Due Diligence for Franchise Resales

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					                 Due Diligence for F ranchise Resales


What You Must Know

The purchase of a franchise will require you to do your investigation on two
fronts. First, like any other business for sale, you will have to investigate the
business itself to determine if it makes sense for you to buy it. Next, you will
have to determine what specific obligations and/or restrictions you may be
under from the Master Franchiser.

The good news is that you will be able to learn this from contracts the
franchisee has in place. The bad news is that some contracts may be
prohibitive to the point of killing a deal. Since each franchise comes with its
own contracts and rules, there is no “typical” franchise. The verification of
contracts is no different with a franchise resale than it is with a distribution
company where you have to ensure that all contracts are both reasonable and
transferable.
Contracts

Get the broker to give you a copy of the contract in place between the
franchisee and the Master Franchiser as soon as possible. Don’t wait until
you meet with the Seller. If the business is of interest to you then you must
review the franchise agreement immediately. Some franchise contracts
change over time or the Master Franchiser may have the right to force you to
sign a new contract instead of taking over the existing one.

As such, if you find a franchise business that is of interest, I would suggest
that you contact the Franchiser directly. Have them provide you with a copy
of their current contract in the materials that they send you. Hire an
attorney who specializes in franchising (because it is highly specialized).
The investigation that you must do is as detailed on the contractual side
as it is on the financial side, so get professional help.

The things you want to look for in any contract include:

    Is the franchise itself transferable?
    Is the franchise contract transferable/assumable? Is there a transfer
     fee?
    Is there a transfer fee that must be paid? If yes, the Seller usually
     factors this into their Asking Price. If the contract refers to one, be
     sure that your Offer to Purchase outlines who is responsible to pay
     this (should be the Seller).
    Can the current franchisee sell the business directly or must it go
     through the Master Franchiser?
    What approval process will you be subjected to?
    Does the MF have the “First Option” or “Right of First Refusal” to
     buy the business? Many contracts contain this clause. This means that
     whatever price you and the Seller agree upon, the MF can match it
     and the business is theirs, not yours. Most contracts give the
     Franchiser these rights, so find out about this early on so you don’t
     waste time. Also, if this clause is in effect, find out if the Franchiser
     plans on exercising this option. In either case, get this in writing!


Factors to review include:

    What is the contract term? Is it renewable? Under what terms and
     conditions?
    Is the Seller in good standing on all payments with the Franchiser?
    What are the royalties? Are there minimal annual royalty payments?
    Are you restricted to buying all of the products from the Franchiser?
    Does the franchise fee (if applicable) seem reasonable?
    Are you required to participate in all company promotions? Can you
     use your advertising fund for your own promotions?
    Does the MF indemnify you against potential product claims or are
     you solely liable?
    Must you purchase minimum amounts of certain products regardless
     of your sales activity?
    Can you purchase any products that you want for your franchise?
    If you buy products from the MF that don’t perform well, can you
     return them for credit or exchange?
    Do you have a protected territory? How large is it? Under what
     conditions can it be modified by the MF?
    Can you own or operate another business (franchise or not) at the
     same time?
    Can you resell the business?
    Is there an annual quota? What happens if you fall short?
    Under what conditions can the MF terminate the agreement?
    Under what conditions can you terminate the agreement?
    What training are you obligated to undertake and at what cost?

WARNING: Some MFs will not allow you to begin training until the
purchase is complete. Often, this training is at their headquarters. This is a
sticky issue since you cannot leave the business alone while you’re away
training. The remedy can be to have the former owner operate the busin ess
until your training is completed. In this case, the actual purchase can take
place between you and the Seller but ALL funds must remain in escrow to
be released after your training is completed. This way, you’re certain they
perform as agreed. The Seller may buck at this; however, it may be the only
option. You cannot tie any strings to the money and the Seller has to get
their funds as long as they run the business in the normal course they had
always done prior to the sale.

If circumstances do not allow this remedy, then you and the MF must arrive
at a mutually acceptable alternative which can be to have a staggered
training period or training at your premises, etc.
Due Diligence

Here again, there are two avenues that you must pursue while investigat ing
the business. First, the Due Diligence of the business itself. This will follow
the same format as with any other resale, which we will cover extensively in
the “Due Diligence” chapter. The second part is to review the Franchiser and
other franchisees operating in other locations.

(i) Other Franchisees

Investigating a franchise may take a bit more time than a non-franchise
business but there is one major advantage. You can visit and speak to
owners and employees of other similar, if not exact, businesses (even though
we agree there is no such thing as two “exact” businesses). This is a big plus.
You will likely get more honest answers from other franchisees than you
will from the Seller. The reason is obvious: the Seller’s agenda is to sell you
while the other franchisees have nothing to gain by not being honest with
you. Let them know that you may purchase a franchise like theirs in another
area.
Actually, you would be best served to visit locations far outside your
community – if you go to the local outlet, the franchisee may try to convince
you to buy their business and you won’t accomplish your agenda. When you
meet with other franchisees make them feel comfortable. If you have a
business card, give it to them – you do not want them to think you are a
competitor. Let them know your name, where you work, and what your
mission is so that they are not suspicious. Visit several locations until you
find a franchisee with whom you can cultivate a relationship; they can be of
great assistance to you. After getting some answers from them, ask if you
can come back to speak with them again.

If you are progressing with the purchase, ask this franchisee if you could
spend a day or two at their location. You will get a first-hand view of what a
franchisee does on a daily basis. The franchisee whose business you may
purchase may not be as willing to let you do this. This strategy may very
well be the best Due Diligence possible.

Feel free to ask them some of the questions noted above as well as the
following:

      How’s business?
      Do you enjoy doing what you do?
      If you had to do it over again, would you make the same decision?
      Did you buy your franchise from the MF or was it a resale?
      Does the Master Franchiser appear to have adequate funding to
       continue to expand and support the franchisees?
      Has the franchise met the expectations that you were promised or had
       hoped for?
      How effective and frequent is the training?
      Do they train management and employees?
      How frequently do they visit your premises?
      How quickly do they respond to inquiries?
      Did the MF help you with financing?
      How thoroughly did the MF investigate you? Not that you have
       anything to hide; rather, wouldn’t you feel more confident knowing
       that the MF has rigid guidelines in who they sell franchises to? This
       ensures that their brand will be protected and cherished. In other
       words, are their criteria for selling you as strict as your guidelines for
       buying from them?
    How supportive are they with advertising materials, systems,
     marketing, etc.?
    Do they help out if you have overstocks?
    Would you encourage others to buy this franchise?
    Is the business profitable?
    What is the single most important thing that drives the business (i.e.
     advertising, location, marketing, product, customer base, customer
     service)?
    What is the biggest complaint you have about the business and the
     franchisor?

(ii) The Master Franchiser

Have the Seller introduce you to the MF once your discussions begin to get
serious. You will probably have to do this over the phone, so be prepared.

It is best if you visit other franchisees prior to this contact so that you can
ask the MF to elaborate on any matters that may now be a concern to you.
You should also do a credit check on the MF prior to the call to ensure that
they are strong enough financially and to ensure that they have the financial
strength to continue to expand.

The questions you want to discuss with the MF include:

      What is the failure rate among franchisees?
      What volume are other locations doing?
      Are the franchisees profitable?
      Will the MF retrain you? Is there any cost to you? How long is it?
       Where does it take place? How much advance warning does the MF
       need?
      Must you go through training and be approved before you close on the
       business? This is important because you may have to attend an out-of-
       town session at your cost.
      What ongoing training support is provided?
      Do they provide management training?
      Will they train employees?
      How often does a representative from head office visit each location?
      Is there a regional manager responsible for your location? Who is it
       and when can you meet them?
    How does this region rank within the company?
    Can they give you a list of the top franchised locations in your
     region/state (visit these guys and see what they are doing!).
    Will the Franchiser help you with financing? How?
    What support do they provide for advertising, marketing, public
     relations, etc.?
    What systems do they offer for operations (inventory control,
     accounting)?
    Are their criteria for having you as a franchisee as stringent as your
     criteria for buying the franchise? It should be.
    Will they require you to sign a new agreement?

As you can see there are many questions to be answered. The beauty is that
you have lots of resources to find answers. As usual, be diligent when
gathering information.

Keep in mind that, as a franchisee, you will be serving many masters (the
Master Franchisee, customers, suppliers). It is essential that you become
clear on their role, influence and impact on the business. Good franchises
offer a lot of benefits; weigh all of them. Do your investigation thoroughly
and you will be able to determine if this is a good option for you. Balance all
of the benefits with the limits that may be imposed upon your potential
upside.

Good resources for listings of Master Franchisers is The Franchise
Handbook or visit any of these Websites:

http://www.franchiseadvantage.com (easy-to-navigate site with thousands of
franchise and business opportunities available for purchase)

http://www.findafranchise.com (over 1,000 franchises. There is a wealth of
information to assist in researching the many franchise opportunities available. The site
also presents many other helpful resources for prospective franchisees, including lenders
who provide franchise purchase financing, a free franchise-consultation service, and a
helpful pre- investment checklist)

http://www.businessesforsale.com (franchise section)

				
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