Franchising

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					                    Franchising
• Franchising
   – A marketing system revolving around a two-party
     agreement, whereby the franchisee conducts business
     according to the terms specified by the franchisor
• Franchisee
   – An entrepreneur whose power is limited by a
     contractual agreement with a franchisor
• Franchisor
   – The party in the franchise contract that specifies the
     methods to be followed and the terms to be met by
     the other party
                   Franchising Arrangements
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
   – Training
       • Franchisor-provided                 – Restrictions on business
                                               operations
   – 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
  operating hours
• 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
   easily replicated.

 • 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
       Circular [UFOC]
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
         • http://www.ftc.gov/bcp
Before Buying a Franchise




 ASK QUESTIONS
Questions to Ask Before Buying a Franchise

• Does the franchisor have an excellent reputation in the
  industry?
• 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
  conditions?
Questions to Ask Before Buying a Franchise -
                     2
 • Will the franchisor reveal the certified financial figures for
   one of its franchises and can those figures be verified with
   the franchisee?

 • 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 -
                     3

  • 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
    successfully?

  • 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
    and ask…
      – 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

• www.franchise1.com
• www.franchising.com
• www.en.wikipedia.org/wiki/franchising
• www.entrepreneur.com/franchiseopportuniti
  es/index.html
• www.franchiseinfosite.com


                                    Getty Images
                            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?
                        Acquisition of
 Reduction of             Ongoing
 Uncertainties         Operations and
                        Relationships


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

•   Attorneys
•   Accountants
•   Bankers
•   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
  own business.

• Demonstrate strong financial qualifications

• Be willing to move to a new location to take advantage of a business
  opportunity

• Keep an open mind about the type of business; consider a wide range of
  opportunities.

• 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
    downturns.

•   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
    vendors.

•   Manageable seasonality

•   Cost cutting potential
           Investigating and Evaluating
               Available Businesses

• Due Diligence
   – The exercise of prudence, such as would be expected
     of a reasonable person, in the careful evaluation of a
     business opportunity

• Relying on Professionals
   – Accountants
   – Attorneys
   – 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
  five years.

• 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
  business.
             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
• Competition
• Market
• Future Community
  Development
• Legal Commitments
• Union Contracts
• Buildings
• 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
                                            Getty Images
    management (staff) and customers.
    Without those relationships, there is
    no business.
Possible Conditions on the Purchase of a
            Service Business
• 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
         and guarantees
           Do Your RESEARCH!
•   Develop a set of criteria for
    judging the business based on
    the entrepreneur’s needs and
    goals.

•   Understand the industry and the   Getty Images

    market niche in which the
    business will operate

•   Examine the records of the
    business
         More Ways to RESEARCH!
• Talk to employees, suppliers, and
  customers

• Examine equipment and facilities to
  make certain they are current and in
  good working order
                                           Getty Images


• Examine all contracts

• Verify the value of the business based
  on industry statistics and perhaps the
  advice of a professional business
  appraiser.
                 Valuation
• There are a number of tools available to
  predict value including complex software tools
  that promise to reduce valuation to a simple
  formula.
• However, all of valuation comes down to this
  simple truth:
• A business is worth what a buyer is willing to
  pay.
                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.
                  Methods for
               Valuing a Business
• Adjusted Book Value

• Multiple of Earnings

• Discounting Cash Flows

• Capitalization of Earnings
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            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.




                             Getty Images
              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.




                                           Getty Images
             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
     subtracted.

2.   Compute the opportunity cost of this investment. How much would the
     investor/buyer earn by investing the same amount in another,
     comparable investment?

3.   Forecast net earnings. Earnings from previous income statements can
     provide a basis for the forecast, which is made before subtracting the
     owner’s salary.
             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

				
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