Can You Buy An Existing Franchise and Should You?
If you have decided to start a franchise, you will need to decide between buying an established franchise or a new one. There are two types of units for sale when it comes to existing franchises- the successful one making money and the other struggling to make ends meet. Both of these groups are an opportunity for you, but the risks in the second category are much higher.
Some of the most well-known franchise business models include Subway and McDonalds. In fact, McDonald's has 38,695 restaurants worldwide, of which 36,059 are franchises. That means that nearly 93% of the total capacity of McDonald’s are franchises. The reason why McDonald’s is so popular is because of its impressive margins. However, not every location of McDonald’s is profitable.
Before you buy an established franchise, figure out if it is successful or struggling. Doing so will help you understand the motivation of the seller to transition out of the franchise. Talk not just to the seller but also use other sources of information to find out. It may also be good to contact the franchiser to investigate the franchise, just like you would when opening one from scratch.
In the franchise industry, buying an existing unit is called a resale. Franchise resales can be great, provided you have done thorough research and investigation before investing your money.
What is the Process of Buying a Franchise?
Owning a franchise can be an attractive alternative to starting an independent business. However, before acquiring one, you need to investigate and analyze the product or service, the market, and the return on investment.
You should check out as many franchises as you can in-person to help clarify your thinking on what sort of franchise you want or whether you want one at all. Once you’ve determined the type of franchise you are interested in, you can start investigating prospective franchisers. Examine the track record of the franchiser and the nature of the franchise agreement you will be entering into. You may also consult a lawyer if you are not familiar with certain aspects of the franchise agreement.
You can also request a promotional kit from the franchiser. Such kits usually contain its philosophy, a brief history of its development, the number of outlets and their locations, and financial data on the performance of a sample franchise.
The promotional kit also contains an application form requesting basic personal information. Some franchisers may require you to pay a fee when submitting the application form.
If your application is accepted, your franchiser may call you for an interview to decide if you have the right qualities to become a successful franchisee. Buyers are generally assessed on their qualifications, business experience, motivation, net worth, and ability to manage the franchise. You will also need to demonstrate that you have the financial ability to make the necessary investment on your own.
Buying an Established Franchise vs. A New Franchise
Owning a franchise can be a great way to entrepreneurship. However, most people face the dilemma of whether to buy an existing franchise or open a new one at a new location.
Both the choices have their own advantages. It is up to the buyer to decide which of the benefits suits their needs.
Most people would like to believe that buying an established franchise is a safer option. Usually, established franchises already have a track record of success and profitability. Also, you do not need to conduct employee training as the previous owner would have most likely done it. There are also high chances that an existing franchise already has a loyal customer base.
Opening up a new franchise also has its upsides. It allows you to start on a clean slate, unaffected by the work habits or shortcomings of the previous owner. You may have to work harder to get the business off the ground, but you don’t need to worry about negative customer experiences or other such problems at that location.
New franchises are also a lot less expensive than established ones. You pay a bit more for an already established business with a strong customer following than you would for a brand new location.
Both new and existing franchises have their benefits and drawbacks. It ultimately depends on your personality, preferences, and risk threshold regarding buying an established franchise or a new one.
What are the Advantages of Buying an Established Franchise?
Generally, people prefer buying an existing franchise over a new one. The main reason behind this is that when a unit is already in operation and performing well, the chances of success are higher.
Here are some other advantages of buying franchise resales:
- You can start earning from day one. Since the franchise unit is already up and running, your business is already underway, generating cash flow. You can start earning revenue as soon as you take over the unit from the previous owner.
- You already have a loyal customer base. One of the toughest aspects of starting a new business is building a customer base. However, if you buy an existing franchise, you automatically inherit its customer base along with the revenue it generates.
- You inherit trained staff. With an existing franchise, you also inherit its employees and do not need to go through the process of recruiting and training new staff. When you take on a business, having knowledgeable and experienced staff can be a huge advantage.
- You know what to expect. Analyzing your existing franchise's actual historical financial data will help you determine if it is a good business or not. You get the opportunity to review the previous owner’s books and records and predict the future performance based on actual numbers. Having a clear idea of the actual revenue helps you determine if you want to continue with the existing marketing plan or make changes.
- It is easier to secure funding. Since an established franchise already has a proven track record, it is easier to secure funding compared to a new business.
What are Some of the Disadvantages of Buying an Established Franchise?
There are also some disadvantages of buying an established franchise, such as:
- You may require additional investment. Some franchise owners sell their business because it is not performing as well as they had hoped. This should not necessarily be a deterrent. You may need to put more money, time, effort, and passion into the business than the previous owner to turn it around. However, if you purchase a neglected unit, you have to make additional investments to ensure that it turns into a successful business.
- You may need extra due diligence. The financials of the existing business can tell a whole story. However, you must conduct due diligence to figure out why the owner is selling the business. You should also find out the trend for that location. Have they been going strong, or is it on the decline? Are there any changes in the neighborhood that have motivated the sale? You must also be on the lookout for new competitors as they could affect your future performance.
- You may face resistance from the existing staff. The existing staff may be apprehensive about the change of ownership. Since they are already used to working in a certain way, they may not like the changes you bring in and resist them.
- There may be changes in terms of the franchise agreement. It would be wise not to assume that the franchiser would keep the same terms and conditions when buying an established franchise. You may need to renegotiate the terms and the price again with the franchiser. Make sure that you review the franchise agreement very closely. Seek help from an attorney if needed.
Reviewing Financial Records
When you buy a new franchise or start a new business, there is zero income and no assets. An established franchise has a track record, assets, and cash flow, making it a preferable choice for many.
One of the biggest upsides of buying an established franchise is the opportunity to review its financial records. Reviewing balance sheets, profit and loss statements, and cash flow statements for at least the last few years. Doing so will help you figure out if there are any new or increased costs that you should anticipate. You will also be able to identify if there are any debtors or cash flow issues.
By properly reviewing the financial records, you will be able to predict the business's future performance.
How to Determine the Value of the Franchise
You have to consider several factors when determining the value of a franchise:
- Current inventory The level of inventory is generally dictated by the franchiser, especially in a restaurant franchise. For instance, a restaurant franchise could have a significant amount of inventory if they also sell liquor. You need to factor in all of the current inventory when determining the value of a franchise.
- Physical assets All physical assets such as furniture, computers, point of sale systems, and inventory are relevant to determining the value of a franchise. You may need to depreciate them to their present value to figure out what someone may be willing to pay for them.
- EBITDA EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is generally a rough calculation of the available revenue of your business but may also be used to determine the value of the franchise, along with other calculations.
- Location The location of a franchise can also play a big role in its valuation. For instance, a pizzeria franchise located in a busy area will find many customers during lunchtime. The location of such a unit adds significant value to the franchise.
- Recent sales Recent sales can be used as a comparable when valuing a franchise. However, it is not a good idea to focus only on the recent sales as a measure of valuation. Growth in overall profit and profit margins, sustainable cash flow, and clean financial statements also add value to a franchise.
Read and Understand the Franchise Disclosure Document
According to the FTC (Federal Trade Commission) rule, every franchisor needs to create a franchise disclosure document and give it to every potential franchisee. The FDD should be able to provide validated and vetted information to help buyers make a decision.
The FDD offers the following information:
- History It gives you an overview of the history of the franchiser, including any parent companies or entities affiliated with the brand. It also gives you information about the management team and the business’s history. It covers all litigation in the past few years and reveals if the franchiser has filed for any bankruptcies in the past. The FDD also provides information about all the current operating outlets at different locations and other franchise information.
- Cost The FDD provides details about the initial fees and any ongoing expenses such as royalty, marketing fees, or technology fees. It also gives you an idea about the initial investment required and estimates the total expenditure involved in opening a new franchise location.
- Support The FDD provides details about supply sources and ongoing operational items. It also provides details about operations, training, and ongoing support that you receive as a franchisee. You will also find information about other support issues such as renewing your franchisee fee, transfer formalities, and dispute resolution.
- Franchisee obligations The FDD also covers any restrictions regarding sourcing materials and products. It also outlines your franchisee obligations, such as how involved the franchiser wants you in the business.
The FDD may also contain financial information about how the franchise system is performing. It is an important document, and you should ensure to read and understand all pertinent information before buying a franchise.
Review Transfer Requirements and Pay the Transfer Fee
Most franchisers require buyers to pay a transfer fee when purchasing a franchise resale. The fee covers the cost of the transfer and the franchiser’s cost of evaluating a buyer as the new franchise owner. The transfer fee may either be paid by the buyer or the seller and is generally a percentage of the transfer cost.
Regardless of who pays the transfer fee, it must be paid before the transfer can happen. If you are planning to buy an established franchise, be sure to factor in the transfer fee. Also, you must remember to review all transfer requirements before buying the franchise.
Questions to Ask the Exiting Franchisee
When you buy an existing franchise, you get an opportunity to talk to the owner about their experience. Here is some information that you can get from them.
- How long have you been running this franchise store? If they have been running it for several years, it is a good sign and reflects well on the franchise.
- Were you given proper training to run this franchise? When you receive proper training, you feel confident when running the franchise.
- Do you receive enough support? It is always best to work with a franchiser that provides initial training and ongoing support.
- Are you happy with the financial returns? Asking a direct question about their earning may make the previous owner uncomfortable. Instead, ask if they are happy with their returns.
- Would you invest in this franchise again? The answer to this question will provide a lot of information about their overall experience.
If there are other questions on your mind, you should not hesitate to ask them. However, it would be best to speak to the franchiser to ensure that you got accurate information.
Hire a Franchise Attorney
Before finalizing your purchase, we recommend hiring a franchise attorney to look over the agreement. An attorney’s job is to protect you. They keep up with ever-changing franchise laws and know exactly what to look for in franchise contracts.
A franchise attorney can also help you choose the business entity, and in the event of unforeseen circumstances, can protect you legally.
How to Find an Existing Franchise for Sale
Suppose you are looking for an existing franchise for sale on BizBuySell. Under Buy A Business, add a filter with the keyword “Franchise,” and you have your list ready.
Conclusion
Buying an existing franchise comes with a host of benefits and is a great way to become an entrepreneur. You get to be your own boss and make a difference in the lives of those who work for you.