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Buying an Existing Business OR Considering a Franchise

Stage 10 & 11

Karen Campbell

on 31 March 2017

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Transcript of Buying an Existing Business OR Considering a Franchise

Broad Classes of Franchises
Product Distribution Arrangements
Entire Business Format
What is a Franchise?
Types of
Interested in a Franchise?
Franchising is...
What is a Franchise?
Entire-business-format has been primarily responsible for the most of the growth of franchising since 1950!
Advantages of Franchising
In Conclusion...
Stage 10 and 11
Buying a Business!
Considering a Franchises?

The Franchise Agreement
Stage 4:
Buying a Business
(c) 2011, McGraw-Hill Ryerson
Legal considerations
Company policies
Historical practices

Get lawyer and account involved early
Other Concerns
(c) 2011, McGraw-Hill Ryerson
Company’s trading area
Population demographics
Trend and size of market
Recent changes in market
Future market patterns
Market Conditions
(c) 2011, McGraw-Hill Ryerson
Cash problems
Poor management
Overly generous credit terms
Excessive inventory
Cash Flow
(c) 2011, McGraw-Hill Ryerson
Accounts receivable
Fixed assets – buildings, furniture, equipment, fixtures (what are they really appraised at?)
Liens, mortgages
Unpaid bills
Value of Tangible Assets
(c) 2011, McGraw-Hill Ryerson
Physical facilities may be old and obsolete
Union/management relations may be poor
Present personnel may be unproductive
Inventory may contain a large amount of “dead” stock
May have poor quality accounts receivable
Location may be poor
Financial condition and relations with financial institutions may be poor
You may inherit any ill will that may exist
You have less freedom to define the nature of the business
Disadvantages of Buying an Established Business
(c) 2011, McGraw-Hill Ryerson

Determining an Appropriate Price to Pay for a Business

Rule of Thumb: A common approach:

(The fair market value of the company’s assets)
(the owner’s cost of current inventory)
(approx. 90% of what appear to be good accounts receivable)
(a percentage of the company’s net income before taxes as
The Approximate Value of the Business
(c) 2011, McGraw-Hill Ryerson
Key people
Present employees
Quality and quantity
Human Factors
(c) 2011, McGraw-Hill Ryerson
Franchising and licensing rights
Patents, trademarks, copyrights (don’t forget about IP*)
*Intellectual property (IP) is a legal concept which refers to creations of the mind for which exclusive rights are recognized.[1] Under intellectual property law, owners are granted certain exclusive rights to a variety of intangible assets, such as musical, literary, and artistic works; discoveries and inventions; and words, phrases, symbols, and designs. Common types of intellectual property rights include copyright, trademarks, patents, industrial design rights, trade dress, and in some jurisdictions trade secrets.
Value of Intangible Assets
Gross sales $ 428
Less: Returns 3
Net Sales $ 425 (A)

Cost of goods sold:
Beginning inventory $ 75
Plus: Net purchases 297
Cost of goods available 372
Less: Ending inventory 80
Cost of Goods Sold 292 (B)

Gross Profit (C = A - B) $ 133 (C)

Selling Expenses $ 29 (D)
Administrative expenses:
Office salaries $ 60
Interest 9
Depreciation 10
Other administrative expenses 7
Total Administrative Expenses 86 (E)

Profit Before Income Tax (F = C - D - E) $ 18 (F)

Income Tax (G = 25% of F) 4.5 (G)

Net Profit (G = F - G) $ 13.5 (H)
Example of a Simplified Income Statement
These are ratios that have become generally accepted.

Collected and published trade associations and organizations
1. Current Ratio
2. Quick Ratio
3. Debt to Net Worth Ratio
4. Gross Profit to Sales Ratio
5. Net Profit to Sales Ratio
6. Return on Assets
7. Sales to Inventory Ratio
8. Average Collection Period
Ratio Analysis (see page 95)
(c) 2011, McGraw-Hill Ryerson
Analysis of financial statements – make sure they’re accurate
Most important financial factors are:
Trend in profits (study the records)
Ratio analysis
Value of the business’s tangible assets
Cash flow
Financial Factors
(c) 2011, McGraw-Hill Ryerson
To assess and evaluate a business operation:

Get professionals involved – lawyers, accountants, business evaluator

You should have an understanding of the nature of the business and the industry

Why is it for sale?
Important Factors to Consider
(c) 2011, McGraw-Hill Ryerson
Current job contacts
Local newspapers and trade associations
Confidential advisors (loan officers, brokers, lawyers, accountants etc.)
Your personal network
How To Find the Right Business
to Buy
(c) 2011, McGraw-Hill Ryerson
Can reduce the risk
Increases the likelihood of a successful operation
Has a proven location
Already has a product or service
Has already developed a clientele
Financial relations have already been established
Production equipment is already available
Can often be acquired at a good price
Advantages of Buying an Established Business
(c) 2011, McGraw-Hill Ryerson
Rule of Thumb: Some examples

Book Store – 15% of annual sales + inventory
Daycare Centre – 2-3 times annual cash flow
Dental Practice – 60-70% of annual revenues
Florist Shop – 34% of annual sales plus inventory
Restaurant (non-franchised) – 30-45% of annual sales
Travel Agency – 40-60% of annual commissions
Determining an Appropriate
Price to Pay for a Business
(c) 2011, McGraw-Hill Ryerson
Earnings-Based Methods
Capitalization of Earnings
Discounted Future Earnings
Discounted Cash Flow
Balance Sheet Methods
Net Book Value
Modified Book Value
Liquidation Value
How To Determine an Appropriate
Price to Pay for a Business
* Debt is due within 12 months. ** Debt is due after 1 year.
ASSETS (000s)
Current Assets
Cash $ 25
Accounts receivable 53
Inventory 80
Total current assets $ 158 (A)
Fixed Assets
Machinery $ 40
Less: Accumulated depreciation 25 15
Equipment and fixtures 30
Less: Accumulated depreciation 18 12
Total fixed assets 27 (B)
Total Assets (C = A + B) $ 185 (C)

Current Liabilities*
Accounts payable $ 60
Notes payable 35
Total current liabilities 95
Long-Term Liabilities
Notes payable** $ 40
Total long-term liabilities 40
Total liabilities $ 135 (D)

Capital investment 20
Retained earnings 30
Total owner’s equity 50 (E)

Total Liabilities and Owner’s Equity (F = D + E) $ 185 (F)
Example of a Simplified Balance Sheet
(c) 2011, McGraw-Hill Ryerson
Other concerns
Why is the
Business for sale?
Purchase shares of business
Purchase assets of business
and trade
brokers and
real estate
Determine an appropriate price
Evaluate all the aspects of the potential acquisition
Where can you find a business to buy?
Buy an Existing Business
Buying a Business
(c) 2011, McGraw-Hill Ryerson
Other concerns
Why is the
Business for sale?
Purchase shares of business
Purchase assets of business
and trade
brokers and
real estate
Determine an appropriate price
Evaluate all the aspects of the potential acquisition
Where can you find a business to buy?
Buy an Existing Business
Buying a Business
(c) 2011, McGraw-Hill Ryerson
Other concerns
Why is the
Business for sale?
Purchase shares of business
Purchase assets of business
and trade
brokers and
real estate
Determine an appropriate price
Evaluate all the aspects of the potential acquisition
Where can you find a business to buy?
Buy an Existing Business
Buying a Business
(c) 2011, McGraw-Hill Ryerson
Could be considerable negotiation in agreement

Franchisors like to see exclusive territoriality kept to minimum

May restrict the protection provided to you to a grant of first refusal
(c) 2011, McGraw-Hill Ryerson
Require use of physical facilities that may be owned by franchisor

Franchisors maintains control of physical facilities

Required to purchase or lease fixtures, furnishings, equipment, and signs from franchisor
(c) 2011, McGraw-Hill Ryerson
The high degree of control which franchisors exercise over their franchisees
Contractually required to report regularly to the franchisor and subject to frequent inspection and constant supervision
The cost of the services provided to you by the franchisor is based on your total sales revenue, not your profitability
Franchisor may add a mark-up to the supplies and equipment you are required to buy from them, thereby increasing your operating costs
Must pay the franchisor an initial franchise fee as well as periodic royalty payments and advertising contributions
(c) 2011, McGraw-Hill Ryerson
The franchisee provides:
The motivation
The entrepreneurial spirit
The money
(c) 2011, McGraw-Hill Ryerson
Stats Canada: a system of distribution in which one enterprise (the franchisor) grants to another (the franchisee) the right or privilege to merchandise a product or service.

Int’l Franchise Association: a continuing relationship in which the franchisor provides a licensed privilege to do business, plus assistance in organizing, training, merchandising, and management in return for consideration from the franchisee
(c) 2011, McGraw-Hill Ryerson
Do your own research, and take your time
Don’t be afraid to cold-call current franchisees and ask all kinds of questions
Try to talk to former franchisees whose business went under
Talk to knowledgeable people in the franchise industry
Have an experienced franchise lawyer review your contract
If you do decide to go ahead, assume that nothing will ever again work the way you are used to.
(c) 2011, McGraw-Hill Ryerson
Increasing emphasis on senior care
Child care and education
Technical support
Pet care
Home improvements
(c) 2011, McGraw-Hill Ryerson
Ads in newspaper, business journals, trade magazines
Franchise directories – see textbook FYI
Narrow the selection
Request a promotional kit
(c) 2011, McGraw-Hill Ryerson
See textbook for a current sampling from the Franchise Canada Directory 2010, Canadian Franchise Association (www.cfa.ca)
(c) 2011, McGraw-Hill Ryerson
Usually need approval of franchisor

Ensure agreement allows for transfer to spouse or adult children

Most franchisors require transfer to external party who meets their criteria

Right of first refusal – response time of franchisor should be 15- 30 days in contract
(c) 2011, McGraw-Hill Ryerson
1 – 50 years

Most are 10 – 20 years

Not all agreements contain provisions for renewal

Beware the termination of agreement

Often franchisor has right to purchase everything upon termination
(c) 2011, McGraw-Hill Ryerson
May include training schools, field experience, training manuals, on-location training

Usually start up advisory training

Periodic refresher training

Franchisors want tight control so often provide operating assistance

(c) 2011, McGraw-Hill Ryerson
Required to purchase products and services from them or designated sources

Franchisor can earn profit from this
(c) 2011, McGraw-Hill Ryerson
Initial franchise fee on signing the agreement
Royalties: contribute a portion of your gross revenues to an advertising fund
Require you to support your own local advertising
May provide service like bookkeeping, accounting, management consulting which are billed on a fee-for-service basis
(c) 2011, McGraw-Hill Ryerson
In a typical franchise agreement there are:

Obligations Undertaken by the Franchisor

Obligations Imposed on a Franchisee
(c) 2011, McGraw-Hill Ryerson
Other payments that must be made to the franchisor
Ongoing training requirements
Cooperative advertising fees
Insurance requirements
Interest charges on financing
Requirements regarding purchasing supplies from the franchisor and prices
Restrictions that apply to competition with other franchisees
Terms covering termination, renewal rights, sale of the franchise and similar topics
(c) 2011, McGraw-Hill Ryerson
The full initial costs and what they cover
Use of the franchisor’s trademarks by the franchisee
Licensing fees
Land purchase or lease requirements
Building construction or renovation requirements
Equipment needs
Initial training provided
Starting inventory requirements
Promotional fees or allowances
Use of operations manual
Royalties payable
(c) 2011, McGraw-Hill Ryerson
It requires franchisors to provide a disclosure document including:
The business background of the directors and officers of the franchisor
Details of any litigation against the franchisor
Details of bankruptcy, insolvency, or criminal proceedings against the franchisor or its directors
The names and addresses of existing and former franchisees
The particulars of any advertising fund expenditures
A set of financial statements
Who's on Top!
(c) 2011, McGraw-Hill Ryerson
(c) 2011, McGraw-Hill Ryerson
(c) 2011, McGraw-Hill Ryerson
Reduced risk of failure
May be able to take advantage of large-scale, centralized buying
May have access to special financing and credit arrangements
The opportunity to acquire a proven system that has already been developed, tested and refined
Enables you to compete through the use of a well-known trademark or trade name
Franchisor may provide you with assistance in such areas as site selection, equipment purchasing, national advertising, bookkeeping, the acquisition of supplies and materials, business counseling and employee training
(c) 2011, McGraw-Hill Ryerson
A continuing relationship between two parties
A legal contract that describes the responsibilities and obligations of each party
Tangible and intangible assets provided by the franchisor for a fee
The operation of the business by the franchisee under the franchisor’s trade name and managerial guidance
(c) 2011, McGraw-Hill Ryerson
The franchisor provides:
Business expertise
A proven product or service
An operating system
A marketing plan
A site location
Financial controls
(c) 2011, McGraw-Hill Ryerson
A legal and commercial relationship between the owner of a trademark, trade name, or advertising symbol and an individual or group of people seeking the right to use that identification in a business
a Franchise

(c) 2011, McGraw-Hill Ryerson
Source: Joey’s Only (www.joeys-only.com/franchising/startup_costs.html) accessed May 13, 2010
Franchise fee $25,000
Opening promotion fee $3,000-5,000
Leasehold improvements $125 – 150,000
Smallwares (merchandise) 9,000 - $12,000
Furniture, fixtures and kitchen equipment $115-130,000
Miscellaneous $5,000-13,000
Food and supplies $10,000-14,000
Training and pre-opening expenses $4,000-11,000
Deposits $4,000-10,000
Total Estimated Cost to Open $337 ,000 - 437,000
Master franchise
Area franchise
Single-unit franchise
Business Format
Concentrates on a product line!
Complete identification of the dealer with the supplier

The benefits available through franchising may not always materialize

Termination policies of many franchisors give franchisees little or no security in many cases
Most popular & simplest. Right to establish and operate a business at a single location.
Right to establish more than one outlet within a specified territory.
Rights to open multiple locations but also to sell subfranchises to others within the territory.
What is the process?
Read about this "Labourer to Owner" story on page 309 in your text
Ask yourself...Why is the business for sale?
Analyze the financial ratios!
Ask for their financial statements!
Read "Entrepreneurs in Action" on page 319
How to determine an appropriate price to pay...
Buying an existing business - Stage 10
Canada is said to be one of the franchise capitals of the world, led only by the U.S.A! (Good, Mayhew, 2014)
Source: Building Your Dream - Good & Mayhew, 2014)
The End
Full transcript