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Researching a Franchise

Buying an Existing Franchise

What you need to know when you plan to buy a ‘used’ franchise instead of a new one.

Jeff Elgin

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If you’re considering buying an existing franchise operation from an acquaintance, and want to be careful, there are certain things you should look out for. You also need to know how to find out if the selling price of the business is reasonable.

In franchise terminology, the purchase of an existing unit in any system is referred to as a ‘resale’. A resale can have some wonderful advantages over starting a new unit from scratch, but it can also be a nightmare. It’s essential that you know what to seek and what to avoid in this process.

There are two types of franchise units offered for sale. The first group consists of successful operations that are making money. The other group consists of units that are not successful and are either losing money or barely making ends meet. Each group can potentially represent an opportunity for you, but the risk associated with the second group is substantially greater. During your investigation, you must determine which group the unit falls into right now, and which group you think it will fall into after you’ve owned it for a while. Do not make the assumption that it’ll stay in the same group it’s currently in. So how do you figure this out?

The first question to ask yourself is, “What is the motivation of the seller to sell the business? Why do they want to get out of the business, and why now?” Are they ready to retire, or just want a change of pace? Or are they trying to escape an unbearable grind of 80-hour work weeks and constant employee hassles? Do they know about some future change that’ll make the business less viable, and want to get out before it happens?

At the risk of appearing cynical, this is critical information. It’ll probably take a little digging on your part to find the truth. Most sellers are smart enough to figure out that if they tell you the business is horrible, you’re not going to want to buy it from them. They all dress up the business in its Sunday clothes for your inspection.

Ask the right questions

To be safe, you need to not only talk with the seller, but also look at other sources of information. These other sources should include the franchisor as well as competing chains in the business or other industry sources.

From the seller, you need to find out:

  • What is their motivation for selling? Is their reason completely believable, and does it suggest anything negative in the future?
  • What has the financial performance of the franchise been over the past year or two? What are the trends, and what are the reasons given for the trends, particularly if the recent trend data is flat or negative?
  • What is the status of the employees of the franchise? How important is retaining key employees in successfully producing future projected results? How sure are you that they are going to stay?
  • If the franchise is site-dependent for success, what is the status of the real estate? Is there any challenge with the continuation of the lease? Is there any scheduled future road construction or other impairment that might affect otherwise positive results?
  • Do they know of anything that has not yet been disclosed to you that might hinder future performance of the business? Make sure to ask this question point blank; your attorney can include their answer in the purchase contract to protect you.

You should also go to the franchisor and conduct a complete investigation of the franchise just as if you were going to open a new unit from scratch. This exercise will give you valuable information to understand the business and to make sure you’ve asked the seller all the right questions.

Verifying answers

Finally, you should ask the franchisor to confirm the information you’re receiving from the seller, including specifics. They won’t want to do this, because they don’t want the legal liability, but they also don’t want you to join their system under false pretences. If the seller is not being honest with you, you’ll often pick up clues from comments made by the franchisor.

This article focuses on the negative potential of the resale process. Don’t misunderstand, though: resales can be great, as long as you avoid a few basic mistakes. Invest the time to gather the relevant information, and you should be fine.

Getting the right price

You first need to determine whether you think the future performance will be positive under your ownership. If the answer is no, or you’re uncertain about potential risk factors, your best strategy is to forget the resale. The risk is just too great.

But if the answer is yes, and the business is currently successful, you’ll have a fairly easy time dealing with pricing, since you have existing earnings to work with. The best valuation method is to use a multiple of the net cash flow you will receive from the business.

Net cash flow is the difference between the revenue of the business and the necessary business-related expenses required to produce the revenue. You should have access to the historical financial statements of the business to derive this number.

Most business owners run expenses through their business that aren’t really required to operate the business. These can be expenses like company cars, football season tickets or meals and entertainment. There might also be extraordinary salary costs associated with the owner. Take the net income of the business and add back these unnecessary expenses to determine the true net cash flow you can expect.

The price of this type of successful business should be about two to five times this net cash flow number. The more stable and dependable the cash flow, the higher the multiple that’s reasonable for you. The multiple is also higher when the trends of the business growth are positive rather than flat or negative.

Turning it around

The second type of resale, when the business is not currently performing well, is more difficult to price. The existing owner will always have many good arguments about why the business isn’t performing, but ultimately it comes down to whether you are convinced that a simple change in ownership will fix the problems.

About the only time this is true is when the existing owner is not operating the business according to the system designed by the franchisor. If you have confirmed that most or all other franchisees following this system are doing fine and have determined that there are no other problems related to, say, a bad location, then you can proceed with some confidence.

In this circumstance, you are looking for a real bargain. If you’re not going to get a great deal on the resale, why bother? You can always open a new unit with this franchise as an alternative to buying this resale. To evaluate the resale price, start with the total cost to open a new unit in the system, including all the marketing costs and operating reserves necessary to operate a new unit until you reach the average breakeven time on operations.

From this figure, subtract a liberal allowance for the money you need to invest in marketing and operating expenditures to get the resale unit to breakeven. Also subtract a liberal allowance for any infrastructure investments you feel might be necessary to get the physical plant and employees of the unit up to scratch.

The difference in this calculation represents the absolute maximum price you should even consider paying for this unit. A reasonable person would almost certainly discount this difference substantially to offset the risk associated with buying someone else’s problem.

If the seller is not happy with this method of valuation, that’s OK. You’re the one who’s going to have to live with this purchase, and you want to walk away from this type of resale unless it looks like a very strong opportunity to you. Feel free to tell the seller to try to find a buyer at a higher price and call you back if that attempt is not successful. There’s no line of people waiting to buy unsuccessful units, and you’ve got time on your side.

Professional advice

You don’t need an advisor to determine whether this may be a reasonable transaction for you to pursue. You absolutely do need a good attorney who is experienced with business purchase agreements if you want to go forward with the purchase.

Your attorney will assist you with the letter of intent, the purchase agreement, the assignment documents, the bill of sale and all the other requirements to complete this transaction.

This process isn’t brain surgery, but a good attorney will point out a host of protections that you might not have thought of, and the fees are generally not a large percentage of the purchase price.

Resales can be a wonderful way to enter the franchise business. You can avoid much of the pain associated with starting a new business by buying one. Just make sure you are careful and diligent, and this process should work to your advantage.

Jeff Elgin has developed a consulting system that matches pre-screened, high-quality prospective franchisees with the franchise opportunities that best fit their personal profile.

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Researching a Franchise

Maximise Your Social Media Reach This Holiday Season

Quick and cost-effective, social media is your best tool to reach target markets when it matters most – during the holidays.

Diana Albertyn

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It’s not just the end of the year that can be lucrative for businesses. School holidays and other major breaks during the year present consumers with more time to spend shopping. Why not ensure money is spent at your franchise by capitalising on the minimal cost and maximum exposure of social media?

You don’t have to create entirely new deals or promotions from what you may already have running on your store, but find a way to make it special for your social media followers, suggests Kelly Mason, marketer at Customer Paradigm.

Holiday campaigns on Twitter, benefitting from popular hashtags, streaming live content, and receiving information instead of just distributing it via social media are just some of the ways to stay ahead of the competition.

Related: Why Your Business’ Social Media Marketing Strategy Is Probably Wrong

Know your customers well

The first step to attracting customers and getting them to complete a sale is understanding their customer journey.

“Being able to document where they spend their time online, which social channels they use most, and what they’re reading or watching on those channels is a huge plus. Finding that crucial information is fairly easy to do, thanks to modern-day marketing tools and resources,” advises Paul Herman, ‎VP: Product and Solutions Enablement Group, at Sprinklr, a unified customer experience management platform for enterprises.

The better you understand your customers, the easier it is to reach them through a campaign optimised for their interests.

Master social listening

You could be using social media all wrong in the run up to all your holiday campaigns. Perhaps it’s time you used this platform to listen to your customers?

“Through social listening, marketers can identify major trends and product keywords in their industries,” says Herman. “For instance, knowing those keywords can help marketers identify which social platforms are more popular for a target audience. With that information, they can make smarter decisions about where to spend their money and which products or services to promote on each platform.”

Related: 10 Laws Of Social Media Marketing

Use the information gathered to determine what customers like about your product, what they dislike about it, and how you can improve upon it so they can buy more of it. The more of this data you collect, the better and more effective your interactions with customers will be.

Try something new

50% of consumers look for a video of the product they want to buy before going to an ecommerce store to buy it, according to a 2016 Google survey. “Video can be an extremely effective way to get your customers to take action – in this case, to make a purchase with your store,” adds Mason.

Video adverts are often used as an experimental tool in social marketing and switching it up on platforms such as Facebook Live, Instagram Live, Instagram Stories, or Snapchat – depending on your brand’s activity and your audiences’ interests – can help attract customers during seasonal periods.

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Researching a Franchise

Selling Your First Franchise? Consider These Key Pointers

You’re ready to franchise your business, but who do you sell to and how? Your first few franchisees may be the hardest to acquire, but the process will be smoother if you get some basics right.

Diana Albertyn

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Business experience gained running your independent brand will come in handy, but looking for franchisees is a different ballgame. “We have to attract the right people in enough numbers to make the difference; and, the key to more leads is to have a multi-prong strategy to marketing,” says franchise strategist and expansion expert Lizette Pirtle.

Using media (social, or otherwise), trained experts in franchise sales, and keeping in mind that whoever you sell to will become an extension of your brand, are important considerations before selling your to first franchisee:

1. Use (all) media wisely

Website marketing, print advertising and social media are just some of the many different ways to attract potential owners to your franchise. But the most cost-effect of the three may be a ‘tweet’ or ‘post’ away, says former Director of Marketing at the International Franchise Association and owner of Burris Branding and Marketing, Jack Burris.

Related: To Buy Into A Franchise Or Purchase A Licence? 3 Factors To Consider

“Three out of four people using the Internet are either on Facebook or LinkedIn or Twitter or all of them. Take advantage of social media,” he says.

“There’s typically no cost to play in the space except for the time that you need to invest to build your brand with a social media presence.”

2. Seek out franchise coaches or brokers

While this is a more traditional method of making reliable franchise sales, it’s a great way to form lasting associations that will take you beyond your first few sales. “Using broker networks is a great way to supplement your own efforts. However, you must spend time developing relationships with these people if you want to get results,” advises Pirtle. “Don’t think that just listing your opportunity with them is sufficient.”

Franchise coaches and brokers have multiple options for potential franchisees, so to put yourself high on their list of consideration when prospects enquire, you have to form memorable relationships.

Related: 3 Factors To Focus On When Opening Your First Franchise

3. Always consider the bigger picture

Out of all the people your marketing efforts attract, always keep in mind that few will check all the boxes and compromising could cost you in the long run.

“The franchise relationship is a long-term one. If you’re going to be successful as a franchisor, you should start with the attitude that every franchisee will be someone who you’ll have to live with for years to come. And nowhere is this philosophy more important than when awarding your first franchise,” says Mark Siebert, CEO of the iFranchise Group, a franchise consulting organisation.

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Researching a Franchise

To Buy Into A Franchise Or Purchase A Licence? 3 Factors To Consider

So you want to become an entrepreneur, but prefer support from an established brand? Franchising isn’t your only option, but is licensing right for you?

Diana Albertyn

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Opening a new business under a successful brand is a sure-fire way to success. Given that you’ve done your homework and the projections are looking good, you could be running a profitable operation in no time. However, the choice between buying into a franchise and purchasing a licence to operate under the brand, in exchange for a fee and portion of your profits can go one of two ways.

“It is essential to understand the difference between a franchising agreement and a licensing agreement, especially when seeking funding from a financial services provider,” says Morné Cronjé, head of franchising at FNB Business.

“Each business model is governed by a completely different agreement or contract and they operate in a unique way.”

Related: Should You Purchase An Existing Franchise?

When contemplating which option is right for you, consider how much independence you’d like to hold as a business owner, what kind of investment and share of the profits you’re willing to make and the type of relationship you’d like with your mother brand.

1Support vs autonomy

When toy industry behemoth Toys “R” Us filed for bankruptcy in September 2017, Toys “R” Us South Africa distanced itself from its US affiliates saying that the SA business is performing so well, it’s embarking on an expansion drive. How can the mothership be suffering while its SA counterpart is thriving?

Toys “R” Us SA is a privately-owned independent company operating under a license agreement with Toys “R” Us Inc. While the local version of the toy giant has purchased the right to use licensed material and intellectual property, the licensor has no control over the operations of the licensee.

With franchising, however, the franchisor exerts more control over the franchisee, but where the franchise lacks in autonomy, it makes up for in support.  “While entering into a franchise requires more of an initial investment, the benefits of an entire organisation supporting you are powerful,” say the owners of US-based fitness studio Barre Forte.

2Financial implications

While both franchisees and licensees pay an upfront fee and ongoing royalty payments to the owner of the brand or intellectual property – the franchisor or licensor – as a licensee, you bear the developmental cost and the risk associated with launching foreign operations.

Cronjé explains a franchising agreement as a duplication of a specific business model, governed or controlled through a franchise agreement where the franchisor holds all rights, including the business model.

“While franchise and license agreements vary significantly, looking at the cost distinctions between the two, it is generally more affordable to pursue a license agreement than a franchise agreement,” he says.

Related: Owning A Franchise – Good Idea Or Bad Idea?

3Relationship matters

The initial investment may be higher for a franchise operation, but access to a proven concept, an established customer base and ongoing product and service innovation could end up wing worth the cost. Not to mention the support franchisees get in the form of ongoing training and assistance with the initial setup process.

“When it comes to training, the licensing model would only train staff on the product they are selling,” explains Cronjé. “This is very different to franchising, where comprehensive training is provided on how to operate the entire business.”

Licensing generally includes some components of franchising, however what the difference is that specific operational support systems aren’t dictated by the group, which could bode well for you if you’re looking for the benefits of a big brand without the red tape.

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