If you’re planning to buy a company, you’ve probably debated between buying an existing business or a new franchise.
Some of the advantages of buying an existing independent business could include a proven track record of sales and profits, a well-known name and location, a strong mix of products and services, knowledgeable employees and a good customer base.
There are benefits with buying a franchise too. When buyers purchase an established franchise business, it comes with a proven plan with step-by-step guidelines. Plus, most franchisors offer training and operational support due to their incentive of the royalty fee that they will earn from the franchisee. Usually, the franchisee will also have access to other owners for help, ideas and moral support.
When considering a franchise, buyers routinely assume that they never fail that couldn’t be further from the truth—every business venture is risky. To increase your chance of being successful, find out the answers to the following four questions when conducting your due diligence:
1. What is the total cost of ownership? Franchise buyers need to understand the immediate out-of-pocket expenses they will incur upon purchase, as well as any other ongoing fees. All franchises are not created equally. Some will structure a purchase with lower start-up fees or allow you to make incremental payments; others may provide incentives for multiple territories, growth and sales volume. Along with the up-front franchise fee, you will likely have to pay the franchisor a royalty based on a percentage of your sales. You may also be required to lease equipment, purchase supplies or services directly from the franchisor. Depending on location requirements, the additional expense to make leasehold improvements and outfit your new business with furniture and fixtures specifically required by the franchisor may fall in your lap. Finally, in some cases special advertising fees are levied against sales to pay for franchisor marketing costs.
Understanding all the upfront and ongoing costs of ownership enables new owners to compare their forecasted return on investment with their expectations.
2. What is the turnover rate? Unpleasant as it may seem, buyers need to ask the franchisor what percentage of their franchisees fail each year and how many close within the first two years.
Do not be surprised to find some failures; even the best franchisors experience some bumps in the road. Also research the frequency of franchisee failures in your industry, and ask questions about why they failed—look for common traits. For example, you may discover that a number of failures were caused by poor management skills, franchisees’ reluctance to follow the franchisor’s script, inadequate promotions and poor location choices. Most important, compare their traits to your own situation.
Understanding the turnover rate of franchise ownership will help paint a picture of how attractive it is compared to buying an existing business in the same industry or shopping for a different franchisor. This will go a long way to help you make an informed decision.
3. Will my territory be protected? It’s critical to explore the level of regional protection you’ll have. For example, does the franchisor guarantee that it won’t sell other franchises in your area, and for a certain time period?
Similarly, you will want to uncover what kind of empire-building opportunities you will have. Some of the more successful franchise owners have multiple outlets in the same area and are able to tap into economies of scale. You will need to find out if you have first right of refusal for new franchises, for which market area and under which parameters.
By uncovering the opportunities or limitations to growth, you will ensure there are no disappointing surprises down the road.
4. What happens when I want to leave? As with purchasing any business, you not only need to have a plan going into the business but an exit strategy as well. As a franchise buyer, you need to identify which kinds of restrictions you’ll be under when you want to get out.
Will you be able to sell it to anyone or only back to the franchisor? You should also research the comparable sales prices of franchises that have recently sold. And you must know if there will be any transfer fees associated with your resale. Many franchisors charge a one-time transfer fee to buyers of existing franchises, and the fees can be extensive.
Although it’s difficult to make blanket statements about which franchise models are better than others, buyers need to understand where their franchisor’s interests lie before they purchase. The best thing you can do is to thoroughly read and digest the disclosure materials and franchise agreement; probe and question the areas that are unclear; and visit and speak directly with the franchisor to be able to make an informed purchase decision. It’s also imperative, before signing anything, to consult a lawyer who has experience in franchise agreements. Remember, franchisors complete a thorough investigation of you before they approve you as a franchisee. It’s in your best interest to do the same with them.
Bill Sivell is a salesperson with VR Windsor Inc., which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. He blogs about selling businesses at Maxbizvalue.blogspot.ca.
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