How to avoid a costly mistake when you buy an established franchise
An established business can be a good option for a franchise buyer, but it’s possible to make an expensive mistake and pay too much. The right professional advice can help you reduce risk and increase the chance of making a good return on your investment.
The franchise wasn’t going as Steve had hoped. Far from it! After just two weeks he’d encountered multiple problems: the wages bill was eye-wateringly huge, the monthly recurring revenue was 20 percent lower than he’d expected, and there was a problem with the lease which meant he’d need to find and fit out a new location. Steve was in despair and wondered whether he’d end up losing the $300,000 he’d paid for the business.
Here are two steps that would have helped avoid Steve’s expensive problem.
Carefully assess the business value
“Is the price reasonable?” This is a question we’re often asked by franchise buyers. It’s an important question to consider because it’s all too easy to end up paying too much and leaving yourself with no upside for your efforts.
There are several factors to consider when you’re deciding what a business is worth, including:
- The value of the fixed assets that you’ll be acquiring, including the equipment, fitout and furniture. The assets have a value in themselves, but it will be affected by any refurbishment requirements made by the franchisor or landlord.
- The cost of any refurbishments or repairs needed to bring the equipment and fitout up to scratch.
- The ordinary operating profit that the business has made after paying the wages of the owner for the job they do in the business.
- The pattern of sales revenue over the last few years.
- What’s expected to happen to revenue and costs in the future.
- The amount of time left on the lease and franchise agreements.
- The up-front fees that the buyer will need to pay to the franchisor.
- Whether there are good staff in place and the likelihood of being able to retain them.
- The track record and experience of the franchisor.
- Your ability to sell the business as part of your exit strategy.
Based on this information, you and your accountant can create a financial forecast of the future profit of the business and assess the potential for making a reasonable return on your investment. If needed, you can use this work to help negotiate a better price!
Get thorough professional advice
No matter how savvy you think you are, business, accounting and legal advice are an essential part of the franchise buying process. It’s not just another box to tick. It’s a core part of the due diligence process.
Your financial advice should help you work out whether the franchise can at least make enough money to cover the cost of operation, pay you a wage, and repay the money you invest in the business. If the financials don’t work out on paper at the start they are unlikely to get better later!
In addition, it’s often important to work out the cash flow of the business. For instance, cash flow forecasts are essential if it takes months or years to reach the point where monthly income exceeds costs, or if you’ll need to spend money on refurbishments.
If the financial side stacks up, it’s time to get legal advice.
Legal advice is not just a lawyer telling you what the contractual obligations are. It’s important to understand the practical implications of being in the franchise, including:
- What the franchise agreement means for the day-to-day operation of the business e.g., your choices of staff and suppliers, and your ability to market and promote the business.
- Your options for exiting the franchise and the costs associated with exit.
- Under what circumstances the franchisor could terminate your franchise agreement or refuse to renew it.
- Whether the franchisor can increase their fees or impose additional charges.
- Any requirements to upgrade equipment or premises.
If you operate from physical premises, it’s vital to obtain specific advice on the lease and ensure nothing is in the way of you being able to continue to operate from the premises.
Your lawyer can also advise you on terms that you might want to include in the contract of purchase from an existing franchise owner, for instance:
- The obligations of the outgoing owner to assist you on handover of the business
- The process for valuing any stock on hand
- The outgoing owner’s obligations regarding the condition of equipment on handover
You’re probably thinking that all this advice sounds time consuming and expensive. The truth is that proper advice does take time and costs money. Buying a business is a serious thing (as well as an exciting thing) and it pays to do your due diligence to increase your chance of a good outcome.
Kate Groom is co-founder and director of Franchise Accounting and Tax. She has previously worked for franchisors and as a business adviser. Kate’s focus is on helping clients understand the financial aspects of running a business and on business planning and coaching. She is also a director of a number of ‘not for profits’. https://www.franchiseaccountingandtax.com.au/