The purchase and sale of existing franchise businesses are occurring more frequently and for various reasons in the current economic climate. One might think that financial institutions would find these types of businesses easier to finance and consider them as a lower risk… after all it’s a franchise and it’s an existing business which has already built up clientele.
Here are some important considerations which financial institutions take into account when assessing financing this type of business… surely you should ponder these too?
The Franchise Concept
- Do you understand the franchise concept itself (what is the management service fee / royalty structure; do you how the brand is perceived by the target market; who are the suppliers etc)?
- Is the franchise concept well known on a national, regional and local basis?
- Have you completed the franchisor’s application process and been approved as the franchisee for this specific business?
- Have you scrutinised the disclosure document of the franchise concept?
- Have you read at least a draft copy of the franchise agreement to understand your potential rights and responsibilities in terms of this agreement?
- Have you engaged with other existing franchisees of this franchise concept to hear their thoughts as to how they run their business, satisfaction with the franchisor etc?
The Business History
- Do you understand how the existing business was run and what changes you could possibly make to improve the business where required?
- Have you scrutinised the historical financial statements of the existing business, is it profitable, can the business meet its debt obligations etc? If the business is not profitable, what is your plan to turn the business around?
- What is the reason for the current owner selling the business?
- Have you engaged with the staff and current clientele of the business to gauge their perception and loyalty to the business?
- Have you considered your legal obligations to the existing staff of the business when the transfer of the business occurs? (e.g. the automatic substitution of the new employer (the purchaser) for the old employer (the seller)) – for further detail refer to section 197 of the Labour Relations Act 66 of 1995.
- Will you be buying the existing business entity (The company or closed corporation itself) or will you be using your own business entity? It is advisable to usually try use your own legal entity as this avoids a lot of red tape, especially when seeking financing.
- Have you spoken to the landlord regarding how and on what terms the lease agreement will handled?
- Have you scrutinised at least a draft copy of the purchase and sale agreement to understand your potential rights and responsibilities in terms of this agreement?
- Does the purchase and sale agreement regulate who will be responsible for the advertising of the sale of business – refer to Section 34 of Insolvency Act 24 of 1936.
- Do the representations of the existing financial statements match those figures provided by the franchisor? (often the franchisor can accurately report on turnover / sales as they have systems in place to measure this so that their management service fees or royalties are correctly accounted for).
- Have you evaluated the sustainability of this business, e.g. how long has the existing business been trading; has there been stable growth in sales etc during this time; is the market still growing; are the projections provided by the franchisor realistic when compared to the historical financial statements of the business etc?
- When is the next revamp of the business due? This would have major financial implications for you.
- Do you understand the purchase price? (what is it made up of: goodwill; existing stock; existing equipment of the business etc).
- How was the goodwill valuation calculated? (Often franchisors have a formula or calculation they use to fairly calculate goodwill or purchase price of their franchise businesses).
- Do you understand the total costs involved in purchasing the business (eg: in addition to the purchase price do you need to pay an initial franchise fee and training fees to the franchisor; do you need to pay a lease deposit to the landlord; do you need working capital for cash flow purposes)?
- Has the franchisor recommended what amount of unencumbered own contribution you should have available to invest to purchase the business and similarly what is the maximum level of funding the business can afford?
- As you can see there are many aspects to consider when purchasing an existing franchise business and with widely variable answers to the above considerations, you can see why financial institutions may proceed with some caution when assessing the risk of financing these businesses. If you research these questions and include the answers in your business plan submitted to the bank for finance, you will have a greater chance to succeed at the finance application.
- On the positive side there is an existing customer base and history of information available to assist in this assessment. Also, this may be your only opportunity to gain access to a mature franchise brand.