The Pros and Cons of Buying an Existing Franchise
In theory, the franchise concept is a brilliant business model. However, buying a new franchise does not guarantee success. It is, for the most part, a concept that has proven effective in some areas under certain conditions. Given the generally dismal failure of start-up businesses, there is another option if you wish to buy a franchise: buy an existing franchise. But just because the purchase price is going to be lower than the cost of starting a new franchise, does not mean the franchise is a good investment.
The business is already up and running, so you may be able to start doing business immediately, with vendors, customers, trained employees, and cash flow on day one. You will also avoid all the issues of choosing a location, building out a site, and reviewing demographic studies - it's not uncommon for a new franchisee to wait a year or more until their location is ready to start doing business.
An existing franchise has a history. Instead of guessing whether your new business will be successful, you can analyze actual historical financial data to determine whether or not it is a good business. It is far easier to investigate a known entity than a start-up. With an existing franchise, you have the opportunity to review the seller’s books and records and make a determination of future performance based on real numbers in an operating location.
With an existing franchise, you can negotiate the purchase price. New franchises come with a set price and terms, on which the franchisor is rarely flexible. With a resale, you can sometimes negotiate the price, payment terms, training from the seller, and every other aspect of the deal. But although it's a new business, you also need to find out the terms of the agreement your franchisor is going to be willing to grant you.
Finally, you can speak with other franchisees in the system. If you conduct your research discreetly, they will provide you with insight about the specific business and the franchisor that you may never be able to determine on your own.
Not all franchise companies advertise the locations that may be for sale. As such, your search may take a bit longer than what you would normally experience in a non-franchise business search.
The franchisee's financials will tell you quite a bit, but in addition to the normal issues you want to look at in conducting due diligence for a new franchise, you should find out:
- Why is the franchise leaving the business?
- Will the existing staff, especially the managers, be staying?
- Trends for the location – have they been continually strong, or have they been on the decline?
- Are the neighborhood and its demographics beginning to change?
- Are there new competitors coming into the market that could affect future performance?
Once you have identified an opportunity, look at the location as if you were starting fresh. If the business has been on a decline for the past several months or years, don't assume that you will work any harder or smarter than the seller. And if the franchisor requires you to bring the location up to then-current standards, you need to understand your additional capital requirements. Understanding the cost of upgrading the location, the time you have to make the improvements, and whether or not you will need to close the location during the remodeling is essential for you to know in advance.
The franchisor generally has the right of first refusal to buy any individual franchises within their system. You will want to get confirmation from the franchisor whether they intend to do so. If not, you can go through the entire negotiation only to learn someone else is going to buy the business.
Don't assume that you are going to be able to assume the existing agreement that the seller has, and don't assume that assuming an existing agreement is even going to be beneficial for you. The franchise agreement that you may be required to sign may be different from the sellers. Your fees and other terms may be different than the seller has been operating under, and those changes may be significant.
Obtaining third-party financing may be more difficult because the better franchisors have relationships in place with some lenders to help to finance their new sales.
Most franchisors won't require you to pay a new franchise fee, but many will still charge a transfer fee that either you or the selling franchisee will need to pay. Some franchisors will also charge the buyer for the initial training they will require. The franchisor will likely want to see how much you are paying for the business and how you plan on financing your purchase: there is little advantage to any franchisor if you overpay for the business and then can’t service your debt and fail.
You may be also be required to complete a time-consuming and costly orientation before the franchisor gives you their final approval as a franchise. In this case, you clearly need a mechanism to extract yourself from the deal if, for any reason, you are not approved.
Buying an existing franchise is a great way to become a franchise, and it has a host of significant benefits. However, just as with any investment, you need to do your homework, and you need to have qualified legal and business advisors working with you.