1. Franchising and Buyouts
PART 2 Starting from Scratch or Joining an Existing Business

2. Looking Ahead After studying this chapter, you should be able to:
Define franchising and identify franchise options.
Understand the pros and cons of franchising and the structure of the industry.
Describe the process for evaluating a franchise opportunity.
List four reasons for buying an existing business and describe the process of evaluating a business.

3. Franchising Franchising Franchisor Franchisee
A marketing system involving a legal agreement, whereby the franchisee conducts business according to the terms specified by the franchisor.
Franchisor
Party in franchise contract that specifies methods to be followed and terms to be met by the other party.
Franchisee
An entrepreneur whose power is limited by a contractual agreement with a franchisor.

4. Franchising Options Franchise Contract Franchise
The legal agreement between franchisor and franchisee
Franchise
The privileges conveyed in the franchise contract

5. Franchising Options Types of Franchising Arrangements Area Developers
Piggyback Franchising
Multi-Brand Franchising
Product and Trade Name Franchising
Business Format Franchising
Master Licensee
Multiple-Unit Ownership
Co-Branding

6. 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).

7. The Pros and Cons of Franchising
Advantages
Probability of success
Proven line of business
Pre-qualification of franchisee
Training
Franchisor-provided
Financial assistance
Franchisor assistance
Operating benefits
Franchisor-aided
Limitations
Franchise costs
Initial franchise fee
Investment costs
Royalty payments
Advertising costs
Restrictions on business operations
Loss of independence
Lack of franchisor support

8. Exhibit 4.2 Advantages of the Franchise Model
Reduced risk of failure
Going into business for yourself, but not by yourself
Use of a valuable trade name and trademark
Access to a proven business system
Management training provided by the franchisor
Immediate economies of scale
A way for an existing business to diversify

9. Exhibit 4.3 Ace Hardware’s Support for Co-Op Members
Our startup assistance includes help with:
Financing programs for qualified individuals
Finding the right location
Set-up and design, including store planning, visual merchandising, pricing strategy development, office set-up, and product selection
Ace’s comprehensive training covers strategies for:
Effective store management
Managing each revenue center
Purchasing and inventory
Implementing superior customer service
Financial management and back-offi ce procedures
Hiring, training, and managing employees
Effective marketing techniques
Our on-site support includes:
Hands-on, on-site support at your grand opening
Visits from our experienced retail support staff
In-store tools for continual improvement, such as customer surveys, customer comment card programs, and mystery shopper programs
Marketing and advertising support includes:
Grand opening planning, assistance, and awareness programs
Local store marketing programs, such as newspaper ad slicks, direct marketing materials, and regional radio and television opportunities
Comprehensive and effective national advertising
Public relations strategies and materials
Community involvement programs and local charity tie-ins
Ace Rewards—our one-to-one consumer loyalty program
System-wide website with store directory and e-commerce functions

10. Exhibit 4.4 Government Concerns about Franchising
Misleading or exaggerated earnings claims by franchisors
Opportunity behavior by which the franchisor becomes a competitive threat to franchisees
Restrictions on franchisees who desire to liquidate their holdings in favor of alternative investment opportunities
Conflicts of interest, such as when a franchisor forces franchisees to be captive outlets for other suppliers owned by the franchisor
Churning: terminating a successful franchise operation in order to resell it and gain additional franchise fees
Encroachment: locating a new outlet or point of distribution too close to an existing franchisee, causing a material loss of sales
Imposing noncompete clauses on franchisees
One-sided contracts devised by franchisors
The imposition of new restrictions as a requirement of contract renewal
Franchisor intimidation of franchisees who attempt to form franchisee associations, seek alternative sources for products, or make other efforts to create a more level playing field

11. Exhibit 4.5 An Estimate of Investment Costs and Benefits by Ace Hardware
Source: accessed August 6, Reprinted by permission of Ace Hardware Corp.

12. 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 operating hours
Controlling advertising

13. Evaluating Franchise Opportunities
Selecting a Franchise
Personal observation
Advertisements
Investigating the Potential Franchise
Information sources
Independent, third-party sources
Federal Trade Commission
Internet
Franchise consultants
Franchisors themselves
Disclosure documents
Existing and previous franchisees

14. Exhibit 4.6 Evaluating Franchise Opportunities
Is the franchisor dedicated to a franchise system as its primary mechanism of product and service distribution?
Does the franchisor produce and market quality goods and services for which there is an established market demand?
Does the franchisor enjoy a favorable reputation and broad acceptance in the industry?
Will the franchisor off er an established, well-designed marketing and business plan and provide substantial and complete training to franchisees?
Does the franchisor have good relations with its franchisees, and do the franchisees have a strong franchisee organization that has negotiating leverage with the franchisor?
Does the franchisor have a history of attractive earnings by its franchisees?

15. Exhibit 4.7 Profiles from the Franchise Opportunities Guide (2009)
Source: accessed January 24, 2009.

16. Exhibit 4.8 Entrepreneur’s 2009 Top 10 Fastest-Growing Franchises
Franchise Start-up Costs (2008)
1. Jan-Pro Franchising Int’l. Inc. $3,300–54,300 Commercial cleaning
2. Subway $78, 600–238,300 Submarine sandwiches & salads
3. Instant Tax Service $39,000–89,000 Retail tax preparation and electronic filing
4. Stratus Building Solutions $3,500–57,800 Commercial cleaning
5. Snap Fitness Inc. $71,100–241, hour fitness center
6. Dunkin’ Donuts Varies Coffee, doughnuts, baked goods
7. Jazzercise Inc. $2,980–38,400 Dance/exercise classes
8. Bonus Building Care $8,800–14,700 Commercial cleaning
9. Anytime Fitness $30,000–292,600 Fitness center
10. Vanguard Cleaning Systems $8,200–38,100 Commercial cleaning
Source: accessed January 24, 2009.

17. Becoming a Franchisor Franchisor Considerations The Business Model
Financial Considerations
Required Assistance
Franchisor Considerations
Operations Manual Development
Government Regulations
Adding Long-Term Value

18. Becoming a Franchisor Benefits Drawbacks
Reduction of capital requirements
Increase in management motivation
Speed of expansion
Drawbacks
Reduction in control
Sharing of profits
Increase in operational support costs

19. Legal Issues in Franchising
The Franchising Contract
Signed with legal counsel present
Contains a termination and transfer provision
Contains statement of rights to renew contract

20. Franchise Disclosure Requirements
Rule 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

21. Buying an Existing Business?
Reduction of Uncertainties of Startup
Acquisition of Ongoing Operations and Relationships
A Bargain Price
A Quick Start

22. Pros and Cons of Buying an Existing Business
High chance of success
Less planning
Existing customers/ suppliers
Necessary equipment
Bargain price
Experienced employees
Existing business records
Cons
Existing problems
Poor quality of current employees
Poor business image
Modernization required
Purchase price based on inaccurate data
Poor business location

23. Finding a Business to Buy
Due Diligence
The exercise of prudence, such as would be expected of a reasonable person, in the careful evaluation of a business opportunity.
Matchmakers
Specialized brokers that bring together buyers and sellers
Relying on Professionals
Accountants
Attorneys
Other experienced business owners

24. Exhibit 4.9 Documents Required for Due Diligence
Term Sheets, Corporate Summary Fact Sheet
Business Plan
Marketing Plan
Key Personnel Resumes
Financial Planning, Cash Flow Model, Analysis Reports, Glossary
Financial Statements
Profit and Loss Statements
Balance Sheets, Intercompany Transfers
Accounts Receivable/Accounts Payable Aging Summaries
Tax Returns
Asset Ledger
Client List and Actual Sales
Shareholder Statements
Credit and Security Agreements
Book of Meeting Minutes
Summary of Litigation
Non-Competition, Non-Solicitation, or Non-Disclosure Agreements
Filings with agencies (U.S. and foreign) having jurisdiction over business operations
Customer and Vendor Contracts
License or Royalty Agreements
Promissory Notes, Bonds or Debentures
Options or Rights for Capital Stock or Company Assets
Partnership, Joint Venture, Marketing, or Similar Agreements
Material Contracts and Agreements
Cost-Sharing Agreements, Intercompany Transfers (Company Affiliates)
Contracts or Other Documents Affecting the Business Assets
Development or Technology Agreements and Documents Relating to Business Assets
Corporate Policies (Insurance, Operational, Health, Safety, HR)
Summary of Pending or Proposed Assessments or Tax Liens
Listing of Sales and Use Tax Returns (All Affected Jurisdictions)
Implementation Plan
Source: accessed on January 24, 2009.

25. Finding Out Why a Business Is For Sale
Owner’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.

26. 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 overstated/understated
Income underreported
Unrecorded debts
Adjust asset valuations to reflect the true state of the business.

27. Asset-Based Valuation
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.

28. Nonquantitative Factors in Valuing a Business
Competition
Market
Future community development
Legal commitments
Union contracts
Buildings
Product prices

29. Negotiating and Closing the Deal
Terms of Purchase
Assets purchase or total entity
Indemnification clause
Payment in full or partial payments over time
Closing the sale
Best handled by a third party
Bill of sale
Tax certifications
Payment-to-seller agreements and guarantees

30. Key Terms franchising franchisee franchisor franchise contract
product and trade name franchising
business format franchising
master licensee
multiple-unit ownership
area developers
piggyback franchising
multi-brand franchising
co-branding
churning
encroachment
disclosure document
Franchise Rule
Franchise Disclosure Document
matchmakers
due diligence