ACCESSING RESOURCES FOR GROWT.

H
FROM EXTERNAL SOURCES

OPEIVNG PROFILE

BILL GROSS

.
.'" ,

How does a start-up company take advantage of the seemingly endless opportunties
of the Internet by using the creative talents of one person and then letting other selected entrepreneurs tke over the responsibility of running these businesses? lt
sounds like a repeat of history when Thomas Edison rnade invention a business. But the

new kid on the block is Bill Gross, whose vision is to grow

his ldealab by nurturing and monitoring other Internet

that have rsulted because of his ingenuity. He

refers to ldealab as Internet start-ups in a box. Basically the

businesses

concept is simple. Bill comes up with an idea for an Internet start-up. He locates some-

- one. either a former executive or even an engineering student, who he thinks is right
i.. .' for the job. That person is then given the reins to start
this venture all under the roof
..
' ': , of an incubator-like operation, where Bill provides the structure and services necessary
to make these start-ups rapidly grow into successful enterprises.
.

I
.
:'
.

.
'

Bill describes ldealab as a combination of incubatot venture capitalist, and creative

think tank. Like an incubatol it provides shared space and administrative services, it offers seed financing for a minority equity position (up to 49 percent), and it uses everyone to brainstorm on the most opportune technology applications. Started in 1996 in
Pasadena, Calfornia, to date the company has created 30 lnternet ventures, all at various stages of development. Each idea came from Gross or one of his ldealab staff managers. For each firm a CEO was found and hired using Bill's networking skills in the
Internet industry and at Caltech, his alma mater. Then the core expert staff becomes
involved to get these ventures up and running as quickly as possible. This involves de-

. . : . .. .
: i '
veloping the technology, conducting marketing
.

"

research. preparing a business plan,

,:--..,...,;., hiring managernent, launching the venture, and finally either going public or setling
the business. The seed financing that ldealab provides to these start-ups does not ex- , ceed $250,000. Bill believes that Internet start-ups do not need large amounts
of capi,:, tal to get started but, more importantly, do need knowledge, intelligence, and speed.

'
:-,:

Knowledge and intelligence are provided by Bill and the ldealab's staff experts, and
speed focuses on the ability to quickly grow a start-up, but with few mistakes. According to Bill, these two elements are much more important in the successful launch and

growth of an Internet company than money.

411

412

PART

FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING TI{E NEW VENTURE

Bill Gross personifies the real meaning of an entrepreneur. He probably holds

the unique distinction in the field of entrepreneurship of not only starting many
businesses but also turning all of them into successful enterprises. As an enterprising
12-year-old he noticed that the corner drugstore was selling candy at 9 cents, and at

the Sav-On nearby it was selling for 7 cents. He quickly figured out that with no overhead he could make an easy profit on the price spread. Bill then moved on to his next
successful enterprise by placing adsin Popular Mechanics, where he sold $25,000 worth
of solar devices and plans. The proceeds from this effort were used to finance his freshman year's tuition at Caltech. While at Caltech he proceeded to launch GNP Inc., a
stereo equipment maker. This enterprise not only was very successful but was recognized as one of /nc. magazine's top 500 growth ventures in 1982 and 1985. Hs next enterprise was created when Bill and his brother found a way to make Lotus l-2-3 obey
simple commands. Mitch Kapor, the founder of Lotus, was impressed with their software and purchased their business for $ 1 0 million.
The success streak continued with the launch of Knowledge Adventure in 1991. This
venture developed and marketed educational software and was considered to be his
most successful venture to date. He sold the business in 1997 for $100 million. ldealab
actually was created in 1996 when Bill was stepping down from Knowledge Adventure
and negotiating the sale.
A sample of sorne of the companies launched by ldealab includes CitySearch, which
competes with Microsoft and provides online services for urban communities; Entertain-

Net, an Internet broadcaster that provides news and related information; and
Answer.com, a Web site that will answer any question you might have and which has already been acquired by another company. Last year Bill expanded his operations into
Silicon Valley. He wanted to be close to the acton and take advantage of ldealab's abil-

ity to quickly transform some of these Internet opportunities into successful ventures.
Growing these start-ups is a challenge to Bill Gross, and although there is high

risk in the Internet industry, Bill feels that ldealab will continue to stay focused on
its mission.l

USING EXTERNAL PARTIES TO HELP GROW A BUSINESS

In Chapter 3, we introduced franchising as a means of new entry that can reduce the risk
of downside loss for the franchisee. Franchising is also an alternative means by which an
entrepreneur may expand his or her business by having others pay for the use of the
name, process, product, service, and so on. Using franchising as a growth mechanism is
the primary focus of this chapter. Given the importance of franchising for both new entry and growth, the hrst section explores franchising from the perspective of the entrepreneur looking to use franchising to reduce the risks of new entry and from the perspective
ofthe entrepreneur looking to use franchising as a way to grow his or her business. The
second section explores other external mechanisms for growing a business, namely,

joint

CHAPTER

14

ACCESSING RESOURCES FOR GROWTH FROM

DfiERNAL SOURCES 413

ventutes, acquisitions, and mergers. Finally, this chapterprovides some useful advice for
those entrepreneurs who need to negotiate to obtain the human and f,rnancial resources
necessary to fuel business growth.

FRANCHISING
franchising An
arrangement whereby a
franchisor gives exclusive
rights of local distibution

to a franchisee in return
for payment of royalties
and conformance to

'?n arrangement wherby the manufacturer or sole distributor of a trademarked product or service gives exclusive rights of local distribution to independent retailers
in return for their payment of royales and conformance to standardized operating procedures."2 The person offering the franchise is known as the
franchisor T\e franchs is the
person who purchases the franchise and is given the opportunity to enter a ner/ business with
a better chance to succeed than if he or she were to start a new business from scratch.
Franchising is

standrdized operating

Advantages of Franchising-to the Franchisee

procedures

Jranchisor

The person

offering the franchise

franchisee The person

who purchases the
franchise

One of the most impofant advantages of buying a franchise is that the entrepreneur does
not have to incur all the risks associated with creating a new business. Table 14.1 summarizes the important advantages of a franchise- Typically, the aeas that entrepreneurs have
problems with in starting a new venture are product acceptance, management expertise,
meeting capital requirements, knowledge of the market, and operating and structural controls. In franchising, the risks associated with each are minimized throueh the franchise relationship, as discussed in the following.

Product Acceptance The franchisee usually enters into a trusiness that has an accepted
name, product, or service. In the case of Subway, any person buying a franchise will be using the Subway name, which is well known and established throughout the United Sttes.
The franchisee does not have to spend resources trying to establish the credibility of the
business. That credibility already exists based on the years the franchise has existed. Subway has also spent millions of dollars in advertising, thus building a favorable image of the
products and services offered. An entrepreneur who tries to start a sandwich shop would be
unknown to the potential customers and would require signifrcant effort and resources to
build credibility and a reputation in the market.

Management

rial

Expertise

Another important advantage to the franchisee is the manage-

provided by the franchisor. Each new franchisee is often required to take a

training program on all aspects of operating the franchise. This training could include
assistance

classes in accounting, personnel management, marketing, and production. McDonald's,

for

414

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FROM FUNDING THE VENruRE TO LAUNCHING. GROWING, AND ENDING THE NEW VENruRE

example, requires all its franchisees to spend time at its school, where everyone takes
classes in these areas. In addition, some franchisors require their new franchisees to
actually work with an existing franchise owner or at a company-owned store or facilify
to get on-the-job training. Once the franchise has been started, most franchisors will
offer managerial assistance on the basis of need- Toll-free numbers are also available so
that the franchisee can ask questions anytime. Local ofhces for the larger franchises
continually visit the local franchisees to offer advice and keep owners informed of new
developments.
The training and education offered is actually an important criterion that the entrepreneur should consider in evaluating any franchise opportunity. If the assistance in staf-up is
not goo4 the entrepreneur should probably look elsewhere for opportunities unless he or
she already has extensive experience in the field.

Capitat Requirements As we've seen in previous chapters, starting a new venture

can be costly in terms of both time and money. The franchise offers an opportunity to
start a new venture with up-front support that could save the entrepreneur significant
time and possibly capital. Some franchisors conduct location analysis and market research of the area that might include an assessment of traffic, demographics, business
conditions, and competition. In some cases, the franchisor will also hnance the initial
investment to stat the franchise operation. The initial capital required to purchase a
franchise generally reflects a fee for the franchise, construction costs, and the purchase
of equipment.
The layout of the facility, control of stock and inventory and the potential buying power
of the entire franchise operation can save the entrepreneur significant funds. The size of the
parent company can be advantageous in the purchase of health cae and business insurance,
since the entrepreneur would be considered a participant in the entire franchise organization. Savings in start-up are also reflected in the pooling of monies by individual franchisees for advertising and sales promotion. The contribution by each franchisee is usually
a function of the volume and the number of franchises owned. This allows advertising on
both a local and a national scale to enhance the image and credibility of the business, something that would be impossible for a single operation.

Knowledge of the Market Any established franchise business offers the entrepreneur
years of experience in the business and knowledge of the market. This knowledge is usually reflected in a plan offered to the franchisee that details the profile of the target customer and the strategies that should be implemented once the operation has begun. This is
particularly important because of regional and local differences in markets. Competition,
media effectiveness, and tastes can vary widely from one market to another. Given their
experience, franchisors can provide advice and assistance in accommodating any ofthese
differences.
Most franchisors will be constantly evaluating market conditions and determining the
most effective strategies to be communicated to the franchisees. Newsletters and other publications that reflect new ideas and developments in the overall market are continually sent
to franchisees.
Operating and Structural Controts Two problems that many entrepreneurs have in
starting a new venture are maintaining quality control of products and services and escablishing effective managerial controls. The franchisor, particularly in the food business, will
identify suppliers that meet the quality standards established. In some instances, the supplies are actually provided by the franchisor. Standardization in the supplies, products, and

CHAPTER

14

ACCESSING RESOURCES FORGROWTH FROM DfiERNALSOURCES 415

services provided helps ensure that the entrepreneur will maintain quality standards
that are
so important. Standadization also supports a consistent image on which the franchise
business depends for expansion.

Administrative controls usually involve financial decisions relating to costs, inventory

and cash flow, and personnel issues such as criteria for hiring and frring, scheduling, and
training to ensure consistent service to the customer. These conols will usually be outlined
in a manual supplied to the franchisee upon completion of the franchise deal.
Although all the preceding are advantages to the franchisee, they also represent important strategic considerations for an entrepreneur who is considering growing the business
by selling franchises. Since there are so many franchise options fr an entrepreneur, the
franchisor will need to offer all the preceding services to succeed in the sale of franchises.
one of the reasons for the success of such franchises as McDonald's, Burger King, KFC,
Boston Markeg Subway, Midas, Jiffy Lube, Holiday Inn, Mail Boxes Erc., und M",,y
Maids is that all these hrms have established an excellent franchise system that effectivelv
provides the necessary services to the franchrsee.

Advantages of Franchising-to the Franchisor

The advantages a franchisor gains through franchising are related to expansion risk, capital requirements, and cost advantages that result from extensive buying power. Consider the
success ofthe Subway chain. Clearly, Fred Deluca would not have been able to achieve
the size and scope ofhis business without franchising it. To use franchising as an expansion
method, the franchisor must have established value and credibility that someone else is
willing to buy.

Expansion Risk The most obvious advantage of franchising for an entrepreneur is

that it allows the venture to expand quickly using little capital. This advantage is significant when we reflect on the problems and issues that an entrepreneur faces in trying to
manage and grow a new venture (see Chapter l3). A franchisor can expand a business
nationally and even internationally by authorizing and selling franchises in selected locations. The capital necessary for this expansion is much less than it would be without
franchising. Just think of the capital that Deluca would require to build 8,300 Subway
sandwich shops.
The value of the franchise depends on the to-date track record of the franchisor and
on the services offered to the entrepreneur or franchisee. Subway's low franchise fee has
.
enhanced expansion opportunities, as more people can afford it.
Operating a franchised business requires fewer employees than a nonfranchised business- Headquarters and regional offices can be lightly staffed, primarily to support the
needs of the franchisees. This allows the franchisor to maintain low payrolls and minimizes
personnel issues and problems.

cost Advantages The mere size of a franchised company offers many advan[ages to
the franchisees. The franchisor can purchase supplies in large quantities, thus achieving
economies of scale that would not have been possible otherwise. Many franchise businesses produce parts, accessories, packaging, and raw materials in large quantities, and
then in turn sell these to the franchisees. Franchisees are usually required to purchase
these items as part of the franchise agreement, and they usually beneht from lower
prices.
One of the biggest cost advantages of franchising a business is the ability to commit
larger sums of money to advertising. Each franchisee contributes a percentage of sales

Sf-N f,
RE:CA

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over the past four quarters--ven as the depths of the

that clean tech ki d of rides above the economic uncertion's economic problems became evident-venture capital- tainty, " says Mark Heesen, president of the Natonal Venture
ists invested more ihan $ziljion in seed and earty-stage capitat Assn. Demand forclean

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in more than

1,400 deals, according to the aroundtheglobe,alongwithrenewedattentintgcutting

'' [tdoneyTree Report from the National Venture Capital Assn. emissions from the incoming Obama Administriion, has
Tfiat's more money raised by young companiesthan in any convinced investors to bet on solar and wind power, as well
..
<afendar year since the dot-com bubble burst in 200-|.
as hybrid cars.
In the largest deals of the past yeat venture capital firms
Likewise, Heesen says, biotechnology and medical device
poured money into companies tackling the global problems companies will continue to draw investors
beiause' the
of climate change and disease. The challenges are great-and promise of ther products to extend lives is so important.
investors bet that the payoffs will be, too-for the startups "We all are living longe and we want to live longer, more
that successfully commercialize ideas like solar powe6 low- productive lives, and biotech is at the cusp of that,;, h says.
emission cars, and new medications.
. : The startups Heesen predicts will suffer most from the downWho are these hot startups? To find out, we followd the turn are lT firms that ultimately sell their products to conmoney, looking at deals that took place in the four most re- sumers or businesses, because both are cutting spending.
cent quarters available, from October 2007 to Septembr Still, developing drugs or clean technology takei.a lot of
2008' based on the MoneyTree repoit, which uses data from money, with long time frames for exits pientially made
Thormon Reuters- We then eached outto a selection of the longer by an lPo drought nd a tough market for acquisiseed and early-stage companies that.raised the most money tions. one drug development company, IRX Therapeutics in
and irrofiled them in a slide showNew york, has raised more than $60 mllon since its found_
At the top of the list are some veteran entrepreneurs ing more than a decade ago, mostly from hgh-net-worth
who have already proven themselves to investors by found- individuals and some VCs, to develop treatments to restore
ing companies that led to acquisitions- The team behind immune function in head and neck cancer patients. ,,We,re
Relypsa, a Santa Clara (Calif.) drug development company obviously a company without revenue in a business
tht
working on a treatment for life-threatening hyperkalemia eats capital," says Chief Financial Officer Jeffrey Hwang. fle
in heart and kidney patients, sold their last company to says the firm has had to cut staff by a third and delay clinical
Amgen (AMGN) for $420 million in 2007. Relypsa, founded trials it planned for 2009, because he's not sure whether the
months after the acquisition, raised $33 million in late 2007. funding will be there to complete them- ,,we,re not gong
But even for well-capitalized startups with proven track to start anything we can't finish,,' he says.
records, the uncertain funding outlook means they have to
Heesen says many startups may face the same problem
make every dollar count. Gerrt Klaerner, Relypsa's chief op- next year. He expects fewer companies to get funded. Those
erating officer; says startups that are only now thinking of entrepreneurs that do will have to prove the value of their
ways to trim may be in trouble. "Operating a small company, ideas and their ability to execute them even in a downturn.*
I think you have to be lean and mean. lf you start thinking
about capital efficiency today, it,s too tate,,, he says.
companies

For other businesses, the downturn carres the scent of ADVICE TO AN ENTREpRENEUR
An ndividual who is looking to start and grow a business
opportunty. Ron Gonen, co-founder and chief executive
cer of RecycleBank, says the sudden need for cities and house- approaches you and asks you the following questions:

offi-

holds to conserve cash puts his company in a position

to .t ,., J__ have the track record of starting and running

] ::l't
'lt su,ccessful
a
business, then what else can I do to enhance

grow. The 85-emproyee New york firm ,.rn, ..".v.1-nn ,un"rnl

for cities that ret resdents earn points, b"r"d
they recycle, that they can redem at retarers. lj;*
cities really need to save money and people ur"

.;;;;;;;;;

il
r.""ivlootinq

my likelihood of raising funds to start up and grow

new business?

forawaytogetdisposableincome,we,reataunqtmei 2. Whyare"greenopportunities"soattractiveduringan
our growth curve," Gonen says. He says families can earn

up

economic downturn? Will they "disappear" when the

re-

money. Given the trends that make biotech attractve,

what other businesses are also ikely to be high growth?

economy "heats up"?

to $400 a year in RecycleBank points. RecycleBank, whic|
raised$30millionlastyearontopof$l5millioninanearlier 3. Biotechrequiresscientificknowledgeandconsiderable
round, takes a cut of the savings that the cities get from
ducing how much trash they send to
Venture capitalists see other companies that focus on
conservation, renewable power, and reducing the emissions
that ca use g loba I wa rm ing as strong bets even in bad times.

landfills.

,,No matter how

much worse the
.,r g"1
over the next six to 1 2 months, there are".ono,f
ma ny who believe
416

frorn December 19, 2008 issue of Businessweek bv special

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CHAPTER

T4

ACCESSING RESOURCES FORGROWTH FROM

DOERNALSOURCES 417

(l to 2 percent) to an advertising pool. This pooling ofresources allows the franchisor to

conduct advertising in major media across a wide geographic area If the business
were not
franchised' the company would have to provide funds for the entire advertising
budget.
Disadvantages of Franchisin g
Franchising is not always the best option for an entrepreneur. Anyone investing
in a franchise should investigate the opportunity thoroughly- Problems between the franchisor
and the franchisee ae common and have recently begun to receive more
attention from the
government and trade associations.
The disadvantages to the franchisee usually center on the inability ofthe franchisor
to provide services, advertising, and location. Wben promises made in the franchise

may
N
dow Works franchises.
The franchisee

by another company.

or being bought out

ownerof three Win_

franchises when the
franchise was sold to Apogee Enterprises and then resold four years later to a group of investors- This caused many franchises to fail. The failure of these franchises has made
it difficult for Niagra to continue because crstomers are apprehensive about doing business with
him for fear that he will also go out ofbusiness. None ofthe support services that had been
promised were available.a
The franchisor also incurs c
alternative. In some cases, the
chisees. Poor management, in s
ual fanchise failures and, therefore, can reflect negatively on the entire franchise system.
As the number of franchises increases, the ability to maintain tight controls becomes more

difficult-

Types of Franchises
There are three available types of franchises.s The first type is the dealership, a form commonly found in the automobile industry. Here, manufacturers use franchises to distribute
their product lines. These dealerships act as the retail stores for the manufacturer. ln some
instances, they are required to meet quotas established by the manufacturers, but as the
is
case for any franchise, they benefit from the advertising and management support provided
by the franchisor-

The
doin
Th

of
lnn.
can be

and method
and

Holidav

information.

A third type offranchise offers services. These include personnel agencies, income tax
prepaation companies, and real estate agencies- These franchises have established names
and reputations and methods ofdoing business. In some instances, such as real estate, the
franchisee has actually been operating a business and then applies to become a member of
the franchise.

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PART

FROM FUNDINGTHEVENruRETOLAUNCHING,GROWING.AND ENDINGIHENEWVENTURE

Franchising opportunities have often evolved from changes in the environment as well
as important social trends. Several of these are discussed in the following.T

Good health. Today people are eating healthier food and spending more time keeping
fit. Many franchises have developed in response to this trend. For example, Bassett's
Original Turkey was created in response to consumer interest in eating foods lower in
cholesterol, and Booster Juice was created to provide freshjuice and smoothies as a
healthy alternative to other snacks and drinks. PeterTaunton founded Snap Fitness Inc.
in 2003 to offer patrons a convenient and affordable place to work out, and Gary
women-only fitness center.
Heavin created Curves for Women

Time saving or convenience. More and more consumers prefer to have things delivered
to them as opposed to going out of their way to buy them. In fact, many food stores
now offer home delivery services. In 1990, Auto Critic of America Inc. was started as
a mobile car inspection service. About the same time, Ronald Tosh started Tubs To Go,
a company that delivers Jactzzis to almost any location for an average of $ 100 to $200

-a

per night

Health care. There is an increasing number of opportunities in health care for aging
people. For example, Senior Helpers was founded in 2001 and started franchising in
2005 to offer care for seniors so that they can live independently in the comfort of their
own home. Healthsource Chiropractic and Progressive Rehab started franchising in
?N6 andoffers chiropractic care with "Progressive Rehabilitation" where chiropractors
work side by side with therapists, massage therapists, and athletic trainers.

The second baby boom. Today's baby boomers have had babies themselves, which has
resulted in the need for a number of child-related service franchises. Child care
franchises such as KinderCare and Living and L,earning are thriving. In 1989, rwo
aftomeys, David Pickus and Lee Sandoloski, opened Jungle Jim's Playland. This is an
indoor amusement park with small-scale rides in a 20,D- to 27,000-square-foot
facility. One franchise, Computertots, teaches classes on computers to preschoolers.
This franchise has spread to 25 locations in 15 states.

INVESTING IN A FRANCHISE
Franchising involves many risks to an entrepreneur. Although we read about the success of
McDonald's or Burger King, for every one of these successes there are many failures. Franchising, like any other venture, is not for the passive person. It requires effort and long
hours, as any business does, since duties such as hiring, scheduling, buying, and accounting are still the franchisee's responsibility.
Not every franchise is right for every entrepreneur. He or she must evaluate the franchise
alternatives to decide which one is most appropriate. A number of factors should be assessed before making the hnal decision.
|

Unproven versus proven franchise. There are some trade-offs in investing in a proven
or unproven franchise business. Whereas an unproven franchise will be a less expensive investment, the lower investment is offset by more risk. In an unproven franchise,
the franchisor is likely to make mistakes as the business grows. These mistakes could
inevitably lead to failure. Constant reorganization of a new franchise can result in confusion and mismanagement. Yet, a new and unproven franchise can offer more excitement and challenge and can lead to significant opportunities for large prohts should
the business grow rapidly. A proven franchise offers lower risk but requires more

financial investment.

FAIR ENO ucFl

to Tell the Difference between a Lie

and a tre
really likes to think about how much lying
,.1.!,,gqn"
.goes-on at the bargaining table. Of 'course not_t,s
troubling. On the one hand, we aspire t principled
negotiation, win-win solutions, and civility with our
opponents. On the other; our whole notion of nego_
tiation is built or'ethical quicksand: To.succeed. you
must deceive.

for the things he does-a good one and the real

" 5o after you get the good ones, ask for the real
ones by saying, "And why else?,, Also, get important
promises in writing, and scrutinize their wording
sons
one.

with and without your lawyer. To discourage dishonesty, tell your opponent you will independently verify
the important stuff. lf you can, do it. By the way, ex-

logically honest among us find them disturbing. But

perts say it's easier to detect lying on the phone than

in person. The voice all by itself (wthout distracting
visual cues) is more of a giveaway.
To the terminally honest. I say: Negotiation is not
group therapy. Generally, if you bare your soul. you
will be fleeced. Respect the rules-or have someone
else do your bargaining foryou. lf you're a liar (and
you know who you are), I hope you get nailed big
time. And if you're morally sturdy and find yourself
unsure of what to say or omit, just keep Richard
Nixon's comments about Watergate in mind: ,'l was
not lying. lsaid things that later on seemed to be

we have a place for those people . . . in the back room.

far away from any bargaining table.
Still. some evasiveness and deception we conside,

Source: Reprinted with permission of Entrepreneur Media, Inc., "To

fla
do
cla

when you're posturing) is not lying. lt,s a show of

strength. Pretending to bend over backward to make

meaningless concessions is not lying. lt's applied psy_
chology. Sawy businesspeople accept these rituals

without undue introspection. Of course, the patho_

out of bounds. Forowins are some tips for stayins

bounds without gettng

clobbered.

in

ntrue. "

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www.enreDreneur.com.

2' Financial stability offranchise.

The purchase ofa franchise should entail an assessment of the financial stability of the franchisor. A potential franchisee should seek
answers to the following questions:
How many franchises are in the organization?
How successful is each of the members of the franchise organization?
Are most of the prohts of the franchise a function of fees from the sale of franchises
or from royalties based on proirts of franchisees?
Does the franchisor have management expertise in production, hnance, and
marketing?

.
'
'
'

Some of the preceding information can be obtained from the profrt-and-loss statements
of the franchise organization. Face-to-face contact with the franchisor can also indicate
the success of the organization. It is also worthwhile to contact some of the franchisees
directly to determine their success and to identify any problems that have occurred. If

hnancial information about the franchisor is unavailable, the entrepreneur may purchase a
419

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PART

FROM FUNDING THE VENTT'RE TO LAUNCHING. GROWING, AND ENDING THE NEW VENTURE

hnancial rating from a source such as Dun & Bradstreet. Generally, the following are
good external sources of information:

.
.
.
.
.
.
.

Franchise association
Other franchisees

Government
Accountants and lawyers

Libraries
Franchise directories and journals
Business exhibitions

the new franchise.It is important for the entrepreneur to

evaluate the market that the franchise will attract. A starting point is evaluating the
traffic flow and demographics of the residents from a map of the area. Trafhc flow
information may be observed by visiting the aea. Direction of traffic flow, ease of
entry to the business, and the amount of traffic (pedestrian and automobile) can be
estimated by observation. The demographics of the area can be determined from
census data, which can be obtained from local libraries or the town hall. It can also
be advantageous to locate competitors on the map to determine their potential effect
on the franchise business. Marketing research in the market area is helpful. Attitudes
about and interest in the new business can be assessed in the maket research. In
some instances, the franchisor will conduct a market study as a selling point to the
franchisee.
4. Profit potential for a new franchise. As in any start-up business, it is important to
develop pro forma income and cash flow statements. The franchisor should provide
projections to calculate the needed information.

3. Potential marketfor

In general, most of the preceding information should be provided in the disclosure staement or the prospectus. The Federal Trade Commission's Franchise Rule requires franchisors to make full presale disclosure in a document that provides information about 20
separate aspects of a franchise offering.8 The information required in this disclosure is summarized in Table 14.2. Some of the information will be comprehensive and some will be
sketchy. There are always weaknesses that must be evaluated before making a commitment.
The disclosure statement represents a good resource, but it is also important to evaluate the
other services mentioned earlier in this chapter.
Front-end procedure fees, royalty payments, expenses, and other information should be
compared with those of franchises in the same field, as well as in different business areas.
If a franchise looks good as an investment, the entrepreneur may request a franchise package
from the franchisor, which usually contains a draft franchise agreement or contract. Generally,
this package will require a deposir of $400 to $600, which should be tully refundable.

The contract or franchise agreement is the hnal step in establishing a franchise arrangement. Here a lawyer experienced in franchising should be used. The franchise agreement
contains all the specifrc requirements and obligations ofthe franchisee. Things such as the
exclusivity of tenitory coverage will protect against the franchisor's granting another franchise within a certain radius of the business. The renewable terms will indicate the length
of the contract and the requirements. Financial requirements will stipulate the initial price
for the franchise, the schedule of payments, and the royalties to be paid. Termination of
franchise requirements should indicate what will happen if the franchisee becomes disabled or
dies and what provisions ae made for the family. Terminating a franchise generally results in
more lawsuits than any other issue in franchising. These terms should also allow the franchisee
to obtain fair maket value should the franchise be sold. Even though the agreement may be
standad, the franchisee should try to negotiate important items to reduce the investment risk.

CHAPTER

14

ACCESSING RESOURCESFORGROWTH FROM EXTERNALSOURCES 421

JOINT VENTURES
With the increase in business risks, hypercompetition, and failures, joint ventures have occurred with increased regularity and often involve a wide variety of players.e Joint ventures
are not a new concept, but rather have been used as a means of expansion by entrepreneurjoint venture Two or
more companies forming
a

new company

ial frrms for a long time.

What is a joint venture? A joint venture is a separate entity that involves a partnership between two or mote active participants. Sometimes called strategic alliances, joint ventures
can involve a wide variety of partners that include universities, not-for-profrt organizations,

422

PART

FROM FUNDING THE VENruRE TO LAUNCHING, GROWING. AND ENDING THE NEW VENTURE

businesses, and the public sector.l0 Joint ventures have occurred between such rivals as
General Motors and Toyota as well as General Electric and Westinghouse. They have occured between the United States and foreign concerns to penetrate an international market,
and they have been a good conduit by which an entrepreneurcan enter an intemational maket.
Whenever close relationships between two companies are being developed, concems
about the ethics and ethical behavior of the potential partner may arise.

Types of Joint Ventures

Although there are many different types of joint venhrre arrangements, the most common

is still between two or more private-sector companies. For example, Boeing, Mitsubishi,
Fuji, and Kawasaki entered into ajoint venture for the production of small aircraft to shae
technology and cut costs. Microsoft and NBC Universal formed a partnership to create a
cable news channel (MSNBC). There is an elaborate cost-sharing arrangement between e
different entities of the partnership.
Otherprivate-sectorjoint ventures have had different objectives, such as entering new markets (Corning and Ciba-Geigy as well as Kodak and Cetus), entering foreign markets (AT&T
and Olivetti), and raising capital and expanding markets (U.S. Steel and Phong lron and Steel).
Some joint ventures are formed to do cooperative research. Probably the best known of
these is the Microelectronics and ComputerTechnology Corporation (MCC). Supported by
13 major U.S. companies, this for-proht venture does long-range research with scientists
who are loaned to MCC for up to four years before returning to their competing companies
to apply the results of their research activities. MCC retains title to all the resulting knowledge and patents, making them available for license to the companies participating in the
program. Another type of joint venture for reseach development is the Semiconductor
Research Corporation, located in Triangle Park, North Carolina. A not-for-proht research
organization, it began with the participation of I I U.S. chip manufacturers and computer
companies. The goal of the corporation is to sponsor basic research and train professional
scientists and engineers to be future industry leaders. Members of SRC programs have invested $l.l billion in cutting-edge semiconductor research supporting over 7,000 students
and 1,598 faculty members at 237 universities worldwide.rt
Industry-university agreements qeated for the purpose of doing research are another
type of joint venture that has seen increasing usage. However, two major problems have
kept these types ofjoint ventures from proliferating even faster. A proht corporation has the
objective ofobtaining tangible results, such as a patent, from its research investment and
wants all proprietary rights. Universities want to share in the possible hnancial returns from
the patenl but the university researchers want to make the knowledge available through research papers. In spite of these problems, numerous industry-university teams have been
established. In one joint venture agreement in robotics, for example, Westinghouse retains
patent rights while Carnegie-Mellon receives a percentage of any license royalties. The university also has the right to publish the research results as long as it withholds from publication any critical information that might adversely affect the patent.
The joint venture agreement between Celanese Corporation andYale University, created
for researching the composition and synthesis of enzymes, took a somewhat different
form----cost sharing. Although Celanese assumes the expense of any needed supplies and
equipment for the research, as well as the salaries of the postdoctoral researchers, Yale pays
the salaries ofthe professors involved. The research results can be published only after a
454ay waiting period.
Interuational joint ventures, discussed in Chapter 5, are rapidly increasing in number
due to their relative advantages. Not only can both companies share in the earnings and
growth, but the joint venture can have a low cash requirement if the knowledge or patents are

CHAPTER

14

ACCESSING RESOURCES FORGROWTH FROM EXTERNALSOURCES 423

capitalized as a
new internation

financing

venture provides ready access to

attained. Finally, since talent and

come

oint venture causes less drain on

ancial resources than

s to establishing an
L the
b
venture partners can
ult in
problems in the direction and growth of the new entity. In addition, cultural
differences in
ies in the newjoinf venture. Finally, govern_
impact on the direction and operation of the
enced by

jo
th

il*'i":il

(Japan) to develop ard market c

raw materials and was a sole di
bution in the Japanese market.
cerns of the Japanese government and the fundamental difference in motives between the
two partners: Dow was primarily concerned with the profits of the joint venture, whereas
Asaki was primarily concemed with having a purchaser for its basic petrochemicals.

Factors in Joint Venture Success

Clearly' not all joint ventures succeed. An entrepreneur needs to assess this method of
growth carefully and understand the factors that help ensure success as well as the problems involved before using it. The most critical factors for success are:

l.

invol
ventu
hout this chemis
the parties

. The

joint

ew entity in light
if the managers
a low

likelihood

of success and may even fail.

sources that will be provided. Good relationships must be nurtured between the managers in thejoint venture and those in each parent company.

3. The

expectations of the results of the joint venture must be reasonable. Far too often,
at least one of the partners feels that a joint venture will be the cure-all for other corporate problems. Expectations of a joint venture must be realistic.

4. The timing

must be right. With environments constantly changing, industrial conditions being modied, and markets evolving, a particular joint venture could be a success one year and a failure the next. Intense competition leads to a hostile envionment
and increases the risks of establishing a joint venture. Some environments are just not
conducive to success. An entrepreneur must determine whether the joint venture will
offer opportunities for growth or will penalize the company, for example, by preventing it from entering certain markets.

A joint venture is not a panacea for expanding the entrepreneurial venture. Rather, it
should be considered one ofmany options for supplementing the resources ofthe firm and
responding more quickly to competitive challenges and market opportunities. The effective

424 PAR 5

FROM FUNDING THE VENTURE TO I-AUNCTIING, GROWNG, AND ENDING THE NEW VENTURE

for expansion requires tre entrepreneur to carefully appraise

the situation and the potential partner(s). Other strategic alternatives to the joint venturesuch as acquisitions, mergers, and leveraged buyouts-should also be considered.
use

ofjoint ventures

as a sategy

ACOUISITIONS
Another way the entrepreneur can expand the venture is by acquiring an existing business.
Acquisitions provide an excellent means of expanding a business by entering new makets

il"H,fr:ili,T'f i$Tii:1"J.::'"'ff :;#JH"*ilT,li:"j;Hiff ili##.::1

acqukitinn purchasing company. An acquisition is the purchase of an entie companf or part of a company; by
alt or part of a

company

definition, the company is completely absorbed and no longer exists independently- An ac-

lJ[*il*ffi

ffi"Llltr;??lllllli,lL*:trf ,il1fiT["L*;*i*"s

invorved

Although one ofthe key issues in buying a business is agreeing on a price, successful
acquisition of a business actually involves much, much more. In fact, often the structure of
the deal can be more important to the resultant success of the transaction than the actual

;rr,:tTT3.*;
*{fl t*T*T:ffi :il"#f;,ff"}il"*:trlHt"f#fi ":#;:ff

From a strategic viewpoint, a prime concern of fhe entrepreneurial firm is maintaining

the focus of the new venture as a whole. Whether the acquisition will become the core of
the new business or rather represents a needed capability-such as a distribution outlet,
sales force, or production facility-the entrepreneur must ensure that it fits into the overall
direction and structure of the strategic plan of the present venture.

Advantages of an Acquisition
For an entrepreneur, there are many advantages to acquiring an existing business:

l.

Established business. The most signifrcant advantage is that the acquired firm has an
established image and track record. If the frrm has been profitable, the entrepreneur
need only continue its current strategy to be successful with the existing customer
base.

2. kcation New customers are already familiar with the location.

3. Established marleting structure. An acquired firm has its existing channel and sales
structure. Known suppliers, wholesalers, retailers, and manufactufers' reps are important assets to an entrepreneur. With this structure already in place, the entrepreneur can
concentrate on improving or expanding the acquired business.
4. Cost- The actual cost of acquiring a business can be lower than other methods of
expansion.
5. Existing employees. The employees of an existing business can be an important asset
to the acquisition process. They know how to run the business and can help ensure that
the business will continue in its successful mode. They already have established relationships with customers, suppliers, and channel members hnd can reassure these
groups when a new owner takes over the business.

6. More opportunity to be creafive. Since the entrepreneur does not have to

be concerned

with frnding supplien, channel members, hiring new employees, or creating customer
awareness, more time can be spent assessing opportunities to expand or strengthen the
existing business and tapping into potential synergies between the businesses.

CHAPTER

14

ACCESSING RESOURCES FOR GROWIHFROM

EXTERMLSOURCES 425

Disadvantages of an Acquisition
Although we can see that there are many advantages to
acquiring an existing busiuess,there
also disadvantages. The importance ofeach ofthe
advantag and disadvantages
3re
be weighed carefully with other expansion optrons.

l'

should

Marginal success record. Most ventures that are for sale have
an erratic, marginally
successful, or even unprohtable track record. It is important
to review the records
and meet with important constituents to assess that
record in terms of the business,s
future potential. For example, if the store layout is poor, this
factor can be rectified;
but if the location is poor, the entrepreneur might o
etter using some other expansion method.

2'

overconfidence in ability. Sometimes an entrepreneur may

assume that he or she can
succeed where others have failed. This is why a self-evaluation
is so important before
entering into any purchase agreement. Even though tlre entrepreneur
brings new ideas
and management qualities, the venture may never be successful
for reasons that re
not possible to correct. Often managers ae overconfident in
their ability to overcome
cultural differences between their current business and the one
being acquired.
3- Key employee loss. often, when a business changes hands, key
emproyees arso reave.
Key employee loss can be devastating to an entrepreneu whois
acquiring a business
since the value of the business is often a reflection of
the efforts of the employees.
This is particularly evident in a service business, where it is difhcult
to sepaate the
actual service from the person who performs it. In the acquisition
negotiations, it is
helpful for the entrepreneur to speak to all employees individually
,Jobtuir, ,o-"
assutance of their intentions as well as to inform them
of how important they will be
to the future of the business. lncentives can sometimes be
used to ensure that key
employees will remain with the business.

4. overualuation. rt is possible that the actual purchase price is inflated

due to the
established image, customer base, channer members, or suppliers.
If the entrepreneur has to pay too much for a business, it is possible that ihe
return on investment
will be unacceptable. It is important to look at the investment required in purchasing
a business and at the potential profit and establish a reasonable
payuact< to justify
the investment.

-After

balancing the pros and cons ofthe acquisition, the entrepreneur needs
to determine

a fair price for the business.

Synergy
The concept that "the whole is greaer than the sum ofits parts"
applies to the integration
of an acquisition into the enEepreneur's venture. The synergy should
occur in both the business concept, with the acquisition
overall goals,
and the financial performance. The
ottom line, af_
fecting both long-term gains and fu
most frequent
causes of an acquisition's failure to meet its objectives.

Structuring the Deal

Once the entrepreneur has identified a good candida0e for acquisition,
an appropriate deal
must bu structured. Many techniques are available for acquiring
a finru eaJh having a distinct set ofadvantages to both the buyer and seller. The deat structure
involves
the parties,

' . Ais,.sr:eru

lN E'NTREPREN EUR, MAGAZINE

ADVICE T.O. AN ENTREPRENEUR ABOUT ENTERING

ri.trar /tt=rEEn,|FNtTs

.I
. :1
- .,
,
'
1: i
.

',

.:

_.
_ ,. ..:,
.-... -:: -_
.'.., ....r
:.
'which doein't give inventorspatent protection,
jmes Tiicion,49. and'Anthony
- but does allow them to'show their ideas to peolonOeis t ACM Enterprisei in ,
pfq. f'lt is an inexpensive way of protection that
:
.
(ACM),
allows inventors one year for research and develManager
Card
Jhe Auto
opment," Iscione says. ln 2001, he applied for his
that holds. driuerll"i."ns"
"
utility patent.
and up to five credit cards. When users push one
the
selected
case,
on
the
2.
Decide what hetp you need. Because Tiscione had
buttons
the
six
of
never developed a product before. he felt he
credit card is dispensed.

Start-Up: $50,OO0in2000and2001,topayforthe lackedtheexperienceheneededtolaunchthe

idea. He asked his father, Anthony, an invento
first production run of 25.000 units.
for help in finalizing his product design. Tiscione
Sales: g1.8 million in 20O2.
also approached Steve Pagac, a marketing whiz
The Challenge: Bringing a new product to market
who owned a real estte and investment firm.
with a limited marketing budget.
Says Tiscione. "steve invested sweat equity in our
James Tiscione didn't have a lot of money when he
venture, and he is responsible for lining up all our
launched his business, but that dion't stof him from
finding a way to bring his unusual product to market' customers'"
3. Make a prototype. Tiscione knew people wouldn't
Here are the steps he followed:
understand the ACM without trying it' so he
'1 .
obtain a patent.Tiscione started by visiting
made a prototype' Tiscione ended up choosing
\^/ww.uspto.gov the official Web site of the U.S.
a prototype supplier in California' Once he
Patent and Trademark office. to look for similar
ototype' people started

patents.'l I
foundonlycou|dbuyone.Thepositive
major role in moving the
to mine," h
e
search did I
4. Locate a production source. Tiscione's first stop
re than just save
research on
,'l
was the Hong Kong Chamber of Commerce, which
Tiscione money: was trying to hedge my bets
has an office in 5an Francisco. "They sent me a list
before investing dollars in attorney fees, engiof companies I e-mailed," he says' He narrowed
neering design, and prototypes. I also wanted to
it down to one-but only signed the final agreesee what other ideas were outthere. lwas surment after visiting the company several times and
Before
prised no one else ever had the idea."
viewing a few trial production pieces'
patent,
provisional
long, Tiscione applied for a

ass
assets
and/or

the

For example' all or part ofthe

bination of cash' notes' stock'
e time of acquisition' through-

out the first year, or extended over several years.

of
The two most common means of acquisition are the entrepreneur's direct purchase
purthe
direct
the firm's entire stock or assets or the bootstrap purchase of these assets' In

repay the money borrowed to acquire the company.

,, ,

split equally beteen SkyMall and ACM- At press

time. ACM switched to a standard contract,
which requires them to pay forthe ad but allows

promotional company did_AMG of plymouth,

,,AMG

Wisconsin," Tiscione says.

slgne an exclu_
sive agreement with us for the protionat prod_
ucts market in 2001.', Tiscione and pagac also

them to retain all sales.

ADVICE TO AN ENTREPRENEUR
An inventor has read the preceding article and comes
to you for advice. ,,Th
to do,,,
he says, "l don't

have

oney

to

manufacture the prod

and sell
it. What I need is for someone else to do that for me.

tacted MJ Media,

TV marketer in phoenix that

signed a nonexclusive agreement to sell the ACM
through TV ads. ,,We revarnped our original

Here are my questions:

agreement with MJ Media to include a broader

base of distribution,,, Tiscione says. ,,Originally,
the contract was for TV advertising only. Since
then, MJ Media has expanded into Internet sales
and master distribution to small distributors.,,
Now. Tiscione has a broad range of customers
selling his products. As a bonus. Taylor Gifts, a
maJor consumer catalog, picked up the ACM
for

the 2002 Christmas season.

6. Sign deals that maximize marketing exposure

1.

ls it really that simple to find and then establish

a
relationshp with someone to produce my prod_
uct? Should the producer have a manufacturing
license or should I enter into a joint venture?
2. Same sorts of issues on the marketing end, but I
also want to know how much control I can main_

tain over howthe product is marketed and sold.

Or should I not worry about that and let the
experts do their thing?
3. One dilemma for me is how much money I should
invest in the prototypes. The more money I invest,

the better the prototype looks, but I don't want

but limit financialnsk Advertising anj market_

Ing expenses can kill a product_but Tiscione

to waste money either.

avoided these expenses by signing contracts

with limited risk. Both AMG and MJ Media

signed agreements to purchase the product

tages

bootstrap purchase, acquiring a

cash. He or she then purchases
is paid off over time out of the
is type of deal often results in more favorable tax advan_

to both the buyer and the seller.

Locating Acquisition Candidates

If

brokers

People who

companies

sell

entrepreneur is seriously planning to buy a business,

there are some sources of assistance. There are professional business brokercwho
operate in a fashion similar to a real estate broker. They represent the seller and will sometimes
aggressively hnd
an

either_referrals, advertising, or direct sales. Since these

brkers
the sale, they often expend more effort on their
best deals.

*" j*a

buyers through

a commission

on

42A

PART

FROM FUNDING THE VENruRE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

Accountants, attorneys, bankers, business associates, and consultants may also know of
good acquisition candidates. Many of these professionals have a good working knowledge
of the business, which can be helpful in the negotiations.
It is also possible to hnd business opportunities in the classihed sections of the newspaper or in a trade magazine. Since these listings are usually cornpletely unknown, they may
involve more risk but can be purchased at a lower price.
Determining the best option for an entrepreneur involves significant time and effortThe entrepreneur should gather as much information as possible, read it carefully, consult
with advisors and experts, consider his or her own situation, and then make a construc-

tive decision.

MERGERS
,nl8.r Joining two or
more companres

A merger----or a transaction involving two, or possibly more, companies in which only one
company survives-is another method of expanding a venture. Acquisitions are so simila
to mergers that at times the two terms are used interchangeably. A key concern in any
merger (or acquisition) is the legality of the purchase. The Deparlment of Justice frequently
issues guidelines for horizontal, vertical, and conglomeratre rnergers which further define
the interpretation that will be made in enforcing the Sherman Act and Clayton Act. Since
the guidelines are extensive and technical, the entrepreneur should secure adequate legal
advice when any issues arise.
Why should an entrepreneur merge? There are both defensive and offensive strategies
for a merger, as indicated in Figure 14.1. Merger motivations range from survival to protection to diversification to growth. When some technical obsolescence, market or raw material loss, or deterioration of the capital structure has occurred in the entrepreneur's venture,
a merger may be the only means for survival. The merger can also protect against market
encroachment, product innovation, or an unwalTanted takeover. A merger can provide a
great deal of diversihcation as well as growth in market, technology, and hnancial and
managerial strength.
How does a merger take place? It requires sound planning by the entrepreneur. The
merger objectives, particularly those dealing with earnings, must be spelled out with the

Source: F. T. Haner, Business Polc, Plaming, ond Struteg (Cambridge, MA: Mnthrcp,1976)' p.399.

CHAPTER

14

ACCESSINGRESOURCESFORGROWTH FROM
DCTERNALSOURCES 42g

resulting gains for the owners of both companies

delineated. Also, the entrepreneur must
carefully evaluate tlre other company's management
to ensure that, if retarned,

it would be

dervalued nancial strength, whether or no

mon procedure for determining value is

flows and the expected after-tax earnings

on optimistic, pessimistic, and probable
ous acceptable rates

of retum.

LEVERAGED BUYOUTS
leveraged bayoul (LBO)
Purchasing an existing
venture by any employee

group

A leveraged buyout (LBo) occurs when an entrepreneur (or

any employee group) uses
borrowed funds to purchase an existing ve ture
for cash. Most LBOs occur because the
entrepreneur purchasing the venture believes
that he or she could run the company more
effrciently than the current owners. The current owner
is frequently an entrepreneur or other
owner who wants to retire. The owner may also
be tu.g"
desiring to divest
itself of a subsidiary that is too smail or that does "
not rrt its "o.pration

long-term strategic plans.

The purchaser needs a great amount of external
funding ,in th" p"rronal financial re_
tgll:"t needed to acquire the f,rrm directly are frequentl-y limired.

6in"" ,n" issuance of

additional equity as a mans of furiding is usuany
not possible, capitar is acquired in the
form of long-term debt ltnancing (hve years or more),
and the assets of the firm being acquired serve as collateral. who usually provides
this long-term debt financing? Banks,

venture capitalists, and insurance companies

have been the most active providers of the
debt needed in LBOs.
actual financial package used in an LBo reflects
the lender,s risk-reward profile.
Whereas banks tend to use
usually use subordinated

debt issues with warrants

or

used, the repayment

plan

established must be in line

e company expects to be
generated' The inerest rates are usually variable
and are consistent wittr trre current yields
of comparable risk investment.

o-u:l to cover the principal and inerest payments

th

ability depends on the skills of the entreprlneur and

How does the entrepreneur determine whether a

for an LBo? This determination can be made through

1' The

the following evaluation procedure:

entrepreneur must determine whether the present

owner,s asking price is reason_
able' Many subjective and quantitative techniques
can be used in this determination.
Subjective evaluations need to be made of theiollowing:
the competitiveness of the
industry and the competitive position of the firm in
that industry, the uniqueness of the

430

PART

THE NEW VENTURE

FROM FUNDING THE VENTURE TO LAUNCHING, GROWNG, AND ENDING

the abilities of management

offering of the firm and
ve techniques are used to
and other key personne
ratio ofthe LBO prospect
evaluate the fairness of
companies, as well as
comparable
of
those
should be calculated and compafed with
valuebook
its
prospect
and
the
of
the present value of future earnings

to be in the form of equity from the entrepreneur or other investors.

of the long-term debt is frequently required.

OVERCOMI NG CONSTRAI NTS BY NEGOTIATING

FOR MORE RESOURCES

d.istibation task
Negotiating how the
benefrts

will

of

the relationshiP

be allocated between

the parties

integratian tsk
Exploring possible
mutual benefits from the
relationship so that the
"size of the pie" can be
increased

CHAPER

14

ACCESSING RESOURCES FORGROWTHFROM EXTERNALSOURCES

ments. B
gotiation

ating wit

reservaton

pi.ce The
of

price (the bundle

resources from the

agreement) at which the

entrepreneur is indifferent
about whether to accept
the agreement or choose
the alernative

bargaining

zone The

range of outcomes
between the

entrepreneur's reservation
price and the reservation
price of the other party

431

and Margaret Neale,

that an entrepreneur

432

PART

FROM FUNDING THE VENruRE TO IUNCHING. GROWING. AND ENDING THE NEW VENTURE

Being aware of the assessments that need to be made is an important step toward a successful negotiation but requires stra0egies for eliciting information from the other party that can
benefit the distributive and/or integrative elements of a negotiation. Again based on the work
of Bazerman and Neale (1992),13 we offer a number of these straegies. These strategies should
be thought of as tools. No one tool is perfect for every job. Some jobs require that a number of
different tools be used simultaneously, while other jobs require thaf ttre tools be used sequentially. The entrepreneur needs to make his or her own decision as to which strategies should be
used and when. This may not be known in advance, and the entrepreneur might experiment
with different sategies to get an idea of which ones will work best for the current negotiation1: Buitd Trust and Share Information As has been discussed, the best nego'
tiated outcome likely arises from integration, where the parties find mutually beneficial
trade-offs. To find them requires both parties to have information about each other's underlying issues and the relative importance of those issues. Although providing information is
beneficial to integration, it can be detrimental to the entrepreneur in distributing benefits if

Strategy

the other party has kept hidden his or her own preferences (e.g., the other party is awae of
the entrepreneur's reservation price but the entrepreneur is unaware of the other party's
reservation price). Therefore, releasing information requires trust-a trelief that the other
party will not act opportunistically to the detriment of the entrepreneur.
Building trust is an important aspect of negotiation and is important for the ongoing relationship if an agreement is reached. One way to start this process is to share some information with the other party, such as the relative importance of a particular issue (not one's
reservation price). The other party may reciprocate by also sharing information, as part
of an incremental process of building trust. If possible, the entrepreneur should assess
the other party's trustworthiness (maybe by investigating the other party's previous relationships). If the other party appears to be untrustworthy, then the worst outcome for the
entrepreneur would be that an agteement is reached, because a relationship with an untrustworthy partner can be detrimental to the long-run performance of the firm-

Strategy 2: Ask Lots of Ouestions Asking questions provides an opportunity to learn

more about the preferences of the other party, because this information is the foundation for
finding the trade-offs necessary for integrative agreements. Even ifthe other party does not
answer certain questions, the nonanswer itself might provide some information. For example, an entrepreneur negotiating an exclusive license agrement could ask the potential
licensee, "How much would it cost you to get out of your current contract with hrm YY to

free yourself up to license our technology?'

Strategy 3: Make Muttipte Offers Simultaneousty Relationships are rarely dehned by

one dimension, and therefore there can be numerous possible offers based on combinations
of different levels on different dimensions- Recognizing this, the entrepreneur can simultaneously make multiple offers. By deermining which offer is the closest to being acceptable, the entrepreneur can infer which issues are of greatest importance to the other partyThis information is valuable in reaching an integrative agreement. It also sends a signal to
the other party that the entrepreneur is flexible.

Strategy 4: Use Differences to Create Trade-Qffs That Are a Source of Mutually

Beneficiat Qutcomes Differences between the entrepreneur and the other party in expectations, risk preferences, and time preferences all provide opportunities to reach an integrative agreement. We can investigate these differences in the context of an entrepreneur
negotiating a license agreement. One difference could be in expectation-the entrepreneur

CHAPTER

14

ACCESSING RESOURCES FOR GROWTH FROM DffERNALSOURCES

433

expects the introduction of the

licensed technology into the other party,s product to in_

crease sales more subslantially than the other party expects.
This difference in expectation
could be the basis for an integrative agreement. For example,
both parties

would prefer
to have a lower "up-front- fee for the technology and a greater
royuity percentage.
Both
parties perceive that they do better based on their expectations
of sares.similar license agreement would be mutually benehcial when the
entrepreneur has
-lessArisk
aversion than the other party-that is, when the entrepreneur
is more willing to
give up a certain gain from the up-front fee br a greater,
but uncertain, stream ofrevenue
frol an increased royalty payment. Alternatively, differences in time preference
could lead
to the preceding negotiated license agreement. The entrepreneur
prefers to accept less now

for more late whereas the licensee is prepared to pay more later,
when the income from

the license is generated.

IN REVIEW

SUMMARY

434

PART

FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

skilled employees. Besides. the cost of an acquisition can be cheaper than other mechanisms for growth. However, history suggests that acquisitions have only a marginal
success record. Entrepreneurs seem to be overly <onfident about their ability to
achieve envisioned synergies, integrate organizational cultures, and retain key employees. After balancing the pros and cons of the acquisition, the entrepreneur needs to
determine a fair price for the business.
Mergers and leveraged buyouts are other ways that entrepreneurs can grow their
businesses. An essential skill for all these alternatives is the ability of the entrepreneur
to negotiate. Good negotiation involves two tasks. The first task involves determining
how the benefits of the relationship are going to be distributed between the parties.
The second task is exploring the mutual benefits that can be gained f rom the relationship. To negotiate in a way that maximizes benefits requires the entrepreneur to use
information about one's own preferences and those of the other party to create an
outcome that is mutually beneficial. This requires an initial assessment of oneself and
the other party and the use of strategies to elicit more information during the negotiation interactions to better inform those initial assessments. To these ends, this chapter
offered four important assessments an entrepreneur should make and four strategies

that can be used to achieve a successful neootiation.

RESEARCH TASKS
1. Find information about three joint ventures that were failures, and be prepared to
discuss the underlying reasons for the failure in each case.

2.

Search on the Internet for franchises for sale. Choose three. What commonalities are
there across the businesses and the information provided? Wht differences are
there? For one of these businesses, obtain all franchise information. For this business,
what are the benefits of being a franchisee rather than setting up an independent
business? What are all the associated costs of being a franchisee for this business?
3. Interview three franchisees to better understand ther relationship with the
f

ranchisor.

4.

of business license agreements (only one of these should be a

software license agreement). In what ways are these license agreements the same
and in what ways are they different? Why have these companies decided to
license their product or technology rather than simply sell it?

5.

Find three reports of acquisitions that were unsuccessful. Why were these
acquisitions deemed unsuccessful?

Find three types

CLASS DIS cuSStoN

ie

'l

2.

Being a franchisor seems to be a mechanism for growth, but what are the growth
prospects for entrepreneurs who are franchisees? lsn't the entrepreneur limited
in his or her ability to pursue all the differenttypes of growth strategies? ls being
a franchisee simply substituting one type of employment for another type of
employment? How can a franchisee grow his or her business(es)?
Recently the Chinese government has been encouraging foreign firms to enter
into joint venture relationships with local (Chinese) firms. What are the benefits

to the Chinese economy from these joint venture relationships? What are the
benefits to the local Chinese firm? What are the benefits to the foreign firm?
What is the impact of the joint venture on the foreign firm's domestic economy?

CHAPTER

14

ACCESSING RESOURCESFOR GROWTH FROM DOERNALSOURCES

435

3. ldentify

a local franchise in your area, and determine where

the competitors are
located and where other franchises from the same organization
are rocated.
Evaluate the existing potential for the franchise.
4. Why are there so many different techniques for
h of a firm? In
any given situation, is there one ,,right answer,.
? What effects
do your answers to these questions have on the
an acquisition?

SELECTED READINGS
Bazerman, Max H.; and Jared R. curhan. (2ooo). Negotiatio.n.
Annuar Review
.1.
Psychology, vol. 51, no.

pp. 279_315.

of

Dietmeye4 Brian J.; and Max H. Bazerman. (2001). value Negotiation.

Executi ve Excellence, vol. 18, no. 4, p. 7.
This article
value n
developing wise
trades in va
tust an
in an open and
truthful ma
s, makin
ultaneously, and
searching fo
ments.
George, Gerard; shaker A. Zahra; and D. Robrey wood,
Jr. (2002). The Effects of
Bylnes-University Alliances on Innovative output and Financial performance:
of Publicfy Traded Biotechnology Companies . Journal of Business venturing, A 5tudy
vol. 17,
no. 6, pp. 557-90.

Gulati, Ranjay; and Monca c. Higgins. (2003). which Ties Matter when?
The contingent Effects of Interorganizational Partnerships on IPO Success.
Strategic Management
lournal, vol. 24, no. 2, pp. 12745.
This paper investigates the contingent value of interorganizational
relationships at
the time of a young firm's initiar public offering (p. Resu/b show
that ties to

436

PART

FROMFUNDINGTHEVENTURETOLAUNCHING.GROWING.ANDENOINGTHENEWVENTURE

Holmberg, Stevan R.; and Kathryn Boe Morgan. (2003). Franchise Turnover and Failure:
New Research and Perspectives. Journal of Businessventuring, vol. 18, no. 3, pp. 403-19.
This paper's new franchise failure concept reconcles many prio seemingly inconsistent study results based largely on franchisors' suveyl Overall franchisee turnover
rates are significant and appear to have increased over time.

Katila, Ritta; Jeff Rosenberger; and Kathleen Eisenhardt. (2008). Swimming with
Sharks: Technology Ventures, Defense Mechanisms and Corporate Relationships. Adminstrative Science Quarterly, vol. 53. no. 2, pp. 29r-332-

own

reso,Jrces (i.e., secrecy and timing). [Abstract from authors-]

Kenis, Patrick; and David Knoke. (2002). How Organizational Field Networks 5hape
Interorganizational Tie-Formaton Rates. Academy of Management Reviey vol.27'

no.2, pp.275-94.
The authors investigate the impact of communietion in field-level nelvvorks on rates
of formation of interorganizational collaborative fiet such as strategic alliances and

joint ventures.
Marino,Louis;KarenStrandholm;KevinH.Steensma;andMarkK'Weaver'(2002)'The
Moderating Effect of National Culture on the Relationship between Entrepreneurial
Orientatio and Strategic Alliance Portfolio Extensiveness. Entrepreneurship: Theory &
Practice, vol.26, no. 4, PP. 145-61.
This article examines the moderating effect of national culture on the relationship
between entrepreneuria! orientation and strategc alliance portfolio exfensiveness.
Michaef, Steven C. (2003). First Mover Advantage through Franchising. Journal of Business Venturing, vol. 18, no. 1, pp. 61-81.

ket share lead and, finally, superior profitablity.

Michael, Steven C. (2000). Investmentto Create Bargaining Power: The Case of Franchising. Strategic Management Journal, vol. 21, no. 4, pp. 497-517 '

program.
02). Firm Resources as ModeraChen
Strategic Alliances in Semicontors of the Relationship betw
l. 45. no. 3, pp' 52746'
ps.
Academy of
ductor Start-U
resource-rich firms access
markets,
The results of this study indicate that, in volatile
firms are /ess lkely to
resource-poor
whereas
alliances
through
resources
external
do so. However, in relatively stable markets, this relatonshp reverses, and resourceDoor firms become more active in alliance formation'
pearce . John A.; and Louise Hatfield. (2002). Performance Effects of Alternative Joint
Venture Resource Responsibility Structures. Journal of Business Venturing, vol. 17, no. 4'
pp.343-65.

park, seung H.; Roger R.

CHAPTER

14

ACCESSINGRESOURCESFORGROWTHFROM EXTERNALSOURCES
437

wiklund, Johan; and Dean A. shepherd. (2009). The Effectiveness of

Alliances and Acquisitions: The Role of Resource Combination Activities.
Entrepreneurship: Theory

Practice, vol.33, no.

l, pp.

193-212.

END NOTES
1.

"The Start-up Factory,', /nc. (February 9, 1997), pp.4O_52;

Matson, "He Turns rdeas into companies-at Net Speed,,' ia'st company
(December 1996), p.34; and ldealab Web site, www.idealab.com.
D. D. Seltz, rhe comprete Handbook of Franchising (Reading,
MA: AddisonSee J. Useem,
E.

2.

Wesley Publishing, 1982), p.1.

3. L. Bongiorno, "Franchise Fracas,,, BusinessWeek (March 22, 19931, pp.6g_71.

4. F. Huffman, "Under New Ownership,', Entrepreneur Qanuary 1993i, pp. 101_5.
5. W. Siegel, Franchising (New york: John Wley & Sons, t gS3i, p. 9.
6. Directory of Franchising organizations (Babylon, Ny: pilot inirrtr"r, r ggs).
7. K. Rosenburg, "Franchising, American styre," Entrepreneur (January 1991),

8'
9.

pp. 86-93.

D. J. Kaufmann and D. E. Robbins, "Now Read This," Entrepreneur (January

1991). pp. 100-10s.
For some different perspectives on joint ventures, see R. D.
Hisrich, "Joint
Ventures: Research Base and use in International Methods,., in Donald
L. sexton
and John D. Kasarda (eds.), re State of the Art of Entrepreneurship (Boston:
PWS-Kent Publishing, r992), pp. 520-79; and J. Mcconneil

and T. J. Nanteil,
"corporate combinations and common Stock Returns: The case of
Joint
Ventures," Journal of Finance 40 (June 19g5). pp.519_36.
10. For a discussion of some different types of joint ventures, see R. M.
cyert,
"Estabf ishing university-lndustry Joint Ventures.,' Research
Management2S
(January-February r 985), pp- 27-28; F. K. Berrew, "The
Joint veniurer-a way
into Foreign Markets.', Harvard Business Review (July_August lfiga), pp.
ag9
and 54; and Kathryn Rudie Harriga n, strategies for iointentures (Lexington,
MA: Lexington Books, 19g5).
11. Semicond uctor Research corporation, www-src.orglmember/a
bouvsrc.asp.
12. Max H. Bazerman and Margaret A. Neare, rttegotiiting Rationaily (New york:
Free Press. 1 992).

13. tbid.

&