How business works

A GRAPHIC GUIDE TO BUSINESS SUCCESS





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$ A GRAPHIC GUIDE TO
BUSINESS SUCCESS
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Contents

Senior editor Georgina Palffy Introduction 8
Project art editor Saffron Stocker 10
Anna Fischel, Alison Sturgeon, HOW COMPANIES WORK
Editors Suhel Ahmed, Hannah Bowen,
Joanna Edwards, Alex Beeden Business ownership 12
Designers Natalie Clay, Stephen Bere, Sole proprietorships and partnerships 14
Phil Gamble, Vanessa Corporations 16
US senior editor Hamilton, Jemma Westing Private and public companies 18
US editor Margaret Parrish Multinationals 20
Christine Heilman Franchises 22
Managing editors Stephanie Farrow, Gareth Jones Not-for-profit 24
Senior managing Lee Griffiths
Start-ups 26
art editor Liz Wheeler Start-ups from concept to launch 28
Publisher Karen Self Types of start-up 30
Deputy art director Jonathan Metcalf Business plans 32
Publishing director Phil Ormerod Raising money 34
Art director Mark Cavanagh Business accelerators and incubators 38
Senior jacket designer Claire Gell
Jacket assistant Sophia MTT
Jacket design manager Ben Marcus, Nikoleta Parasaki
Pre-production producers Christine Ni
Producer

First American edition 2015

Published in the United States by
DK Publishing, 345 Hudson Street

New York, New York 10014

A Penguin Random House Company

15 16 17 18 19 10 9 8 7 6 5 4 3 2 1 Buying and selling business 40
001—196402—Mar/2015 Mergers and acquisitions 42
Divestitures 44
Copyright © 2015 Vertical vs. horizontal integration 46
Dorling Kindersley Limited Management buy-ins and buy-outs 48

All rights reserved. Who’s who 50
Board of directors 52
Without limiting the rights under copyright reserved above, Company hierarchy 56
no part of this publication may be reproduced, stored in or introduced Stakeholders 60
into a retrieval system, or transmitted, in any form, or by any means Business cultures 64
(electronic, mechanical, photocopying, recording, or otherwise), without
the prior written permission of both the copyright owner and the above

publisher of this book.

Published in Great Britain by Dorling Kindersley Limited

A catalog record for this book is
available from the Library of Congress.

ISBN: 978-1-4654-2979-7

DK books are available at special discounts when purchased in
bulk for sales promotions, premiums, fund-raising, or educational use.
For details, contact: DK Publishing Special Markets, 345 Hudson Street,

New York, New York 10014 or [email protected].

Printed in China

A WORLD OF IDEAS:
SEE ALL THERE IS TO KNOW

w w w.dk .com

HOW FINANCE WORKS 98

Financial reporting 100
The accounting cycle 102
Financial statements 104

Corporate structure 66 Financial accounting 110
Functional structure 68 International accounting standards 112
Divisional structure 70 Profit-and-loss statement 114
Matrix structure 72 Balance sheet 116
Network structure 74 Cash-flow statement 120
Team-based structure 76 Environmental accounting 122
Depreciation 124
Human resources 78 Amortization and depletion 128
The human resources cycle 80
Recruitment and selection 82 Management accounting 130
Evaluating staff 84 Cash flow 132
Motivation and rewards 86 Budgets 136
Leadership strategy and styles 88 Assets and inventory 138
Leadership for team building 90 Costs 140
Employee relations and Product costing and pricing 142
92
communications 94 Measuring performance 144
Project management 96 Key performance indicators (KPIs) 146
Negotiating strategy Financial ratios 148
Forecasting 150
Tracking fraud 152

Raising financing 154
Internal financing 156
External financing 158
Going public 160
Shares and dividends 164
The capital market 170
Gearing ratio and financial risk 174

HOW SALES AND 176
MARKETING WORKS

Marketing mix 178 Inbound marketing 220
Product 180 Outbound vs. inbound marketing 222
Product positioning 182 Blogging 224
Product life cycle 184 Social media marketing 228
Price 186 Search engine optimization (SEO) 230
Place 188
Promotion 190 Business development 232
Market research 192 Branding and rebranding 234
Market segmentation 194 Lead generation 236
Lead conversion 238
Marketing approaches 196 Customer retention 240
Niche vs. mass marketing 198 Return on marketing
Traditional marketing 200 242
Digital marketing 202 investment (ROMI) 244
Engagement marketing 204 Intellectual capital
Sensory marketing 206 246
Relationship marketing 208 Information management 248
Business intelligence 250
Outbound marketing 210 Business analytics 252
Traditional offline advertising 212 Marketing and IT 254
Online advertising 214 Collecting consumer data 256
Direct mail 216 Data warehousing 258
Telemarketing 218 Customer profiling 262
Big data
Customer relationship 264
266
management (CRM)
Compliance

HOW OPERATIONS 268 Resources 336
AND PRODUCTION WORK Index 344
Acknowledgments 351

Manufacturing and production 270
Job production 272
Batch production 274
Flow production 276
Mass customization 278
Continuous production 280
Hybrid processes 282

Management 284 Contributors
Economies and diseconomies of scale 286
Lean production 288 Dr. Julian Sims (consultant editor) entered academia
Just-in-time 290 after a successful career in industry in the US and UK. He
Total quality management 292 is a lecturer in the Department of Management at Birkbeck,
Time-based management 294 University of London, UK; a Chartered Accountant (CPA Aus);
Agile production 296 and a Chartered Information Technology Practitioner (CITP).
Kaizen 298 His work is widely published in academic journals.

Product 300 Philippa Anderson is a business writer and communications
New product development 302 consultant, who has advised multinationals including 3M,
Innovation and invention 304 Anglo American, and Coca-Cola. She collaborated with
Design 306 Lord Browne, former CEO of BP, on his memoir, Beyond
Quality management 308 Business, and was a contributor to DK´s The Business Book.
Product-process matrix 310
Alexandra Black studied business communications before
Control 312 writing for financial newspaper group Nikkei Inc. in Japan.
Managing capacity 314 While in Tokyo, she was an editor at the Risk Analysis division
Inventory 316 of investment bank JP Morgan. Now based in Cambridge,
Quality control 318 UK, she covers subjects as varied as business, technology,
Six Sigma 320 and fashion. She was a contributor to DK’s The Business Book.

Supply chain 322 Joe Stanley-Smith is a reporter at the International Tax
Value chain 324 Review in London, UK, where he specializes in indirect tax
Outsourcing 326 and tax disputes. He graduated in journalism with a business
Offshoring 328 specialty from Kingston University, UK, and has previously
Reverse supply chain 330 worked in social media and local news.
Benchmarking 332
Corporate social responsibility 334 Paul McDougall (US/Canada writer) is Deputy Technology
Editor for the International Business Times. He has written
for Scientific American, InformationWeek, SHAPE magazine,
and others. A native of Toronto, Canada, he currently resides
in New York City.

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HOW BUSINESS WORKS 89
Introduction

Introduction

The term “business” refers to an organization or commercial
enterprise engaged in producing and trading goods and services for
money. We can trace the origins of business to the very foundations
of human society. When Homo sapiens evolved, mankind left behind
the nomadic hunter-gatherer lifestyle to become farmers. This allowed
for specialization of work, where individuals would become skilled
at specific tasks to serve a particular community need. Over time, this
enabled more complex goods and services to be produced and traded,
in order to provide for all members of society. Thus, human society
has been engaging in “business” for thousands of years.

Today the world of business is inescapable—businesses are no longer
just local providers of goods and services, but extend to vast corporate
enterprises operating on a global scale. For governments to function
and economies to flourish, a successful and thriving business sector
is essential. Whether businesses are small or large, public or private,
for-profit or nonprofit, they each play a key role in supporting the global
economy, and together they form the backbone of the modern world.
Business underpins every aspect of the world we live in today, and
understanding how it works is the key to understanding society.

This book explains the complex world of business in a simple and
graphic way. It examines every aspect of how a business works,
including forming a company, raising capital, product development
and marketing, management strategies, tracking revenue, financial
reporting, and legal, social, and environmental responsibilities.
Through visual explanations as well as real-life examples to make
even the most complex concept immediately accessible, How Business
Works offers a clear understanding of what business is all about and
how business, in its many forms, shapes modern society.



HOW
COMPANIES

WORK

Business ownership ❯ Start-ups
Buying and selling business ❯ Who’s who
Corporate structure ❯ Human resources

Business
ownership

Every type of business has to choose an ownership structure. Although there are
variations globally, most countries offer similar types of legal entities, from a single-
person private enterprise to a massive organization trading on a stock exchange.
There are three key considerations: how big the venture is expected to grow; the
complexity of financial recording, management, and reporting that the proprietor
is willing to take on; and the amount of liability the owner is willing to accept.

Small and simple Private Public companies
companies
❯ A sole proprietorship ❯ Companies that go public
or partnership is simple ❯ More complex to set are large businesses, and they
to set up and requires up and run, a private have many legal and financial
little capital. company is a legal entity reporting obligations.
separate from its owner
❯ One or more owners or owners. ❯ The general public and other
conduct business as institutions can buy shares in
a legal entity. ❯ The company structure public companies.
means the owners are
❯ Owners are personally not usually personally ❯ The public company structure is
liable for business debts. liable for business debts. good for a major capital injection,
See pp.14–15. allowing the business to expand.
❯ Private companies are See pp.16–19.
owned by shareholders,
who are often the
company’s managers.
See pp.16–19.

12 13HOW COMPANIES WORK
Business ownership

7% NAMING A COMPANY

of global economic Do Don’t
activity is accounted
for by the world’s ❯ Use a domain suggestion ❯ Include your name—if the
100 largest companies tool to search for available venture fails, your name will
internet domain names and be associated with it.
work back from there.
❯ Ape competition, because
❯ Be descriptive so potential if your name is unique, you
customers instantly grasp the have a better chance of
nature of the business. topping search-engine results.
If your name is similar to that
❯ Say the name out loud—it of competitors, customers
may come across differently can’t distinguish.
from the written word. The
goal is that people can search ❯ Spend time thinking of a
and find it, especially online, name until your product and
just from hearing it. brand is finalized. Get the
product right first and the
❯ Keep it short and simple and name will follow naturally.
avoid puns.

Multinationals Franchises Nonprofit
sector
❯ For both growth and flexibility, ❯ In this model, a business (the
multinationals have operations franchisor) authorizes a franchisee ❯ Common nonprofit
in various countries. to set up a branch under its name, organizations include
in return for a fee. charities and trade
❯ Multinationals can save money by associations.
setting up operations in countries ❯ The franchisor needs less capital
where costs are cheaper. than it otherwise would to ❯ Their organizational
develop a business. structure is similar to
❯ Foreign branches can adapt to that of a company.
the local market and also find ❯ The franchisee takes on a known,
new markets. See pp.20–21. successful business model and ❯ They may generate
name, so minimizing risk. substantial sums of
See pp.22–23. money, but plow it back
into beneficial causes
rather than distributing
profits. See pp.24–25.

Sole proprietorships
and partnerships

The simplest business structures are those formed by one person as a
sole proprietor, or by two or more people as a partnership, for commercial
activity. Many cost little to set up and some are easy to run.

How it works Unlimited liability: NEED TO KNOW
business debts
Many businesses start out as the most paid personally ❯ Firm Collective term for
basic unit—either a sole proprietor or individuals in a partnership
a partnership. A sole proprietor is an
individual who is the only owner of ❯ Limited liability partnership
the business. This structure is easy to (LLP) Partners not personally
set up and there are no extra taxes to accountable for business debts
pay, unlike with a company. Instead,
the sole proprietor files a personal tax Tax-efficient Simple
return. There is risk attached, though. way to be registration
A sole proprietor has unlimited liability,
so if the business fails, the owner must self-employed process
personally pay debts. Partnerships have
more than one owner, and each can be
held liable for the whole debt of the
business in case of failure.

Pros and cons $$ Easy to move from
sole proprietor to
Both sole proprietorships and Little company status
partnership structures are excellent capital
for anyone starting out or running needed
a small business—as long as the
business stays out of debt: owners are $
personally liable for business debts.

Schedule C Trade under own Keep all business
filed with IRS name or chosen profits after paying
Form 1040 business name
tax on them

Sole proprietorship

Working alone requires only
simple administration and
relatively few start-up costs.

14 15HOW COMPANIES WORK
Business ownership

FROM INDIVIDUAL 66% WCOHMENPATNOYMSOTAVTEUTSO
TO MULTINATIONAL
of EU private badiIenfecnctobhremteefisapcgnsiareaeonsle.wyd(Sa)menf,eofdaorpyrpcpmbao.1peti6nei–tnga1tl7ia. l
Sole proprietorships and partnerships sector jobs are in
may grow into global names. small or medium-
size enterprises
❯ Richard Branson Sole proprietor-
ship that expanded into Virgin empire Profit and
control of the
❯ Steve Jobs and Steve Wozniak business shared
Partnership that created Apple brand

❯ Bill Hewlett and David Packard
Partners who founded HP technology

❯ John D. Rockefeller, William
Rockefeller, Henry Flagler, Jabez
A. Bostwick, Samuel Andrews,
Stephen Harkness Partnership that
grew into Standard Oil corporation

Allows for Option to set up a
specialization by limited liability
partnership
each partner

If partner leaves, Each partner $
new partnership pays tax on own $
portion of profit
needed

Furnish Schedule More partners New partners
K-1 (IRS Form mean more capital bring new

1065) to partners and expansion business skills

Partnership

Like sole proprietors, partners
file only personal tax returns
and are liable for business debts.

Corporations

A corporation is a business entity considered distinct from its
employees and shareholders. The primary purpose of forming a
corporation is for shareholders to avoid personal liability.

How it works distribute it to the stockholders in the form of
dividends. Corporate and securities laws regulate
A corporate structure protects management and the sale of shares. Legally, the stockholders cannot
workers in the case of litigation or other claims. It is, be held liable for the company’s actions and debts.
however, a more complex structure and subject to
greater regulation than the simpler business entities of
sole proprietorships and partnerships. A corporation is
owned by one or more stockholders, and is managed
by a board of directors and run by the company’s
officers, who are appointed by the board of directors.
The company retains any profit made and may

Types of incorporation Publicly traded
company
Anyone who operates a business may incorporate by registering articles
of incorporation. General incorporation (C Corporation) is the most A publicly traded company is
common structure. An S Corporation, created through IRS tax election, usually a large business—such
provides limited liability; it is favored by small businesses because it as a technology company—
combines the advantages of sole proprietorship, partnership, and the with stock traded on a stock
corporate forms of business structure. Nonprofits can also incorporate. exchange, such as NASDAQ.

NEED TO KNOW Public characteristics

❯ Stockholder An individual, group, ❯ Issues securities through an Initial Public Offering (IPO)
or organization that owns shares ❯ Can sell future equity stakes
in a company ❯ Has greater access to financing
❯ Must meet reporting requirements set out by Securities
❯ Doing business as (DBA) Operational
rather than company name and Exchange Commission (SEC)
❯ Reduced control for initial owners
❯ Professional corporation (PC)
Corporate form used for primarily
for doctors, lawyers, and similar
professional service providers

16 17HOW COMPANIES WORK
Business ownership

Corporation LIMITED LIABILITY COMPANIES IN THE US

Corporations operate as legally A limited liability company (LLC) is a hybrid between a corporation
and financially independent and a partnership. The upside of an LLC is that it offers many
entities. They may be publicly of the advantages of a corporation, but is cheaper to create
traded or privately held. and maintain. Taxation rules vary, depending on the Articles of
Organization of the LLC. Laws also differ from state to state. A
56.5% limited liability company is an “LLC,” not an “Inc.” or “Corp.”

of UK limited Privately held CANADIAN
companies have company COMPANIES
employees; the
remaining 43.5% In a privately held company, Businesses in Canada can
are single-member a limited group of private stock be sole proprietorships,
companies (SMCs) owners controls the company. partnerships, or
These companies do not offer corporations. A business
shares to the general public on can also be run as a
stock exchanges. cooperative, a business
that is owned and
controlled by its
members. Canadian
companies must
register in the province
or territory in which
they are domiciled.

Private characteristics

❯ May issue stock and have shareholders. Shares,
however, do not trade on public exchanges

❯ Management is not required to file disclosure
statements with the SEC

❯ Dependant on private funding

Private and public
companies

While the owner-shareholders of a private company may buy and sell
their shares privately (usually with director approval), any investor in
the financial market can trade the shares of a public company.

How it works Differences between private
and public companies
Although most of the world’s companies are set up as
private, public companies are seen as more prestigious Private company directors have to weigh up the potential
and profitable. For business ventures requiring large capital increase of floating on the stock exchange against
amounts of capital, a public company offers greater the legal red tape aimed at protecting public shareholders.
opportunity for raising funds, since shares can be sold
to public investors to generate cash. Private companies Private
must rely on private investors or use the capital
investment of their owners. Public companies are
subject to more stringent legal controls than private
ones, and are expected to disclose financial details.

27million Directors

the number of companies Usually control all of the shares.
in the US, fewer than Reporting
1% of which are public
In the US, no disclosure is required outside
FAMOUS PRIVATE COMPANIES the company; in the UK, it is mandatory to file
accounts at Companies House.
❯ Mars Confectionery and pet food; Shareholders and management
third-largest private US company
Shareholders are often actively involved in
❯ Rolex Swiss-based English company management so decisions can be made quickly.
making status-symbol watches Financing

❯ LEGO® Danish company producing Company must rely on private investment, which
household-name toy bricks is often harder to attract because there are fewer
financial details available.
❯ Hearst Corporation Mass-media Valuation
multinational based in New York City
Value of the company is more likely to fluctuate;
❯ IKEA Swedish retailer registered in it is more difficult to assess because there are
Netherlands selling flat-pack furniture fewer available financial details.
Size
❯ PwC Largest professional services
network Number of shareholders is limited, usually to
fewer than 2,000.

18 19HOW COMPANIES WORK
Business ownership

$55billion GOING PUBLIC

the amount raised on 141 There are legal requirements at each stage of converting
IPOs at the NYSE in 2013 a company from private to public, such as voting in a
board of directors and deciding on a new name.

Choose board members

Usually at least three directors to
allow future board decisions to
be made with only two members
present (representing a majority)

Public Inform staff
Must notify in writing anyone with
Directors an interest (including employees
Not necessarily shareholders. and proposed board members)
Reporting that company intends to go public
Companies have a legal obligation to disclose
accounts and submit regular financial reports. Vote for conversion
Shareholders and management Board meeting held to vote in
Clear boundary is drawn between the role of favor of changing company’s
shareholders and management; may lead to Articles of Incorporation (specifying
a conflict of interest. private or public company)
Financing
Can tap financial markets to raise capital by Register company
selling stock or bonds. Documents setting out board
Valuation resolutions sent to Secretary of
Value of the company is easier to assess, from the State, who issues certificate
trading price of shares and financial statements. declaring the company is public
Size
Number of shareholders is unlimited. Make public announcement
Press releases issued, events for
business held, and emails sent to
inform contacts of change

NEED TO KNOW

❯ Unquoted/unlisted company Another term for
a private company

❯ Initial public offering (IPO) Stock-market launch
❯ Secondary stock offering Second-round sale of

shares to raise more capital
❯ Ticker symbols Unique code assigned to publicly

traded companies and used by stock exchanges

Multinationals

A multinational corporation has business operations in more than one
country. It usually starts as a national company and sets up subsidiary
(branch) companies abroad for production and sales.

How it works to local cultural/market differences. United Kingdom
A company may achieve such goals London
Multinationals have several goals: by outsourcing (using external
to increase revenue by finding new suppliers) or offshoring (relocating One of many country HQs in major
markets; to streamline operations functions). Companies may also European cities, the London office
and production by taking advantage insource (move operations in-house) serves the UK market. Nike also has
of global locations with lower labor to rightsource (find a good balance). a product creation center in Italy.
and/or transport costs; and to adapt
Regional HQ Management
Case study: mapping a multinational and core admin functions

Sportswear company Nike has successfully spread around the globe from Marketing UK campaigns
its corporate base in the US. It has manufacturing functions where technical and merchandising
expertise maximizes efficiency and keeps costs down; distribution hubs in
strategic locations; marketing and retail departments in countries where it United States
is establishing local markets; and call centers where they are cost-effective. Beaverton, Oregon

GLOBAL VS. MULTINATIONAL Senior management are located
at the company’s corporate base,
A global company has facilities in different countries but operates as a or “campus”, its center for decision-
single corporate culture with common processes. A multinational has making on global strategy, design,
facilities in different countries but each functions as its own entity, and marketing, and core functions.
adapting locally, with little communication between geographic divisions.
World HQ Management,
Global finance, legal, IT, and admin

hello hola! Apple is an example of Global marketing
a global company—the Branding and marketing
product is essentially
the same except for R and D Sport research
a language change. lab and design facilities

Multinational Retail Online sales and
stores across North America
McDonald’s is a
multinational—the Memphis, Tennessee
product changes to
suit the market. For Distribution Hi-tech hub
example, it serves a in location with good links
shrimp burger in Japan
and chicken rice
porridge in Malaysia.

20 21HOW COMPANIES WORK
Business ownership

The Netherlands NEED TO KNOW ❯ Platform corporation
Hilversum Multinationals that do not
❯ Transnational corporation manufacture, but outsource
Based in a central location, a European Similar to a multinational but products they have designed
headquarters supports operations does not identify itself with
across Western, Central, and Eastern any particular parent nation
Europe, and is close to the company’s
European distribution center in Belgium. China
Shanghai
European HQ Management,
finance, legal, IT, and admin The company’s second-largest and fastest-growing market, China is also a
major manufacturing base due to local expertise and low production costs.
Design HQ for global soccer
apparel business Chinese HQ Operations Manufacturing Sportswear
and core support functions factories and innovation hubs
Retail Online sales and stores
across Europe

Marketing Campaigns for Retail Continually expanding
the Chinese market retail network for sports brand

Japan
Tokyo

Most manufacturing is based in
the Asia-Pacific region, benefiting
from expertise and lower wages.
Regional offices in 13 countries
also support production and retail.

Regional HQ Core
operations and marketing

Manufacturing Sites
in several countries

Brazil India
São Paulo Bangalore

Operations, marketing, and distribution for the Central and South American Call centers draw on a supply of
market are based in Brazil, with offices and retail outlets in all major countries. English-speakers on lower wages.

Central and South American Distribution Hub for retail Customer support
HQ Operational center stores across the continent Complaints and returns

Franchises

The franchise is a business model in which an independent
entity—the franchisee—is entitled to set up a branch of an
established brand. There are advantages for both parties.

How it works develop the business with NEED TO KNOW
modest capital outlay while the
Rather than developing an original franchisee takes on a proven ❯ Franchise disclosure
business idea, the franchisee business model and brand name, documents (FDD) Pre-
pays for the right to represent so everyone reaps the benefits. agreement information
an existing, successful brand
in a particular location. The size “I put the ❯ Microfranchising Support and
of a franchise can vary from a hamburger on training for small-scale businesses
single unit—one outlet only— the assembly line.” in the developing world
to an area development in which
the franchisee takes on the option Ray Kroc, founder of McDonald’s ❯ International Franchise
to represent the brand through Association (IFA) The oldest
several branches in a city or and largest franchise organization
region. The franchisor can

Three types of franchise

The franchisor’s level of control varies from managing the contracts for the entire supply chain
to input on every detail down to the last French fry. In a product franchise, the franchisor lends
its trademark and brand but not an entire business system.

Manufacturing franchise Product franchise

This is a supplier-dealer relationship in which
the franchisee sells the franchisor’s products.
Examples include cars, gasoline, and tires.

A company that manufactures a specific range
of products grants retailers the right to distribute
its products and use its brand name and trademark.
For example, a soft-drink makers sell syrups to the
franchisee, who then bottles the drink.

22 23HOW COMPANIES WORK
Business ownership

TOP 10 CASE STUDY

Fastest-growing franchises Business-format franchise: fast-food outlets
worldwide
The business-format franchise, in A limited and uniform menu was
1. Subway fast-food sandwich which a franchisee takes on a whole the key to the success of these
outlets blueprint for running a business franchises. The consistency of the
as well as the product itself, was menu, service, and surroundings
2. McDonald’s fast-food outlets pioneered in the US in the late 1940s. helped to establish a strong brand
3. KFC fast-food outlets identity, since customers were
4. Burger King fast-food outlets Fast-food outlets were a new assured that the product and
5. 7-Eleven convenience stores concept at the time and were experience would be the same
6. Pizza Hut restaurants generating great demand. To increase anywhere in the country.
7. GNC health and beauty products the rate of expansion, these original
8. Wyndham Hotel Group hotels fast-food entrepreneurs developed McDonald’s is the most successful
9. Dunkin’ Donuts bakery/coffee a franchise system under which example, collecting an estimated
the franchisee was contractually 11.5 percent royalty fee from its
shops obliged to run the outlet according 31,000 franchises worldwide.
10.Dia grocery stores to strict guidelines.

Business-format franchise

The most common type, this has high input from
the franchisor including brand name and trademark,
training, store identity, marketing plan, and company
culture. The franchisee buys supplies from the franchisor
and pays fees and royalties. Fast-food outlets are
typical business-format franchises.

Not-for-profit

Some organizations are run not for the benefit of shareholders, but for
the benefit of their members or an external community or charity.
Unlike conventional businesses, profit is not the goal.

How it works 9.2%

Organizations that do not intend to generate profit for of all wages and salaries
their shareholders, are self-governing, and committed paid in the US come from
to a common cause come under the broad umbrella of the not-for-profit sector
not-primarily-for profit, not-for-profit, and nonprofit
entities. On this spectrum, cooperatives may disburse
profits to members, but charities are strictly nonprofit.
Although their goals differ, not-for-profits have a similar
type of company status and structure to businesses.

The not-for-profit universe Cooperative
Owned by members;
There are many forms of not-for-profit can benefit from profit;
organization (NPO). Joel L. Fleishman, clear ethos of pursuing
Professor of Public Policy and Law at Duke common economic, social,
University, has characterized the not-for-profit or cultural goals; one
sector as a universe that embraces all NPOs,
whatever their mission. member, one vote

Private Fraternal
foundation organization
Similar to a charity but Based on common
funded by one source, not interests or beliefs such as
the public; generates social or academic interest
revenue from investments; or a benevolent cause;
makes grants to other Freemasons and college
charitable bodies fraternities are
both examples

THRIVING SECTOR ❯ US Nationwide Mutual Assurance: $23 billion
❯ Germany Edeka Zentrale AG cooperative:
Despite being NPOs, many cooperatives and
mutuals have a sizable annual turnover (gross $16 billion
revenue transacted). ❯ UK Co-operative Group: $16 billion
❯ Japan Zen Noh cooperative: $53 billion ❯ Spain Mondragon cooperative: $14 billion
❯ France Crédit Agricole Group of

cooperatives and mutuals: $32 billion

24 25HOW COMPANIES WORK
Business ownership

NEED TO KNOW NOT-FOR-PROFIT
STRUCTURE
❯ Philanthropic sector Alternative ❯ Associated charity An
umbrella term for the not-for-profit organization related to a main Chairman coordinates
sector or universe charity that takes on a particular work of the directors.
aspect of the charity’s work
❯ 501(c) corporation An IRS- Board of directors
recognized nonprofit; one of several ❯ Payouts 5 percent of assets that are usually unpaid;
types of nonprofits, organized for private foundations must pay out may also be called the
purposes specifically designated each year; no such requirements board of trustees.
in the Internal Revenue Code exist for public charities
Committees formed
Mutual Nongovernmental by board members
Raises funds from organization (NGO) carry out specific tasks
members (usually Funded by government or by such as fundraising.
customers); often takes the international donor agencies
form of financial institutions; such as the World Health Administration
profits reinvested in the Organization (WHO); staff often include
mutual or to sustain or operate independently a proportion of
grow the organization voluntary workers.
Chamber of commerce
Social enterprise Chambers from various Charity
May sell goods or services regions gather to promote Must be registered as a
to fund community projects; trade, investment, and charity; tax exempt; all
cooperation; usually funded resources must be devoted to
any surplus revenue by subscriptions from the charity’s stated charitable
reinvested in the enterprise activities; may be organized
local businesses as a trust, corporation,
for the community
or association

Start-ups

A start-up is a new business in the early stages of development and operation,
during which an entrepreneur or founding group comes up with an idea for
a product or service, researches it, develops a business plan, raises funds,
and launches with the goal of rapid growth. Registering intellectual property
(IP)—a unique creation, not just an idea—to protect it is an important stage of
the start-up process. Protection includes trademarks, patents, and copyright.

The early days 476,000

Before a company is fully developed, new businesses are started
with a working business model, it every month in the US
is known as a start-up. The start-up
evolves from an entrepreneur, or INTELLECTUAL PROPERTY (IP) VALUE
group of entrepreneurs, with an
idea or invention. It can take a The term ”start-up” became ™ ®
few years to turn the initial concept commonplace during the dot.com ©
or prototype into a viable, profitable boom of the late 1990s, when
venture, so the start-up founder thousands of entrepreneurs with
tries to attract support and financial web-based products and services
backing to achieve rapid growth. found funding, many on the
During this phase, which can take strength of their intellectual
anything from a few months to several property alone. Giants Google
years, the business changes quickly. and Amazon both started up at
that time. Since then, technology
NEED TO KNOW businesses have become one of the
most talked-about start-up types.
❯ Internal start-ups Start-ups Their value is often based 100
that originate from inside a large percent on intellectual property.
organization

❯ Patent trolls Companies or
individuals who buy up the patents
of failed start-ups and attempt to
collect licensing fees from potential
infringers of the patent

26 27HOW COMPANIES WORK
Start-ups

The big idea

Consider Launch
the IP
❯ Win? Lose?
❯ Register IP ❯ Research indicates
❯ Find a name
❯ Buy a domain that, in most Western
❯ Research market countries, 80–90 percent
of start-ups fail.
Choose a
start-up type? Prepare to launch

❯ With a social conscience? ❯ Plan a marketing campaign
❯ Primed to grow big? ❯ Run a test launch and refine
❯ To fit lifestyle?
See pp.30–31. message and offer
See pp.196–197.

Make a Find funding
business plan
❯ Invest savings
❯ Explain how the
business will make money ❯ Ask friends $ $
and family
❯ Describe the unique 40%
aspects of the business ❯ Take out a bank loan

❯ Set out how much money ❯ Seek venture capital
the business will need and
how much it will make ❯ Try crowdfunding

See pp.32–33. See pp.34–37.

Seek help ❯ Enter a business the sales growth
incubator achieved by online
❯ Join a business start-ups in France,
accelerator ❯ Go it alone in 2011–2012
❯ Find an investor

See pp.38–39.

Start-ups from
concept to launch

A new business can be described as a start-up in the early phases of
its launch, when an entrepreneur comes up with the idea for a product
or service, and develops the concept into something that will sell.

How it works break the start-up, so it is worth NEED TO KNOW
spending some time doing online
The idea is just the start. Next research to make sure no one ❯ Lean start-up Method of
comes the process of expanding else is using an intended name, learning fast and discarding what
the concept into a viable business. especially in a negative context. does not work to keep start-up
Specialized help may be needed in Location is another consideration costs down
some areas—hiring a website and with significant cost implications.
logo designer, for example, and an It may be possible to create a virtual ❯ Start-up pivot Quickly changing
accountant to advise on the best office and work from home. Finding direction or correcting mistakes
structure and financial setup. premises is an extra stage, but the based on customer feedback or
What the business and product goal at start-up is to keep costs low. technology changes
or service are called can make or

START Come up with a Register IP
good idea
For an invention or
Develop a product, or innovation, register
an idea for a product. your intellectual
property (IP).

@ Set up an online Decide on a name
presence
Check to determine whether your
Register the domain proposed name is available; check
name and set up that the domain name is available;
web hosting. search online for competitors with
similar names.

Create a look Make a website

Design a logo and Build a website.
visual identity for Research search
the business. engine optimization
(SEO) words to use on
it (see pp.230–231).

28 29HOW COMPANIES WORK
Start-ups

START-UP STRUCTURE 75%

Business Pros Cons of all US
start-ups
Sole Low cost, easy to set up, May be seen to lack credibility; failed between
proprietor- minimum of financial challenge to raise capital 2004 and 2010
ship reporting
Harder to dissolve in case of
Partnership More input, more potential failure; partners liable for debts
to raise funding
More financial reporting
Limited Low risk of personal liability; necessary; more paperwork
company tax benefits; dividends can
supplement wages

Limited Personal liability of partners is Must file annual accounts;
liability
partnership limited to the amount they can be dissolved once a

invest in the business partner leaves

Research market Decide structure

Study your proposed Choose a business
target market and structure that suits
potential competitors, your initial needs, but
and evaluate the also allows flexibility
viability of the idea. for growth.

Obtain backing Devise a plan
$ funds
Draw up a plan (see
Consider a business pp.32–33), including
incubator if the your goals, mission
business requires statement, and key
large-scale support. financial information.

Set up finances Start marketing LAUNCH

Include an accounting Plan a marketing
campaign. Run a
$ and cash-flow system, test and make any
sales tax if applicable, refinements to the
and bank account. message or strategy.

Types of start-up

Entrepreneurs go into businesses for many reasons. Some start-up
decisions are based on personal ethos and conviction, while others
are founded firmly on the desire to make money.

How it works those that are aimed from the NEED TO KNOW
outset to be large ventures within
Not all start-ups fit the same mold. a corporate environment, and ❯ Enterprise portal Dedicated
Although they often follow a similar those intended to work on a more website providing content
process in their initial evolution, personal scale to suit the lives for staff, usually intended for
they are as varied in type as the and passions of individuals. larger companies
personalities behind them. Start-
ups can broadly be divided into ❯ Micropreneur Entrepreneur
who keeps their business small
Lifestyle so they can control and manage
it alone
Motivation
Working is a passion ❯ Burn rate How fast the start-up’s
initial cash balance is going down,
month by month

Example Social start-ups
Ex-athlete starts
fitness coaching Motivation
Making a difference
business
Example
173% Type of funding Malaria blood-test kit
Self, friends,
the projected peers, bank loan for smartphone

revenue increase Type of funding
Community, charity,
over three years government, donation

for mobile gaming

start-ups

30 31HOW COMPANIES WORK
Start-ups

ve withMinotaivaltaiornge corp ScalaMbolteivasttioanrt-up

Initiati Innovating oration Readiness to grow

0101010011
0100010101

Small business Example Example
PC manufacturer starts Phone app
Motivation developer
Feeding the family a separate business
providing cloud
Example data storage
Small-town
grocery store Type of funding Type of funding
Internal company Crowdfunding,
funding angel funding

AcquisMiottiiovantiotnargets

Intent to sell the business
on from the beginning

Type of funding
Self, family,
bank loan

Example
Biotech
laboratory

Type of funding
Outside
investment

Business plans

Writing a business plan is one of the most important steps in
developing a start-up. The plan sets out the new business’s
goals, market analysis, and projected income and profit.

How it works new business will be uniquely positioned to capture
that market, given the services or products offered. An
Before a start-up entrepreneur can write a business outline of existing finances and an accurate projection
plan, they need to have done enough research to of sales and profit are essential components, especially
identify a clear opportunity in the market for the if seeking external funding.
product or service, and to define how the proposed

Key elements Executive summary Business
background
Preparing a business plan can take Fill in this section last, bearing in
several weeks, and it is worth doing mind that it may be the only part Provide details of each person
thoroughly. It is a vital document a busy person reads: in the business:
for securing funding, so the financial
forecast must be both realistic and ❯ Business summary Company ❯ Experience Relevant work
accurate. If showing it to others, pare structure, name, product or carried out to date
the executive summary down to two service, and customer profile
pages, write it in plain English, and ❯ Qualifications Credentials,
explain any technical terms. ❯ Business goals Three objectives such as diploma in horticulture
over one, three, and five years for a gardening service
Start-ups in
the US are ❯ Financial summary Expected ❯ Training Past and future,
sales and costs, and funding including business skills such
2.5x as assertiveness
❯ Elevator pitch Two-minute talk
more likely to sell your idea to a customer
to go into
business if Products and The market
they have a services
written plan Set out specific details of your
Describe what the business is potential market:
going to sell:
❯ Typical customer Businesses
❯ Product or service With a or individuals and their profile;
picture if product is new local, national, or international

❯ Range If more than one, such as ❯ Market research What the
garden design and maintenance local market is for similar
products or services
❯ How it is different What makes
the product or service stand out
from the crowd?

Marketing strategy

Choose about three of ❯ Business literature
these methods: ❯ Direct marketing
❯ Social media
❯ Word of mouth ❯ Website

❯ Advertising

32 33HOW COMPANIES WORK
Start-ups

TOP FIVE REASONS TO WRITE A PLAN NEED TO KNOW

❯ The process Working through each ❯ Areas of expertise Making a ❯ SWOT analysis Stands for
element ensures nothing is forgotten. business plan clarifies where outside Strengths, Weaknesses,
help is needed—for instance, in Opportunities, and Threats
❯ Costing The only way to find out bookkeeping or marketing.
whether the business is viable is to ❯ Unique selling point (USP)
work out details of costs and sales. ❯ Getting to know the competition The feature that makes a product
Conducting market research is the different from the competition
❯ Funding A good business plan best way to give a business an edge.
improves chances of getting a loan.

Competitor analysis Operations
and logistics
Show how the business idea
compares with the competition: Describe from start to finish
how the business will run day to day:
❯ Table of competitors Who and
where they are, what they sell and ❯ Supply and delivery How the
for how much, how good they are goods or service will get from A to B

❯ SWOT analysis Including how ❯ Equipment Details of transportation,
to remedy any weaknesses and office items, and premises
combat known threats, such as
a garden center opening nearby ❯ Payment, legal, and insurance
How customers will pay and
❯ USP Unique selling point of the how that translates into salaries;
product or service compliance with the law

See Need to Know box, above.

Costs and pricing Financial forecasts
strategy
Predict sales and costs over the year,
Work out how much the product allowing for seasonal fluctuation, such
or service costs and its sale price: as spring demand for lawn services:

❯ Cost How much each unit or ❯ Sales calculations For each month,
batch costs to make and deliver the expected number of sales

❯ Price How much each unit or ❯ Costs calculations The costs of
batch will sell for the predicted sales each month

❯ Profit margin The difference ❯ Cash-flow forecast The money
between cost and price per unit coming in and out of the business

See How Finance Works, pp.98–175.

Back-up plan ❯ Longer-term changes Shifts such
as working online, not on premises
Make a Plan B in case something
goes unexpectedly wrong: ❯ Closure Lessons learned and skills
acquired if the business closes
❯ Short-term changes Cutting costs
or boosting sales immediately

Raising money

Almost every new enterprise needs funding to get it going, and to
keep afloat until it turns a profit. Financial help is at hand from a
variety of sources, suitable at different stages of start-up growth.

How it works capitalists (VCs), provide equity
capital in the form of a share
Capital for new enterprises comes in the business that may include a
from two main sources: lenders proportionate share of control and
and investors. Lenders, such as rewards. Both types of funding can
banks, provide debt capital in the be corporate—from a company—or
form of a loan that is returned more quirky and alternative, such
with interest. Investors, such as crowdfunding.
as business angels and venture

Types of start-up funding $ Lenders

Corporate, traditional, and substantial funding Debt capital most often takes
comes largely from banks and VCs, while smaller the form of loans paid back
sums come from more personal sources. with interest.

Term loan Paid back regularly Bank overdraft or credit card Factoring/invoice discounting
over a set period of time Interest charged monthly if balance Unpaid invoices sold at a discount
not paid in full to a company that collects them
for commission

❯ Bank Offers either personal or ❯ Bank or credit company ❯ Factors and discounters
business loans Financial organization that makes Companies that offer advance
loans to commercial ventures on unpaid invoices, for a profit
❯ Government Offers low-interest
start-up loans $ NEED TO KNOW
$
❯ Credit union Cooperative that ❯ P2P lending Loans made
gives members low-interest loans between individuals over internet

❯ Peer-to-peer (P2P) lending ❯ Crowdfunding Debt or equity
Unsecured personal loans raised via internet platforms

❯ Friends and family May give
interest-free loans

Sta rt-up fund ing 34 35HOW COMPANIES WORK
Start-ups
Investors
5–10%
Equity capital is paid to the
start-up in return for a share of small and
of the business. medium-sized
enterprises in
the UK need no
start-up funding

Grants

Financial awards and
prizes are provided
by public bodies.

Founders, friends, family Local, national, global
(FFF) May buy shares in the Funded by a local authority,
company rather than lending government initiative, or
money international charity

Crowdfunding Large number SUPER ANGELS

$ of supporters, each contributing ❯ What they are Serious investors in technology
a small amount of money, start-ups. Facebook was funded by super angels,
some of whom are now famous in their own right.
usually online
❯ Who they are Former Silicon Valley professionals
Business angels Investors who who invest their personal money in new ventures.
give favorable terms because
their focus is on the company’s ❯ How they differ from ordinary angels and
success rather than profit venture capitalists (VCs) Funding level straddles
the two, often reaching millions of dollars as what
Venture capitalists (VCs) started out as a hobby becomes a profession.
Companies that provide capital
for new businesses in the hope ❯ Pros and cons Super-angel investing acts like a
of making a profit magnet to other investors, but individual super
angels can rarely provide the full funding of a VC.

RAISING MONEY

Alternative models CREDIT ANALYSIS CRITERIA FOR LENDING

Since the start of the economic Capacity Collateral
downturn that started in 2008,
several innovative and more The borrower’s ability to repay the The borrower is often expected to
personal types of funding, such loan is shown by the business plan. pledge an asset that can be sold to
as crowdfunding and peer-to-peer Capital pay off the loan if funds are too low
(P2P) lending, have evolved and to pay the monthly interest or repay
blossomed on the internet. All The borrower’s net worth is assessed the capital at the end of the term.
involve the principle of raising to check that assets exceed debts.
small amounts of money from large Character Conditions
numbers of individuals who pool
their resources to provide the loan The lender usually looks for a The lender is swayed by the current
or equity needed. borrower with a good credit history. economic climate as well as by the
sum requested.

Life cycle of Founde rs, friends, family (FFF) Crowdfunders
investment
$
The key to successful funding is to
choose the right type of finance RISK
at each stage of a company’s early INVESTMENT
growth. Start-ups usually begin
modestly, with self-funding and help
from friends, family, and anyone else
who is prepared to take a high risk.
Crowdfunders and business angels
are amateurs willing the entrepreneur
to succeed, while venture capitalists
become interested when the level of
risk goes down and they can expect
a healthy profit in return for injecting
substantial funds. Public markets such
as stock exchanges may step in as
sales soar and success looks probable.
At all stages, investors will conduct
credit analyis to asses a company’s
ability to repay its debt.

$

REVENUE

TIME Seed

Idea

36 37HOW COMPANIES WORK
Start-ups

Start-up finance of small and medium-sized enterprises (SMEs)

The chart shows sources of start-up finance of SMEs over a three-year period in the UK, taken
from a 2004 survey by Warwick Business School. Most funding comes from individual savings,
and least from equity (shares), a type of investment associated more with larger companies.

66% Personal 5% Home
savings mortgage

12.5% Friends and 5% No funds
family used

10%$ Bank $ 1.5% Equity
loan investment

Business angels V enture capitalis ts Public markets

SALES Mid Late

Early

Business accelerators
and incubators

Starting a new venture can be a long process. Business (also called
venture) accelerators and incubators are specialized organizations
devoted to developing and supporting start-ups.

How it works support including mentorship, business advice,
and connections to potential sources of financing.
Business accelerators and incubators provide expertise Business incubators, on the other hand, provide a
and connections in the formative stages of a business supportive environment in which fledgling start-ups
in return for a percentage of ownership. They are can develop, with technical assistance, working space,
two separate types of services. Business accelerators and networking opportunities.
are short-term programs that offer wide-ranging

Business accelerators

Suited to start-ups that have limited financing, accelerators offer short–term (one
to three months) boot camps. Clients include web and software developers.

Help with bank $$ Introduction $ Links to
loans, funds to potential potential
and guarantees investors
programs partners
Access to
Accounting mentors and
and financial advisory
services advice boards

Networking Start-up pays Marketing
Seed capital accelerator % of advice
equity in the business.
Management
In return, accelerator of intellectual
provides help and property
services.

Business incubators 38 39HOW COMPANIES WORK
Start-ups
Often sponsored by nonprofit
organizations, incubators tend to be Start-up pays
longer term (one to five years) and incubator %
cater for a variety of clients, many of equity in the
science-based. business. It may
also pay rent to
Start-up share part of the
introduced incubator’s work
space. In return,
to it receives a range
incubator of benefits.

NEED TO KNOW Support and education Mentorship

❯ Incubator networks Office space to
Collaboration of incubation work from
centers, research facilities,
and science parks Seed money
to get started
❯ Virtual business incubator
Online hothouse for start-ups

33 Specialized facilities such as
science laboratories
months
the average time Interaction with
US start-ups spent other start-ups
in an incubator,
during 1999–2002

Buying and
selling business

Both private and public companies regularly change hands—they are bought,
sold, and restructured to reflect changing business conditions. These deals
all come under the umbrella term of mergers and acquisitions (M and A).
Acquisition financing is usually needed to pay for the purchase of another
company, often in the form of a loan or venture capital.

How to acquire a company rget company

A company is typically acquired in one of two ways—either by
a management team or by another company. When a company
is buying, the result can be a merger, in which two companies
join forces, an acquisition (outright purchase), or a divestiture,
in which part of a company is hived off and sold. Management
team purchases are often funded by private equity.

Ta

Management team acquiring FOR
SALE
Private equity firms look for companies
to buy and then sell their shares when Divestiture
profits have maximized. They fund the
management team. See pp.48–49. Part of company
is split off to form
Buy-out new company; may
become acquisition
The existing management team buys out target. See pp.44–45.
the company they work for.
Buy-in

An external management team buys into
the company.

40 41HOW COMPANIES WORK

Buying and selling business

$311.5 SIZING UP M AND A’S
million
Measuring a big deal
the average size of M and A The corporate world categorizes acquisition
deals, globally, in 2013 deals according to the capitalization size (the
value of the company’s shares).
Another company acquiring
$ Small Under $500 million
Companies may want to expand by
joining with another business. $ $ Mid-market $500 million
to $2 billion
Merger
The company combines with $ $ $ Large $2 billion to
another company. See pp.42–43. $10 billion

Acquisition $ $ $ $ Megadeal
Horizontal The company buys Above $10 billion
another company that makes
similar products. Due diligence
Vertical The company buys Before any company sale, the potential buyers
another company that makes see a detailed report prepared by lawyers,
different products. covering key aspects of the target business.
See pp.46–47.
❯ Financial Identifies problem
areas that could affect the
future value of the company.

❯ Legal Gauges possible legal
risks attached to corporate
status, assets, securities,
intellectual property, and
employee reshuffling.

❯ Commercial Includes industry
$ trends, market environment,

the company’s capabilities,
and the competition.

❯ Environmental Uncovers
potential liabilities such as land
or water contamination and
estimates remediation costs.

Mergers and
acquisitions

Two of the quickest ways to accelerate expansion are REASONS TO PURSUE
for a business to buy out another—an acquisition—or M AND A
to amalgamate with another business in a merger.
❯ Improved economies of scale
How it works a reasonably equal footing to Wider operations streamline
create a new company, which will production and sales.
Mergers and acquisitions (M and A) make both parties better off, an
is a general term used to describe acquisition is usually a purchase ❯ Bigger market share
the ways in which companies are of a smaller company by a larger Combining the existing markets
bought, sold, and recombined. In one. This benefits the company expands share of the total market.
the case of either a merger or an making the purchase but may
acquisition, two separate legal not necessarily benefit the target ❯ Diversification A different
entities are unified into a single company. M and A can be friendly product lineup gives the chance
legal entity. While a merger or hostile—agreed to or imposed. to cross-sell or create more
combines two companies on efficient operations if the
products are complementary.
Merger Company A
manufactures luxury Company B
cars in the US. manufactures
luxury cars in Italy.

merges with

AB

Acquisition

A Btakes over

Company A produces movies. Company B creates animations.

42 43HOW COMPANIES WORK

Buying and selling business

FRIENDLY AND HOSTILE NEED TO KNOW

❯ The target company’s board of ❯ The acquiring company bypasses ❯ Pacman strategy The target
directors and management agree management and goes straight to company tries to take over the
to be bought out. the target company’s shareholders. very company attempting the
hostile buyout
❯ The acquiring company makes an ❯ The target company’s management
offer of cash or stock to the target fight the deal. ❯ Swap ratio An exchange
company’s board and management. rate between the value of
❯ The buying company convinces the shares of two companies
❯ The stock or cash offer is set at a shareholders to vote out the when merging
premium level. management (a proxy fight) or it
makes an offer to shareholders to ❯ Defensive merger Undertaken
❯ Because the offer is above actual buy shares at an above-market price to anticipate a merger or takeover
market level, shareholders usually (a tender offer). attempt that threatens a company
agree to it.
❯ Economies of scale Benefit to
company of M and A expansion

New company A + B now has $112
an expanded market spanning billion
Europe and North America.
the record annual
A+B spend by Japanese
companies on
A Expanded overseas mergers
company A and acquisitions,
now has in 2012
in-house
expertise for
producing
animated films.

Divestitures

While a merger results in a bigger company, a divestiture reduces
the size of a business by breaking it down into smaller components
or divisions, which are then sold off or dissolved.

How it works of view, those which have promise SUCCESSFUL
but are not yet profitable. The SPIN-OFFS
The typical scenario for a divestiture process of restructuring by
is a company that is struggling divestiture is designed to free Mondelez The spin-off of Kraft
to pay off debt it has taken on to the company of divisions with Foods owns snack foods Oreos,
expand into new areas of business low return, to reduce debt and Ritz, and Trident.
that are not yet profitable. To financing requirements, and to give
save the rest of the company from the shareholders a stronger return. Coach Sara Lee food’s spin-off
the burden of debt, management The market price of the parent makes luxury leatherware.
decides to start a divestiture. company’s shares often bounces
Generally, the goal is to shed the back strongly and its spin-off Expedia Media company IAC
least profitable areas of operation, companies may thrive too. hived off online travel to Expedia.
or from the potential buyer’s point

Divestiture in practice

Smith Industries Inc. is one example of an industrial paint conglomerate that has grown
rapidly over the past five years, due to an increase in profits from its expanding sales in
China. It diversified into agricultural chemicals, textiles, and biotechnology, and set up a
separate division for each. Share prices fell in response to poor financial performance.

Making a decision Announcing the sale

Faced with a downturn in business, the company Smith Industries Inc. now announces the sale of its
divests the newer business areas that have not yet three remaining divisions: agricultural chemicals,
shown strong returns despite positive signs of growth. textiles, and biotechnology.

INDUSTRIAL TEXTILES INDUSTRIAL
PAINT PAINT

Smith Industries Inc. Smith Industries Inc.

FOR SALE FOR SALE FOR SALE

AGRICULTURAL BIOTECHNOLOGY
CHEMICALS
AGRICULTURAL TEXTILES BIOTECHNOLOGY
CHEMICALS

44 45HOW COMPANIES WORK

Buying and selling business

NEED TO KNOW 52%

❯ Spin-off New company formed as ❯ Reverse merger Not to be the potential
the result of a divestiture; also called confused with a divestiture, this rise in a parent
a hive-off is a quick and cheap method company’s
for a private company to go share price
❯ Tracking stock Special type public by buying a shell stock— following a
of shares issued by a parent a public company that is no divestiture
company for the division or longer operating because it went
subsidiary they will sell; tracking bankrupt or was simply closed.
stock is tied to the performance
of the specific division rather than ❯ Demerger Term commonly used
the company as a whole; also known in the UK for divestiture
as targeted stock

❯ Letter of intent Letter stating
serious intention to do business,
often concerning M and A

The shareholders benefit

Shareholders in the original company also receive the same
percentage holding in shares from the three new companies.

One company becomes four West Inc. Jones Inc. Brown Inc.

The three divisions are sold off to separate AGRICULTURAL TEXTILES BIOTECHNOLOGY
investors and become three separate CHEMICALS
companies. Shares for each are sold on the stock
market. The parent company is reduced to its
core business. Its share price rebounds.

Smith Industries Inc.

INDUSTRIAL
PAINT

Vertical vs. horizontal
integration

Companies that want to expand through a merger or acquisition
may decide on a strategy of either horizontal or vertical integration,
combining businesses involved in similar or dissimilar activities.

How it works merger or acquisition, the newly NEED TO KNOW
formed company can make cost
Companies can choose from several savings in production, distribution, ❯ Lateral integration Another
strategies when they merge or are sales, and marketing. Vertical deals term for horizontal integration
part of an acquisition. Two of the are usually between businesses
most common are horizontal and involved in the same industry but ❯ Horizontal monopoly When
vertical integration. at different stages—for example, a company controls the market
a computer maker and a component after buying up the competition
Horizontal deals are always done manufacturer. These deals can
between competitors that produce be upstream (toward the market) ❯ Synergy The potential of merged
similar types of products, such as or downstream (in the direction companies to be more successful
cars or mobile phones, and often of operations and production). as a single entity
share—or compete for—the same
suppliers and clients. As a result of

Integration models in practice

In these hypothetical examples, a cluster of printers, publishers, and bookstores
merge or acquire each other in horizontal or vertical deals that aim to strengthen
their market position, take advantage of economies of scale, and exploit synergy.

Horizontal integration

Two publishing companies, both involved
in the process of book creation but with
different areas of specialization, agree to a
merger deal to gain a larger market share.

PUBLISHER A PUBLISHER AB PUBLISHER B

Publisher A, a general publisher,
acquires specialized academic
Publisher B to strengthen its
textbook division.

46 47HOW COMPANIES WORK

Buying and selling business

ONLINE 31%
BOOKSTORE
of businesses
A worldwide
planned to
Forward PUBLISHER/ONLINE expand through
(upstream) BOOKSTORE A a merger or
Publisher A buys acquisition in
Vertical the three years
integration Online bookstore A from 2014
to improve brand presence
A publisher acquires MERGER AND
two related businesses— and provide direct sales. ACQUISITION TYPES
a printer and an online
bookstore—so that it can PUBLISHER A Conglomerate
have greater control over
production of its books Combining two companies with
and their route to market. nothing in common: for example,
in 1985, tobacco-producer Philip
Backward PUBLISHER/ Morris purchased General Foods, a
(downstream) PRINTER A new line of business unconnected
to legal wrangles around smoking.
Publisher A buys Printer A
to improve print capacity Market extension
and production costs and
provide warehouse space. Combining two companies that sell
the same products but in different
PRINTER A markets: for example, in 1996, the
Union Pacific Railroad Company
acquired the Southern Pacific Rail
Corporation to link railroads in
adjacent US regions.

Product extension

Combining two companies that sell
different but related products in
the same market: for example,
in 2014, Microsoft bought Nokia’s
mobile-phone unit to address
flagging PC sales and its weakness
in the mobile device market.

Management buy-ins
and buy-outs

A company’s ownership may undergo a change, which can be
driven either externally, known as a management buy-in, or
internally, known as a management buy-out.

How it works company’s existing management NEED TO KNOW
team purchases all or part of the
In a management buy-in (MBI), company they work for. Despite ❯ Earnout A percentage of the
a group of managers or investors the name, MBOs are not restricted purchase price paid to the sellers
from outside the company raises to managers, and they can include after acquisition if the business
the funds to buy a majority stake employees from any level of the has performed as expected
in the company and then takes organization who wish to make the
over its management. This type transition from employee to owner. ❯ Leveraged buy-out Acquisition
of action occurs when a company of a company using equity and
appears to be either undervalued borrowed money, with company
or underperforming. In a typical as collateral for loan
management buy-out (MBO), the

Buy-in

Some companies, such as investment banks or venture capitalists, can make
sizable profits by purchasing undervalued businesses and transforming them.

Company Company

+$– =

An outside They raise funds They fire and replace the They overhaul the business
management team to buy a majority previous management team. to improve performance and
or investment group shareholding. realize its true value.
sees that a company
is undervalued.