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Refranchising: Should You Buy In?

Consider these factors before buying a company-owned franchise unit.
November 6, 2009
URL: http://www.entrepreneur.com/article/203932

Lately, more and more franchise companies are converting a significant number of their company-owned units by selling them to franchisees. This trend, commonly referred to as refranchising or retro-franchising, can be driven by any number of motivations on the part of the company, and it may represent a wonderful opportunity for a careful buyer if the circumstances are right.

In order to understand whether or not purchasing a company-owned unit would be a good opportunity for you, you need to know why the company acquired the unit in the first place and what has changed so that they now want to sell it. There are a number of factors that might motivate a franchisor to acquire company-owned units:

Earnings: Franchise companies often begin acquiring units in their system (either by opening new ones themselves or by buying out existing franchisees) because they believe that this will be a good way to increase their company's earnings. They have excess capital and decide to invest it in this manner. This is the most common motivation for investing in company-owned stores, especially in large franchise systems where hundreds or even thousands of units are owned by the franchisor.

Operational experience: Many franchise companies purchase and operate units in their systems in order to stay closer to the point-of-sale experiences that their franchisees are facing every day. This helps them avoid criticisms that they have developed an "ivory tower" mentality because they are too far removed from the day-to-day operational challenges faced by their franchisees. It also allows them to develop operational support staff that have the real-world experience needed to give them credibility with the franchisees.

Training facilities: Franchisors sometimes also acquire company-owned units to use as live training facilities for new franchisees or staff. They feel that this type of environment is far better for learning than a completely academic classroom setting and therefore the investment is warranted

First right of refusal purchases: Many franchisors acquire units in order to facilitate or control the exit of one franchisee in favor of finding another that will be more effective for the system. Such purchases might be based on negotiation with a franchisee that desires to leave or they might be based on the company exercising a first right of refusal on a proposed sale by a franchisee. In either case, the franchise company typically isn't buying the units to hold onto but rather with the intent of reselling to another franchisee as soon as possible.

Just as there are a number of reasons why a company might decide to acquire units in their system, there are also a few different reasons they might decide to sell them off. It is very important that you understand their reasoning if you are contemplating purchasing a company-owned unit. Here are the most common reasons:

Financial management: Many of the franchises with lots of company-owned units are very large publicly traded companies. They typically have purchased units as an investment and use this ownership position to control fluctuations in their cash or earnings position, often in time frames as short as a calendar quarter. These decisions are usually driven by financial executives rather than operational executives. If this is the reasoning that drives a decision to sell, it can be a great opportunity for the buyer since there isn't necessarily any negative stigma attached to the unit for sale. Many large fast food franchises like McDonalds, Hardees, Yum Brands and Arby's conduct these types of unit sales on a fairly regular basis.

Overall strategic decision: Sometimes a company will decide, for strategic reasons (often after a change in senior management or majority ownership,) to sell a significant percentage or even all of their company-owned units and deploy their investment cash in a different manner. These are the decisions that usually make the news because the number of conversions can be quite large. In the past decade we have seen such decisions made by companies such as 7-Eleven, Sylvan and ampm. These situations can be great opportunities because, again, the decision to sell was not necessarily driven by poor performance at the unit level.

Poor operating results: Sometimes a company will decide to sell units because their performance is bad and the company doesn't want to keep losing money operating them. Though this can represent an opportunity to get a good price or terms on the sale, a potential buyer needs to be very careful about purchasing someone else's problems. Franchisee-owned units tend to perform better than company-owned units, but if the problem with the poorly performing unit is related to something like real estate, a good operator may still end up losing a lot of money. You need to be very careful evaluating a potential purchase if the seller is motivated by a desire to eliminate losses.

The overall advantage a buyer has when purchasing a company-owned unit is that there is an operating history that they can review. It is often possible to gain an immediate, profitable customer base and have positive cash flow from the first day of ownership. You are certainly going to have to pay more for such immediate success, but for many this type of purchase represents a safer option than starting a new franchise from scratch.

Just as with any franchise acquisition, the key to success in buying a company-owned unit is to make sure you've done thorough research. You should also involve experienced advisors such as an attorney and accountant to make sure that you have covered all the bases necessary to reduce your risk and increase your chances for a great result. Know the motivation of the seller and follow this advice and you're well on your way to a good result from converting a company-owned unit into a franchise.