Tutorial Questions
Chapter 8
1) Entering a Small Enterprise: Methods, Advantages, and Disadvantages
Three main ways: starting a new enterprise, purchasing an existing business, joining a family
enterprise.
Starting a New Enterprise
Advantages:
Full control to design the business around assessed market demand.
Legal structure, financing, cash flow, and break-even can be planned from scratch.
Disadvantages:
High demands on entrepreneurial skills, finance, management, and supplier networks.
Time lag to profitability; small-firm finance differs from large firms, with unique
constraints.
Purchasing an Existing Enterprise
Advantages:
Business infrastructure is already in place: customers, suppliers, employees, and possibly
past break-even.
Reduces initial market uncertainty; may offer trade advantages.
Disadvantages:
Information risk: sellers may overstate business performance.
Must investigate reasons for sale and legacy issues.
Financial considerations:
Purchase price must allow required returns exceeding alternatives and cover
owner's salary. Overpaying reduces returns, lifestyle, and resale value.
Entering a Family Enterprise
Advantages:
Strong family ties, loyalty, long-term focus.
Potentially low-cost intra-family financing and easy transfer, simplifying valuation.
Disadvantages:
Nepotism, family-business conflicts, favoritism, and misaligned roles.
Financial implications:
Early-stage challenges often overcome; family loans common and sometimes
cheaper.
Mechanisms may be needed to buy out non-participating heirs.
2) Financial Implications of Legal Structures
Main structures: sole proprietorship, partnership, incorporation.
Sole Trader
o Liability: Unlimited; owner responsible for all debts.
o Tax: Profits taxed as personal income.
o Finance: Limited to owner's resources; low start-up cost.
o Profit/loss: Owner receives all.
Partnership
o Liability: Generally unlimited, shared among partners.
o Tax: Pass-through; partners taxed individually.
o Finance/management: Larger pool of resources and skills. Requires agreements
on profit sharing, drawings, roles, and dissolution.
Incorporation (Private/Public)
o Liability: Limited; separate legal entity.
o Ownership/finance: Shares can be sold; easier access to finance; potential for
stock market flotation.
o Tax/administration: Higher disclosure requirements, regulatory costs, and
possible loss of control.
o Private companies: Fewer finance sources than public; lenders may require
shareholder guarantees.
3) Franchising: Rationale, Types, and Implications
Motivations for franchising:
o Access franchisees' capital, skills, and local knowledge to overcome resource
limits.
o Improve efficiency via economies of scale.
o Align goals to reduce agency problems between franchisor and franchisees.
Advantages for franchisees:
Established business model, recognized brand, easier fundraising, lower failure
rates.
Disadvantages for franchisees:
Fees and charges, limited autonomy, expansion restrictions, buy-back clauses,
legal constraints.
Types of franchise:
Product franchise: Dealership/outlet (e.g., cars, fuel).
System franchise: Standardized business system under common brand (e.g., fast
food).
Process franchise: Licensing essential inputs for production (e.g., beverage
concentrates).
4) Exiting a Small Enterprise: Methods and Financial Implications
Exit routes: family succession, transfer to managers/employees, sale, winding up, stock market
flotation, merger/takeover.
Family Succession:
Requires planning, training, and professional advice.
Financial implications: Retirees may rely on dividends; successors earn salary; sole
traders may sever financial links.
Passing to Managers/Employees:
Via ESOPs or management stock options, depending on family interest.
Selling an Enterprise:
Requires accurate valuation; sale price determines capital gains or losses.
Winding Up:
Asset disposal without a going-concern buyer may incur distress costs; planned wind-down
can maximize value.
Stock Market Flotation:
Rare for small firms; provides valuation and capital gains if size, profits, and history are
sufficient.
Merger or Takeover:
Alternative to flotation; offers valuation benefits but entails loss of control.
5) Agency Theory vs. Financial Considerations in Ownership Structure
Core principle: Ownership structure should balance agency alignment, financing capacity, cost
of capital, control, and liability.
Agency theory:
Franchising aligns franchisee and franchisor goals, reducing monitoring costs.
Family enterprises risk nepotism and favoritism; governance must address emotion vs. task
conflicts.
Financial considerations:
Incorporation provides limited liability and better financing access but with disclosure
costs and potential control dilution.
Overpaying in acquisitions reduces returns and exit options.
Ownership structure affects succession planning and payout capacity (dividends vs.
salary), determining long-term viability.