72, 174-178, 206
_ c qf, 0039
HD 62.5 -A46 199
if ^ ■
Allen. l^auu
Launching new venture^
CABRINI COLLEGE LIBRARY

610 KING OF PRUSSIA RD.
RADNOR, PA 19087-3699
CABR Nl COUU^PE L BRA
Business 3 8471 00027 61 $32.95

ranted in U.S.A.
Launching New Ventures

An Entrepreneurial Approach
“An invaluable guide for new business owners who need a comprehensive overview and ‘'how¬
to’ approach for starting new ventures. Allen has captured the critical elements of entrepreneur-
ship along with providing the latest information and contemporary examples of how to build
world-class companies.”
—Courtney Price, Ph.D.
President, Entrepreneurial Education Foundation,
Scholar-In-Residence, Center for Entrepreneurial Leadership,
Ewing Marion Kauffman Foundation
A s the year 2000 approaches, successful high-growth start ups will need to embrace new
organizational approaches in order to compete in a global market. Whether your
company is built around a single product, new technology, or a new marketing idea,
you’ll need to know the fundamentals of building a world-class venture. Grounded on the
business, marketing, and operational planning process, this comprehensive entrepreneurship
text includes real-world case studies and “new venture checklists” to help organize your start¬
up. The author focuses on the how-to aspects of:
▲ Recognizing entrepreneurial opportunities for the next century
a Building a “virtual enterprise” with a team approach
A Protecting your idea
a Researching your industry and evaluating your target market
A Financing growth without losing control
A Planning for change as you grow
Kathleen R. Allen, Ph.D., is Assistant Professor of Clinical

Entrepreneurship at the University of Southern California, co-founder
of Genteeh Corporation, and two other entrepreneurial companies. She
i is the co-author of Entrepreneurship and Small Business Management.
UPSTART
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UPSTART PUBTISHING COMPANY, INC.

Copyright © 1995 by Upstart Publishing Company, Inc.

Library of Congress Cataloging-in-Publication

Printed in the United States of America

Part 1: The Entrepreneur and the Entrepreneurial Venture 1

Part 2: Finding, Analyzing, and Testing Opportunity 81

Part 3: The New Venture and the Law 133

Part 4: The Operating Structure of a New Venture 171

Part 5: The Financial Plan 281

Part 6: A Plan for Growth 343

Part 7: Contemplating the Future 403

Part 8: A World-Class Venture 445

Part 1: The Entrepreneur and the Entrepreneurial Venture 1

Chapter 2: Recognizing and Testing Opportunity 23

Chapter 3: Developing the Business Concept 43

Chapter 4: The Founding Team 61

Part 2: Finding, Analyzing, and Testing Opportunity 81

Chapter 5: Understanding the Industry: Prelude to Success 83

Chapter 6: Evaluating the Target Market 99

Identifying the Competition 101

Chapter 7: Distribution Channels: Getting the Product or Service

Part 3: The New Venture and the Law 133

Chapter 8: The Legal Structure of the Business 135

Additional Sources of Information 148

Chapter 9: Regulations Affecting New Businesses 149

Part 4: The Operating Structure of the New Venture 171

Chapter 10: The Big Picture 173

Chapter 11: The Operational Plan 195

Matenals Requirements 206

Chapter 12: The Marketing Plan 225

Chapter 13: The Management and Organization Plan 255

Additional Sources of Information 273

Part 5: The Financial Plan 281

Chapter 14: Financing the New Venture 283

Chapter 15: Preparing the Financial Plan 297

Part 6: A Plan for Growth 343

Chapter 16: Growing the Business 345

Diversification Growth Strategies—Growing Outside the Industry 357

Chapter 17: Financing Growth 369

Part 7: Contemplating the Future 403

Chapter 18: Planning for Change 405

Chapter 19: Packaging and Presenting the Business Plan 423

Additional Sources of Information 437

Part 8: A World-Class Venture 445

Chapter 20: Achieving World-Class Status 447

Figure 11.4: Gannt Chart 211

Profile 9.2: Taking Care of Workers’ Comp 157

entrepreneurs and would-be entrepreneurs understand the nature of the new

Know what you are doing.

Fie must have been talking about entrepreneurs.

Launching New Ventures: An Entrepreneurial Approach is written in a practical,

• Outline of a feasibility plan

The Entrepreneur and the

Develop a vision, and never lose sight of that vision.

Death, Taxes, and Change—The Only Certainties

Accordingly, this book refers to these new types of entrepreneurial ventures

• Be smaller and more responsive

Need for Achievement

Turning Failure into Success

Internal Locus of Control

Tolerance for Ambiguity