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HOW TO BUY A FRANCHISE/ FRANCHISE DISCLOSURE 101!
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HOW DOES REFRANCHISING WORK?
‘Refranchising’ as a concept involves the resale and buying of an existing franchise within the franchisor's chain of locations. For Refranchising to work successfully there has to be a clear legal agreement between three parties – the franchisor, the existing franchisee, and the proposed new franchisee/entrepreneur. From the existing franchisee's point of view, there has to be a clear legal ability to conduct a franchise resale in a franchise agreement. That typically will be found in a franchise disclosure document and is important to your purchase agreement. That's a very important disclosure document.
In practice, a good franchisor will want to ensure the prospective purchaser meets any financial and experience criteria that they demand of their franchise base. Significant time and expense can be avoided by ensuring the franchisor is ‘on side ‘with the sale of the business. Other issues that may need to be addressed are initial franchisee fee (same or different?), agreed-upon valuation, and, often forgotten – approval of the landlord under any existing lease.
Logically franchise royalty fees will probably remain the same but should be verified at the time of negotiation. Other issues that might need to be addressed are non - compete agreements for the existing franchisee, as well as training within the franchise network or head office.
In certain cases, the refranchise arrangement might be of a corporate store that has been taken back by the franchisor. Franchisees are strongly guided to investigate the general circumstances around the loss of the initial franchise. In certain other cases enter blocks of corporate stores might be franchised as part of a new business direction, or done to reduce franchisor debt.
What are the differences between buying a new franchise?
One key difference in a refranchising arrangement is that financing arrangements are significantly different. If the franchisor has a program arrangement with a finance firm or bank the proposed franchisee can be suitably guided to that organization. In the case of purchase price the sale of the business must be guided by a proper valuation of assets, profits (or losses) and cash flow.
The current franchisee, as well as the prospective buyer both, have the ability to maximize a successful transaction – that is because the business is no longer a start-up and proper values around financial performance and growth potential can be both touted by the current franchisee, or discounted and negotiated against by the proposed buyer.
When it comes to the actual refinancing of the business it is prudent for both the current owner and franchisee to seek a third-party appraisal of any business assets. Certain assets might have diminished in value – others may have stayed the same or in fact appreciated.
In many circumstances, the concept of goodwill must be addressed by the purchaser - Goodwill resulting out of the excess of the purchase price to book value of the assets. This will have to be treated as an intangible on the new balance sheet and potentially written off over time.
The ability to successfully ‘ turnaround ‘ a poor performing location is a great business challenge and can provide a great return on investment for an experienced business owner/franchisee.
What factors are needed to make refranchising beneficial for the new franchisee?
As in any business arrangement, a win/win attitude by all three parties typically makes for a solid refranchise arrangement. However, from the new franchisee's point of view, the entrepreneur has the ability to more properly value business potential based on current store performance. A good franchisor will help in benchmarking the results of that location against others in the chain.
The good news is that many refranchise arrangements are easier to finance – as assets, cash flow and growth potential are more definable from the lenders perspective. At the end of the day proper disclosure of financial performance by the existing franchisee, with the assistance of the franchisor is critical.
We commonly recommend a very logical method of ascertaining business success through a refranchise – simply to obtain 3 months of business bank account statements to validate inflows, outflows, reported income, etc. Knowing that the current franchisee had a reputable accounting firm also helps.
The ability to have the right amount of time to execute a proper level of due diligence is key to franchising success.
Conclusion
Starting a new business or purchasing an existing one are important life decisions. So if you want to buy a franchise, or open a new one, seek out and speak to a trusted, credible and experienced Canadian business financing advisor who can assist you with franchise resale financing success.
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Stan Prokop
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