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Selling an existing franchise? Read this first.

By Jason Gerkhe
Wednesday, 25 August 2010

Selling a franchise, like any other small business, takes time and effort. This is further complicated by the requirement in most franchise agreements that any buyer must be approved by the franchisor.


It is generally accepted that the franchisor will apply the system’s then-current franchisee selection criteria, which may be more stringent than the time when the selling franchisee originally joined the system, particularly if they joined a number of years before.


This requirement to meet the selection criteria is designed to protect and maintain the overall integrity and operating standard of the franchise system, but franchisors cannot abuse this right of veto.


Under the franchising code of conduct, a franchisor cannot unreasonably withhold consent to the sale of a franchise. The nature of what is “unreasonable” may differ from one business to another depending on the specific circumstances of that business and industry.


Rather than go through the process of finding a buyer and getting upset if they are rejected by the franchisor, a selling franchisee should familiarise themselves with the their franchisor’s current selection criteria applied at the very start of their sales process.


Here are some other tips on selling an existing franchise business:


Set a realistic price


Many business and franchise resales fail to sell because the owners have set too high a price. In some instances, the price is based on a figure the owners need to reduce or clear their business and personal debt, plus a premium to recover their “sweat equity” or unpaid effort in operating the business.


Unfortunately this approach often defies conventional business valuation models based on profit multiples, which vary from one business type to another.


The result is that businesses are listed for sale (and sometimes sold) at grossly inflated prices that have no bearing on their true market value and will inevitably cause difficulty for the new operators to achieve an acceptable return on investment.


Provide an information memorandum


When the code of conduct came into being more than 10 years ago, it originally required both franchisors and franchisees to provide disclosure information in the event of a resale. The requirement for vendor franchisees to provide disclosure was removed shortly afterwards, but the usefulness of providing information from an outgoing franchisee to a prospective buyer remains.


This can be by way of an information memorandum, which outlines key data about the business, as well as its track record of financial performance. The best way to approach an information memorandum is to think of it as a business plan in reverse, summarising the financial and non-financial achievements of the business to date.


Provide accurate financial information


Small business owners frequently (including franchisees) load their businesses with personal expenses, such as leases for private motor vehicles, mobile phones, non-business repair costs charged to the business as repairs and maintenance, additional wages for family members, education and travelling costs, and so on.


Such practices significantly distort and artificially lower the true performance of the business. When a multiplier is applied to the profit to determine the value of the business, the overall price will be lower than if “true” profit had been used.


Alternatively, a price can also be so great that its profit multiple would appear so high as to make it impossible for a buyer to make a reasonable return on their investment.

Of course business owners attempt to get around this by providing an estimation of their personal charge-backs to the business so that a potential buyer must read the profit and loss statement and balance sheet with a grain of salt.


On top of this, further creative accounting may result in an alternative set of financial statements that may artificially reduce turnover for those franchises where royalties to the franchisor are calculated as a percentage of turnover.


Somewhere in this conflagration of excessive costs to reduce profits, and lower-than-actual turnover, might be the real performance of the business, but only if the buyer can work this out for themselves.


Independently source inquiry together with the franchisor


Many franchisees who decide to sell their business expect that a buyer will promptly materialise from the stream of general franchise inquiries received by the franchisor. Unfortunately this is rarely the case.


Inquiries received by the franchisor may be for locations anywhere in the region, state or nation, and may primarily be for new or greenfield sites. Furthermore, these inquiries are yet to be qualified into acceptable candidates that meet the system’s selection criteria, and finally, the price offered by the selling franchisee may be too expensive compared to the cost of setting up a new location for a potential buyer.


It is therefore essential that selling franchisees also seek their own potential buyers by conducting their own advertising (subject to the franchisor’s approval) and listing with one or more business brokers who service their area.


Brokers often have an ongoing stream of inquiry for businesses in their area, and in reviewing the business for sale before listing can help the franchisee determine a realistic market price for their business.


Talk with other franchisees


Once a franchisee has decided to sell their business, they should also inform other franchisees of the same system in neighbouring sites or territories. These franchise colleagues will have an interest in the sale because the sale price may provide a benchmark to help determine the value of their own businesses.


Also, adjoining franchisees may well be potential buyers in their own right, and able to move more quickly to settle a sale than a complete newcomer because of their existing operational expertise and cultural affinity with the system.


And existing franchisees will have a better understanding of the creative accounting that may appear in the seller’s financial statements. Existing franchisees will generally have a greater likelihood of being approved by the franchisor (so long as they are operating their current businesses in compliance with the franchise agreement), and the need for an extended handover from seller to buyer will not be as great compared to selling to someone from outside the system.


Set an open timeframe


Businesses can take a long time to sell – months or even years depending on the price, location, industry, sale conditions and other factors. Franchisees and small business owners often make the mistake of setting an unreasonably short fixed deadline to sell the business, then panic or blame the franchisor, the business broker or someone else when it doesn’t sell in that timeframe.


Often these timeframes are set by the next thing that a franchisee has already committed to move on to, such as another business elsewhere, or a return to the workforce often for a former employer or colleague.


As the deadline approaches for the franchisee to commence their new undertaking, their desperation to sell increases, and with it the pressure they apply to their franchisor and their business broker to find a buyer.


At the same time, the price becomes increasingly negotiable and the franchisee can potentially cost themselves a lot of money by selling at a much lower price in order to meet their next commitment.


The reality is that the business will take an unpredictable length of time to sell, and in that time the franchisee really needs to keep operating at full steam to maintain both the financial performance of the business, as well as their own motivation.

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