Entrepreneurs who want to operate a franchise location must choose whether to start a new establishment or purchase an existing business. While opening a new location comes with its own perks, those who decide to buy an existing franchise will find other benefits, such as pre-trained staff and an established reputation. However, before signing any contracts, you should consider a few factors.
Here are eight things you should know before buying an existing franchise.
1. Understand The Franchise Disclosure Document
A Franchise Disclosure Document (FDD) is a legally binding contract between a franchisor and a franchisee that encapsulates all the requirements, terms, and conditions that come with owning a franchise. This franchise agreement, spelled out by the franchisor, informs a franchisee of all the responsibilities they must uphold as an owner and describes how the franchisee should conduct the business. It includes information regarding branding and advertising (such as logos), training, quality control, indemnification, fees, and other required purchases. Buying a franchise is much like buying a mortgage on a home and comes with enforceable obligations over the course of the agreement.
2. Review Transfer Prerequisites and Financial Risks
If you’re considering the purchase of an existing franchise, you’ll want to review transfer requirements and consider the responsibilities and financial pitfalls—which include economic health, government regulations, competitors coming into the market, etc.—involved before moving forward.
Start by obtaining approval from the franchisor. Prerequisites in existing contracts could put restrictions on a franchise’s transfer, or the franchisor could have the right of first refusal—meaning they can buy back the franchise, instead of transferring ownership.
Before continuing with the purchase, ensure nothing is preventing the transfer of the franchise from being a success. A transfer without approval could have costly consequences.
3. Discover the Business Value
A business’ current inventory, goodwill, brand recognition, equipment, assets, and current state all contribute to its value. For example, outdated, broken, or unmaintained equipment can be a big financial risk for a new franchisee and would require a major investment to repair.
Browse through reviews of the business as well and talk to locals to ensure the business doesn’t have a negative reputation that will impact its performance. Determine how the business’ desirability and location play into its overall value.
4. Understand the Seller and Franchisor
Do your research before buying an existing franchise and find out why the seller has decided to sell. Though financial hardship, life changes, or retirement is often the cause, it’s important to verify that the seller is not offloading the property due to poor performance or history.
Talk to existing employees and the seller about their experience working with the franchisor, as well. If they are selling the business due to a contentious relationship, this could indicate the franchisor is hard to work with.
The franchisor is required to provide a list of contact information for all operating franchises in their system. There is a lot you can learn from these other franchisees’ perspective as they are not trying to sell to you and have no reason to sugarcoat anything. Ask them to list 3 things they like about owning the franchise and 3 things they wish they could change.
5. Review Financial Records
Ensure the longevity of your investment by thoroughly reviewing the franchise’s financial history. A franchisee should be able to produce financial documents dating back at least three years, according to the IRS.
Important records to review include the business’ balance sheet, outstanding debts and income, profit and loss, and cash flow statements. When reviewing records, consider the financial risks that may apply to the business and understand your obligations as the new owner.
6. Employ a Franchise Consultant
An outside franchise business consultant can ensure you are getting a good value for your investment. With a high level of industry knowledge, outside consultants can be a great asset for new franchisees by helping research the business and confirming it is in good health to continue functioning without major changes.
With a professional’s help, new franchisees can objectively view the business and obtain an appraisal that is fair.
7. Pay Transfer Fees
When buying an existing franchise, the franchisor will charge a transfer fee, typically paid at signing, whether the seller or the new franchisee pays the fee depends on the transfer agreement. Determine whether you will be responsible for the transfer fee, along with start-up fees and royalties, and consider how this could impact your budget. If necessary, include this fee when negotiating the business’ value and sale price.
8. Prepare For the Transition
Prepare for the franchise takeover by deciding which employees to keep, hiring new ones, and planning staff training. Talk to the current franchisee and key stakeholders to identify the top-performing employees. Consider keeping the franchisee as a consultant. Since the business will be under new management, it’s essential to develop and employ a marketing plan as well. This revitalizes the business and informs customers of the change in ownership.
When deciding whether to start or buy an existing franchise, entrepreneurs should consider the benefits and risks of each option. Working with a franchise consultant can help new franchisees make an informed decision. In addition, preparing for the transition by planning staff training and developing a marketing plan is crucial for a smooth takeover.