Everything You Need to Know Before Purchasing an Existing Franchise

There are currently close to 750,000 franchises operating in the United States. The industry is expected to generate $710 billion in 2017. More than one new franchise system has started up every day for the past two years. It’s clear that there is a lot of money in franchising, and that people and companies are out there looking to launch the next greatest franchise, on a daily basis. But what about all of the franchises that have been in business for years and the owners that are ready to move on or retire?

As a franchise consultant, I work with clients that want to start their own franchise and build an empire, while I have others that shudder at the idea of starting from scratch, and will only entertain opportunities that have an existing cash flow, an established client/customer base, and employees. Does purchasing an existing franchise that has all of those things mean you’ll be more successful than someone that buys a new one? Not necessarily.

Often, what seems like a benefit to purchasing an existing franchise could actually be a pitfall as the chart above depicts. Here are some suggestions on how to ensure the potential benefits to buying an existing business, don’t turn into liabilities:

Existing Cash Flow

When purchasing an existing business, there’s no more important work than scrutinizing the financials. This rule applies to new and existing, but it’s even more critical for existing businesses.

Profitable businesses for sale are rarely advertised. They are typically sold to friends, family, or competitors. And when they are, an owner will inflate the asking price, hoping to get something they consider to be fair. However, it’s not uncommon that the books they have don’t match up to what they’re asking. You often find what we like to call “creative accounting” when it comes to bookkeeping for small businesses, for reasons that include tax purposes, how an owner accounts for personal use of items that are also used to support the business, as well as how employees are compensated.

It’s important to understand all of those details, and if you’re not a CPA, it’s highly recommended that you hire one to review the information prior to making an offer. Keep in mind that there are other benefits to a business that aren’t necessarily reflected in the bottom line that should also be considered. The good thing about purchasing a franchise is that at the very least, you have a franchisor that can validate the weekly gross sales that the business is doing as the franchisor is collecting royalties from those sales on a regular basis.

Existing Employees

While you might be excited to know you’re buying a business that has employees that don’t need to be trained and very likely know the business better than you, you should find out if those employees are happy. Are they willing to stay on for a new owner, and do you want them to stay? Are they good employees that fit the type of business you want to build?

You may assume that you will be able to find all of this out prior to the sale, however, it’s not uncommon that sales are being done confidentially because an owner doesn’t want staff or customers to know a sale is in progress, so as to not disrupt business. Make sure you request all pertinent information about staff before signing a Purchase Agreement.

Established Customer Base

At this year’s Black Enterprise Entrepreneurs Summit in Houston, I met a former business owner that shared his story with me about selling his very successful photography business. The buyer was very excited about the business. Unfortunately, what she didn’t realize was that the business was so successful because the clients loved the owner!

After the new owner took over, the customer base began to fall off. Now, not only was the new owner trying to build up new clientele, but had to spend a lot of time and money trying to retain the existing customers. Unfortunately, she was unsuccessful, and the business closed.

When buying a resale business, it’s important to understand the customer base, and the value that the business is offering. Is it mainly the product and service that people are patronizing, or is it a relationship business where they love and support the owner? If it’s the latter, and you’re not sure you can replicate that, you may want to reconsider the franchise purchase. You could also request the owner with a dedicated customer following remain active in the business for a transitional period—actually, quite standard in the franchise resale process.

Buying a resale business may be a great opportunity, particularly if you have an owner that is ready to retire, perhaps willing to negotiate on price, and has a great staff that’s been in place for years that enjoy their jobs. It can also sometimes be easier to get a loan for a resale business as opposed to new because it has cash flow that the bank finds favorable. However, you must peel back the layers and understand what you’re getting. Sometimes, it can be better to start from scratch to know exactly where you stand!