Investing in a resale can have many advantages over starting a new unit from afresh, but always remember to do your research carefully first,
Franchises being offered for resale usually fall into two categories – those that are profitable operations and those that have not been so successful for their current owner. Both can potentially represent a good opportunity for you, but the risk associated with the second may be greater.
While carrying out your research you must discover which category the franchise you are looking at falls into and which one it will fall into after you have owned it for a while.
In order to do this, you need to receive satisfactory answers to a number of questions, including:
Why is the business being sold? Is it because the current franchise owner wishes to retire, or due to ill health or wants try something different?
How has the franchise performed over the past year or two? What are the trends and what are the reasons given for these?
What is the status of the employees of the franchise? How important is retaining key employees to continue producing future projected results?
If the franchise is dependent on its site for success, what is the status of the real estate? Will there be any issues with the continuation of the lease?
Is there anything that has not yet been disclosed to you that might hinder the business? Make sure to ask this question directly so that your solicitor can include the answer in the purchase contract to protect you.
All this information is vital and the answers you receive will have an enormous influence on your decision. It will probably take some effort on your part to find the truth.
To unearth the best information possible, you will need to not only talk to the seller but also look at other franchisors for further information.
You should also go to the franchisor and conduct a complete investigation of the franchise just as if you were going to launch a new franchise territory. This exercise will give you valuable information to understanding the business and to make sure you have asked the seller all the right questions.
Finally, you should ask the franchisor to confirm the information you are receiving from the seller. They won’t want to because they do not want the legal liability, but they also do not want you to invest in their franchise under false pretences.
If the seller is being liberal with the truth, you will often pick up clues from comments made by the franchisor.
If the business is currently successful, you will have a fairly easy time dealing with pricing, since you have existing earnings to refer to. The best valuation method is to use a multiple of the net cash flow you will receive from the business.
Net cash flow is the difference between the revenue of the business and the necessary business-related expenses required to produce the revenue. You should have access to the historical financial statements of the business to derive this number.
Most franchise owners run expenses through their business that are not really required to operate the business. These can be expenses like company cars, meals and entertainment. There might also be extraordinary salary costs associated with the owner. Take the net income of the business and add back these unnecessary expenses to determine the true net cash flow you can expect.
The price of this type of successful business should be about two to five times this net cash flow number. The more stable and dependable the cash flow, the higher the multiple that is reasonable for you will be. The multiple is also higher when the trends of the business growth are positive rather than flat or negative.
The second type of resale, when the business is not currently performing so well, is more difficult to calculate a price for. The existing owner will always have many good arguments about why the business is not performing as well as it should, but ultimately it comes down to whether you are convinced that a simple change in ownership will rectify the problems.
The only time this is true is when the existing owner is not operating their territory according to the model designed by the franchisor. If you have confirmed that most or all other franchise owners following this model are doing fine and have determined there are no other problems related to – for example a bad location – then you can proceed with some confidence.
In this circumstance, you are looking for a real bargain. If you are not going to get a great deal on the resale, why bother? You can always open a new unit with this franchise as an alternative to buying this resale.