Engineering Entrepreneurship

Engineering Entrepreneurship

Entrepreneurship and the Entrepreneurial Mind-Set 

Corporate Entrepreneurship

Generating and Exploiting New Entry opportunities 

Creativity and the Business Idea

Identifying and Analyzing Domestic and International Opportunities

Protecting the Idea and Other Legal Issues for the Entrepreneur

The Business Plan

The Marketing Plan

The Organizational Plan 

The Financial Plan

Sources of Capital

Strategies for Growth and Managing the Implications of Growth

Succession Planning and Strategies for Harvesting and Ending the Venture

Case Studies 

The Marketing Plan

Industry Analysis

Prior to the preparation of the marketing plan, the entrepreneur will need to complete the in- dustry analysis section of the business plan. The primary focus of the industry analysis is to provide sufficient knowledge of the environment (national and local market) that can affect marketing strategy decision making. 

Marketing research for the new venture

Information for developing the marketing plan may necessitate conducting some marketing research. Marketing research involves the gathering of data to determine such information as who will buy the product or service, what is the size of the potential market, what price should be charged, what is the most appropriate distribution channel, and what is the most effective promotion strategy to inform and reach potential customers. Since marketing research costs vary significantly, the entrepreneur will need to assess available resources and the information needed. There are also some research techniques that are not costly and can provide, at least initially, significant evidence to support the market potential for the new venture. One of these techniques is the focus group, which is discussed later in this section. 

Market research begins with a definition of objectives or purpose. This is often the most difficult step since many entrepreneurs lack knowledge or experience in marketing and often don’t even know what they want to accomplish from a research study. This, however, is the very reason why marketing research can be so meaningful to the entrepreneur. 

Step One: Defining the Purpose or Objectives
Step Two: Gathering Data from Secondary Sources
Step Three: Gathering Information from Primary Sources 

Difference between a business plan and a marketing plan. 

An entrepreneur should understand the differences between a marketing plan and a business plan. The marketing plan focuses on all marketing activities of a venture for one year or more. The marketing plan will vary significantly for a firm depending on the industry, target market, and the size and scope of the organization. It is an integral part of a business plan, yet, as dis- cussed below, it is also a standalone document that needs to be managed on a short-term basis to ascertain whether the venture is meeting its goals and objectives. The business plan, on the other hand, is the road map for the entire organization over time. It focuses on not just market- ing issues but also such decisions as research and development, operations, manufacturing, personnel, financial projections and analysis, and future growth strategies. It also should be updated on a regular basis to help the management stay focused and meet organization goals. 

Preparing the marketing plan

Characteristics of a marketing plan

The marketing mix

Steps in preparing the marketing plan.

The Organizational Plan

Developing the management team

We can see from the Sara Blakely and her company Spanx example the importance of em- ployees and their loyalty and commitment to the organization. Also significant to potential investors is the management team and its ability and commitment to the new venture. 

Investors will usually demand that the management team not attempt to operate the busi- ness as a sideline or part-time venture while employed full time elsewhere. It is assumed that the management team is prepared to operate the business full time and at a modest salary. It is unacceptable for the entrepreneurs to try to draw a large salary out of the new venture, and investors may perceive any attempt to do so as a lack of psychological commitment to the business. Later in this chapter, the roles of various team members are discussed, particularly as the firm evolves into a legitimate ongoing concern. In addition, the entrepreneur should consider the role of the board of directors and/or a board of advisors in supporting the man- agement of the new venture. At this point, however, the entrepreneur needs to consider the alternatives regarding the legal form of the organization. Each of these forms has important implications for taxes, liability, continuity, and financing the new venture. 

legal forms of business

There are three basic legal forms of business formation with some variations available depending on the entrepreneurs’ needs. The three basic legal forms are (1) proprietorship, (2) partnership, and (3) corporation, with variations particularly in partnerships and corporations. The newest form of business formation is the limited liability company (LLC), which is now possible in all 50 states and the District of Columbia. The typical corporation form is known as a C corporation. describes the legal factors involved in each of these forms with the differences in the limited liability partnership (LLP) and S corporation noted where appropriate. These three basic legal forms are compared with regard to ownership, liability, start-up costs, continuity, transferability of interest, capital requirements, management control, distribution of profits, and attractive- ness for raising capital. Later in the chapter, the S corporation and the LLC are compared and discussed as alternative forms of business, especially for the new venture. 

Tax attributes of forms of business

The tax advantages and disadvantages of each of the forms of business differ significantly. Some of the major differences are discussed next. There are many minor differences that, in total, can be important to the entrepreneur. If the entrepreneur has any doubt about these advantages, he or she should get outside advice.

Tax Issues for Proprietorship 

For the proprietorship, the IRS treats the business as the individual owner. All income appears on the owner’s return as personal income. Thus, the proprietorship is not regarded by the IRS as a separate tax entity. 

Tax Issues for Partnership 

The partnership’s tax advantages and disadvantages are similar to those of the proprietor- ship, especially regarding income distributions, dividends, and capital gains and losses. Limited partners in a traditional general partnership have the advantage of limited liability (they are liable only for the amount of their investment), but they can share in the profits at a percentage stipulated in the partnership agreement. 

Tax Issues for Corporation 

Since the IRS recognizes the corporation as a separate tax entity, it has the advantage of being able to take many deductions and expenses that are not available to the proprietor- ship or partnership. The disadvantage is that the distribution of dividends is taxed twice, as income of the corporation and as income of the stockholder. 

The limited liability company versus the S-corporation

Although the perception among entrepreneurs is that the C corporation is the entity desired by investors, the actual entity desired by venture capitalists is the limited liability company (LLC), which is similar to the S corporation. The emergence of the LLC as a more popular alternative has resulted from a change in regulation. Regulations now allow an LLC to be automatically taxed as a partnership, unless the entrepreneur actively makes another choice (taxed as a corporation). This easing of election is one important factor that has enhanced the LLC’s popularity. 

S CORPORATION 

The S corporation combines the tax advantages of the partnership and the corporation. It is designed so that venture income is declared as personal income on a pro rata basis by the shareholders. In fact, the shareholders benefit from all the income and the deductions of the business. Before the passing of the Small Business Job Protection Act of 1996, the rules governing the S corporation were considered too rigid. 

THE LIMITED LIABILITY COMPANY 

As stated earlier, the new flexibility offered by LLC status has enhanced its choice by en- trepreneurs. The tax rules for an LLC fall under Subchapter K, and this business form is considered a partnership-corporation hybrid with the following characteristics: 

• Whereas the corporation has shareholders and partnerships have partners, the LLC has members. 
• No shares of stock are issued, and each member owns an interest in the business as designated by the articles of organization, which is similar to the articles of incorporation or certificates of partnership.
• Members may transfer their interest only with the unanimous written consent of the remaining members. 

Designing the organization

Generally, the design of the initial organization will be simple. In fact, the entrepreneur may find that he or she performs all the functions of the organization alone. This is a common problem and a significant reason for many failures. The entrepreneur sometimes thinks that he or she can do everything and is unwilling to give up responsibility to others or even include others in the management team. In most cases when this occurs, the entrepreneur will have difficulty making the transition from a start-up to a growing, well-managed business that maintains its success over a long period of time. 

The design of the organization will be the entrepreneur’s formal and explicit indication to the members of the organization as to what is expected of them. Typically, these expec- tations can be grouped into the following five areas:8 

• Organization structure. This defines members’ jobs and the communication and relationship these jobs have with each other. These relationships are depicted in an organization chart. 
• Planning, measurement, and evaluation schemes. All organization activities should reflect the goals and objectives that underlie the venture’s existence. The entrepreneur must spell out how these goals will be achieved (plans), how they will be measured, and how they will be evaluated. 
• Rewards. Members of an organization will require rewards in the form of promotions, bonuses, praise, and so on. The entrepreneur or other key managers will need to be responsible for these rewards. 
• Selection criteria. The entrepreneur will need to determine a set of guidelines for selecting individuals for each position. 
• Training. Training, on or off the job, must be specified. This training may be in the form of formal education or learning skills. 

Building the management team and a successful organization culture

In conjunction with the design of the organization, the entrepreneur will need to assemble the right mix of people to assume the responsibilities outlined in the organization structure. Some of the issues identified in the organization design will be revisited here since they are not only critical to the building of the team but are just as important in establishing a posi- tive and successful organization culture. This strategy must be maintained through the stages of start-up and growth of the enterprise. There are some important issues to address before assembling and building the management team. In essence, the team must be able to accomplish three functions: 

• Execute the business plan. 
• Identify fundamental changes in the business as they occur. 
• Make adjustments to the plan based on changes in the environment and market that 
  will maintain profitability. 

The role of a board of directors

An entrepreneur may find it necessary in his or her organization plan to establish a board of directors or board of advisors. The board of advisors is discussed in the next section. The board of directors may serve a number of functions: 

1. reviewing operating and cap- ital budgets
2. developing longer-term strategic plans for growth and expansion
3. sup- porting day-to-day activities
4. resolving conflicts among owners or shareholders
5. ensuring the proper use of assets
6. eveloping a network of information sources for the entrepreneurs. 

These functions may be a formal part of the organization, with re- sponsibilities assigned to the directors depending on the needs of the new venture. 

The board of advisors

Compared to a board of directors, a board of advisors would be more loosely tied to the organization and would serve the venture only in an advisory capacity for some of the functions or activities mentioned before. It has no legal status, unlike the board of direc- tors, and hence is not subject to the regulations stipulated in the Sarbanes-Oxley Act. These boards are likely to meet less frequently or depending on the need to discuss important venture decisions. A board of advisors is very useful in a family business where the board of directors may consist entirely of family members. 

The Financial Plan

Operating and capital budgets

Before developing the pro forma income statement, the entrepreneur should prepare oper- ating and capital budgets. If the entrepreneur is a sole proprietor, then he or she is respon- sible for the budgeting decisions. In the case of a partnership, or where employees exist, the initial budgeting process may begin with one of these individuals, depending on his or her role in the venture. For example, a sales budget may be prepared by a sales manager, a manufacturing budget by the production manager, and so on. Final determination of these budgets will ultimately rest with the owners or entrepreneurs. 

Forecasting sales 

As stated earlier, there are many different methods for projecting sales, some very quantita- tive and some more qualitative. Most start-ups would not likely use any of the quantitative techniques but would rely on more qualitative methods. Our focus here will be to try to understand how to project sales simply and reasonably using more qualitative methods. To begin with, the entrepreneur should research everything he or she can find about other start-ups in the same industry. Reviewing their experience can often provide reasonable expectations for early sales. Local chambers of commerce, or any other business organiza- tion, may provide contacts and information on what might be expected in first year sales. No matter what approach entrepreneurs use, they must be aware that sales estimates may be wrong. As a result, it is sometimes beneficial for the entrepreneur to provide sales estimates at different levels of activity. For example, sales estimates may be shown at one level and also at levels such as 5 percent less or 10 percent less. Each sales estimate may reflect different assumptions about the market and show costs and profits or losses with each sales forecast. 

Pro forma income statements

The marketing plan discussed in Chapter 8 provides an estimate of sales for the next 12 months. Since sales are the major source of revenue and since other operational activi- ties and expenses relate to sales volume, it is usually the first item that must be defined. 

summarizes all the profit data during the first year of operations for MPP Plas- tics. This company makes plastic moldings for such customers as hard goods manufacturers, toy manufacturers, and appliance manufacturers. As can be seen from the pro forma income statement in Table 10.3, the company begins to earn a profit in the eleventh month. Cost of goods sold remains consistent at 50 percent of sales revenue.  

Pro forma cash flow statement

Cash flow is not the same as profit. Profit is the result of subtracting expenses from sales, whereas cash flow results from the difference between actual cash receipts and cash pay- ments. Cash flows only when actual payments are received or made. For example, if some- one owes you $100 for work you completed you have earned that amount as income. If you wanted to spend this $100 at the supermarket you would have to get them to let you buy on credit (you would owe them the amount of the groceries) or you would pay with a credit card. The fact is that at that point you have income of $100 (no cash yet) and expenses of $100 (not yet paid in cash). Similarly, for a business, sales may not be regarded as cash since it is common for buyers to have at least 30 days to make the payment. In addition, not all bills are paid immediately. Just as your buyer has at least 30 days to make payment, you would likely do the same for any of your purchases.  

Pro forma balance sheet

The entrepreneur should also prepare a projected balance sheet depicting the condition of the business at the end of the first year. The balance sheet will require the use of the pro forma income and cash flow statements to help justify some of the figures.

The pro forma balance sheet reflects the position of the business at the end of the first year. It summarizes the assets, liabilities, and net worth of the entrepreneurs. In other words, it tells the entrepreneur a measure of the company’s solvency. For example, a ratio analysis of current assets (those expected to be converted into cash within the year) to cur- rent liabilities (those that must be paid within the current year) indicates how well the firm can pay its bills. A ratio of less than 1:1 would indicate that the company needs an infusion of cash in order to meet its current obligations.  

Break-even analysis

In the initial stages of the new venture, it is helpful for the entrepreneur to know when a profit may be achieved. This will provide further insight into the financial potential for the start-up business. Break-even analysis is a useful technique for determining how many units must be sold or how much sales volume must be achieved to break even. 

The break-even formula is derived are: 

Pro forma sources and applications of funds statement

The pro forma sources and applications of funds statement illustrates the disposition of earnings from operations and from other financing. Its purpose is to show how net income and financing were used to increase assets or to pay off debt. 

It is often difficult for the entrepreneur to understand how the net income for the year was disposed of and the effect of the movement of cash through the business. Questions often asked are, Where did the cash come from? How was the cash used? and What hap- pened to asset items during the period? 

 

Software packages. 

There are a number of financial software packages available for the entrepreneur that can track financial data and generate any important financial statement. For purposes of com- pleting the pro forma statements, at least in the business planning stage, it is probably easiest to use a spreadsheet program, since numbers may change often as the entrepreneur begins to develop budgets for the pro forma statements. Microsoft Excel is the most widely used spreadsheet software and is relatively simple to use. 

 The value of using a spreadsheet in the start-up phase for financial projections is simply being able to present different scenarios and assess their impact on the pro forma state- ments. It helps answer such questions as, What would be the effect of a price decrease of 10 percent on my pro forma income statement? What would be the impact of an increase of 10 percent in operating expenses? and How would the lease versus purchase of equipment affect my cash flow? This type of analysis, using the computer spreadsheet software, will provide a quick assessment of the likely financial projections given different scenarios. 

Sources of Capital 

An overview

One of the most difficult problems in the new venture creation process is obtaining financing. For the entrepreneur, financing for the private firm should be considered from the perspective of debt versus equity and using internal versus external funds. 

personal funds

Few, if any, new ventures are started without the personal funds of the entrepreneur. Not only are these the least expensive funds in terms of cost and control, but they are absolutely essential in attracting outside funding, particularly from banks, private investors, and venture capitalists. Often referred to as blood equity, the typical sources of personal funds include savings, life insurance, or mortgage on a house or car. These outside providers of capital feel that the entrepreneur may not be sufficiently committed to the venture if he or she does not have money invested. As one venture capitalist succinctly said, “I want the entrepreneurs so financially committed that when the going gets tough, they will work through the problems and not throw the keys to the company on my desk.”  

Family and friends

After the entrepreneur, family and friends are the usual source of capital for a new ven- ture. They are most likely to invest due to their relationship with the entrepreneur. This helps overcome one portion of uncertainty felt by impersonal investors—they have knowl- edge of the entrepreneur. Family and friends usually provide a small amount of equity funding for new ventures, reflecting in part the small amount of capital needed for most new ventures at this time. Although it is relatively easy to obtain money from family and friends, like all sources of capital, there are positive and negative aspects of obtaining and using these funds. Although the amount of money provided may be small, if it is in the form of equity financing, the family members or friends then have an ownership position in the venture and all rights and privileges of that position. 

Commercial banks

Commercial banks are by far the source of short-term funds most frequently used by the entrepreneur when collateral is available. The funds provided are in the form of debt financing and, as such, require some tangible guaranty or collateral—some asset with value. This collateral can be in the form of business assets (land, equipment, or the building of the venture), personal assets (the entrepreneur’s house, car, land, stock, or bonds), or the assets of the cosigner of the note. 

Types of Bank Loans 

There are many types of bank loans available. To help ensure repayment, these loans are based on the assets or the cash flow of the venture. The asset base for loans is usually accounts receivable, inventory, equipment, or real estate. Sometimes the assets of the entre- preneur or an investor are used when the venture does not have enough. 

• Accounts Receivable Loans 
• Inventory Loans 
• Equipment Loans 
• Real Estate Loans 
• Installment Loans 
• Straight Commercial Loans 
• Long-Term Loans 
• Character Loans 

Role of Government Agencies in small-business financing

Frequently, an entrepreneur is missing the necessary track record, assets, or some other ingredient to obtain a commercial bank loan. When the entrepreneur is unable to secure a regular commercial bank loan, an alternative is a guaranty from the Small Business Admin- istration (SBA). The SBA offers numerous loan programs to assist small businesses. In each of these, the SBA is primarily a guarantor of loans made by commercial banks and other institutions. The Basic 7(a) Loan Guaranty is the SBA’s primary business loan pro- gram. This program helps qualified small businesses obtain financing when they cannot obtain business loans through regular lending channels. The proceeds from such a loan can be used for a variety of business purposes, such as working capital; machinery and equip- ment; furniture and fixtures; land and building; leasehold improvements; and even, under some conditions, debt refinancing. 

Research and development limited partnerships

Research and development limited partnerships are another possible source of funds for entrepreneurs in high-technology areas. This method of financing provides funds from investors looking for tax shelters. A typical R&D partnership arrangement involves a spon- soring company developing the technology with funds being provided by a limited partner- ship of individual investor(s). R&D limited partnerships are particularly good when the project involves a high degree of risk and significant expense in doing the basic research and development, since the risks, as well as the ensuing rewards, are shared. 

Government grants

The entrepreneur can sometimes obtain federal grant money to develop and launch an innovative idea. The Small Business Innovation Research (SBIR) program, designed for the small business, was created as part of the Small Business Innovation Development Act. The act requires that all federal agencies with R&D budgets in excess of $100 million award a portion of their R&D funds to small businesses through the SBIR grants program. This act not only provides an opportunity for small businesses to obtain research and development money but also offers a uniform method by which each participating agency solicits, evaluates, and selects the research proposals for funding. 

Private placement

Another source of funds for the entrepreneur is private investors, also called angels, who may be family and friends or wealthy individuals. Individuals who handle their own sizable investments frequently use advisors such as accountants, technical experts, financial planners, or lawyers in making their investment decisions. 

Bootstrap financing

One alternative to obtaining the needed private capital that should be considered is bootstrap financing.12 This approach is particularly important at start-up and in the early years of the venture when capital from debt financing (i.e., in terms of higher interest rates) or from equity financing (i.e., in terms of loss of ownership) is more expensive, if available at all. 

In addition to the monetary costs, outside capital has other costs as well. First, it usually takes between two and six months to raise outside capital or to find out that there is no outside capital available. During this time, the entrepreneur may not be paying enough attention to the operations of the venture, the important areas of marketing, sales, product development, and operating costs. A business usually needs capital when it can least afford the time to raise it. One company’s CEO spent so much time raising capital that sales and marketing were neglected to such an extent that the forecasted sales and profit figures on the pro forma income statements were not met for the first three years after the capital infusion. This led to investor concern and irritation that, in turn, required more of the CEO’s time. 

Financing the business

Frequently, an entrepreneur is missing the necessary track record, assets, or some other ingredient to obtain a commercial bank loan. When the entrepreneur is unable to secure a regular commercial bank loan, an alternative is a guaranty from the Small Business Admin- istration (SBA). The SBA offers numerous loan programs to assist small businesses. In each of these, the SBA is primarily a guarantor of loans made by commercial banks and other institutions. The Basic 7(a) Loan Guaranty is the SBA’s primary business loan pro- gram. This program helps qualified small businesses obtain financing when they cannot obtain business loans through regular lending channels. The proceeds from such a loan can be used for a variety of business purposes, such as working capital; machinery and equip- ment; furniture and fixtures; land and building; leasehold improvements; and even, under some conditions, debt refinancing. 

Informal risk-capital market

The informal risk-capital market is the most misunderstood type of risk capital. It consists mostly of a virtually invisible group of wealthy investors, often called business angels, who are looking for equity-type investment opportunities in a wide variety of entrepreneur- ial ventures. Typically investing anywhere from $10,000 to $500,000, these angels provide the funds needed in all stages of financing, but particularly in the start-up.

Firms funded from the informal risk-capital market frequently raise second- and third- round financing from professional venture-capital firms or the public-equity market. 

Venture capital

The important and little understood area of venture capital will be discussed in terms of its nature, the venture-capital industry in the United States, and the venture-capital process. 

Nature of Venture Capital 

Venture capital is another misunderstood area in entrepreneurship. Some think that venture capitalists do the early-stage financing of relatively small, rapidly growing technology com- panies. It is more accurate to view venture capital broadly as a professionally managed pool of equity capital. Frequently, the equity pool is formed from the resources of wealthy indi- viduals or institutions who are limited partners. 

Valuing your company

A problem confronting the entrepreneur in obtaining outside equity funds, whether from the informal investor market (the angels) or from the formal venture-capital industry, is determining the value of the company. This valuation is at the core of determining how much ownership an investor is entitled to for a certain amount of funding for the venture. This is determined by considering the factors in valuation. This, as well as other aspects of securing funding, has a potential for ethical conflict that must be carefully handled. 

Going public. 

Going public occurs when the entrepreneur and other equity owners of the venture offer and sell some part of the company to the public through a registration statement filed with the securities commission of the country. In the United States, this is the Securities and Exchange Commission (SEC) pursuant to the Securities Act of 1933. The resulting capital infusion to the company from the increased number of stockholders and outstanding shares of stock provides the company with financial resources and generally with a relatively liquid investment vehicle. Consequently, the company will have greater access to capital markets in the future and a more objective picture of the public’s perception of the value of the business. However, given the reporting requirements, the increased number of stock- holders (owners), and the costs involved, the entrepreneur must carefully evaluate the advantages and disadvantages of going public before initiating the process. 

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