Franchising

1
Franchising

• Franchising
• A marketing system revolving around a two-party
  agreement, whereby the franchisee conducts
  business according to the terms specified by the
  franchisor
• Franchisee
• An entrepreneur whose power is limited by a
  contractual agreement with a franchisor
• Franchisor
• The party in the franchise contract that
  specifies the methods to be followed and the
  terms to be met by the other party

2
Franchising Arrangements

• THREE KINDS OF FRANCHISES
• Trade Name Franchise
• Grants the right to use a widely recognized name
  within a particular territory
• True Value Hardware, Associated Grocers Inc
  (AGI), Century 21
• Product Distribution Franchise (Dealership)
• Allows you to sell a specific, brand-name product
  in a specified territory
• Snap-On Tools, Toyota
• Business Format Franchise
• Provides an entire business plan, marketing, and
  operating system
• Guidance from the franchisor is ongoing
  supervision monitoring are continuous
• Subway, McDonalds
• 
  
• Single Franchise Owner
• Owns the franchise rights to operate in just one
  business location or territory
• Multiple-Unit Owner/Master Franchisee
• Has the right to open several franchised outlets
  in a given area or territory
• Piggyback Franchise
• A retail franchise operation within the physical
  facilities of a host store a Subway inside
  WalMart

3
The Pros and Cons of Franchising

• Advantages
• Probability of success
• Proven line of business
• Pre-qualification of franchisee
• Overall lower failure rates
• Training
• Franchisor-provided
• Financial assistance
• Loans loan guarantees
• Operating benefits
• Location feasibility study
• Marketing assistance
• Quick start-up time

• Limitations
• Franchise costs
• Initial franchise fee
• Investment costs
• Royalty payments
• Advertising costs
• Restrictions on business operations
• Products sold
• Hours of operation
• Restrictions on expansion/growth
• Franchisor only source of supplies
• Loss of independence
• Lack of franchisor support
• Termination/renewal clauses

4
Franchisor Controls on Franchisees

• Restricted sales territory
• Requires site approval and imposes requirements
  on the outlets appearance
• Restricts the goods/services that can be sold
• Requires specific operating hours
• Controls advertising

5
An Attractive Franchise Opportunity Includes - 1

• Registered trademarks
• Successful prototype stores with a track record
  of profitability and a positive reputation
• A business that can be systematized so that it
  can be easily replicated.
• A product or service that can be successful in
  many different geographic regions.

6
An Attractive Franchise Opportunity Includes -
2

• An operations manual that specifies all the
  functions of the business and their associated
  policies
• A training and support system
• Site selection criteria and architectural
  standards
• A detailed prospectus that spells out the
  franchisees rights, responsibilities, and risks.
  
• The Federal Trade Commission requires
  disclosure...Uniform Franchise Offering Circular
  UFOC

7
Franchise Disclosure Requirements

• Rule 436 of the Federal Trade Commission
• Uniform Franchise Offering Circular (UFOC)
• A document accepted by the Federal Trade
  Commission as satisfying its franchise disclosure
  requirements
• Litigation and bankruptcy history
• Investment requirements
• Conditions that would affect renewal,
  termination, or sale of the franchise
• http//www.ftc.gov/bcp

8
Before Buying a Franchise
ASK QUESTIONS
9
Questions to Ask Before Buying a Franchise

• Does the franchisor have an excellent reputation
  in the industry?
• Is the franchisor in partnership or any other
  legal relationship with another franchisor? If
  so, how will the franchisee be protected should
  that relationship fail?
• Is the franchisee required to do anything that
  appears questionable from a legal or ethical
  perspective?
• Under what circumstances can the franchisee or
  franchisor terminate the franchise agreement and
  what are the consequences to either party?
• Will the franchisor grant an exclusive territory?
  Is that area subject to reduction or
  modification? If so, under what conditions?

10
Questions to Ask Before Buying a Franchise - 2

• Will the franchisor reveal the certified
  financial figures for one of its franchises and
  can those figures be verified with the
  franchisee?
• Will the franchisor provide a management training
  program, an employee training program, public
  relations and advertising support, or credit?
• Does the franchisor assist in finding a suitable
  location?
• What is the financial health of the franchisor?
  Can financial statements be verified?

11
Questions to Ask Before Buying a Franchise - 3

• What is the track record of the franchise?
• Has the franchisor conducted an in-depth
  investigation of the franchisee to assure that he
  or she has the necessary skills and financial
  requirements to operate the business
  successfully?
• How much capital will be required to start and
  operate the business to a positive cash flow?
  Does the initial fee include an opening inventory
  of products and supplies? What do royalties pay
  for and how are they calculated?

12
How Risky is that Franchise? Jeff
Elgin, Entrepreneur.com/article /217285 9/2010

• Are the number of franchise units growing/staying
  constant/or declining? (Item 20 of the FDD)
• Has there been an increase in litigation between
  franchisor and franchisees during the last couple
  of years? (Item 3 of the FDD)
• Scrutinize the last three years audited
  financial statements as part of the FDD.
• Strong capital reserves, cash flows, and good
  profits?
• Are accounts receivables increasing? (may be a
  bad sign if franchisees cant pay monthly fees!)
• Are the same-store sales figures increasing,
  holding steady, or declining? Is the business
  susceptible to economic downturns?
• What is the attitude of the existing franchisees?
  Call them and ask
• How do you feel about the business?
• How have the past couple of years been?
• Knowing what you know now, would you do it again?

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Where to Find out about Franchises

• www.franchise1.com
• www.franchising.com
• www.en.wikipedia.org/wiki/franchising
• www.entrepreneur.com/franchiseopportunities/index.
  html
• www.franchiseinfosite.com

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The Top 20 Franchises for 2010

• Subway Submarine sandwiches salads 84,300
  - 258,300
• McDonalds Hamburgers, chicken, salads
  1,057,200 - 1,885,000
• 7-Eleven, Inc Convenience stores 40,500 -
  775,300
• Hampton Inn/Suites Hotels 3,716,000 -
  13,148,800
• Supercuts Hair Salons 112,600 - 243,200
• H R Block Tax preparation filing 34,438 -
  110,033
• Duncan Donuts Coffee, doughnuts, etc 537,750
  - 1,765,300
• Jani-King Commercial cleaning 13,200 -
  93,200
• Servpro Disaster restoration cleaning
  127,300 - 174,700
• AmPm Mini Market Gas/Store 1,835,823 -
  7,615,065

• Jan-Pro Commercial cleaning 3,300 - 54,300
• Kumon Math Supplemental education 36,538 -
  145,250
• Stratus Building Commercial cleaning 3,450 -
  57,750
• Miracle-Ear Hearing instruments 122,500 -
  570,000
• Pizza Hut Inc Pizza, pasta, wings 302,000 -
  2,100,000
• Hardees Burgers, chicken, biscuits
  1,182,000 - 1,583,500
• Dennys Inc Full-service restaurant
  1,200,000 - 2,600,000
• Jazzercise Inc Dance/fitness classes 2,980 -
  38,400
• Matco Tools Mechanics Tools Equip 79,926 -
  188,556
• UPS Store Postal/Business Services 150,980 -
  337,950

Source Entrepreneur.com, 2010 Franchise 500
Rankings
15
Top 12 Low-Cost Franchises - 2010

• H R Block Tax preparation and electronic
  filing
• 34,438 - 110,033
• Jani-King Commercial cleaning
• 13,200 - 93,200
• Jan-Pro Intl Commercial cleaning
• 3,300 - 54,300
• Kumon Math Centers
• Supplemental education 32,958 - 131,070
• Stratus Building Solutions Commercial cleaning
  3,450 - 57,750
• Jazzercise Inc Dance fitness classes
• 2,980 - 38,400
• Instant Tax Service Retail tax preparation
  39,000 - 89,000
• Source Entrepreneur.com Top Low-Cost
  Franchises in 2010

• Vanguard Cleaning Commercial cleaning 8,125 -
  38,100
• ServiceMaster Clean Disaster cleaning 20,926 -
  132,623
• Bonus Building Care Commercial cleaning
  9,000 - 15,000
• Merry Maids Residential cleaning 24,750 -
  59,450
• Anago Cleaning Systems Commercial cleaning
  8,543 - 55,306

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The Top 20 New Franchises for 2010

• Stratus Building Solutions Cleaning 3,450 -
  57,750
• Senior Helpers In-home care for seniors
  69,800 - 96,300
• Mr. Sandless Wood floor refinishing 28,000 -
  56,000
• HealthSource Nutrition weight loss 52,950
  - 249,795
• Oreck Home Cntr Vacuums, etc 84,600 -
  221,000
• Guard-A-Kid Kids ID safety products 19,900
  - 20,900
• Fresh Coat Interior painting 38,800 - 63,800
• Murphy Bus Fin Bsns brokerage/real estate
  61,600 - 128,700
• Oxi-Fresh Carpet cleaning 33,495 - 55,950
• Seniors Choice Nonmedical home care 54,000 -
  72,000

• Mister Sparky Residential electrical 24,420 -
  490,740
• FocalPoint Business consulting 75,550 -
  121,950
• Synergy HomeCare Nonmed home care 53,300 -
  115,300
• Z-Coil Pain relief footwear 88,150 -
  160,800
• Clix Studio on-location photography 38,500
  - 373,040
• Stroller Strides Stroller fitness program
  4,009 - 17,889
• Speedpro USA Large format imaging 202,200 -
  230,100
• Superior Wash Onsite mobile fleet washing
  59,820 108,405
• Ripiccis Italian Ice Italian Ice 35,140 -
  150,500
• Soccer Shots Soccer programs for children 3-8
  13,935 - 18,550

Source Entrepreneur.com, Top New Franchises
2010
17
Buying an Existing Business?
Acquisition of Ongoing Operations and
Relationships
Reduction of Uncertainties
A Quick Start
A Bargain Price
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Good Reasons to Purchase an Existing Business

• It is less risky than starting from scratch,
  because facilities, employees, and customers are
  likely to be in place.
• To acquire a business with ongoing operations and
  established relationships with loyal customers
  and reliable suppliers
• The business has established trade credit, which
  is crucial because relationships with suppliers
  and others take a long time to develop.
• It is an easier route to owning a business if the
  entrepreneur has limited business experience,
  especially if the owner stays on for a time to
  help with the transition.
• To begin a business more quickly than starting
  from scratch
• To obtain an established business at a price
  below what a new business or franchise would cost

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Pros and Cons of Buying an Existing Business

• Pros
• Higher chance of success
• Less planning
• Existing customers/ suppliers
• Necessary equipment
• Bargain price
• Experienced employees
• Existing business records

• Cons
• Existing problems
• Poor quality of current employees
• Poor business image
• Modernization required
• Purchase price based on inaccurate data
• Poor business location

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Where to Find Business Opportunities

• Attorneys
• Accountants
• Bankers
• The Wall Street Journal
• Liquidation auctions
• Business brokers
• The internet

21
What is a Business Broker?

• When a business owner is looking to sell her
  business, she may turn to a business broker, who
  will look for a buyer for the business. Brokers
  typically charge one to 10 percent of the
  transaction price for their services.

22
Looking to Buy a Business? How to Attract the
Attention of a Business Broker

• Demonstrate your strong interest in acquiring a
  business by providing information to the broker
  about your knowledge and interest in running your
  own business.
• Demonstrate strong financial qualifications
• Be willing to move to a new location to take
  advantage of a business opportunity
• Keep an open mind about the type of business
  consider a wide range of opportunities.
• Be persistent and follow up with the broker
• Be ready to respond quickly when an opportunity
  emerges. This means having financial records in
  order and money available.

23
What to Look For in a Business

• A business that had a broad scope that would
  insulate it from market downturns.
• A business with existing customers and vendors
• A low-tech business but with high growth
• A market that was not so large so as to encourage
  major players but not so small that the company
  couldnt grow.
• Available float from suppliers in other words,
  leeway in having to pay vendors.
• Manageable seasonality
• Cost cutting potential

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Investigating and EvaluatingAvailable Businesses

• Due Diligence
• The exercise of prudence, such as would be
  expected of a reasonable person, in the careful
  evaluation of a business opportunity
• Relying on Professionals
• Accountants
• Attorneys
• Other experienced business owners

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Find Out Why the Business Is For Sale

• Owners stated reasons for selling the business
• Poor health or illness in the family
• Wants to retire while he can still enjoy life
• Desires to relocate to a different section of the
  country
• Has accepted a position working for another
  company
• Wants to start a new business in a different
  industry
• Has to sell the business to generate funds to
  settle a divorce, lawsuit, etc.
• Beware of sellers who may have priced the
  business at more than its worth, or who have
  cooked the books to make the business appear to
  be more attractive than it really is.

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The REAL reason the Business Is For Sale

• Larger companies are squeezing the firm out of
  the market
• Key employees have been leaving
• The industry is very mature and there arent any
  new ways or places to grow
• Competitors products (or services) are superior
• The business has developed a negative reputation
  in the community
• The firm is facing a pending lawsuit
• The business is just not profitable
• The physical facilities are old or obsolete and
  in need of major renovation/repairs

27
Examining the Financial Data

• Review financial statements and tax returns for
  the past five years.
• Recognize that financial data can be misleading.
• Assets overvalued
• Expenses under-stated
• Income over-stated
• Unrecorded debts
• Adjust asset valuations to reflect the true state
  of the business.

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Valuing the Business

• Asset-Based Valuation
• Estimates the value of the firms assets does
  not reflect the value of the firm as a going
  concern.
• Market-Comparable Valuation
• Considers the sale prices of comparable firms
  difficulty is in finding comparable firms.
• Cash-Flow-based Valuation
• Compares the expected and required rates of
  return on the amount of capital to be invested in
  the business.

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Non-quantitative Factors in Valuing a Business

• Competition
• Market
• Future CommunityDevelopment
• Legal Commitments
• Union Contracts
• Buildings
• Product Prices

30
Placing a Value on a Service Business

• The biggest asset of a service company is its
  employees, including senior management, followed
  by customers and the business system.
• The value of a service company is found in the
  quality of the relationship between its
  management (staff) and customers. Without those
  relationships, there is no business.

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Possible Conditions on the Purchase of a Service
Business

• The owner must stay on as an employee for two
  years or perhaps as an employee for one year and
  as a consultant for two more.
• Any loss of an account or a large customer that
  was in place at the closing of the sale will
  reduce the payout by some defined amount.
• One-third of the total purchase price will be
  paid at closing. The remainder will be paid in
  equal payments over three years.

32
Negotiating and Closing the Deal

• Negotiating the Terms of the Agreement
• Continuation agreement
• Non-competition clause
• Seller financing
• Earnouts and Indemnification agreements
• The final price
• Full payment vs installments
• Closing the sale
• Best handled by a third party
• Bill of sale
• Tax certifications
• Payment agreements and guarantees

33
Do Your RESEARCH!

• Develop a set of criteria for judging the
  business based on the entrepreneurs needs and
  goals.
• Understand the industry and the market niche in
  which the business will operate
• Examine the records of the business

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More Ways to RESEARCH!

• Talk to employees, suppliers, and customers
• Examine equipment and facilities to make certain
  they are current and in good working order
• Examine all contracts
• Verify the value of the business based on
  industry statistics and perhaps the advice of a
  professional business appraiser.

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35
Valuation

• There are a number of tools available to predict
  value including complex software tools that
  promise to reduce valuation to a simple formula.
  
• However, all of valuation comes down to this
  simple truth
• A business is worth what a buyer is willing to
  pay.

36
What can the term value mean?

• Fair market value.
• This is the price at which a willing seller
  would sell and a willing buyer would buy in an
  arms-length transaction. By this definition,
  every sale would ultimately constitute a fair
  market value sale.

37
What can the term value mean?

• Intrinsic value. This is perceived value arrived
  at by interpreting balance sheet and income
  statements through the use of ratios, discounting
  cash flow projections, and calculating liquidated
  asset value.
• Investment value. This is the worth of the
  business to an investor and is based on the
  individual requirements of the investor as to
  risk, return, tax benefits, and so forth.

38
What can the term value mean?

• Going-concern value.
• This is the current status of the business as
  measured by financial statements, debt load, and
  economic environmental factors, such as
  government regulation, that may affect the
  long-term continuation of the business.

39
What can the term value mean?

• Liquidation value. This value assumes the selling
  off of all assets and calculating the amount that
  could be recovered from doing so.
• Book value. This is an accounting measure of
  value and refers to the difference between total
  assets and total liability. It is essentially
  equivalent to shareholders or owners equity.

40
Methods for Valuing a Business

• Adjusted Book Value
• Multiple of Earnings
• Discounting Cash Flows
• Capitalization of Earnings

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41
Adjusted Book Value

• The book value of a going concern is simply the
  owners equity, that is, the value of the assets
  less the outstanding debts.

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42
Multiple of Earnings

• Using a price/earnings (P/E) ratio to value a
  business is a common method among publicly owned
  companies because its simple and direct.
• This ratio is determined by dividing the market
  price of the common stock by the earnings per
  share.
• P/E RATIO STOCK PRICE / EARNINGS PER SHARE

43
Discounting Cash Flows

• Calculating how much an investor would pay today
  to have a cash flow stream of X dollars for X
  number of years into the future.

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44
Three Factors Determine the Discount Rate

• The rate achievable in a risk-free investment
  such as U.S. Treasury notes over a comparable
  time period. For example, for a five-year
  forecast, the current rate on a five-year note is
  appropriate.
• A risk factor based on the type of business and
  the industry should be added to the interest rate
  in item 1.
• 3. The life expectancy of the business, because
  typically discounting is based on this factor.

45
Excess Earnings Method

• Compute the adjusted tangible net worth of the
  business. Tangible assets are adjusted up or down
  for market value then liabilities are
  subtracted.
• Compute the opportunity cost of this investment.
  How much would the investor/buyer earn by
  investing the same amount in another, comparable
  investment?
• 3. Forecast net earnings. Earnings from previous
  income statements can provide a basis for the
  forecast, which is made before subtracting the
  owners salary.

46
Excess Earnings Method

• Calculate the extra earning power, which is the
  difference between forecasted earnings and
  opportunity costs.
• Estimate the value of intangible assets or
  goodwill. If the business has extra earning
  power, that figure can be multiplied by what is
  known as a years-of-profit (YOP) figure.
• Calculate the value of the business by adding the
  figures.

47
Capitalization of Earnings

• Either EBIT or EBITDA is divided by a
  capitalization rate, which is the return the
  buyer requires on the investment
• For example, if the companys EBITDA was 500,000
  and the buyer needed a 20 percent return on
  investment, the price the buyer would be willing
  to pay would be 2,500,000.
• EBITDA / REQUIRED ROI MAXIMUM PURCHASE PRICE