"Chapter 14ACCESSING RESOURCES FOR GROWTH FROMEXTERNAL SOURCESLEARNING OBJECTIVES1To understand how joint ventures can help an entrepreneur grow his or her business andacknowledge the challenges of finding, and maintaining, an effective joint venturerelationship.2To be aware of the pros and cons of using acquisitions to grow a business and to know whatto look for in an acquisition candidate.3To understand the possibilities of achieving growth through mergers and leveraged buyoutsand the challenges associated with each.4To understand franchising from the perspective of both the entrepreneur looking to reduce therisk of new entry and the entrepreneur looking for a way to grow his or her business.5To understand the tasks of negotiation and develop the skills to more effectively conductthese tasks.382OPENING PROFILEBILL GROSSwww.idealab.comHow does a start-up company take advantage of the seemingly endless opportunities of theInternet by using the creative talents of one person and then letting other selectedentrepreneurs take over the responsibility of running these businesses? It sounds like a repeatof history when Thomas Edison made invention a business. But the new kid on the block isBill Gross, whose vision is to grow his Idealab by nurturing and monitoring other Internetbusinesses that have resulted because of his ingenuity. He refers to Idealab as Internet start- ups in a box. Basically, the concept is simple. Gross comes up with an idea for an Internetstart-up. He locates someone, either a former executive or even an engineering student, whohe thinks is right for the job. That person is then given the reins to start this venture all under the roof of an incubator-like operation, where Gross provides the structure and servicesnecessary to make these start-ups rapidly grow into successful enterprises.Gross describes Idealab as a combination of an incubator, a venture capitalist, and a creativethink tank. Like an incubator, it provides shared space and administrative services, it offersseed financing for a minority equity position (up to 49 percent), and it uses everyone tobrainstorm on the most opportune technology applications. Started in 1996 in Pasadena,California, till date the company has created 30 Internet ventures, all at various stages ofdevelopment. Each idea came from Gross or one of his Idealab staff managers. For each firm,a CEO was found and hired using Gross’s networking skills in the Internet industry and atCaltech, his alma mater. Then the core expert staff became involved to get these ventures upand running as quickly as possible. This involved developing the technology, conductingmarketing research, preparing a business plan, hiring management, launching the venture,and finally either going public or selling the business. The seed financing that Idealabprovided to these start-ups does not exceed $250,000. Gross believes that Internet start-upsdo not need large amounts of capital to get started but, more importantly, do need knowledge,intelligence, and speed. Knowledge and intelligence are provided by Gross and the Idealab’sstaff experts, and speed focuses on the ability to quickly grow a start-up, but with fewmistakes. According to Gross, these two elements are much more important in the successfullaunch and growth of an Internet company than money.383Bill Gross personifies the true meaning of an entrepreneur. He probably holds the uniquedistinction in the field of entrepreneurship of not only starting many businesses but alsoturning all of them into successful enterprises. As an enterprising 12-year-old, he noticed thatthe corner drugstore was selling candy at 9 cents, and at the Sav-On nearby, it was selling for7 cents. He quickly figured out that with no overhead he could make an easy profit on theprice spread. Gross then moved on to his next successful enterprise by placing ads in PopularMechanics, where he sold $25,000 worth of solar devices and plans. The proceeds from thiseffort were used to finance his freshman year’s tuition at Caltech. While at Caltech, heproceeded to launch GNP Inc., a stereo equipment maker. This enterprise was not only verysuccessful but also recognized as one of Inc. magazine’s top 500 growth ventures in 1982 and1985. His next enterprise was created when Gross and his brother found a way to make Lotus1-2-3 obey simple commands. Mitch Kapor, the founder of Lotus, was impressed with theirsoftware and purchased their business for $10 million.The success streak continued with the launch of Knowledge Adventure in 1991. This venturedeveloped and marketed educational software and was considered to be his most successfulventure to date. He sold the business in 1997 for $100 million. Idealab was actually created in1996 when Gross was stepping down from Knowledge Adventure and negotiating the sale.A sample of some of the companies launched by Idealab includes CitySearch, whichcompetes with Microsoft and provides online services for urban communities; EntertainNet,an Internet broadcaster that provides news and related information; and Answer.com, a Website that will answer any question you might have and which has already been acquired byanother company. Last year, Gross expanded his operations into Silicon Valley. He wanted tobe close to the action and take advantage of Idealab’s ability to quickly transform some ofthese Internet opportunities into successful ventures.Growing these start-ups is a challenge to Bill Gross, and although there is high risk in the1 Internet industry, Gross feels that Idealab will continue to stay focused on its mission. USING EXTERNAL PARTIES TO HELP GROW A BUSINESSIn Chapter 13, we detailed the financial pressures faced by entrepreneurs of growing firms.Over and above the effective management of one’s own resources, entrepreneurs can use theresources (financial, knowledge, and so on) of others to help grow the business. This can beachieved through joint ventures, acquisitions, and mergers. The first section of the chapterexplores these modes of growth. Franchising is also an alternative means by which anentrepreneur may expand his or her business by having others pay for the use of the name,process, product, service, and so on. Given the importance of franchising for both new entryand growth, this chapter explores franchising from the perspective of the entrepreneur384looking to use franchising to reduce the risks of new entry and from the perspective of theentrepreneur looking to use franchising as a way to grow his or her business. Finally,regardless of the mode used, entrepreneurs need to be good negotiators. They need tonegotiate with external parties to obtain the human and financial resources necessary to fuelbusiness growth. We provide some useful advice on how to become a better negotiator.JOINT VENTURESWith the increase in business risks, hypercompetition, and the need for experimenting withnew projects to gain an understanding of an uncertain future, joint ventures have occurred2 with increased regularity and often involve a wide variety of players. Joint ventures are not anew organizational form but rather have been used as a means of expansion byentrepreneurial firms for a long time.joint venture Two or more companies forming a new companyWhat is a joint venture? A joint venture is a separate entity that involves a partnershipbetween two or more active participants. Sometimes called strategic alliances, joint venturescan involve a wide variety of partners that include universities, not-for-profit organizations,3 businesses, and the public sector. Joint ventures have occurred between such rivals asGeneral Motors and Toyota as well as General Electric and Westinghouse. They haveoccurred between the United States and foreign concerns to penetrate an international market,and they have been a good conduit by which an entrepreneur can enter an internationalmarket.Whenever close relationships between two companies are being developed, concerns aboutthe ethics and ethical behavior of the potential partner may arise.Types of Joint VenturesAlthough there are many different types of joint venture arrangements, the most common isstill between two or more private-sector companies. For example, Boeing, Mitsubishi, Fuji,and Kawasaki entered into a joint venture for the production of small aircraft to sharetechnology and cut costs. Microsoft and NBC Universal formed a partnership to create acable news channel (MSNBC). There is an elaborate cost-sharing arrangement between thedifferent entities of the partnership.Other private-sector joint ventures have had different objectives, such as entering newmarkets (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 Ironand Steel).Some joint ventures are formed to do cooperative research. Probably the best known of theseis the Microelectronics and Computer Technology Corporation (MCC). Supported by 13major U.S. companies, this for-profit venture does long-range research with scientists whoare loaned to MCC for up to four years before returning to their competing companies toapply the results of their research activities. MCC retains title to all the resulting knowledgeand patents, making them available for license to the companies participating in the program.Another type of joint venture for research development is the Semiconductor ResearchCorporation, located in Triangle Park, North Carolina. A not-for-profit research organization,it began with the participation of 11 U.S. chip manufacturers and computer companies. Thegoal of the corporation is to sponsor basic research and train professional scientists andengineers to be future industry leaders. Members of SRC programs have invested $1.1 billionin cutting-edge semiconductor research supporting over 7,000 students and 1,598 faculty4 members at 237 universities worldwide.Industry–university agreements created for the purpose of doing research are another type ofjoint venture that has seen increasing usage. However, two major problems have385 keptthese types of joint ventures from proliferating even faster. A profit corporation has theobjective of obtaining tangible results, such as a patent, from its research investment andwants all proprietary rights. Universities want to share in the possible financial returns fromthe patent, but the university researchers want to make the knowledge available throughresearch papers. In spite of these problems, numerous industry–university teams have beenestablished. In one joint venture agreement in robotics, for example, Westinghouse retainspatent rights while Carnegie-Mellon receives a percentage of any license royalties. Theuniversity also has the right to publish the research results as long as it withholds frompublication any critical information that might adversely affect the patent.The joint venture agreement between Celanese Corporation and Yale University, created forresearching the composition and synthesis of enzymes, took a somewhat different form—costsharing. Although Celanese assumes the expense of any needed supplies and equipment forthe 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 45-day waitingperiod.International joint ventures, discussed in Chapter 5, are rapidly increasing in number due totheir relative advantages. Not only can both companies share in the earnings and growth, butthe joint venture can have a low cash requirement if the knowledge or patents are capitalizedas a contribution to the venture. Also, the joint venture provides ready access to newinternational markets that otherwise may not be easily attained. Finally, since talent andfinancing come from all parties involved, an international joint venture causes less drain on acompany’s managerial and financial resources than a wholly owned subsidiary.There are several drawbacks to establishing an international joint venture. First, the businessobjectives of the joint venture partners can be quite different, which can result in problems inthe direction and growth of the new entity. In addition, cultural differences in each companycan create managerial difficulties in the new joint venture. Finally, government policies cansometimes have a negative impact on the direction and operation of the international jointventure. In spite of these problems, the benefits usually outweigh the drawbacks, as evidenced by thefrequency rate of establishing international joint ventures. For example, an international jointventure was established between Dow Chemical (United States) and Asaki Chemicals (Japan)to develop and market chemicals on an international basis. While Asaki provided the rawmaterials and was a sole distributor, Dow provided the technology and obtained distributionin the Japanese market. The arrangement eventually dissolved because of the concerns of theJapanese government and the fundamental difference in motives between the two partners:Dow was primarily concerned with the profits of the joint venture, whereas Asaki wasprimarily concerned with having a purchaser for its basic petrochemicals.Factors in Joint Venture SuccessClearly, not all joint ventures succeed. An entrepreneur needs to assess this method of growthcarefully and understand the factors that help ensure success as well as the problems involvedbefore using it. The most critical factors for success are:1. The accurate assessment of the parties involved to best manage the new entity in lightof the ensuing relationships. The joint venture will be more effective if the managerscan work well together. Without this chemistry, the joint venture has a low likelihoodof success and may even fail despite how good it looks on ?paper.?2. The degree of symmetry between the partners. This symmetry goes beyond chemistryto objectives and resource capabilities. When one partner feels that he386 or she isbringing more to the table, or when one partner wants profits and the other desiresproduct outlet (as in the case of the Asaki-Dow international joint venture), problemsarise. For a joint venture to be successful, the managers in each parent company, aswell as those in the new entity, must concur on the objectives of the joint venture andthe level of resources that will be provided. Good relationships must be nurturedbetween the managers in the joint venture and those in each parent company. Theyneed to feel that the relationship is fair—it respects and reflects what each partybrings to the table.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 othercorporate problems. Expectations of a joint venture must be realistic. They also needto be consistent across joint venture partners. If not, then the partners may be workingat cross-purposes where it becomes impossible to achieve a win–win for both parties.4. The timing must be right. With environments constantly changing, industrialconditions being modified, and markets evolving, a particular joint venture could be asuccess one year and a failure the next. Intense competition leads to a hostileenvironment and increases the risks of establishing a joint venture. Someenvironments are just not conducive to success. An entrepreneur must determinewhether the joint venture will offer opportunities for growth or will penalize thecompany, for example, by preventing it from entering certain markets. That is, whilethe joint venture may open some doors, it may close others. It is important to not onlylook at what the joint venture can provide but also the opportunity costs of enteringinto the relationship.A joint venture is not a panacea for expanding the entrepreneurial venture. Rather, it shouldbe considered one of many options for supplementing the resources of the firm andresponding more quickly to competitive challenges and market opportunities. The effectiveuse of joint ventures as a strategy for expansion requires the entrepreneur to carefully appraise the situation and the potential partner(s). Other strategic alternatives to the jointventure—such as acquisitions, mergers, and leveraged buyouts—should also be considered.Acquisition Purchasing all or part of a companyACQUISITIONSAnother 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 markets ornew product areas. One entrepreneur acquired a chemical manufacturing company afterbecoming familiar with its problems and operations as a supplier of the entrepreneur’scompany. An acquisition is the purchase of an entire company, or part of a company; bydefinition, the company is completely absorbed and no longer exists independently. Anacquisition can take many forms, depending on the goals and position of the parties involvedin the transaction, the amount of money involved, and the type of company.Although one of the key issues in buying a business is agreeing on a price, successfulacquisition of a business actually involves much, much more. In fact, often the structure ofthe deal can be more important to the resultant success of the transaction than the actualprice. One radio station was successful after being acquired by a company primarily becausethe previous owner loaned the money and took no principal payment (only interest) on theloan until the third year of operation.From a strategic viewpoint, a prime concern of the entrepreneurial firm is maintaining thefocus of the new venture as a whole. Whether the acquisition will become the core of387 thenew business or rather represents a needed capability—such as a distribution outlet, salesforce, or production facility—the entrepreneur must ensure that it fits into the overalldirection and structure of the strategic plan of the present venture.Advantages of an AcquisitionFor an entrepreneur, there are many advantages to acquiring an existing business:1. Established business. The most significant advantage is that the acquired firm has anestablished image and track record. If the firm has been profitable, the entrepreneurneed only continue its current strategy to be successful with the existing customerbase.2. Location. New customers are already familiar with the location.3. Established marketing structure. An acquired firm has its existing channel and salesstructure. Known suppliers, wholesalers, retailers, and manufacturers’ reps areimportant assets to an entrepreneur. With this structure already in place, theentrepreneur can concentrate on improving or expanding the acquired business.4. Cost. The actual cost of acquiring a business can be lower than other methods ofexpansion. For example, it may be cheaper (and with lower risk) to acquire acompany than to start one from scratch.5. Existing employees. The employees of an existing business can be an important assetto the acquisition process. They know how to run the business and can help ensurethat the business will continue in its successful mode. They already have establishedrelationships with customers, suppliers, and channel members and can reassure thesegroups when a new owner takes over the business. 6. More opportunity to be creative. Since the entrepreneur does not have to be concernedwith finding suppliers, channel members, hiring new employees, or creating customerawareness, more time can be spent assessing opportunities to expand or strengthen theexisting business and tapping into potential synergies between the businesses.Disadvantages of an AcquisitionAlthough we can see that there are many advantages to acquiring an existing business, thereare also disadvantages. The importance of each of the advantages and disadvantages shouldbe weighed carefully with other expansion options.1. Marginal success record. Most ventures that are for sale have an erratic, marginallysuccessful, or even unprofitable track record. It is important to review the records andmeet with important constituents to assess that record in terms of the business’s futurepotential. For example, if the store layout is poor, this factor can be rectified; but ifthe location is poor, the entrepreneur might do better using some other expansionmethod.2. Overconfidence in ability. Sometimes, an entrepreneur may assume that he or she cansucceed where others have failed. This is why a self-evaluation is so important beforeentering into any purchase agreement. Even though the entrepreneur brings new ideasand management qualities, the venture may never be successful for reasons that arenot possible to correct. Often managers are overconfident in their ability to overcomecultural differences between their current business and the one being acquired.Integrating two organizations with strong cultures is a very difficult task. Of course,you could keep the two companies somewhat separate to avoid388 cultural conflictbut then it is difficult to gain the synergistic benefits motivating the acquisition in thefirst place.3. Key employee loss. Often, when a business changes hands, key employees also leave.Key employee loss can be devastating to an entrepreneur who is acquiring a businesssince 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 difficult to separate theactual service from the person who performs it. In the acquisition negotiations, it ishelpful for the entrepreneur to speak to all employees individually to obtain someassurance of their intentions as well as to inform them of how important they will beto the future of the business. Incentives can sometimes be used to ensure that keyemployees will remain with the business.4. Overvaluation. It is possible that the actual purchase price is inflated due to theestablished image, customer base, channel members, or suppliers. If the entrepreneurhas to pay too much for a business, it is possible that the return on investment will beunacceptable. It is important to look at the investment required in purchasing abusiness and at the potential profit and establish a reasonable payback to justify theinvestment. Some acquisitions proceed because of the entrepreneur’s ego, which isnot a good justification for an acquisition decision.After balancing the pros and cons of the acquisition, the entrepreneur needs to determine afair price for the business and the terms of the sale.Synergy The concept that ?the whole is greater than the sum of its parts? applies to the integration ofan acquisition into the entrepreneur’s venture. The synergy should occur in both the businessconcept, with the acquisition functioning as a vehicle to move toward overall goals, and thefinancial performance. The acquisition should positively impact the bottom line, affectingboth long-term gains and future growth. Lack of synergy is one of the most frequent causesof an acquisition’s failure to meet its objectives. Again, the difficulty in integrating the neworganization’s culture with the existing organizational cultural is the main reason whyacquisitions fail to generate the expected synergies and subsequent benefits.Structuring the DealOnce the entrepreneur has identified a good candidate for acquisition, an appropriate dealmust be structured. Many techniques are available for acquiring a firm, each having a distinctset of advantages to both the buyer and the seller. The deal structure involves the parties, theassets, the payment form, and the timing of the payment. For example, all or part of the assetsof one firm can be acquired by another for some combination of cash, notes, stock, and/oremployment contract. This payment can be made at the time of acquisition, throughout thefirst year, or extended over several years.The two most common means of acquisition are the entrepreneur’s direct purchase of thefirm’s entire stock or assets or the bootstrap purchase of these assets. In the direct purchase ofthe firm, the entrepreneur often obtains funds from an outside lender or the seller of thecompany being purchased. The money is repaid over time from the cash flow generated fromthe operations. Although this is a relatively simple and clear transaction, it usually results in along-term capital gain to the seller and double taxation on the funds used to repay the moneyborrowed to acquire the company.389To avoid these problems, the entrepreneur can make a bootstrap purchase, acquiring a smallamount of the firm, such as 20 to 30 percent, for cash. He or she then purchases theremainder of the company with a long-term note that is paid off over time out of the acquiredcompany’s earnings. This type of deal often results in more favorable tax advantages to boththe buyer and the seller.AS SEEN IN BUSINESS NEWSPROVIDE ADVICE TO AN ENTREPRENEUR ABOUT ENTERING INTOAGREEMENTSEntrepreneurs: James Tiscione and Anthony TiscioneCompany: ACM EnterprisesProduct Offered: A thin metal case that holds a person’s driver’s license and up to five creditcards. The case has a button corresponding to each of the cards (license or credit card) and bypushing the button the card is dispensed.Start-Up Cost: The first production run of the ?auto card manager? was 25,000 units and cost$50,000.Sales: In the first year of sales, they were able to generate $1.8 million. Challenge: To expand sales with a limited market budget.Despite not having much money, the Tisciones were able to find a way to bring their productto market and make sales. They were able to do this by following these steps:1. Obtain a patent to protect the intellectual property underlying the product. Theystarted this process by looking at the government Web site for patents. In this case, itwas the U.S. Patent and Trademark Office. By visiting the site, they were able tosearch for patents that were similar in any way to their invention. They were surprisedto find that no one else had come up with a similar idea. Indeed, they looked at over1,000 patents before they were convinced that their invention was novel. Only thendid they go to a patent attorney. This saved them a lot of money. They then filed andreceived a provisional patent. The provisional patent did not necessarily give themmonopoly over the intellectual property underlying the technology, but it did provideprotection for one year until they filed for and received a utility patent.2. Acquire expertise. Because James realized that he lacked expertise in marketing, hereached out to his network for help. In this case, it was his father who had marketingexpertise and he worked hard on the business and through lining up customers earned?sweat equity? in the business.3. Use prototypes to ?communicate? the technology. Recognizing the challenge in beingable to communicate to people how the technology works and its potential benefits,the Tisciones realized that they needed to make a prototype. Once they had aprototype and began using it, people started to ask where they could buy one. Thepositive feedback that they received from introducing the prototype provided theimpetus for them to push the business forward.4. Research and select a production process. The Tisciones approached the Hong KongChamber of Commerce branch in their city (San Francisco), which provided a list ofcompanies that could produce the product. Working from a large list, they narrowedthe field and after visiting the manufacturers’ headquarters and assessing the qualityof the production through trial runs, they entered into a contract with a manufacturer.5. Research and select distribution outlets. The Tisciones approached a number of retailoutlets to see if they would be interested in selling their products but wereunsuccessful. But they found that a promotional company was interested and signedan agreement with them. In conjunction with the promotional company, the Tiscionesapproached SkyMall (a catalog for airline passengers), and after six months, theirproduct was the number one selling product in the catalog. They also entered into anonexclusive relationship with a marketing company that promoted the product ontelevision and the Internet and were able to secure a position in another major catalog.6. Negotiate deals that maximize benefits but minimize risks. Marketing expenditurescan be high and put a lot of strain on a new organization. The Tisciones were able toaccess considerable marketing expertise and were able to promote their productwithout investing their own resources in those efforts. Rather, they were able to enterrelationships that provided the promotion while at the same time limiting downsiderisk. They were creative in how they structured these deals in order to limit risks. Forexample, they first entered into a relationship with SkyMall where they did not haveto pay to be in the catalog but in return they did not receive any of the revenue untilsales reached a threshold and thereafter revenue was equally split. But once theproduct had proved itself a winner, they switched to a different contract with SkyMallwhere they paid to be in the catalog but now kept all the revenue. ADVICE TO AN ENTREPRENEURAn inventor has read the preceding article and comes to you for advice. ?This is exactly whatI want to do,? he says, ?I don’t have the expertise or the money to manufacture the productmyself or to market and sell it. What I need is for someone else to do that for me. Here aremy questions:1. Is it really that simple to find and then establish a relationship with someone toproduce my product? Should the producer have a manufacturing license or should Ienter into a joint venture?2. Same sorts of issues on the marketing end, but I also want to know how much controlI can maintain over how the product is marketed and sold. Or should I not worryabout that and let the experts do their thing?3. One dilemma for me is how much money I should invest in the prototypes. The moremoney I invest, the better the prototype looks, but I don’t want to waste moneyeither.?Source: Reprinted with permission of Entrepreneur Media, Inc., ?Play Your Cards Right.Presenting a Case Study in Striking the Best Deals to Launch Your Own Great Product on aLimited Budget,? by Don Debelak, March 2003, Entrepreneur magazine:www.entrepreneur.com.brokers People who sell companiesLocating Acquisition CandidatesIf an entrepreneur is seriously planning to buy a business, there are some sources ofassistance. There are professional business brokers who operate in a fashion similar to a realestate broker. They represent the seller and will sometimes aggressively find buyers390through referrals, advertising, or direct sales. Since these brokers are paid a commission onthe sale, they often expend more effort on their best deals.Accountants, attorneys, bankers, business associates, and consultants may also know of goodacquisition candidates. Many of these professionals have a good working knowledge of thebusiness, which can be helpful in the negotiations.It is also possible to find business opportunities in the classified sections of the newspaper orin a trade magazine. Since these listings are usually completely unknown, they may involvemore risk but can be purchased at a lower price.Determining the best option for an entrepreneur involves significant time and effort. Theentrepreneur should gather as much information as possible, read it carefully, consult withadvisors and experts, consider his or her own situation, and then make a constructivedecision.391merger Joining two or more companies into one companyMERGERS "