Q: I have the opportunity to buy an existing franchise from the current owner who is a franchisee. How does buying an existing franchise differ from starting a new franchise?
A: There are some significant differences and potentially some advantages to buying an existing franchise instead of starting from scratch.
- You get a head start. You get to skip the hassle of looking for a location, building out the site, purchasing all the necessary furniture, equipment and signage, finding vendors and buying inventory, looking for employees to hire and train, etc., etc., etc.
- There's history. The business already has a reputation in the community and existing customers. You can see how much volume the business has done historically, how much income it has earned, better determine your working capital requirements and understand the location's seasonality and operating trends.
- You know its cost. With an existing operation, the buyer pays a negotiated price that may be based upon the location's asset base, cash flow or some other agreed upon terms or conditions. On the other hand, the information franchisors provide you in their UFOC is, at best, an estimate of your costs to develop a new business.
- You can better gauge your return on investment. Even with an experienced franchisor providing guidance and with all the research available, calculating your return on investment with a new location is still speculative.
- It's easier to finance. Banks like that they can base their lending decisions not only on the franchise system's reputation and your background, but also on the performance of an operating location.
Still, don't assume purchasing an existing franchise means you get a free pass when it comes to research. Seek an attorney familiar with the rules of franchising. And even if the historic information looks solid, you need to dig deeper. Find out:
- why the franchisee is leaving the business.
- whether the staff and existing management will be staying. If you're counting on having a staff ready and trained, you need to be sure the staff will stay with you.
- if the current trends for the business are still strong. Is the market drying up? Has the neighborhood started changing? Are new competitors coming into the market that could affect future performance?
- what location and center your business is in. Will new road construction affect your location? Will there be changes in the retail center's anchor tenants? Is the center's management changing? If so, what is the reputation of your new landlord?
Make sure you look at the location as if you were starting fresh. After all, if the business has been declining for several months or years, there's no guarantee you'll be able to turn it around. Don't think that just because you'll work harder or smarter than the prior owner, you'll perform better.
As a new franchisee, you might expect to receive a copy of the franchisor's disclosure document. This may not be the case when you're assuming an existing agreement without any modification. Since the agreement you're signing is simply a transfer of the seller's agreement, the franchisor may not be required to provide you with a pre-sale disclosure.
However, if the franchise agreement the franchisor is offering you differs from the franchise agreement of the existing franchisee, you should expect to receive a copy of the franchisor's disclosure document. Read the new agreement and disclosure information carefully, because it may contain fees and terms very different from the agreement signed by the existing franchisee. These changes could have a major impact on how much the business is really worth.
Michael H. Seid, founder and managing director of franchise advisory firm Michael H. Seid & Associates, has more than 20 years' experience as a senior operations and financial executive and a consultant for franchise, retail, restaurant and service companies. He is co-author of the bookFranchising for Dummiesand a former member of the International Franchise Association's Board of Directors and Executive Committee.
Kay Marie Ainsley, managing director of Michael H. Seid & Associates, consults with companies on the appropriateness of franchising; assists franchisors with systems, manuals and training programs; and is a frequent speaker and author of numerous articles on franchising.