© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. PowerPoint Presentation by Charlie Cook, The University of West Alabama Franchising and Buyouts PART 2 Starting from Scratch or Joining an Existing Business

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–2 Franchising FranchisingFranchising  A marketing system involving a legal agreement, whereby the franchisee conducts business according to the terms specified by the franchisor. FranchisorFranchisor  Party in franchise contract that specifies methods to be followed and terms to be met by the other party. FranchiseeFranchisee  An entrepreneur whose power is limited by a contractual agreement with a franchisor.

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–3 Franchising Options Franchise ContractFranchise Contract  The legal agreement between franchisor and franchisee FranchiseFranchise  The privileges conveyed in the franchise contract

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–4 Exhibit 4.1 Economic Impact of Franchising Economic Activity in Franchised Businesses There were 909,253 businesses in franchise systems in the United States in 2005, accounting for 3.3 percent of all U.S. business establishments. These businesses directly provided 11.0 million jobs, an annual payroll of $278.6 billion, and output worth $880.9 billion. Their economic activity accounted for 8.1 percent of all private-sector jobs, 5.3 percent of all private-sector payrolls, and 4.4 percent of all private-sector output. Economic Activity Because of Franchised Businesses The economic significance of franchising is greater than indicated by the activity in franchised businesses alone, for it stimulates still more activity and supports the growth of many nonfranchised businesses. If we include economic results from both inside and outside of franchising, franchised businesses in the United States were the source of 21.0 million jobs, or 15.3 percent of private-sector jobs, $660.9 billion of payroll, or 12.5 percent of private-sector payrolls, and $2.31 trillion of output, or 11.4 percent of private-sector output. Source: PriceWaterhouseCoopers, The Economic Impact of Franchised Businesses, Volume II (Washington, DC: International Franchise Association, 2008).

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–5 The Pros and Cons of Franchising AdvantagesAdvantages  Probability of success  Proven line of business  Pre-qualification of franchisee  Reduced risk of failure  Use of a valuable trade name and trademark  Economies of scale  Training  Franchisor-provided  Financial assistance  Franchisor assistance  Operating benefits  Management training provided by the franchisor LimitationsLimitations  Franchise costs  Initial franchise fee  Investment costs  Royalty payments  Advertising costs  Restrictions on business operations  Loss of independence  Lack of franchisor support

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–6 Franchisor Controls on Franchisees Restricting of sales territoryRestricting of sales territory Requiring site approval and imposing requirement on the outlet’s appearanceRequiring site approval and imposing requirement on the outlet’s appearance Restricting the goods/services that can be soldRestricting the goods/services that can be sold Requiring specific operating hoursRequiring specific operating hours Controlling advertisingControlling advertising

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–7 Evaluating Franchise Opportunities Selecting a FranchiseSelecting a Franchise  Personal observation  Advertisements Investigating the Potential FranchiseInvestigating the Potential Franchise  Information sources  Independent, third-party sources –Federal Trade Commission –Internet –Franchise consultants  Franchisors themselves –Disclosure documents  Existing and previous franchisees

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–8 Becoming a Franchisor The Business Model Required Assistance Financial Considerations Operations Manual Development Government Regulations Adding Long-Term Value Franchisor Considerations

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–9 Becoming a Franchisor BenefitsBenefits  Reduction of capital requirements  Increase in management motivation  Speed of expansion DrawbacksDrawbacks  Reduction in control  Sharing of profits  Increase in operational support costs

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–10 Legal Issues in Franchising The Franchising ContractThe Franchising Contract  Signed with legal counsel present  Contains a termination and transfer provision  Contains statement of rights to renew contract

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–11 Franchise Disclosure Requirements Rule 436 of the Federal Trade CommissionRule 436 of the Federal Trade Commission  A rule that prescribes that the franchisor must disclose certain information to prospective franchisees   Franchise Disclosure Document (FDD)  A document accepted by the Federal Trade Commission as satisfying its franchise disclosure requirements –Investment requirements –Conditions that would affect renewal, termination, or sale of the franchise

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–12 Buying an Existing Business? Reduction of Uncertainties of Startup Acquisition of Ongoing Operations and Relationships A Quick Start A Bargain Price

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–13 Pros and Cons of Buying an Existing Business ProsPros  High chance of success  Less planning  Existing customers/ suppliers  Necessary equipment  Bargain price  Experienced employees  Existing business records ConsCons  Existing problems  Poor quality of current employees  Poor business image  Modernization required  Purchase price based on inaccurate data  Poor business location

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–14 Finding a Business to Buy Due DiligenceDue Diligence  The exercise of prudence, such as would be expected of a reasonable person, in the careful evaluation of a business opportunity. MatchmakersMatchmakers  Specialized brokers that bring together buyers and sellers Relying on ProfessionalsRelying on Professionals  Accountants  Attorneys  Other experienced business owners

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–15 Exhibit 4.9 Documents Required for Due Diligence 1.Term Sheets, Corporate Summary Fact Sheet 2.Business Plan 3.Marketing Plan 4.Key Personnel Resumes 5.Financial Planning, Cash Flow Model, Analysis Reports, Glossary 6.Financial Statements 7.Profit and Loss Statements 8.Balance Sheets, Intercompany Transfers 9.Accounts Receivable/Accounts Payable Aging Summaries 10.Tax Returns 11.Asset Ledger 12.Client List and Actual Sales 13.Shareholder Statements 14.Credit and Security Agreements 15.Book of Meeting Minutes 16.Summary of Litigation 17.Non-Competition, Non-Solicitation, or Non- Disclosure Agreements 18.Filings with agencies (U.S. and foreign) having jurisdiction over business operations 19.Customer and Vendor Contracts 20.License or Royalty Agreements 21.Promissory Notes, Bonds or Debentures 22.Options or Rights for Capital Stock or Company Assets 23.Partnership, Joint Venture, Marketing, or Similar Agreements 24.Material Contracts and Agreements 25.Cost-Sharing Agreements, Intercompany Transfers (Company Affiliates) 26.Contracts or Other Documents Affecting the Business Assets 27.Development or Technology Agreements and Documents Relating to Business Assets 28.Corporate Policies (Insurance, Operational, Health, Safety, HR) 29.Summary of Pending or Proposed Assessments or Tax Liens 30.Listing of Sales and Use Tax Returns (All Affected Jurisdictions) 31.Implementation Plan Source: accessed on January 24, 2009.

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–16 Finding Out Why a Business Is For Sale Owner’s Reasons for SellingOwner’s Reasons for Selling  Old age or illness  Desire to relocate in a different section of the country  Decision to accept a position with another company  Unprofitability of the business  Loss of an exclusive sales franchise  Maturing of the industry and lack of growth potential Beware of sellers who may have “cooked the books” to make the business more attractive.Beware of sellers who may have “cooked the books” to make the business more attractive.

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–17 Examining the Financial Data Review financial statements and tax returns for the past five years.Review financial statements and tax returns for the past five years. Recognize that financial data can be misleading.Recognize that financial data can be misleading.  Assets overvalued  Expenses overstated/understated  Income underreported  Unrecorded debts Adjust asset valuations to reflect the true state of the business.Adjust asset valuations to reflect the true state of the business.

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–18 Valuing the Business Asset-Based ValuationAsset-Based Valuation  Estimates the value of the firm’s assets; does not reflect the value of the firm as a going concern. Market-Comparable ValuationMarket-Comparable Valuation  Considers the sale prices of comparable firms; difficulty is in finding comparable firms. Cash-Flow-based ValuationCash-Flow-based Valuation  Compares the expected and required rates of return on the amount of capital to be invested in the business.

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–19 Nonquantitative Factors in Valuing a Business CompetitionCompetition MarketMarket Future community developmentFuture community development Legal commitmentsLegal commitments Union contractsUnion contracts BuildingsBuildings Product pricesProduct prices

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part. 4–20 Negotiating and Closing the Deal Terms of PurchaseTerms of Purchase  Assets purchase or total entity  Indemnification clause  Payment in full or partial payments over time Closing the saleClosing the sale  Best handled by a third party  Bill of sale  Tax certifications  Payment-to-seller agreements and guarantees