HOUSTON BUSINESS REVIEW

Tutorial On Selling Your Business: Buying a Franchise – Part 2
By Ralph Fain

Ralph Fain is a principal in the R/ Fain Group, a professional business brokerage firm which confidentially represents the interests of sellers/ buyers of “Mainstreet to Mid Market” companies (revenues from $1MM to $25MM). Mr. Fain has over 20 years of broad business experience with Fortune 500 companies as well as with small/medium sized companies and has served in various capacities including Controller, Vice President, and President/CEO. Each week he will provide comprehensive information on the many aspects of buying/selling businesses.

Last week’s article discussed franchising in summary form – what constitutes a franchise, how a typical franchise operates, the relationship between franchisors and franchisees, etc.  Today’s article will continue our discussions of franchising where we will cover the advantages and  disadvantages of owning a franchise.

            Several primary advantages are as follows:

1. By and large, franchises are less risky than starting a business from scratch.  Just simply due to the nature of the arrangement, the franchisor shares in the risk of the franchisees and has every motivation to ensure the success of the franchisees.
2. As a franchisee, you are granted an exclusive territory or, better said, exclusive rights to an area or territory.   The franchisor cannot locate another franchisee in your territory thus the competition is somewhat lessened in your area.
3. The franchised business is based on a proven concept.  Whether it is selling fast food, cutting hair, or cleaning carpets, in many cases, there is a franchise providing the product or service;  as a potential franchisee, you can verify how successful the concept is by checking with other existing franchisees.
4. Franchisees have name brand recognition and trade marks, patents, etc.  Unlike start-up businesses, potential customers/clients recognize the name and associate the merits of the product or service with the franchise and franchisee.
5. Related to the above, franchisees are provided with a guide to running the business and are generally also provided with the training and support necessary for themselves and their employees.
6. Financing, in certain situations, can be easier.  With large, well established franchisors, banks are more willing to provide financing; and, there are even a few franchisors who assist the franchisee with the requisite financing.

As is generally the case with most things, there are some negatives along with the positives.
           
Some of the primary disadvantages of franchising are:

1. As a franchisee, you are restricted in what you can do and how you operate the franchise.  You are required to follow franchisor rules/guidelines and are not given wide latitude in how you run your business but instead must run it according to the franchisor’s policies and operating procedures – even if it may be more profitable to do otherwise.
2. Although your risk may be reduced, as mentioned in a previous article, reduced risk, more often than not, translates to reduced earnings potential.  Incomes from various franchises (especially long established ones) generally fall within fairly specific and predictable ranges, with the income potential directly proportional to the investment made – i.e., the larger the dollar investment, the greater the probability for a significant income.
3. Costs, particularly start-up costs, can be much higher than estimated/anticipated and, unlike with the purchase of most existing businesses, positive cash flow is not achieved immediately – it may require many months before the franchise begins to make money.  Additionally, in addition to the initial franchise fee, you pay a continuing royalty to the franchisor and may have to make additional payments to the franchisor for advertising and other expenses.  Further, in many franchise agreements, the franchisee is required to purchase certain items from the franchisor or from specific vendors designated by the franchisor (purportedly to ensure quality control) and is prohibited from purchasing certain similar products from more competitive vendors – this may increase operating costs to you, the franchisee.
4. There is no guarantee than the franchise agreement will be renewed upon expiration.  Although somewhat rare, there have been instances where this or worse (agreement terminated early) have occurred.
5. Similar to the above, the sale of your business is somewhat restricted.  In almost all cases, you can only sell to a party approved by the franchisor and, in certain cases, the franchisor may participate in a percentage of the sales proceeds or may charge a fee to the franchisee.
6. Finally, your franchise’s name and reputation may be adversely affected or seriously damaged by factors beyond your control.  For example, a sister franchise, located miles away but still within your city, serves tainted/damaged products which sickens a large number of people and this event makes the local/national news; you can be assured that the revenue at your franchise location, although you had absolutely nothing to do with the problem, will be diminished for some time as a result of the other franchisee’s negligence or perceived negligence.

The above represent just some of the pros and cons of purchasing a franchise.  Although we have discussed and will continue to discuss the purchasing of businesses and franchises in our articles, it is nevertheless incumbent upon you, the purchaser, to employ and utilize professional counsel – CPAs, attorneys, M&A/business broker advisors, etc.  The reader of these articles can not possibly glean sufficient information from this series of articles to “go it alone”.  Your professional advisors will guide you through the process of purchasing a franchise and /or existing business and are worth every dollar paid to them – do not be “penny wise and pound foolish” by foregoing the employ of professional advisors (they will definitely save you money in the long run).