– A marketing system revolving around a two-party
agreement, whereby the franchisee conducts business
according to the terms specified by the franchisor
– An entrepreneur whose power is limited by a
contractual agreement with a franchisor
– The party in the franchise contract that specifies the
methods to be followed and the terms to be met by
the other party
THREE KINDS OF FRANCHISES
• Trade Name Franchise
– Grants the right to use a widely recognized name within a particular territory
• True Value Hardware, Associated Grocers Inc (AGI), Century 21
• Product Distribution Franchise (…Dealership)
– Allows you to sell a specific, brand-name product in a specified territory
• Snap-On Tools, Toyota
• Business Format Franchise
– Provides an entire business plan, marketing, and operating system
– Guidance from the franchisor is ongoing; supervision & monitoring are continuous
• Subway, McDonalds
* * * * * * * * * * * * * * * * * *
• Single Franchise Owner
– Owns the franchise rights to operate in just one business location or territory
• Multiple-Unit Owner/Master Franchisee
– Has the right to open several franchised outlets in a given area or territory
• Piggyback Franchise
– A retail franchise operation within the physical facilities of a host store …a Subway inside WalMart
The Pros and Cons of Franchising
• Advantages • Limitations
– Probability of success – Franchise costs
• Proven line of business • Initial franchise fee
• Investment costs
• Pre-qualification of franchisee
• Royalty payments
• Overall lower failure rates • Advertising costs
• Franchisor-provided – Restrictions on business
– Financial assistance • Products sold
• Hours of operation
• Loans & loan guarantees
• Restrictions on expansion/growth
• Franchisor only source of supplies
– Operating benefits
• Location feasibility study
– Loss of independence
• Marketing assistance
• Quick start-up time
– Lack of franchisor support
• Termination/renewal clauses
Franchisor Controls on Franchisees
• Restricted sales territory
• Requires site approval and imposes requirements on
the outlet’s appearance
• Restricts the goods/
services that can be sold
• Requires specific
• Controls advertising
An Attractive Franchise Opportunity Includes: - 1
• Registered trademarks
• Successful prototype stores with a track record of
profitability and a positive reputation
• A business that can be systematized so that it can be
• A product or service that can be successful in many
different geographic regions.
An Attractive Franchise Opportunity Includes: - 2
• An operations manual that specifies all the functions of
the business and their associated policies
• A training and support system
• Site selection criteria and architectural standards
• A detailed prospectus that spells out the franchisee’s
rights, responsibilities, and risks.
The Federal Trade Commission requires disclosure...Uniform Franchise Offering
Franchise Disclosure Requirements
• Rule 436 of the Federal Trade Commission
– Uniform Franchise Offering Circular (UFOC)
• A document accepted by the Federal Trade Commission as
satisfying its franchise disclosure requirements
– Litigation and bankruptcy history
– Investment requirements
– Conditions that would affect renewal, termination, or sale
of the franchise
Before Buying a Franchise
Questions to Ask Before Buying a Franchise
• Does the franchisor have an excellent reputation in the
• Is the franchisor in partnership or any other legal relationship
with another franchisor? If so, how will the franchisee be
protected should that relationship fail?
• Is the franchisee required to do anything that appears
questionable from a legal or ethical perspective?
• Under what circumstances can the franchisee or franchisor
terminate the franchise agreement and what are the
consequences to either party?
• Will the franchisor grant an exclusive territory? Is that area
subject to reduction or modification? If so, under what
Questions to Ask Before Buying a Franchise -
• Will the franchisor reveal the certified financial figures for
one of its franchises and can those figures be verified with
• Will the franchisor provide a management training
program, an employee training program, public relations
and advertising support, or credit?
• Does the franchisor assist in finding a suitable location?
• What is the financial health of the franchisor? Can
financial statements be verified?
Questions to Ask Before Buying a Franchise -
• What is the track record of the franchise?
• Has the franchisor conducted an in-depth investigation of
the franchisee to assure that he or she has the necessary
skills and financial requirements to operate the business
• How much capital will be required to start and operate
the business to a positive cash flow? Does the initial fee
include an opening inventory of products and supplies?
What do royalties pay for and how are they calculated?
How Risky is that Franchise? Jeff Elgin, Entrepreneur.com/article /217285 9/2010
• Are the number of franchise units growing/staying
constant/or declining? (Item 20 of the FDD)
• Has there been an increase in litigation between franchisor
and franchisees during the last couple of years? (Item 3 of the FDD)
• Scrutinize the last three years’ audited financial statements
as part of the FDD.
– Strong capital reserves, cash flows, and good profits?
– Are accounts receivables increasing? (…may be a bad sign if franchisees can’t pay monthly fees!)
• Are the same-store sales figures increasing, holding steady, or
declining? Is the business susceptible to economic downturns?
• What is the attitude of the existing franchisees? Call them
– How do you feel about the business?
– How have the past couple of years been?
– Knowing what you know now, would you do it again?
Where to Find out about Franchises
The Top 20 Franchises for 2010
1. Subway Submarine sandwiches & salads $84,300 - $258,300 11. Jan-Pro Commercial cleaning $3,300 - $54,300
2. McDonalds Hamburgers, chicken, salads $1,057,200 - $1,885,000 12. Kumon Math Supplemental education $36,538 - $145,250
3. 7-Eleven, Inc Convenience stores $40,500 - $775,300 13. Stratus Building Commercial cleaning $3,450 - $57,750
4. Hampton Inn/Suites Hotels $3,716,000 - $13,148,800 14. Miracle-Ear Hearing instruments $122,500 - $570,000
5. Supercuts Hair Salons $112,600 - $243,200
15. Pizza Hut Inc Pizza, pasta, wings $302,000 - $2,100,000
6. H & R Block Tax preparation & filing $34,438 - $110,033
16. Hardee’s Burgers, chicken, biscuits $1,182,000 - $1,583,500
17. Denny’s Inc
7. Duncan Donuts
Full-service restaurant $1,200,000 - $2,600,000
Coffee, doughnuts, etc $537,750 - $1,765,300
18. Jazzercise Inc Dance/fitness classes $2,980 - $38,400
8. Jani-King Commercial cleaning $13,200 - $93,200
19. Matco Tools Mechanics Tools & Equip $79,926 - $188,556
9. Servpro Disaster restoration & cleaning $127,300 - $174,700
20. UPS Store Postal/Business Services $150,980 - $337,950
10. AmPm Mini Market Gas/Store $1,835,823 - $7,615,065
Source: Entrepreneur.com, “2010 Franchise 500 Rankings”
Top 12 Low-Cost Franchises - 2010
• H & R Block Tax preparation and electronic filing
$34,438 - $110,033
• Jani-King Commercial cleaning
$13,200 - $93,200
• Jan-Pro Intl Commercial cleaning
$3,300 - $54,300
• Vanguard Cleaning Commercial cleaning
• Kumon Math Centers $8,125 - $38,100
• Supplemental education $32,958 - $131,070
• ServiceMaster Clean Disaster cleaning
• Stratus Building Solutions $20,926 - $132,623
Commercial cleaning $3,450 - $57,750
• Bonus Building Care Commercial cleaning
• Jazzercise Inc Dance fitness classes
$9,000 - $15,000
$2,980 - $38,400
• Merry Maids Residential cleaning $24,750 - $59,450
• Instant Tax Service
• Anago Cleaning Systems
Retail tax preparation
$39,000 - $89,000
Commercial cleaning $8,543 - $55,306
Source: Entrepreneur.com “Top Low-Cost Franchises in 2010”
The Top 20 New Franchises for 2010
1. Stratus Building Solutions Cleaning $3,450 - $57,750 11. Mister Sparky Residential electrical $24,420 - $490,740
2. Senior Helpers In-home care for seniors $69,800 - $96,300 12. FocalPoint Business consulting $75,550 - $121,950
3. Mr. Sandless Wood floor refinishing $28,000 - $56,000 13. Synergy HomeCare Nonmed home care $53,300 - 115,300
4. HealthSource Nutrition & weight loss $52,950 - $249,795 14. Z-Coil Pain relief footwear $88,150 - $160,800
5. Oreck Home Cntr Vacuums, etc $84,600 - $221,000
15. Clix Studio & on-location photography $38,500 - $373,040
6. Guard-A-Kid Kids ID & safety products $19,900 - $20,900
16. Stroller Strides Stroller fitness program $4,009 - $17,889
17. Speedpro USA Large format imaging
7. Fresh Coat
$202,200 - $230,100
Interior painting $38,800 - $63,800
18. Superior Wash Onsite mobile fleet washing $59,820 –
8. Murphy Bus & Fin Bsns brokerage/real estate $61,600 - $128,700 108,405
9. Oxi-Fresh Carpet cleaning $33,495 - $55,950
19. Ripicci’s Italian Ice Italian Ice $35,140 - $150,500
10. Senior’s Choice Nonmedical home care $54,000 - $72,000
20. Soccer Shots Soccer programs for children 3-8 $13,935 - $18,550
Source: Entrepreneur.com, “Top New Franchises 2010”
Buying an Existing Business?
Reduction of Ongoing
Uncertainties Operations and
A Bargain Price A Quick Start
Good Reasons to Purchase an Existing Business
• It is less risky than starting from scratch, because facilities, employees, and
customers are likely to be in place.
• To acquire a business with ongoing operations and established relationships with
loyal customers and reliable suppliers
• The business has established trade credit, which is crucial because relationships
with suppliers and others take a long time to develop.
• It is an easier route to owning a business if the entrepreneur has limited business
experience, especially if the owner stays on for a time to help with the transition.
• To begin a business more quickly than starting from scratch
• To obtain an established business at a price below what a new business or
franchise would cost
Pros and Cons of Buying an Existing Business
• Pros • Cons
– Higher chance of success – Existing problems
– Less planning – Poor quality of current
– Existing customers/ employees
suppliers – Poor business image
– Necessary equipment – Modernization required
– Bargain price – Purchase price based on
– Experienced employees inaccurate data
– Existing business records – Poor business location
Where to Find Business Opportunities
• The Wall Street Journal
• Liquidation auctions
• Business brokers
• The internet
What is a Business Broker?
• When a business owner is looking to sell her
business, she may turn to a business broker,
who will look for a buyer for the business.
Brokers typically charge one to 10 percent of
the transaction price for their services.
Looking to Buy a Business?
How to Attract the Attention of a Business Broker
• Demonstrate your strong interest in acquiring a business by providing
information to the broker about your knowledge and interest in running your
• Demonstrate strong financial qualifications
• Be willing to move to a new location to take advantage of a business
• Keep an open mind about the type of business; consider a wide range of
• Be persistent and follow up with the broker
• Be ready to respond quickly when an opportunity emerges. This means
having financial records in order and money available.
What to Look For in a Business
• A business that had a broad scope that would insulate it from market
• A business with existing customers and vendors
• A low-tech business but with high growth
• A market that was not so large so as to encourage major players but not so
small that the company couldn’t grow.
• Available float from suppliers; in other words, leeway in having to pay
• Manageable seasonality
• Cost cutting potential
Investigating and Evaluating
• Due Diligence
– The exercise of prudence, such as would be expected
of a reasonable person, in the careful evaluation of a
• Relying on Professionals
– Other experienced business owners
Find Out Why the Business Is For Sale
• Owner’s stated reasons for selling the business
– Poor health or illness in the family
– Wants to retire while he can still enjoy life
– Desires to relocate to a different section of the country
– Has accepted a position working for another company
– Wants to start a new business in a different industry
– Has to sell the business to generate funds to settle a divorce, lawsuit, etc.
Beware of sellers who may have priced the business at more than its worth, or who have
“cooked the books” to make the business appear to be more attractive than it really is.
The REAL reason the Business Is For Sale
• Larger companies are squeezing the firm out of the market
• Key employees have been leaving
• The industry is very mature and there aren’t any new ways or places to grow
• Competitors’ products (or services) are superior
• The business has developed a negative reputation in the community
• The firm is facing a pending lawsuit
• The business is just not profitable
• The physical facilities are old or obsolete and in need of major renovation/repairs
Examining the Financial Data
• Review financial statements and tax returns for the past
• Recognize that financial data can be misleading.
– Assets overvalued
– Expenses under-stated
– Income over-stated
– Unrecorded debts
• Adjust asset valuations to reflect the true state of the
Valuing the Business
• Asset-Based Valuation
– Estimates the value of the firm’s assets; does not
reflect the value of the firm as a going concern.
• Market-Comparable Valuation
– Considers the sale prices of comparable firms;
difficulty is in finding comparable firms.
• Cash-Flow-based Valuation
– Compares the expected and required rates of return
on the amount of capital to be invested in the business.
Non-quantitative Factors in
Valuing a Business
• Future Community
• Legal Commitments
• Union Contracts
• Product Prices
Placing a Value on a Service Business
• The biggest asset of a service
company is its employees, including
senior management, followed by
customers and the business system.
• The value of a service company is
found in the quality of the
relationship between its
management (staff) and customers.
Without those relationships, there is
Possible Conditions on the Purchase of a
• The owner must stay on as an employee for two
years or perhaps as an employee for one year and
as a consultant for two more.
• Any loss of an account or a large customer that
was in place at the closing of the sale will reduce
the payout by some defined amount.
• One-third of the total purchase price will be paid
at closing. The remainder will be paid in equal
payments over three years.
Negotiating and Closing the Deal
• Negotiating the Terms of the Agreement
– Continuation agreement
– Non-competition clause
– Seller financing
– Earnouts and Indemnification agreements
– The final price
– Full payment vs installments
• Closing the sale
– Best handled by a third party
• Bill of sale
• Tax certifications
• Payment agreements
Do Your RESEARCH!
• Develop a set of criteria for
judging the business based on
the entrepreneur’s needs and
• Understand the industry and the Getty Images
market niche in which the
business will operate
• Examine the records of the
More Ways to RESEARCH!
• Talk to employees, suppliers, and
• Examine equipment and facilities to
make certain they are current and in
good working order
• Examine all contracts
• Verify the value of the business based
on industry statistics and perhaps the
advice of a professional business
• There are a number of tools available to
predict value including complex software tools
that promise to reduce valuation to a simple
• However, all of valuation comes down to this
• A business is worth what a buyer is willing to
What can the
term “value” mean?
• Fair market value.
This is the price at which a willing seller would sell
and a willing buyer would buy in an arm’s-length
transaction. By this definition, every sale would
ultimately constitute a fair market value sale.
What can the
term “value” mean?
• Intrinsic value. This is perceived value arrived at by
interpreting balance sheet and income statements
through the use of ratios, discounting cash flow
projections, and calculating liquidated asset value.
• Investment value. This is the worth of the business
to an investor and is based on the individual
requirements of the investor as to risk, return, tax
benefits, and so forth.
What can the
term “value” mean?
• Going-concern value.
This is the current status of the business as
measured by financial statements, debt load, and
economic environmental factors, such as
government regulation, that may affect the long-
term continuation of the business.
What can the
term “value” mean?
• Liquidation value. This value assumes the selling off
of all assets and calculating the amount that could be
recovered from doing so.
• Book value. This is an accounting measure of value
and refers to the difference between total assets and
total liability. It is essentially equivalent to
shareholders’ or owners’ equity.
Valuing a Business
• Adjusted Book Value
• Multiple of Earnings
• Discounting Cash Flows
• Capitalization of Earnings
Adjusted Book Value
• The book value of a going concern is simply the
owner’s equity, that is, the value of the assets less
the outstanding debts.
Multiple of Earnings
• Using a price/earnings (P/E) ratio to value a business is a
common method among publicly owned companies because
it’s simple and direct.
• This ratio is determined by dividing the market price of the
common stock by the earnings per share.
P/E RATIO = STOCK PRICE / EARNINGS PER SHARE
Discounting Cash Flows
• Calculating how much an investor would pay today
to have a cash flow stream of X dollars for X number
of years into the future.
Three Factors Determine
the Discount Rate
1. The rate achievable in a risk-free investment such as U.S. Treasury
notes over a comparable time period. For example, for a five-year
forecast, the current rate on a five-year note is appropriate.
2. A risk factor based on the type of business and the industry should be
added to the interest rate in item 1.
3. The life expectancy of the business, because typically discounting is
based on this factor.
Excess Earnings Method
1. Compute the adjusted tangible net worth of the business. Tangible
assets are adjusted up or down for market value; then liabilities are
2. Compute the opportunity cost of this investment. How much would the
investor/buyer earn by investing the same amount in another,
3. Forecast net earnings. Earnings from previous income statements can
provide a basis for the forecast, which is made before subtracting the
Excess Earnings Method
• Calculate the extra earning power, which is the difference between
forecasted earnings and opportunity costs.
• Estimate the value of intangible assets or goodwill. If the business has
extra earning power, that figure can be multiplied by what is known as a
years-of-profit (YOP) figure.
• Calculate the value of the business by adding the figures.
Capitalization of Earnings
• Either EBIT or EBITDA is divided by a capitalization rate, which
is the return the buyer requires on the investment
• For example, if the company’s EBITDA was $500,000 and the
buyer needed a 20 percent return on investment, the price
the buyer would be willing to pay would be $2,500,000.
EBITDA / REQUIRED ROI = MAXIMUM PURCHASE PRICE