The Purchase Decision
The Purchase Decision
To buy an existing business or look for a greenfield (new) location will be only one of the many questions franchise buyers will need to consider. The most critical step when considering the purchase of any business is the ‘due diligence’ process. Simply put, due diligence is a comprehensive study of the business to establish and verify the current position (financial and operational) and to evaluate its future potential.
Some aspects to consider include:
- What is actually being bought? Buyers need to consider the purchase price in light of the sustainability of the business model, condition and suitability of equipment,quality of the stock, lease and franchise terms, goodwill values etc.
- Ingoing costs including working capital, landlord bond, prepayments, stamp duty, GST, training (including travel and accommodation costs) legal and accounting expenses plus a contingency for the unexpected.
- Current financial performance. If considering an existing business, the buyer should look at the historical financial statements (prior 3 years plus management accounts covering the period since the end of the most recent financial year). Analyse trends, benchmarks and prior financial performance, verify turnover, margins, labour costs, overheads, lease terms etc. If the location is greenfield (new).
- Professional input in drafting financial projections is essential. Does the purchase price being asked reflect the financial performance of the franchise? It is not uncommon for a business’s value to decline over time as equipment and fitouts depreciate and lease/franchise terms expire. Purchasers are best to seek expert advice to ensure the purchase price is fair, reasonable and supported by current market evidence.
- Ongoing refurbishment costs, equipment replacement costs and timelines need to be considered. It is not uncommon for leases of retail business to require a major refurbishment prior to any lease extension. Also, franchisors may require equipment and vehicles be replaced at specified times.
- In assessing the expected financial return.Separate the personal excursion component (income the buyer would expect from working in the same job for someone else) and the return on the financial investment. Buyers need to consider the overall risk and ensure they are getting a satisfactory return on their capital.
- How much capital will be required and how will the franchise be financed? Buyers should speak to a banker with expertise in the franchise sector who will be able to assist in understanding the financial, transactional and personal requirements. Buyers need to prepare a comprehensive business plan and detailed application to support any request for finance. This will include copies of personal bank statements, business sale agreements, leases, franchise agreements, historical financial statements, financial projections (with assumptions) etc.
- As part of the purchase process, buyers need to consider their strategy to sell or exit the business. Assumptions and expectations should be discussed with their respective advisors. How the owner maximises the businesses financial return will have the most impact on the sale price. Risks need to be considered and understood. (Increased competition, reduction to profit margin, changes in consumer taste etc.).
- Contacting a wide range of existing and previous franchisees. Contact information will be provided by the franchisor and included in the franchise disclosure document. Intending purchasers should enquire about franchise support, communication with the franchisor, initial and ongoing training, financial returns, trends, quality of suppliers and other issues which may be key factors within the business/industry.
- Buyers need to conduct their own independent research on what it means to be the owner of a franchise business, including their rights and responsibilities. The Franchise Council of Australia (FCA) and Australian Competition and Consumer Commission (ACCC) have a large amount of information and reference material. This could be very useful in building an understanding of the franchise business model.
Purchasers need to ensure this process is not rushed and they have the full co-operation of the vendor, business broker, landlord and franchisor. Purchasers should not proceed unless they are sure they have full disclosure from all parties. Businesses with a seemingly low sale price may hide a higher risk. In addition to the initial purchase price and ingoing costs, the incoming business owner is liable for any ongoing losses (including minimum franchisee fees) and is responsible for the ongoing lease liability and de-fit obligations at the end of the lease. Notwithstanding a seemingly low initial purchase price, these costs quickly add up and magnify potential losses. This often results in dire financial consequences for the purchaser.
Where to start
As already outlined, the purchaser should undertake a comprehensive due diligence process on the business. This should be conducted with the assistance of a business advisor, accountant and lawyer, all of whom are expert in the franchise sector.
The franchise system should be comprehensively researched and disclosure documents, franchise agreements, leases and other documents examined and understood. Research should include details on the background of the franchisor and its executives. Any financial failure by the franchisor will impact the ongoing viability of the business and its value. Several recent franchisor failures have resulted in franchisee businesses being rendered worthless.
Workplace payments to employees need to be verified and tested. Staff rosters should be closely examined for hours worked, payments made and compared to award conditions. Any additional labour costs will reduce the future maintainable earnings of the business being purchased and will have a significant impact on business values. If undetected, this will cause additional financial stress to the purchaser.
A meeting with the landlord will provide an opportunity to ask questions and better understand where the franchise business fits within the location/centre. Ask about possible impacts from redevelopments, both within the centre and within the catchment area. Make enquiries with local authorities to better understand any risks and future impacts.
Meeting with the franchisor to discuss the future direction of the franchise business and the system as a whole will also assist.
Does the franchisor plan to introduce new products/services? Will additional equipment be required? How does the purchase price of stock compare to competitors (franchise and independent)? Does the franchisor receive a rebate or incentive from suppliers and does this get passed back to the franchisee?
On completion of the due diligence process, the buyer should use this information to determine if they want to proceed with the purchase and on what basis.
If the due diligence and research process uncovers information impacting the business the buyer may either decide not to proceed or reassess the price they are prepared to offer. It is important that any sale agreement contains conditions allowing this outcome.
If the purchaser is applying for finance they should speak to a banker who specialises in lending to the franchise sector. Preparation including a completed business plan and supporting documentation will assist in this process.
The purchase of any business, franchise or otherwise, is one of the most important decisions anyone can make in their life. Not only will they need to pledge all their assets (including the family home), they will be liable for any future losses. To be a success they will need to fully commit to the business and be prepared to apply all their time and effort.
Although buying any business has an element of risk, undertaking comprehensive research and completing a due diligence process will provide a better understanding of the opportunity. Experience shows that purchasers who put in time and effort at the investigation stage have a much better understanding of the key business drivers and the importance of relationships with key stakeholders including, franchisor, landlord, suppliers, banker and other franchisees.
If the process is done well, the purchase or establishment of a franchise business can provide worthwhile financial and personal benefits and be highly satisfying.
Additional information is available at Westpac’s Davidson Institute website located at:
Steve Seddon is Westpac’s, Senior Business Development Manager – Franchising, Western Australia, Queensland and South Australia. He is a CPA and a member of the Franchise Council of Australia’s Western Australian committee.
Westpac continues a long-term commitment to the franchise sector in Australia. The bank has a national network of franchise specialist business bankers who are able to assist with the specific needs of the franchise sector.
Contact Steve at:
0407 401 892