“Worry about the pennies and the dollars will take care of themselves.” If you are in the market to buy a business or franchise, keep this old adage in mind.
One of the most costly mistakes franchise buyers can make is not doing enough due diligence on the issue that will matter most to franchise buyers—paying too much upfront for a franchise with little resale value.
Here are five considerations to add precision to your due diligence review of franchise purchase opportunities:
Set higher standards. If your objective is to merely “go into business for yourself” or “own a franchise,” then your aspirations are not high enough to be a successful business owner. After all, you will achieve your goal of business ownership the day you sign the franchise contract! Then what? A more purposeful objective is to own a business that will make money for you.
Understand sales rep motivations. When you start to explore different franchise opportunities, you will come in contact with franchisor representatives and business brokers who have just one purpose—to sell you a franchise as fast as possible. These individuals are not your trusted friends or unbiased financial advisors. Simply stated, they are highly motivated by commissions to sell franchise units. Their success is not at all dependent on your success.
Before signing any commitments, hire a corporate attorney who specializes in franchise law to review the agreement. If you can’t afford the attorney’s fee, then I’d pass on buying any franchise business.
Determine total cash requirements. Sneaky franchise brokers are adept at hiding the true cash cost of a franchise purchase. If you sign up to buy a franchise, your true cash requirements include the down payment plus cash to support ongoing operations until the franchise achieves positive cash flow. This important date may not occur for months, years or at all. Can you afford this higher number? Will you have to scramble to find extra funding or go into deeper debt to keep the franchise afloat?
Because projections provided by the sales broker will likely present a rosy picture of revenue and profit growth, find an independent advisor or accountant to help you translate their blue sky assumptions into real world forecasts.
Evaluate owner’s compensation. Double check all projections for a practical presentation of expenses. Make sure the projections include an allocation for your salary and benefits, especially if you intend to work at the franchise full time. Franchise presentations often provide compensation to the owner only in the form of net profits, not salary. Beware! In my book, year-end profits should be your financial return on your invested capital, not your sole source of compensation for working 40 to 70 hours a week to keep the franchise alive!
Understand market value. Buy low, then sell high. If you pay $25,000, $50,000, or $100,000 to buy into a franchise, then you should find evidence that other franchises can be sold at least for that much or more. Unfortunately, the opposite can be true especially for new franchise brands.
Do some sleuthing. What are the average franchise resale purchase prices in your state? Who buys up franchises when owners want out? Frequently, one strong regional franchise operator or the franchise headquarters buys distressed franchises at deep discounts.
Given all the risks associated with owning a business and personal obligation to repay debt, you should walk away from any franchise that cannot eventually be sold for at least two times your invested capital.
Unfortunately, I get too many letters from desperate franchise buyers who feel like they were snookered and say “I wish I had known better.” They regret not paying attention to the details, all because they were seduced by the dream of business ownership. At the end of the day, they never experienced what the brokers said was going to happen—make lots of money and have lots of fun. Their nightmare of pain was very much the opposite.
Susan Schreter is a veteran of the venture finance community and entrepreneurship educator. For more information and actions steps on strategic planning, raising capital and building a lucrative business, read Susan’s book, Start on Purpose. Follow Susan @StartonPurpose