– 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
What is a FRANCHISE?
A form of business where the franchisor sells or provides to a franchisee:
• the right to do business under a particular trade name or brand
• the right to use/sell a proprietary product, process, or service
• training and assistance in setting up the business
• a business and marketing plan
• economies of scale for purchasing and marketing
• a financial (accounting) system
• regular inspection and quality checks once the business is established
The 20 Fastest-Growing Franchises - 2009
1. Subway Submarine sandwiches & salads $84,300 - $258,300 11. Jiffy Lube Intl Fast oil change $229,000 - $323,000
2. McDonalds Hamburgers, chicken, salads $995,900 - $1,842,700 12. Instant Tax Service $39,000 - $89,000
3. Liberty Tax Service Income-tax preparation $56,800 - $69,900 13. Baskin-Robbins USA Ice cream $41,450 - $373,595
4. Sonic Drive-In Restaurants $1,209,300 - $3,413,800 14. KFC Corp Chicken $1,379,900 - $2,422,500
5. InterContinental Hotels $5,136,370 - $93,855,035
15. Jani-King Commercial cleaning $11,400 - $35,050
6. Ace Hardware Home improvement store $238,500 - $1,566,250
16. Dairy Queen $372,802 - $1,771,860
17. Super 8 Hotels $285,445 - $5,396,983
7. Pizza Hut Pizza, pasta, wings $316,500 - $2,974,000
18. Arby’s Sandwiches $336,500 - $2,400,000
8. UPS Store/Mail Boxes Etc $154,947 - $293,473
19. Jan-Pro Commercial cleaning $3,145 - $50,405
9. Circle K Convenience store $161,000 - $1,353,000
20. Taco Bell Quick-service Mexican $1,324,300 - $2,465,500
10. Papa John’s Intl Pizza $113,823 - $528,123
Source: Entrepreneur, 2009 Franchise 500 Rankings
Top 12 Low-Cost Franchises - 2010
• H & R Block Tax preparation and electronic filing
$26,427 - $84,094
• Jani-King Commercial cleaning
$11,400 - $35,050
• Jan-Pro Intl Commercial cleaning
$3,145 - $50,405
• Kumon Math Centers • Vanguard Cleaning Commercial cleaning
$8,125 - $38,100
• Supplemental education $32,958 - $131,070
• Stratus Building Solutions • ServiceMaster Clean Disaster cleaning
$20,926 - $132,623
Commercial cleaning $3,450 - $57,750
• Jazzercise Inc Dance fitness classes
• Bonus Building Care Commercial cleaning
$9,000 - $15,000
$2,980 - $75,500
• Instant Tax Service Retail tax preparation
• Merry Maids Residential cleaning
$24,750 - $59,450
$39,000 - $89,000
• Anago Cleaning Systems
Commercial cleaning $8,543 - $55,306
Source: Entrepreneur.com “Top Low-Cost Franchises in 2010”
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
• Restricting of sales territory
• Requiring site approval and imposing requirement on
the outlet’s appearance
• Restricting the goods/
services that can be sold
• Requiring specific
• Controlling 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
• 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
Three Types of Franchise
Opportunities and their Associated
Risks and Benefits
• Product and Trade Name Franchise
– Grants the right to use a widely recognized product or name
• Business Format Franchise
– Provides an entire marketing system and ongoing guidance from the franchisor
• Master Licensee
– An independent firm or individual acting as a sales agent with the responsibility for
finding new franchises within a specified territory
• Multiple-Unit Ownership
– The holding by a single franchisee of more than one franchise from the same
• Area Developer
– Individuals or firms that obtain the legal right to open several franchised outlets in
a given area
• Piggyback Franchising
– A retail franchise operation within the physical facilities of a host store
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 - 2
• 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 - 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
• 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?
Where to Find out about Franchises
Buying an Existing Business?
Reduction of Ongoing
Uncertainties Operations and
A Bargain 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
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