Franchises and Buyouts

Transcription

1 CHAPTER OUTLINE Spotlight: Veteran Franchise Centers ( 1 What Is Franchising? Define franchising and become familiar with franchise terminology. Franchising Terminology Franchising A business relationship in which an entrepreneur can reduce risk and benefit from the business experience of all members of the franchise system. Franchisor The party in a franchise contract that specifies the methods to be followed and the terms to be met by the other party Franchisee An entrepreneur whose power is limited by a contractual relationship with a franchising organization. Legal aspects vital and must be understood Franchise contract- The legal agreement between franchisor and franchisee. Franchise- The privileges conveyed in a franchise contract. Product and trade name franchising- A franchise agreement granting the right to use a widely recognized product or name. Business format franchising- A franchise arrangement whereby the franchisee obtains an entire marketing and management system geared to entrepreneurs. Master licensee- An independent firm or individual acting as a middleman or sales agent with the responsibility of finding new franchisees within a specified territory. Multiple-unit ownership- Ownership by a single franchisee of more then one franchise from the same company. Area developers- Individuals or firms that obtain the legal right to open several franchised outlets in a given area. Piggyback franchising- The operating of a retail franchise within the physical facilities of a host store. Multi-brand franchising- The operation of several franchise organizations within a single corporate structure. Co-branding- Bringing two franchise brand together under one roof. The Impact of Franchising Exhibit 4-1 provides the most recent impact results indicating that franchised businesses provided more jobs than entire industries Have students provide the names of franchises in the local community. 2 The Pros and Cons of Franchising Understand the pros and cons of franchising and the structure of the industry. The Pros Trade Names and Trademarks success results from intellectual property such as the names that are well known to prospective customers Operations Manual well-developed and thoroughly tested methods of marketing and management 37

2 Training Support provides a proven track record leading to a probability of success; training programs may be excellent or poor and should be carefully considered Economies of Scale- A franchise network can buy in larger quantities than an individual business can, lowering per-unit costs for franchisees. Financial Support-Some franchisors provide financial support to prospective and existing franchisees. The Cons Financial Issues What are the true costs of becoming and remaining a franchisee Other issues include such things as churning (actions by franchisors to void the contracts of franchisees in order to sell the franchise to someone else and collect an additional fee) Franchisor Competition Encroachment The franchisor s selling of another franchise location within the market area of an existing franchisee Special clauses inserted into some franchise agreements such as noncompete clauses that may not allow franchisees to use personal skills and experience Management Issues Limiting sales territories Requiring site approval for the retail outlet and imposing requirements regarding outlet appearance Limiting goods and services offered for sale Limiting advertising and hours of operation Upon contract expiration, requirement to accept new and often costly provisions The Costs of Being a Franchisee Initial franchise fee Investment costs Royalty payments Advertising costs Exhibit 4-4shows An Estimate of Investment Costs and Benefits by Oreck Clean Home Center Ask students to identify factors that lead to variation in these costs (e.g., nature of the business, reputation of the franchisors, etc.) 3 Evaluating Franchise Opportunities Describe the process for evaluating a franchise opportunity. Selecting a Franchise use publications, advertisements, personal observation, and print stories Investigating the Potential Franchise Two-way effort, each investigates the other in the possible relationship The Franchisor As A Source of Information Review their websites 38

3 Disclosure document A detailed statement provided to a prospective franchisee, containing such information as the franchisor s finances, experience, sixe, and involvement in litigation Existing and Previous Franchisees as Sources of Information Becoming a Franchisor Ask students to suggest franchises they would like to own and tell why they chose that franchise. A Reproducible Model Financial Considerations Required Assistance Operations Manual Government Regulations Franchise Rule (A rule that prescribes that the franchisor must disclose certain information to prospective franchisees) Long-Term Value Legal Issues in Franchising The Franchise Contract Typically a complex document Franchisee should obtain legal counsel to anticipate possible trouble spots and objectionable feature of the contract Also discuss with a banker and a professional accounting firm to examine financial statements Especially examine termination and transfer of the franchise Franchise Disclosure Statements Franchise Disclosure Document (FDD) A document that provides the accepted format for satisfying the franchise disclosure requirements of the FTC 4 Buying an Existing Business List four reasons for buying an existing business, and describe the process of evaluating a business. Reasons for Buying an Existing Business Reduction of Uncertainties Acquisition of Ongoing Operations and Relationships A Bargain Price A Quick Start Finding a Business to Buy Prospective buyer needs to search for a business to buy Matchmakers specialized realtors/brokers that bring together buyers and sellers of businesses Inc. magazine offers the following guidelines on finding a business to buy: Determine your commitment Establish what you can afford Figure out what skills you have. Consider lifestyle impact. Ask students which franchises stand out in their community. Have them tell why. Investigating and Evaluating Available Businesses 39

4 Have students look for advertisements for franchises in the local newspaper, on the Internet, in magazines such as Inc., and Entrepreneur. What common elements occur in these ads? What would attract a person to the ad? Due diligence The exercise of reasonable care in the evaluation of a business opportunity Relying on Professionals Finding Out Why the Business is For Sale Old age or illness Desire to relocate to a different part of the country Decision to accept a position with another company Unprofitability of the business Loss of an exclusive sales franchise Maturing of the industry and lack of growth potential Examining the Financial Data The first stage in evaluating the financial health of a firm is to review the financial statements and tax returns for the past five years or for as many years as they are available (NOTE: if these are not available, think twice before buying the business) Nondisclosure agreement- An agreement in which the buyer promises the seller that he or she will not reveal confidential information or violates the seller s trust. Quantitative Factors in Valuing the Business Three basic approaches (Details in Appendix 4B) Asset-based valuation Market-comparable valuation Cash flow-based valuation Nonquantitative Factors in Valuing a Business Market Competition Future community development Legal commitments Union contracts Buildings Product prices Negotiating and Closing the Deal Calculated value may NOT be the price eventually paid for the business (but does provide the buyer an estimated value to use when negotiating the price) May have an option to purchase the assets only (seller is responsible for settling any outstanding debts previously incurred) Buyer should never go through a closing without the aid of an experienced attorney who represents only the buyer Ask students if they would like to own a franchise and then tell why or why not. 40

5 ANSWERS TO END-OF-CHAPTER DISCUSSION QUESTIONS 1. What makes franchising different from other forms of business? Be specific. Franchising is an alternative to business ownership whereby one party (the franchisee) is granted the privilege of conducting business as an individual owner but is required to operate according to certain methods and terms specified by the other party (the franchisor). This unique association with another party, which brings both benefits and restrictions, distinguishes franchising from completely independent ownership. 2. What is the difference between product and trade name franchising and business format franchising? A franchise that only provides the right to use a trade name is a trade name franchise. Gasoline service stations and soft-drink bottlers are examples. When a franchise provides the legal right to use an entire marketing system and an ongoing relationship of assistance and guidance, it is a business format franchise. Fast food outlets are an example. Trade name franchising and its close cousin, product franchising, account for almost 70 percent of all franchise sales. However, the volume of sales and number of franchise units associated with business format franchising have increased steadily over the years. 3. Identify and describe at least four of the key terms in franchising. The franchisor and franchisee are the two main parties in the franchise system. The franchisor is the party in a franchise contract who specifies the methods to be followed by the franchisee. The franchisee is the party in a franchise contract who is granted selling and other privileges and whose power is limited by the franchising organization. Franchisors can sell franchises directly to franchisees, or they may market these in specific territories through master licensees or area developers. Franchise facilitators (such as industry associations, consulting firms, and federal/state agencies) are often a part of the process, since they promote the sale and implementation of franchises. 4. Discuss the pros and cons of franchising from the viewpoints of both the potential franchisee and the potential franchisor. The major advantages and disadvantages of franchising from the viewpoint of a potential franchisee are as follows: Advantages Formal training Limitations Cost of a franchise 41

6 Financial assistance Operating benefits Restrictions on business operations Loss of independence The major advantages and disadvantages of franchising from the viewpoint of a potential franchisor are as follows: Advantages Limitations Reduced capital requirements Reduction in control Increased management Sharing of profits motivation Speed of expansions Increasing operational costs 5. Should franchise information provided by a franchisor be discounted? Why or why not? Information provided by a franchisor should not be discounted. The franchisor should not, however, be the only source of information. Since franchisors are prohibited from making profit predictions for their franchises, either in writing or orally, a prospective franchisee should be cautious if the franchisor offers any predictions. Otherwise, the franchisor is an excellent source of information. 6. Do you believe that the Franchise Disclosure Document is useful for franchise evaluation? Defend your position. Some students may argue that the government requirement is unnecessary. They may favor self-regulation by the industry. However, most students will perceive the document as useful, since it standardizes the type of information available for evaluation by potential franchisees. For example, knowledge of the bankruptcy history of a franchise can be very valuable in the franchise selection process. 7. Evaluate loss of control as a disadvantage of franchising from the franchisor s perspective. Within certain limits, a franchisor can specify, in the franchise contract, matters that concern him or her about the operation of the business. The franchisee is an independent businessperson and not under the direct or daily control of the franchisor. In most situations, this is not a major problem. Sometimes, however, the franchisor may experience this as a drawback when a franchisee fails to devote sufficient energies to a franchise and it begins to fail. A franchisor may even consider purchasing back the franchise to salvage the image of the franchise. 42

7 8. What are the possible reasons for buying an existing company versus starting a new business from scratch? The entrepreneur wants to start a new business if he/she has a new product or service that necessitates a new business. Also, those businesses that are available for sale may be handicapped by poor locations or undesirable facilities that the entrepreneur wishes to avoid. However, buying an existing business has its advantages. For example, this option involves less uncertainty (since the business is operating), relationships with customers and suppliers are already established, and a business may be available at a price below what it would cost to create one from scratch. 9. What are some common reasons that owners offer their businesses for sale? Which of these reasons might a buyer consider to be negative? As discussed in the chapter, the real reason for offering a business for sale may never be disclosed. However, most sellers will probably explain their motivations, if asked. Some of the common reasons are: 1) Illness or aging of the owner, 2) Desire to relocate and/or retire in a different part of the country, 3) Decision to accept a position in another company, maybe a competing firm, 4) Business is not as profitable as expected more work required than anticipated, 5) Loss of an exclusive sales franchise, and 6) Perception of lack of growth in the market segment. (Reason 4, 5, and 6 can easily be considered negative to the buyer. The instructor should anticipate receiving many other logical reasons from students.) 10. What are some of the nonquantitative factors in valuing a business? A list of these factors can be extremely long! Almost anything can be a consideration. In the chapter, however, the authors have selected the following factors as typical of nonquantitative considerations: a. Competition b. The ability of the market to support the business c. Future community development d. Legal commitments e. Union contracts, if any f. The quality of buildings g. Product prices are they competitive? COMMENTS ON CHAPTER YOU MAKE THE CALL SITUATIONS Situation 1 1. Should the Bone brothers have anticipated an economic downturn as part of their due diligence investigation? 43

8 Due diligence investigations in general consider the business opportunity from many different perspectives. Due diligence should consider the future business atmosphere as one aspect. Informed parties such as bankers and accounting firms in the area should contribute to that investigation. Students should access the web site provided with the situation ( to help with their answers to this question. 2. What steps would you take to attract people to your franchised restaurant when they are trying to save money? Advertising should include information emphasizing value for the money. As the brothers feel that they are operating a cost-efficient operation, the cost per meal or per item on the menu should be compared with more expensive alternatives. 3. What can the Elevation Burger franchisor do to help franchisees during a recession? Elevation Burger can hold expenses. For example, if the franchisor requires the franchisees to purchase from specific venders Elevation Burger can work with the venders to keep costs to a minimum. Elevation Burger can also keep the fees charged down and not increase the fees until franchisees are able to pay higher fees. Elevation Burger should hold fees and expenses to a minimum because it is in their best interests to do so. Situation 2 1. If Siler Chapman had so much trouble running three restaurants as an independent owner, why do you think he was able to manage so many more as a franchisee? Because he had the support of the Franchise. The Franchise could provide him with advice, guidance and management recipe for success. The Franchise could also provide Siler with management training, promotional campaigns, reduced purchasing costs. All of these tools would improve Siler s efficiency as a manager. 2. From a franchisor s perspective, why might you choose to convert an existing chain of stores to your model instead of having franchisees who start from scratch? Several reasons exist: a. Reduction of uncertainties. A successful business has already demonstrated its ability to attract customers, manager costs, and make a profit. 44

9 b. Ongoing operations and relationships, The buyer of an existing business typically acquires it personnel, inventories, physical facilities, established banking connections, and ongoing relations with trade suppliers and customers. You are also acquiring goodwill that the previous owner created.. c. Bargain price. An opportunity exists to purchase a business at a good price. d. Quick start. Buying an existing business may be an excellent way to being operations much more quickly. Situation 3 1. Do you think Garrett s experience is normal for someone looking for a business to buy? Can you think of other sources of information about companies that might be for sale that would fit his criteria? Garrett is looking for a business in manufacturing. With his business experience, he should know about the best aspects of manufacturing. No person should purchase a business that doesn t fit his/her knowledge and/or which seems less likely to be a good investment. Other sources of information could be available on the Internet as well as in trade publications and from contacts that he and his partner have developed over the years. 2. For what reasons might someone bid on a business but not be successful in buying it? Sometimes a person bids on a business and another bidder is more successful in the bidding. If the bid is too low, the seller may not feel it is equitable to sell to that bidder. The seller and the buyer may not be able to negotiate terms that are a win-win for the two parties. SUGGESTED SOLUTION TO CASE 4: Two Men And A Truck, International 1. Limiting sales territories is one of the common restrictions that franchise contracts impose on franchisees. Do an Internet search for Two Men And A Truck franchises in your immediate area. How many are there? Does this number reflect the company s population requirements? Answers will vary. 45

10 3. Which moving companies compete with Two Men And A Truck in your area? Are there differences in their rates of success? How could you measure those differences? Are there differences in their advertising? In their rates for items such as boxes and packing supplies? Which companies have an advantage, and why? Answers will vary. 3. Suppose that after owning a Two Men and A Truck franchise for five years, you decided to go out on your own with a new moving company called Four Movers. What kinds of legal issues would you face? One of the most important legal issues to be faced concerns the franchise contract with Two Men and a Truck, and any provision relating to termination and transfer of the franchise. You should check on contract provisions that contain overly strict or vague cancellation policies, and that your rights to sell the business to a third party are clearly spelled out. Also look for contractual issues that may prohibit you from competing with Two Men and a Truck in the same area for a restricted period of time. ACTIVITIES Purpose: The purpose of these activities is for students to experience the intricacies of buying an existing business and to create a written plan to organize the process of doing so. Setting it up: These activities are suited to individual assignment, but they could also be worked on in teams of two students. It might be difficult to manage this as a short group activity because there is not enough work for the exercise to be a successful in this context. By requiring students to complete a full business plan template for acquiring an existing business, however, you could have students or student teams work on this activity throughout the semester. Tell the students to imagine that each of them have just inherited $500,000 business capital from an elderly relative who admired their entrepreneurial spirit. The only stipulation in the will is that they must use the money to buy, and make plans to run, one of the small businesses that are for sale locally [for this exercise the students may choose what s local ]. Also, before the money will be released to them, they must submit a preliminary business plan to the trustees of the estate [you]. Finally, tell students that they must start the process of buying an existing business immediately or the inheritance will pass to another likely entrepreneur in the family! To begin: 1. Have students search for a local business for sale on the Wall Street Journal s online center for entrepreneurs at 2. Next, have them find the template, Business Plan for an Established Business, on the SCORE Web site, Then have 46

11 Extension: students fill out the General Company Description (page 5) with all the information they can gather on their chosen business for sale and submit it to you as the trustee. 3. When their plan is complete, have them checking it plan against the recommendations of the Small Business Administration at Have students use a template to produce a complete business plan for purchasing the established business they ve selected for this exercise. A robust template can be found at Business Plan for an Established Business, on the SCORE Web site: or at a section of the Wall Street Journal s Web site that will lead to the small business area site for wsj. Sources: S.C.O.R.E., a small business counseling site at the Small Business Association Web site at Wall Street Journal s site for entrepreneurs at 47