Buying an existing franchise
In franchise terminology, the purchase of an existing franchise outlet is referred to as a ‘resale’. When buying a resale, you have to do the same research and assessment you would do if you were buying any business. There are also a few more issues to consider.
Why buy a re-sale?
There is an up-side to buying an existing franchise. Some advantages are:
- The buyer has an existing base from which to grow the business
- Customers already exist so the business has cash flow from the first day of takeover
- The business already employs staff who have the necessary skills and training
- There is already equipment, infrastructure and premises
- Where a certain mature brand (e.g. KFC) is already operating in many locations with a limited number of new sites available, purchasing an existing store may be the only way to get into this particular franchise
Unfortunately there is also the down-side. To avoid making a bad buying decision, various questions need to be asked.
Why is the franchise up for sale?
The owner wishing to retire is an excellent reason for offering a franchise for sale (if that’s the real reason) or perhaps they are tired of the long hours and constant employee hassles.
You must establish how the franchise is performing in relation to other outlets in the same network and whether it is making money. Also look at customer relations, staff relations, supplier relations and a host of other issues that could impact negatively on the continued success of the business.
Will the business remain viable in future?
While the past performance of the business is important, its future prospects are what really matters. While the past financials may look great, something could have happened to the area that reduces the attractiveness of the site. For example, a long-established shopping centre losing traffic to a new competitor down the road.
You also wouldn’t want to invest in the business, only to find that trained staff is leaving, customers were more loyal to the owner than the brand, the lease expires shortly, the equipment keeps breaking down and stock is unsalable.
What is the total investment required?
It’s vital to know exactly what you are in for, financially. Keep in mind that there is not only the initial investment, but the on-going costs to consider as well. Some financial implications of buying an existing franchise:
- If the outlet is trading profitably, the seller will expect to make a capital profit. This could make the deal more expensive than if you just set up a new outlet
- Do the existing financial statements match those figures provided by the franchisor?
- Are the projections provided by the franchisor realistic when compared to the historical financial statements of the business?
- When is the next revamp of the business due?
- What is the purchase price made up of (goodwill; existing stock; existing equipment, etc.)?
- How was the goodwill valuation calculated? (Often franchisors have a formula they use to fairly calculate goodwill or purchase price of their franchise businesses)
- In addition to the purchase price are you responsible for:
- An initial franchise fee and training fees to the franchisor?
- A lease deposit to the landlord?
- Working capital for cash flow purposes?
- Has the franchisor recommended what amount of unencumbered own contribution you should have available to purchase the business, and similarly, what is the maximum level of funding the business can afford?
Is the price right?
The valuation of a franchised business is fairly straight-forward because the franchisor usually has a standard valuation method it applies to all the businesses in its stable.
These simple formulas use a multiple of either turnover or profitability of the business to determine a value. When you are looking at buying a franchise, refer to the franchisor in order to understand the business valuation method to arrive at a fair purchase price.
Factors to consider include how well the business is doing, cash flow projections, existing infrastructure, operating expenses and so on.
Use as many sources of information as possible, including the franchisor, other franchisees, similar businesses in the area.
Get professional advice
The acquisition of a business is a complex transaction, so you may want to consider consulting with a lawyer and an accountant. Given what’s at stake, this will be money well spent.
The accountant will carry out a due diligence investigation, i.e. he/she will examine the business’s financial records and advise on the commercial soundness of the deal.
The lawyer, who should be experienced in the franchising industry, will examine the purchase agreement, the franchise agreement and the lease agreement for the business premises.
Also, you may not realise that if you buy a business as a going concern, you become responsible for any outstanding contractual obligations and tax liabilities. An experienced lawyer can implement steps to protect you from this eventuality, but this requires a thorough examination of all existing legal agreements.
This article first appeared on the SME Toolkit South Africa – southafrica.smetoolkit.org