By Joelle Kidd
As a prospective franchisee looking to start your own franchise business, you might imagine that doing so requires you to buy—or even build—a new location and establish that location from the ground up using the franchise’s system. While this is sometimes the case, franchisees may also acquire their business through a resale: that is, buying an existing location of a franchise and continuing to operate that business.
Resales happen when a franchisee wants to sell their franchised business to a new owner—perhaps because they want to retire, make a profit from selling their business, or exit their franchise agreement. Resales can happen from one franchisee to another, from a franchisor (in the case of a corporate location) to a franchisee, or from a franchisee back to a franchisor.
So how does purchasing a resale differ from investing in a brand-new location? And why might you want to consider a resale when looking for a franchise? We spoke with franchising and legal experts to round up the basics on franchise resales.
Pros and cons
Resales, or transfers, occur in almost all franchise systems, and are a natural part of the franchise model.
“Most franchise agreements don’t contain a franchisee right of termination, so often, a franchisee’s only way to get out of a franchise agreement is by transferring the business to a new owner with the franchisor’s consent, and then mutually terminating the franchise agreement so that the franchisor can sign a new [one] with the new franchisee,” says Noah Leszcz, a franchise law and business associate at Cassels Brock & Blackwell LLP.
For a franchisee, buying a resale means being able to “step into the shoes” of a previous owner “and continue operation,” he says, noting that there are many potential advantages to buying a resale. Not only does the new owner inherit customer loyalty and existing goodwill from the business, but starting up can be a much simpler and faster process.
“The business has already been in operation, so the new franchisee can commence operations immediately,” says Leszcz. Also, “if the same employees continue with the new owner, there’s little training required and the operations continue seamlessly—and customers are typically unaware that a change in ownership even occurred.”
Leszcz also points out that in the case of a resale, the franchisor already has the benefit of the previous franchisee’s experiences, and may be able to offer more tailored assistance to the new franchisee.
“The potential ‘pros’ include existing cash flow, employees, and customers,” says Jania Bailey, CEO of FranNet. Purchasing a resale means that “the buyer doesn’t have to go through the build-out process, the grand opening marketing, [or] trying to build a customer base.”
One con against buying a resale is that it may potentially be a higher cost than starting the business from scratch. “A franchise that’s more than a one-person business will have a much lower resale value than a business that’s not totally dependent on the owner,” Bailey points out. She also notes that paying more money results in a higher debt service.
Beyond this, you may also have a difficult time determining the real cash flow, Bailey adds. When considering a resale, she offers these ‘red flags’ to look out for: the seller is hesitant to give you the financial history you request; the seller is pushing to get a deal done quickly; or you see declining trends in the business.
Should you do it?
There are several reasons you might be considering a resale as a franchise investment, but overall, it’s important to understand the context of the resale, Leszcz says.
“Prospective franchisees should try to ascertain why the existing franchisee is seeking an exit,” he says. “It could be a profitable business that’s been in operation for decades and the existing franchisee is looking to retire, or it could also be a location that was performing less well, and the existing franchisee is looking for a fresh start.” And while “there’s nothing wrong with taking over a location that wasn’t performing as well as some others in the system,” he says, “the purchase price should reflect the realities of the transaction.”
Prospective franchisees should do their due diligence to ensure they’re buying a valuable business, since it’s possible that a location isn’t succeeding for reasons outside an owner’s control.
When considering a resale, Bailey says that a potential franchisee should “take the time to really understand the existing cash flow. You’ll need to do a reconstructed income statement to identify the actual cash flow you can expect.”
You should also clarify what sort of training you’ll receive from the seller or franchisor. And if the business isn’t in a good place, be careful. “Don’t buy a turn-around unless you have experience in turn-arounds,” says Bailey. “Never underestimate the damage that could have been done to the name and reputation of the business by a poor owner.”
Making an informed decision can be easier with a resale than a new location, as there’s more information, Leszcz notes. “Things like historical sales, neighborhood demographics, and leasing issues will all be available for inspection prior to acquiring the existing location.”
When making the decision, a potential franchisee should look out for a history of repeated transfers in the same location, and leasing issues like known plans for the location to be redeveloped or untenably high rent, Leszcz says.
It’s a good idea to have a business evaluation prepared, particularly if you’re uncomfortable with the asking price and need advice on what price to pay—as Bailey says, “Don’t overpay for goodwill.”
“As with any business decision of this magnitude, be sure you have done all the necessary due diligence. Don’t let your emotions make the decision,” says Bailey.
“Anyone purchasing a franchise, whether it’s a resale or a new unit, should be thinking about their exit strategy,” says Bailey. “This is something that should be considered when deciding whether or not the concept is the right fit for you.”
Bailey suggests thinking about what you plan to do with your business in the future, from the very beginning. “If you plan to sell someday, verify that the franchise concept has a good track record of resales. If you plan to turn the business over to your kids, you need to verify the franchisor supports that sort of activity. If you plan to transition to semi-absentee [ownership], does the model have a record of this being done successfully?”
When considering buying a resale, Leszcz recommends contacting existing franchisees within the system to learn more about their experiences. Contact information for current franchisees is required as part of a Franchise Disclosure Document (FDD), which will also tell you how many resales have occurred in the last three years, and contacts of franchisees that recently left the system. “Some of these may be franchisees that resold their existing business, so hearing their insight will be very informative.”
Like any large investment, a resale requires research, he adds. “Speak to existing franchisees, former franchisees, professional advisers, and any other resources available to you. Purchasing a franchise, whether a new one or an existing business, is an important decision and a big investment, and you should do your due diligence to make sure the acquisition is right for you.”