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Looking for a Franchise? Consider Purchasing an Existing Franchise

by Ed Teixeira

If you’re thinking of purchasing a new franchise, you may want to consider purchasing an existing franchise. Statistics indicate that, on average, a typical business changes ownership every four years. Franchised businesses are a part of this universe, and studies undertaken by the business brokerage industry report that franchised businesses follow the same pattern.

The Purchase of an Existing Franchise Business can offer Distinct Advantages over a Start-up Franchise Operation:

The current revenue stream of an existing franchise has value and provides an advantage versus a brand new franchise.
Sometimes, a new franchisee brings a level of enthusiasm and creativity that will translate into added sales.
A franchise resale is already equipped and in operation.
Buying an existing franchise can save time and may save money in comparison to starting up a new franchise.
The price of a franchise business could be the same or even less than the investment requirements for a start-up franchise; since people sell for various reasons, including personal or financial factors, there may be a good opportunity available at a below-market price.
For those who seek a franchise in a particular geographic area, a franchise resale may be an option in cases where new franchise territories are limited.
There is a strong possibility that an existing franchisee selling his or her business will offer buyer financing.

Finding Existing Franchises for Sale:

Since franchisors have a right of first refusal for the sale of an existing franchise, the franchisor will be notified when a franchisee intends to sell. If you're interested in a specific franchise program, contact the franchise department to indicate your interest in acquiring an existing franchise. Most franchisors prefer not operating company owned locations and prefer to have a database of potential buyers. Some large franchisors have franchise resale websites.

If you have an interest in a specific area or territory, you could speak with the current franchisee and indicate your interest in buying a franchise.
If you're uncomfortable asking the franchisee, use a third party.
Look for business listings in local newspapers. Individual owners and business brokers will often list a business in the business opportunity section of their local newspaper
Visit business websites such as www.bizbuysell.com, which is the largest Internet site listing business for sale. There are a number of other sites that list franchise businesses for resale.
Contact local business brokers and/or visit their websites. Franchise brokers who represent franchisors may also have franchise resale listings.

The seller of an existing franchise is obligated to pay the business broker a commission on the transaction. The buyer generally has to pay the transfer fee to the franchisor, which may be buried in the purchase price.

The selling price is usually an important issue in any franchise resale. Business brokerage expert Tom West, owner of the Business Brokerage Press, has found that the larger franchise businesses command a selling price that is approximately 10-20% higher than comparable independent businesses. Smaller or newer franchise systems may have a problem with franchise resale’s, which can preclude franchisees from obtaining a reasonable price for their business.

The method commonly used by business brokers to place a value on a small business is the discretionary earnings or discretionary cash method. This method relies on recasting the profit and loss statement, so that the entire seller's discretionary cash ("SDE") is exposed.

This includes depreciation, owner's salary, and all non-recurring and non-operating expenses. Other expenses are considered to be personal or not actually necessary to the business.

The total of these items is then added to any net profit shown by the business. Obviously, a net loss figure would be subtracted from the total. The resulting figure is the cash that is available to the business owner to be used at his or her discretion.

The term "Discretionary Earnings" has been defined by the International Business Brokers Association (IBBA) as a substitute for terms such as Owner's Discretionary Cash and Owner's Cash Flow. The IBBA definition for discretionary earnings is as follows:

Once the actual owner's discretionary cash has been identified, a multiple can be applied to that number to arrive at a valuation. Most small businesses sell for 2 to 2.5 times this number.

In the case of a franchised business, some valuation models use a multiple or a percent of annual sales. It's important to gather information regarding market values for comparable businesses.

Performing Due Diligence

Once you've identified a franchise business for sale, established a purchase price and met the franchisors qualifications, the next step in the process is to conduct your due diligence.

In addition to the typical due diligence involved in the purchase of any business, purchasing an existing franchise presents other considerations. Unlike a brand new franchise, an existing operation has obligations and commitments including leases, vendor accounts and franchise obligations. Be sure to utilize your attorney and accountant in the due diligence process.

Following are some Important Items to Include on your Checklist:

Are there any outstanding franchisor obligations? This could include a required remodel, which the buyer could inherit.
When you sign a new franchise agreement, will the royalty, franchise term, territory or other key provisions remain the same? Has there been an increase in the advertising fund contribution, which isn't reflected, in the current financials? Be sure that key provisions of the franchise agreement you'll sign are compared to the agreement the franchisee is operating under to identify any changes.
Are there enough years on the lease to protect the value of the location? Location can be critical to future success. Conversely, a franchise which has not performed to its potential may require a change in location.
Have there been changes in the market or territory? Look for any recent changes in the territory or market that could impact revenues. There is a significant difference between a franchise operating within a strong market area versus one that is under siege from other franchisees and competitors.

Acquiring an existing franchise can provide a number of benefits compared to a start-up operation. If the purchase price and territory meet your needs and you exercise proper due diligence, you could be off to a fast start with the potential for faster profits.