There are really two ways a Franchisor can recruit Franchisees. The first, is to operate a business in a respective territory and sell that business as a going concern to a Franchisee. The other, is to sell the opportunity to operate a business in the territory – what is colloquially known as a ‘greenfield sale’ to a Franchisee. Most Franchisors reading this have likely found themselves in a position of doing both of these options at some point, and this article will discuss the benefits and disadvantages of each option. Naturally, the most common way to grow a system – particularly quickly – is to sell greenfield locations to Franchisees. However, having acted for numerous Franchisors for over ten years, and working in a firm that has acted for Franchisors and Franchisees since 1995, readers may be surprised to learn of the number of Franchisors who build the business first and then sell it.
Corporate Owned
As a Franchisor, you know how to make your business succeed. After all, it’s the reason you decided to Franchise. Your model works and you know exactly what needs to be done to get great results. As a Franchisor you know the margins of your goods or services like the back of your hand, and you know the amount of staff required to ensure customers remain loyal and happy, and to ensure the business is profitable. Typically more common in brick and mortar Franchised Businesses, a Franchisor (for the reasons above) may be inclined to establish a great business in a Territory with the intention of selling that as a going concern to a Franchisee.
When a Franchised Business is sold in this manner, the Buyer (or potential Franchisee) not only enters into a Franchise Agreement, but they also enter into a Business Sale Agreement with the Franchisor (or that entity which is an Associate of the Franchisor) for the purchase of the business. This is a key difference firstly from a tax perspective. A Franchisee acquiring a business as a going concern will not pay GST on the purchase price, whereas a Franchisee entering a greenfield Franchise Agreement will. Rather, in this instance, a Franchisee is liable for Stamp Duty for the Purchase Price of the Business.
The Business Sale Agreement should contain special conditions which make settlement subject to and conditional on the Buyer entering into a Franchise Agreement. Typically the Buyer will be required to pay a purchase price pursuant to the Business Sale Agreement only and the Franchise Fee component of the Franchise Agreement will generally be nil, however is not always the case – particularly where training may be provided pursuant to the Franchise Agreement, rather than pursuant to the Business Sale Agreement.
The Benefits of selling corporate owned businesses to Franchisees
The benefit to a Franchisor of setting up and then selling a business as a going concern to a Franchisee is the Franchisor will have actual financial data to present to a Franchisee, that is relevant to that business. This is both helpful in terms of a Franchisee being able to obtain finance (where the Franchise System does not have the required clout to attract lending from the big four banks in Australia) and allows the Franchisor to calculate a Purchase Price reflecting the actual profit of that business.
Where a Franchisor intends to sell a business as a going concern to a Franchisee they would be wise to pay a Service Fee (although not legally necessary) as this will reflect an accurate profit margin for the business. Further, any business operated by a Franchisor is legally required to pay the Marketing Fee (if the Franchisor charges other Franchisees a Marketing Fee) to the Marketing Fund.
Providing earnings information to ‘greenfield’ Franchisees is extremely risky and if earnings information is provided (which includes forecasts or details of the performance of other franchisees in other Territories) it must be done in accordance with the Franchising Code of Conduct. Here, however, in a sale of a going concern business the risk is substantially reduced, because the data provided is data reflecting the actual performance of the business being sold. This is a huge benefit to a Franchisor.
The other major benefit of selling a business as a going concern, operated by the Franchisor (or Associate of the Franchisor), is the ability to charge an amount for the goodwill established in that Territory. Whereas a Greenfield Franchisee is only liable to pay the Franchise Fee (essentially for the opportunity to operate a business) with a sale of a business as a going concern, the Franchisor may charge whatever amount that reflects the goodwill and profit of the business – and this amount will likely far exceed the Franchise Fee.
The disadvantages of selling a business as a going concern to a Franchisee
The most obvious disadvantage is that to sell a business as a going concern, the Franchisor needs to spend time, effort and resources getting a business up and running. The Franchisor needs to enter a Lease (which to be fair, may still occur even when a greenfield business is sold if the Franchisor wishes to retain the control of holding the Lease and granting a Licence to Occupy to the Franchisee), hire staff, conduct and pay for the fitout, acquire the equipment and products, and, in short, invest a lot of effort building the business to a point where it can be sold. The outlay and risk of time, resources and energy by a Franchisor to establish the business is almost counterintuitive to having a Franchise System, where Franchisors have the ability to pass this risk and cost on to a Franchisee.
The second major disadvantage of establishing a business to be sold as a going concern is that it puts the Franchisor back on the tools. In our experience, the most successful Franchise Systems are ones where the Franchisor has created a system that allows them to be off the tools and focus their time and resources on growth, recruitment, support and refining the systems and processes.
A Franchisor who is on the tools, operating a business with the intention to sell – even if it is simply in the capacity of overall management of staff and operations of that particular business – is a Franchisor that now is distracted from national or international growth of the Franchise System. It is for this reason, in our experience acting for Franchisors located all over Australia, we find those Franchisors who elect to establish businesses themselves first and subsequently sell to a Franchisee, will typically grow their Franchise System at a much, much slower rate. Even worse, some Franchisors get stuck ‘on the tools’ and find themselves trapped operating businesses without the time, energy or resources to even think about getting out and recruiting Franchisees.
Summary
For those Franchisors who are not concerned about rapid growth and have the resources and required energy to start businesses with the intention of selling them to Franchisees, the ‘build and sell’ model can work well. Franchisors in this category however typically have a hard time conceptualising that someone else could build a business using their brand from the ground up. If you are a Franchisor that resonates with this type of thinking, you would be encouraged to trust your systems and processes (outlined in the Manual) and have faith in your brand your IP. Whilst you certainly have more control when it comes to the ‘build and sell’ model, the ability to leverage your time across numerous States recruiting Franchisees will be greatly hampered if your attention is on the operations of numerous businesses you own and operate.
Greenfield
The franchise model, if it were to be summarised in a sentence, allows a Franchisor to sell to a Franchisee the opportunity to operate a business using tried and tested systems and a brand developed by the Franchisor. In essence, the franchise model allows the whole concept of selling a ‘greenfield business’ to exist.
By far the most common way to recruit Franchisees, this model is where a Franchisor grants the right to a Franchisee to start a new business, in a new Territory, with training and the right use systems, processes, IP and branding established by the Franchisor.
As discussed above, the sale of a Franchised Business is essentially a sale of goods and services – it is not the sale of a business. For this reason, the Franchise Fee (or opportunity fee) will attract GST. It could be called, ‘the sale of right to start a business using someone else’s IP’.
The Benefits of selling a greenfield business to Franchisees
When a Franchisor enters into a greenfield Franchise Agreement with a Franchisee, the Franchisor has not been required to enter into any leases (unless the Franchisor elects to, to maintain control of the premises), the Franchisor has not been required to employ staff, pay for a fitout, purchase stock or equipment (other than that sold to the Franchisee) or take on any risk of starting a new business; this is all done by the Franchisee. This is by far the greatest benefit of growing a franchise system by selling greenfield locations.
The Franchisors time is solely spent on recruitment, ensuring the right people are welcomed into the Franchise System (as discussed in my previous article), and developing and refining the business’ systems and procedures. This means the Franchisor has an ability to grow the Franchise System by 50, 100, 200 Franchisees, and is limited only by the time it takes to find Franchisees and the time it takes to ensure the right people are being recruited as Franchisees – which is important.
The Franchisor who grows in this manner, is trusting in the systems they have developed and reaping the rewards of establishing valuable goodwill in the brand name. It takes hard work to get to this point, but once the brand and systems are strong enough to stand on their own two feet, there is little reason to go out and start a business owned by the Franchisor with the intention of selling it. That said, some of our Franchisor clients operate Franchise Systems where their Franchisees are so successful, they are entering into Franchise Agreements with themselves to make additional profits as Franchisees. In other words, Franchisors (or wives of Franchisors) also becoming Franchisees, because the model works so well. That is a true testament for those Franchisors, that their Franchise System works well.
The disadvantages of selling a greenfield business to Franchisees
The main disadvantage of selling a greenfield business is, as discussed above, the lack of financial data that can be provided to a potential Franchisee. Sure, a Franchisor can provide earnings information based on the performance of the overall Franchise System, however, ultimately a Franchisor will never be in a position to know how a Franchisee (new individual) will operate in a new Territory; this depends on the Franchisee’s own abilities, motivation, dedication, and most importantly, ability to follow the system and adhere to the Manual. Due to the lack of financial data, unless the Franchisor is so well established (or has banking friends) it will be difficult for Franchisees to obtain finance from a big four bank to borrow any start up capital required to pay the Franchise Fee and any other establishment costs.
Summary
The greenfield sale of a franchised business is why the franchise model exists. It allows a business owner, who has worked tirelessly to establish strong brand recognition with customers and clients and has laboured for years to refine systems and processes that result in a profitable business model when adhered to (collectively referred to as Intellectual Property, or ‘IP’), to allow someone else to use that IP to grow their own successful business.
An individual (a Franchisee that is) now can use someone else’s IP and profit, themselves, from the use of that IP. Franchisors in this category know their IP is valuable, and they know that if someone else operates a business the way they did, using their brand, they will make money. It is as simple as that. A Franchisor who has created this IP (or otherwise acquired this IP), is able to enter into a Franchise Agreement with someone whom they trust is the right person to waive the banner of their brand and charge a Franchise Fee for the use of that IP.
Building a franchise system by way of greenfield Franchise Agreements is certainly the fastest way to grow a franchise system. As a Franchisor here, you can help others start new businesses where they might not ordinarily have the ability or know how to do so. In addition, with your support and training, others now have an opportunity to own successful and profitable businesses using your IP.
