BEFORE BUYING A NEW FRANCHISE, INVESTIGATE FRANCHISE RESALES

The franchise resale market can allow you to peek into your possible future.

If you think buying a franchise is a safer way to enter the world of business ownership for the first time, you’re right… kind of.  With an experienced franchisor there to guide you, and a product or service with proven demand, much of the initial start-up risk is removed.

But this comparison isn’t entirely accurate.  Buying a new franchise isn’t really buying a business – it is buying the right to start a business.  The purchase price is usually a combination of a franchise fee paid to the franchisor, and start-up costs including capital equipment.  The business itself will be starting from zero sales, and you will have to build it up, just like starting any other business.  Going down this path with a franchise rather than a non-franchise business is less-risky, as statistics show.  But it is still starting from zero.

Buying an existing business, on the other hand, means starting from a position of greater than zero: a running start.  With existing customers, an existing brand, staff, systems, equipment & trading history, the future performance of the business is easier to predict.  Even those things the business is not doing can present an opportunity – “fixing” these issues can provide much-needed quick wins in the early days after taking over.  A new business has no such quick wins available.

But buying a business without the guidance of an experienced franchisor can feel lonely.  Often there is no playbook to work from to help the new owner decide what to do next.  And businesses that are already very successful, where a lot of the start-up risk and effort have been removed, will be expensive to buy.

There is a third way: franchise resales.  When a franchisee wants to exit his business, selling it on to a new owner is an attractive first option.  As a result, hundreds of franchise resales are advertised on business for sale websites at any one time.  Buying an existing business which is also a franchise can provide the best of both worlds: reduced risk and less work than starting a brand new franchise business, plus support from the franchisor and franchise network.  Franchises naturally come with restrictions that other businesses don’t have, with the franchise agreement dictating aspects of operations from marketing to sales to administration.  And while the up-front franchise fee for new franchisees is usually not applicable, the ongoing franchise management fee (usually a percentage of sales) will still be payable on an ongoing basis.  

There are a multitude of factors that determine which is the best business to buy (franchise resale or otherwise), but the purpose of this blog post isn’t to go into these.  There is another very specific reason for investigating franchise resales: they provide a look into the future for prospective purchasers of new franchises.

There is another very specific reason for investigating franchise resales: they provide a look into the future

INVEST WITH YOUR EXIT IN MIND

Before buying any business, you must have in mind the goal of eventually selling it.  Unless you intend to hand it over to your children, the ultimate goal must be to build up the business and sell it for a price that gives you a great return on your investment.  By speaking to franchisees who have already reached this stage, you will get important insights into how this process could work for you.  On the other hand, it can sometimes be a very sobering experience.

So if you’re considering buying a new franchise, it is imperative that you conduct research on resales of units of the same franchise.  The first thing to look for is how saleable the franchise is.  Does there appear to be a lot of demand for it?  Are there many units for sale, and do they appear to be turning over quickly?  Business for sale websites don’t provide data of successful and unsuccessful sales so it is difficult to know for sure, but the length of time businesses are advertised can provide some initial indication.  If there are a lot of units for resale, they are staying on the market for a long time, and some are offering price reductions, this is not a great initial sign.

The prices of the franchise resale units are also telling.  Successful businesses should sell for a premium to the purchase price of a new franchise, yet in many cases the prices are similar.   For existing businesses the price calculation can be more complicated than a new business, with adjustments to be made for stock, working capital, assets and deal terms, among other things, as we cover in our free eBook on business valuation.  But the headline asking price figure will provide an initial comparison, before you delve into the details in your discussions with the seller.  It might turn out that the business has been priced incorrectly by the seller and represents a bargain, or it could be that the low asking price is simply because the owner can’t attract a buyer at a higher price.  If the latter is due to something specific about this particular franchise unit (its location for example), and you have reason to believe you can do better, then it might not put you off buying a new franchise and doing things differently to avoid this problem.  But it might also suggest that the reality of running this particular brand is different to the picture presented in the franchise prospectus by the franchisor.

It is definitely worth getting both sides of the story

Remember that franchise units that are struggling may not be representative of the franchise as a whole – by their nature, those ones that are for sale for low prices will generally be the lower-performing units in the network.  The franchisor will be able to introduce you to more successful franchise unit owners who can provide a counterpoint to this.  But it is definitely worth getting both sides of the story.

Highly profitable franchise units do come up for sale too of course.  While these will attract more interest and a higher price, the additional investment will often be worth the money.  In these cases you are not only buying into the systems provided by the franchisor, but the proven successful systems used by the high-performing franchisee – the truest example of what franchise sellers like to call a “turn-key” operation.

However, while marketing phrases like this will abound in the brochures for new franchise units, in most cases there will be no such hard-selling from the franchisor in the case of franchise resales. In many cases the franchisee will be largely responsible for selling the franchise on the resale market himself, without a great deal of support from the franchisor, who is not financially incentivised to help since there is no franchise fee paid on these sales.  

THE FRANCHISOR, NOT JUST THE FRANCHISE

It is very worthwhile to gauge the involvement of the franchisor in the resale process.  Besides discussing everything with owner it is obviously critical to speak at length with the franchisor, who you will be in business with should you proceed with either a new franchise or the purchase of a resold franchise.  Besides the details of the business, what should look for here is the willingness of the franchisor to support resales of the franchise units.  Does the franchisor actively market resale units to new buyers?  Or are they only interested in selling new units?  Make enquiries directly to the franchisor (under a different name for anonymity if necessary), asking about franchises for resale, and gauge their response and the process that follows.  

Some franchisors will be very supportive of the secondary resale market for their franchises and will do everything they can to assist the franchisees who are selling.  Other franchisors will be less than helpful with the entire process – mainly because it distracts from (and competes with) their primary objective of selling new franchise units.  

Anything that makes it more difficult for you to buy an existing resale franchise unit will make it more difficult for you to sell it in future

Some franchises are structured in such a way that the buyer of a resold franchise unit still has to pay the initial franchise fee to the franchisor, as if they were buying a new unit.  It is normal for the buyer of a resold franchise to have to pay a training fee to the franchisor for the initial training they will require, but charging the full initial franchise fee is excessive.  This significantly raises the total price of the transaction to the buyer, without any benefit to the seller, thereby dramatically reducing the likelihood of a successful sale.  

Franchise agreements also often contain the “right of approval” whereby the franchisor must provide their approval for a franchise to be transferred to a new buyer on the resale market.  While not often exercised, these clauses can prevent you (or anyone else) from buying the franchise.

Anything that makes it more difficult for you to potentially buy an existing resale franchise unit will make it more difficult for you to sell the franchise unit in future, and warrants great caution before proceeding with the purchase.

In some cases you may be considering a franchise where there don’t appear to be any units available for resale – in cases like this it is worth investigating why.  Some franchises, especially in business services, are so tied to individual relationships within the franchise network that it is not feasible to sell them to an outsider, which means effectively they can’t be sold at all.  We once asked a leading UK business services franchisor what happens when the existing franchisees are ready to retire, and he explained that they have the option to sell their current ongoing work to the other franchisees (note: not a multiple of their annual work, only the projects that are still open and haven’t been completed yet), and only at a rate of £0.75 on the pound.  This is not selling your business, it is simply subcontracting out your work.  It is important to be aware of this eventual outcome in advance.

This is not selling your business, it is simply subcontracting out your work

CONCLUSION

Before purchasing a new franchise, always investigate resales of the same franchise.  Not only will you gain insights about the real-world successes and failures of franchisees, you will gain an understanding of the franchisor’s approach to the resale process, and ultimately the saleability of your own franchise unit when the time comes.  If you find a business that you are confident you can build and eventually sell, you can proceed with the rest of your due diligence and complete the purchase.  Your final decision might be to proceed with a new franchise, to buy an existing franchise within this brand, or not to proceed at all.  But without doing this research it is difficult to make an informed decision on any franchise, new or resale.