If you are buying a franchise, or thinking of franchising your own business, then this article is for you.
Any business owner must consider at all times a potential exit route: the ability to “cash-in” on the fruits of hard labour is crucial. Potential franchisees often overlook the fact that they have the opportunity to build their business and then sell it on at a profit. This article explains the mechanics behind this ability to sell-on a franchise, and why it can be beneficial for both franchisors and franchisees.
Mechanics of a re-sale
Every franchise agreement issued by a franchisor, which is a member of the British Franchise Association, will contain provisions that allow the franchisee to sell their business, but only to a person approved by the franchisor. Most franchisors go further, and lay down certain procedures for franchise re-sales, including the requirement to pay certain fees to the franchisor. These range from fees covering the costs of providing the initial start up services to the prospective franchisee, to the franchisor being entitled to a percentage of the sale proceeds (usually between 5%-10% if the franchisor finds the prospective buyer). Often the franchisor has a pipeline of prospective franchisees and therefore it is common for the franchisor to introduce the prospective franchisee to the selling franchisee. The franchisor will also assist the selling franchisee in the sale process by providing a raft of information, including for example, a prospectus and financial and business information to the prospective franchisee.
Valuing a franchise is often a black art rather than an exact science. Valuations vary from business sector to business sector and depend on the maturity of the franchise itself. Accountants often value franchises based on multiples of earnings or profits. However, the franchisor is usually in the best position to advise on valuations because, particularly with mature franchise networks, they will have seen a stream of re-sales and so will know “the going rate”. Although part of the goodwill of a franchisee’s business, namely the name and brand, always remain the property of the franchisor, we have seen franchisees build up and subsequently sell on franchises for substantial sums.
Advantages to Franchisee
In many businesses, the value lies in potential profits to be generated from an existing customer base and the prospect for future growth. Because of the support of a franchisor, the franchisee should be in a better position to assess the value of the franchise, as there should be a ready market for potential franchises within a particular network. In some ways, this can also act as a safety net for underperforming franchisees as – rather than letting an underperforming franchise fail - a franchisor will usually be keen to find a buyer from its pipeline of potential recruits. This is not true of every franchisor, but is becoming much more common, especially as a way of keeping banks “on-side”.
Advantages to Franchisor
Having a network with a lot of re-sales was often viewed in the old days as a “bad thing” but not any more. It is now viewed as a good way of rewarding the best performing franchisees and helping to refresh the network with enthusiastic recruits. There is also the human aspect – if a franchisee is struggling and wants to leave, it is better that they can exit with a few thousand pounds in their back pocket rather than having their franchise agreement terminated.
If you are buying a franchise you should check whether the franchisor has a good, managed, re-sale process. After all, if you worked hard to build up the value of your business, this could form part of your pension and you should check that your franchisor will encourage that. If you are a prospective franchisor, or indeed an existing one, then make sure that your franchise agreement allows you to manage the process properly, as re-sales can have huge advantages for many franchise networks.
This article was published in Business First magazine, April 2013 edition.