Rocketing Houston Economy -- Small Business 101

Ayn Rand's John Galt could not have built a better machine than Houston's sturdy economic engine of today. In her epic novel, "Atlas Shrugged," published 50 years ago, manufacturing and transportation were Rand's focal points in the plot to stop the engine of the world. She understood the importance of business growth, entrepreneurialism, and free market capitalism. "Texas is a land of buccaneering capitalism." (The Economist, 12/19/02).

In addition to having a low cost of living and a great quality of life, Texas has one of the nation's most favorable business environments. According to Forbes' new 2007 rankings published this month, Texas is in the Top five best states for business for the second year running. Another media outlet, CNBC, a financial news cable channel, this month designated Texas as the #2 state for business in their July 2007 press release. CNBC evaluated each state on 40 measures of competitiveness in 10 categories: Cost of doing business, work force, economy, education, quality of life, technology and innovation, transportation, cost of living, business friendliness and access to capital. And, Houston, the largest city in the State, enjoys Inc. magazine's 2007 ranking in its Top 20 hottest large cities for business in the nation.

By 2030 the U.S. Census Bureau projects Texas population will increase by 60 percent compared with 2000 and will be one of the three other states that account for nearly one-half of total U.S. population growth between 2000 and 2030.

Houston's economy is humming along faster than the rest of Texas as well as the rest of the nation. Houston had a 3.1 percent employment increase between June 2006 and June 2007. During that same 12-month period, the United States added only 1.4 percent new jobs, and the rest of Texas averaged 2.1 percent.

So........with all the prerequisite ingredients in place, such as continued employment requirements, influx of personnel to fill the employment pool, and a "hot" climate for business, it's not surprising that Houston's engine is accelerating. Noted in New York Times article in March, Houston is experiencing its strongest resurgence in more than 20 years. The article cites energy, real estate development, and real estate investment as leading the way for the boom. And, in April, Inc. Magazine further expounded, "Houston is hitting on all cylinders. Not only are manufacturing and energy hot growth areas, there is also a cost advantage on housing, which is a big factor as housing growth in the suburbs, as well as inside Loop 610, is pulsing."

Let's talk about these assertions and other spark plugs powering the boom in Houston's diverse economic health.

Yes, the Lone Star state has been long known as a top producer for oil and gas. But the oil industry is no longer the only energy star in town. It now shares a spot as Texas last year gained acclaim by surpassing California as the nation's top producer of wind energy. And this month University of Houston landed a federal grant for wind turbine research, boosting Texas' position as the nation's leader in wind-generated energy. "This is the birth of a new industry here in Texas," said Texas General Land Office Commissioner, Jerry Patterson. "Once we build these test facilities, the wind turbine and blade manufacturers will come."

Houston's international trade sector is trucking along in the speed zone and will not be putting on the brakes anytime soon. Houston's Gulf Coast has long powered the growth in southeast Texas and Houston's Customs District is the nation's fourth most important Customs District in the nation. The Port of Houston is a primary port of entry for goods coming into the US market ranking first in the country in foreign tonnage, second in total tonnage, and is the sixth largest port in the world. Houston's upward movement as a major player in international trade and the continued influx of business relocations will keep this sector of Houston's economy a target of interest for those who are looking for acquisitions in the industries associated with international trade and logistics. Increasing worldwide trade, the benefits and advantages associated with Houston's Foreign Trade Zone, and the city's expansion of port terminal facilities sets the stage for its continued strength in international commerce.

The manufacturing industry in Texas has emerged as one of the nation’s fastest-growing manufacturing hubs. Between 1990 and 2005, a time frame long enough to encompass an entire business cycle, the state’s factory output grew an average of 5.8 percent a year, eclipsing all other major manufacturing states. A longer-run perspective shows that Texas’ share of the nation’s manufacturing base has been rising for at least four decades. Houston has seen a marked increase in activity that mirrors the overall manufacturing growth in Texas and is the #1 manufacturing city in the country in terms of total jobs. So, what’s behind the rise of manufacturing, in general, in the Lone Star State? Factory operators in Texas have what they need to prosper in a highly competitive, rapidly globalizing business environment. The following list are advantages that have encouraged companies to expand Texas operations, build new plants and relocate from other states:

• A central location within North America.
• Good distribution facilities that include one of the world's largest seaports.
• A fast-growing and flexible labor market.
• A relatively low cost of living and an attractive business climate.
• Low land and construction costs compared with other parts of the U.S.
• The presence of Mexico’s assembly-for-export plants, known as the maquiladora industry, at which imported parts are assembled by lower-paid workers into products for export providing manufacturers with a nearby partner for globalizing supply chains and finishing production in the U.S.

In another category -- in making their research public in May, the Project on Emerging Nanotechnologies announced that Texas joins California and Massachusetts as the states with the highest number of nanotechnology entities. Why is this seemingly small thing important? In 2006, worldwide spending on nanotechnology research and development reached $12.4 billion, a 30 percent increase from the previous year. It is predicted that by 2014, 15 percent of all manufactured goods, roughly $2.6 trillion worth, will incorporate nanotechnology. This should help people realize that this little "nano" thing is big and Houston's manufacturing presence is ready to play a strategic role in this emerging technology.

From 1990 through 2006 Texas’ service categories outperformed its U.S. counterpart in job growth. Houston, for instance, has a thriving software development community, supported heavily by the financial, biomedical, and energy industries. There is no scarcity of programming talent in Houston with Rice University, University of Houston, and Texas A&M University on its doorstep. The market gets pumped full of eager developers at the end of every semester.

Texas' business friendly slogan, "Open for Business," and its commitment to investing in research is reeling in the Biotech Industry and is encouraging Alternative Energy Development as well. With more than 400 public research centers scattered throughout the state, it has a formidable scientific research base. Most notable is the Texas Medical Center in Houston, the world's largest medical complex.

Physicians are flocking to Texas, thanks, in part, to the 2003 tort reform that limits malpractice lawsuit awards. Houston's M.D. Anderson and other well-known medical institutions hold national top 10 rankings in their respective areas of specialization, which also plays a role in boosting the Healthcare-Related Sector in Houston. Each doctor is like a small business, needing staff, suppliers and professional services. The Texas Medical Association estimates that each new doctor would employ five people and contribute $600,000 a year to the economy. About 2,250 license applications from doctors in other states who want to relocate their practices here await processing at the Texas Medical Board in Austin. With the current population growing and projected population growth into the future, an increased number of physicians and health-related services and supporting technology will be necessary to the community, especially as the Texas population grows and ages along with the baby boom generation. Demand will continue for workers in these service areas since the baby-boomers are getting to the age that require such services.

Banking Institutions and other service-oriented businesses are and will continue expanding to Houston as corporations relocate to the Houston area and the population swells as Census statistics foretell.

"Houston continues to lead all Index markets with its 15-point rise in jobs year over year, and the fact that the increase has been broadbased across occupations is an encouraging testament to the diversification of the local economy." (Monster Worldwide, Inc. - NASDAQ: MNST - parent company of Monster®, the premier global online employment solution for more than a decade.) Job growth and population growth are strong in Houston and together are key indicators for its robust economic future and small business marketplace.

Investors and developers will continue to add Texas real estate assets to their portfolios. In this must-read Boston Globe article, "A Climate for Growth," authored by Edward L. Glaeser, a professor of economics at Harvard, poignantly tells the story of why Houston's pro-growth, no nonsense politics will continue to drive developers and other capitalistic-minded investors to Houston.

Houston is already experiencing a high level of business transfer activity of privately-held small to midsize businesses. Small businesses will continue to be valuable commodities for the foreseeable future as individuals, private equity groups, corporations, and business owners from other countries look to Houston, and Texas in general, to buy existing enterprises in order to take part in its expanding economy and continued prosperous future. In Wall Street Journal's May 2007 article, "The Realignment of America," the graphic used to illustrate the story looks like everybody is headed to Texas.

There seems to be a small business 101 lesson to be learned from Rand's fictional village, Galt's Gulch, that she invented in "Atlas." It was a refuge for industrious, ambitious people -- who are the pistons that drive the engine of society -- to continue their chosen fields of endeavor without the yokes of over taxation or regulation.

To Build, To Franchise, or to Buy an Existing Business......That is the Question

Should you be the architect of a new business and start from scratch, buy a new franchise, or buy an established existing business?

Every year, thousands of people consider going into business for themselves and these are the three routes to get there. Each course has advantages and disadvantages that one should consider.

Starting a business from scratch.

Starting your own new venture can be very rewarding but needs to have a unique product, technology or service, and a planned operating procedure. One would need to complete a thorough evaluation of the marketplace, competition, availability of employees, suppliers, marketing collateral would need to be designed and printed -- to name a few. An in-depth Business Plan would need to be formulated. If you start your own business, you will not be paying for Goodwill, Bluesky, Royalty Fees or Franchise Fees. You could, perhaps, even start from your home with no employees and greatly reduce the initial capital requirement. With modern technology today a one-person show can seem like a large operating enterprise.

However, you will need to support yourself (and family) from personal savings. There may be months or years before profits are sufficient to provide the level of income needed. Mistakes will be made along the way and new approaches will need to be taken as the business takes shape. Obtaining financing may be very difficult as there is no track record and no customers. For quite some time the general belief and "rule of thumb" has been that 95% of new business start ups fail within the first five years. After doing some research, the most recent study on the subject that I was able to find was published in 2002 in a report by Brian Headd, an Economist with the SBA Office of Advocacy. Headd cited that a more accurate assessment of new business start ups is a 60% failure rate within five years based on the premises he used. Here is the 11-page report -- Redefining Business Success: Distinguishing Between Closure and Failure.

This is a far cry from the previous long-held belief that 50% of businesses fail in the first year and 95% fail within five years (Patricia Schaefer, in The Seven Pitfalls of Business Failure and How to Avoid Them).

Buying a New Franchise

Franchises are a known entity and have proven concepts. When you buy a new franchise, it comes with franchiser support such as national marketing campaigns and materials for local campaigns, has established relationships with suppliers, and established methods of operation. Training is provided by franchisers and is usually substantial, and some franchisers provide loans. With a new franchise, a good Master Franchiser will do a demographic study to assist with choosing a location for the new business. Population, drive-by traffic, potential customer base and a whole series of factors go into the results of the study that will indicate that "theoretically” the business should do well but they can't guarantee your success.

New locations can take a year or more to build and initial start-up costs of a new franchise can exceed the cost of non-franchised business start-ups or buying an already established business. You will have to pay part of your monthly gross (yes, before expenses) as royalty fees (forever), reducing your profit potential. You will also have to pay a franchise fee and, in some instances, a monthly fee for marketing support. Franchise contracts have very explicit standards, allowing little or no alterations or additions to the brand, stifling any creativity on the part of the franchisee. You must use their system and follow their rules. Some franchise contracts stipulate that franchisees must buy supplies only from an approved list of suppliers, possibly at a higher cost. The reputation of your franchise is only as good as that of the franchiser, so any difficulties that the franchiser encounters will have a direct impact on you.

There’s always risk in starting any new business and a new franchise is no exception. Everyone has heard that new franchises are safer and less risky than non-franchised start-ups and only have a 5% failure rate. Well, I was somewhat suspicious of that standard. So, in order to back up my suspicions, I did the research. There really is very little independent research out there. But what I discovered was not surprising. Since franchisers sponsor most research about franchise success rates, it is important that you ascertain the sponsorship of the information you read. Some of the reasons for not fully understanding the chances of failure in a new franchise include the fact that many are taken back by the franchiser, taken over by a third party by purchasing the assets, resold to a fellow local franchisee, or recapitalized by banks using the assets as collateral. They fall under the radar of failed enterprises. Due diligence is very important before embarking on any new venture. You may want to read the the findings of these five studies that disagree with the assertion of only a 5% failure rate for new franchise start-ups.

Hidden Risks of Franchises
Franchise This
The Failure Interview with author of "Franchising Dreams"
The Truth About Franchising
MIT Sloan Management Review

Buying an Existing Business

Buying an established business may be a more efficient way to business ownership. Here's a list of the advantages of buying an existing business:

aCash Flow
aGoodwill and Reputation
aA Historical financial track record
aEstablished customer / client base
aEstablished suppliers & vendors
aFurniture, Office Machines & Communication Equipment are in place
aExperienced Employees
aRelationships with professional advisers, insurance companies, advertisers
aLocation has already been market tested & proven
aPolicies and procedures are in place
aPricing and competition are a known quantity
aGrowth Potential
aBank Finance Options

The advantages of buying an existing business generally outweigh the disadvantages. Existing businesses can normally obtain financing from financial institutions because they have an established history, assets, and a proven idea. The seller will quite often provide training and a portion of the financing in the form of a loan. Seller financing is beneficial to both buyer and the seller. SBA Financing is also a strong possibility provided the business has good financial records.

Business brokers report that seven out of ten businesses they sell are still in business five years later.

In the long run, buying an existing business is often less expensive than building a new franchised location or launching a start-up. Even if you pay a premium price for an existing business, at least you know what you are getting for your investment if you investigate it properly. You will have far more flexibility when negotiating the purchase of an existing business versus the other options. Everything is negotiable. However, keep in mind that the terms must be beneficial to both the buyer and the seller in order to get the deal done.

In summary, the first two options have higher risks and no proven track record in the new location you choose. In a new business start-up, however, if your idea is a winner, the personal satisfaction and monetary rewards may be worth the gamble. Inc Magazine reported in October 2002 that 14 percent of Inc. magazine's 500 fastest-growing companies in the United States started with less than $1,000.

On the franchising side, there are some great franchises out there but may have frigid rules and ongoing fees that can bog you down. Finding an existing business with all the ingredients for success already in place is a safe investment and a platform from which to grow and launch new ideas. By far a much more flexible and less risky avenue to successful business ownership. No matter which road you take, there are no guarantees. You still need to be a sharp businessperson to make it work.

I have been fortunate to experience two of these types of business ownership. First, turning a vision into a new business venture and nurturing its growth until its sale 15 years later. And, second, purchasing an outstanding existing enterprise that fulfills the entrepreneurial spirit almost as much as the former. Find out if you got what it takes to take the leap to business ownership. Take this 25-question entrepreneurial test and read my short post on some of the Key Characteristics of Successful Business Owners.

Selling a Business -- The Numbers Game and Finding a Buyer

One of the most time consuming tasks performed by business brokers in the process of selling a business is filtering through the mass of inquiries and databases of registered buyers to find qualified prospects.

So, why does it take such a considerable amount of time in the qualifying process?

Some people may think the quantity of buyers interested in buying a certain type of business is most important. Others may think the quality of buyers is most important, regardless of quantity. But, in reality, both are very important, keeping in mind that the key word is "qualified" buyer. You need to start with quantity to get to quality.

In the interest of highlighting key factors considered in the qualifying process we utilized a simplified scenario and used national industry statistical data to help tell the following story.

Let's assume we are selling a $1,000,000 commercial janitorial service on the north side of Houston and have a field of 100 active buyers interested in buying a B2B service company. This may seem to be an ample quantity. But in order to get to the cream of the crop, which is quality prospects, we will have to do some weeding.

First, there are many types of businesses in the service sector category, and during further discussion with interested parties and a more in-depth investigation of the subject janitorial service by these parties, you find that half of these prospects decide they want to acquire a commercial service business in other than the janitorial industry, which narrows the field to 50 prospects. Let's further shorten the list because half of the remaining 50 prospects tell you they prefer an area other than where the janitorial enterprise is located, leaving a list of 25 possible contenders.

So, we have now narrowed prospects to those interested in specifically purchasing a commercial janitorial service in the north Houston area. If you are selling a $1,000,000 janitorial service, you need buyers who have at least $200,000 for a down payment. Of the 25 still on the list, you will find that half of these buyers thought they could buy a $1,000,000 business with less than $150,000 to invest. After quickly crossing off those who do not have the financial capability to purchase the subject business, the list has been depleted to 12 possible candidates.

Since it it very rare that a business acquisition is made without some third party financing, the remaining prospects, who have already said they had the necessary funds for a down payment, would need to have the creditworthiness to be approved by a banking institution to obtain a loan to acquire the business. Even assuming that the commercial janitorial service being offered for sale has satisfactory financial records that support the asking purchase price, half of all buyers fail to qualify because of their own personal financial circumstances. So, starting with what seemed to be a substantial quantity of 100 prospects, only six are financially capable and are looking for a commercial janitorial business in the north Houston area. This can be considered the "quality" list of buyers.

At this point, there has been a substantial amount of time and energy expended "qualifying" interested buyers. An enormous amount of effort can be wasted talking to even "qualified" prospects about a specific business who have no real intention to actually buy it or have the right temperament to pull the trigger -- this group is termed "tire kickers." Now consider the national statistic that only one in ten active buyers actually take the proverbial "leap of faith" and ever purchase a business. This means of the six left on the shortened list, there may be only one bonafide candidate that may actually purchase the business.

In a nutshell, it's all in the numbers. You must have a large number of qualified buyers looking at a business for sale to increase the odds of closing the deal. National industry statistics already tell us that 70 percent of all businesses on the market do not get sold for various reasons. To further improve the odds, you don't want just a large number of qualified buyers looking at your business, you want the largest number possible to create a competitive environment in order to close a deal with the highest sales price the market can bring.

Utilizing an experienced professional business brokerage firm whose only focus is selling businesses provides the environment that is required for the effort at hand. A business brokerage firm that has a prominent presence in the marketplace brings the numbers game into play. Without visibility, even the best business cannot achieve the level of exposure needed to bring enough buyers to the table. Additionally, brokers perform the time-intensive funneling and winnowing process to bring the right buyers to the arena that will further better the odds to win the numbers game. Those who have closed thousands of deals know where potential problems can arise and can help smooth the way and clear the path to the goal...the successful sale of your business.