1. Franchises and Buyouts
Part 2 Starting From Scratch or Joining an Existing Business

2. Looking Ahead After studying this chapter, you should be able to:
Identify the major pros and cons of franchising.
Explain franchising options 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.
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3. Franchising Franchising Franchisee Franchisor
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
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4. 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
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5. Major Pluses and Minuses in the Franchising Calculation
Exhibit 4.1
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6. 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
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7. Estimate of Investment Costs by Great Clips
Note: This is an estimate only of the capital needed to open and operate your salon during the initial 12 months after you open for business. Great Clips cannot guarantee that you will not have additional expenses starting the business.
Exhibit 4.2
Source: April 27, 2004.
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8. Franchising Agreements
Franchise contract
The legal agreement between franchisor and franchisee
Franchise
The privileges conveyed in the franchise contract
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9. Franchising Arrangements
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
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10. Franchising Arrangements (cont’d.)
Multiple-Unit Ownership
The holding by a single franchisee of more than one franchise from the same company
Area Developers
Individuals or firms that obtain the legal right to open several franchised outlets in a given area
Piggyback Franchising
The operation of a retail franchise within the physical facilities of a host store
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11. The Structure of Franchising
Exhibit 4.3
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12. Evaluating Franchise Opportunities
Selecting a Franchise Opportunity
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
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13. The 20 Fastest-Growing Franchises in 2003
Subway
Curves
7-Eleven Inc.
Kumon Math & Reading Centers
Jan Pro Franchising Int’l., Inc.
The Quizno’s Franchise Co.
Jani-King
Coverall Cleaning Concepts
Liberty Tax Service
Jazzercise Inc.
RE/MAX Int’l., Inc.
Jackson Hewitt Tax Service
Choice Hotels Int’l.
WSI Internet
Dunkin’ Donuts
Action Int’l.
Baskin-Robbins USA Co.
Great Clips, Inc.
Rezcity.com
The UPS Store
Source: “The Race Goes to the Swift,” Entrepreneur, February 2004, p. 80. Reprinted by permission of Entrepreneur Magazine. © 2004 all rights reserved. For Subscription Information Call
Exhibit 4.5
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14. Franchising from the Franchisor’s Perspective
Benefits
Reduction of capital requirements
Increase in management motivation
Speed of expansion
Drawbacks
Reduction in control
Sharing of profits
Increase in operational support costs
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15. Legal Considerations in Franchising
The Franchising Contract
Signed with legal counsel present
Contains a termination and transfer provision
Contains a statement of rights to renew contract
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16. 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
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17. Buying an Existing Business?
Acquisition of Ongoing Operations and Relationships
Reduction of Uncertainties
A Quick Start
A Bargain Price
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18. Buying an Existing Business
Reasons for Buying an Existing Business
To reduce some of the uncertainties and unknowns that must be faced in starting a business from the ground up
To acquire a business with ongoing operations and established relationships with customers and suppliers
To obtain an established business at a price below what a new business or franchise would cost
To begin a business more quickly than starting from scratch
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19. 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
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20. 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
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21. Finding Out Why the Business Is For Sale
Owner’s reasons for selling the business
Old age or illness
Desire to relocate to 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.
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22. 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.
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23. Valuing the Business Asset-Based Valuation Market-Comparable 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.
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24. Nonquantitative Factors in Valuing a Business
Competition
Market
Future Community Development
Legal Commitments
Union Contracts
Buildings
Product Prices
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25. 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
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26. Key Terms franchising franchisee franchisor franchise contract
product and trade name franchising
business format franchising
master licensee
multiple-unit ownership
area developers
piggyback franchising
disclosure document
Uniform Franchise Offering Circular (UFOC)
matchmakers
due diligence
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