Should You Buy an Existing Franchise?

By Michael H. Seid, Joyce Mazero

Franchisors often have existing company-owned locations for sale or keep a list of franchisees that are looking to sell their franchises. Buying an existing operation from the franchisor or an existing franchisee may offer advantages over starting from scratch.

Instead of evaluating a potential business, you are evaluating one that is already up and running, with a history of performance, a reputation in the community, and an existing clientele. You will be able to know what the historic profit and cash flow have been for the particular site. The restrictions on a franchisor sharing unit financial information in Item 19 do not apply to the sale of company-owned operations. You will also be able to determine what the trends are for that established location.

The site is fully developed, and you avoid the burden of looking for a location, negotiating a lease, hiring a contractor, and building and equipping the location. This can be a significant advantage in time and costs. The operation may have a trained staff, so you can avoid the hassle of having to immediately recruit new employees and train them before you service your first customer.

On the other hand, keep in mind some of their staff may be poorly trained or, worse, may need to be replaced entirely. The bottom line is you can be in business months sooner than if you start a franchise from scratch, and your cash flow will begin sooner.

From a franchisor’s perspective, a franchisee buying one of their existing company-owned locations makes sense. The franchisor may have made a strategic decision not to operate a company-owned store at that location. The franchisor may have had problems finding employees or a good manager to operate the business and may be hoping that a franchisee can do the job better operating that location.

However, and this unfortunately happens, the location may be a “dog” that the franchisor took back from a failed franchisee and is looking to move away from the business quickly — that’s called churning.

Not every franchisor provides a financial performance representation (FPR) about unit financial information to prospective franchisees before they invest in a franchise. However, even those franchisors that don’t provide an FPR are permitted to provide potential franchisees with information on specific company-owned locations available for sale. If you are interested in an existing company-owned location, make sure you get the financial information about that location.

Franchisors also benefit from franchisees selling their franchises to new franchisees:

  • If the existing franchisee is unhappy, getting a new, enthusiastic franchisee is a good swap.
  • Franchisors typically require new franchisees to sign the then-current form of franchise agreement, which allows the franchisor to alter the terms of the franchise for that location sooner than it probably would have if the franchisee had stayed and operated under the existing franchise agreement.
  • If franchises are selling quickly or at a high price, that news will get out quickly and will increase the franchisor’s ability to recruit new franchisees.

Note that the collection of a transfer fee wasn’t included as a benefit to the franchisor. Most franchisors charge a fee for the transfer of an existing franchise to a new operator. This fee is usually a percentage of the existing franchise fee or a set amount.

Although the franchisor does not have to incur the costs of recruiting the new franchisee or reviewing a site, the franchisor still incurs the costs of evaluating, supporting, and training the new franchisee. Transferring a franchise also involves legal costs for the franchisor. If the franchisor earns any profit on the transfer fee, it is usually negligible.

Before buying an existing operation, whether operated by the franchisor or an existing franchisee, do some digging for market information. Find out why the existing business is up for sale. Did the market dry up? Is the location no longer desirable? Did the franchisee tire of the business and simply want to move on to other things? Is the franchisee retiring? Look at the store location as if you are starting fresh.

If the business is on the decline for any reason, buyer beware. Don’t assume that you are smarter or a better operator than the selling or prior franchisee.

Also don’t assume that just because you are buying a franchise, you have a full term under the franchise agreement with multiple options for additional terms available to you. Some franchisors allow the transfer of franchises but only for the remaining term of the franchise agreement. You may be able to obtain franchise rights for an extended or new term, but the franchisor will likely require you to pay an additional fee.

Other franchisors give you a full term plus options for additional terms as if you were a new franchise. You may be required to execute the then-current form of franchise agreement and pay an additional fee to the franchisor under such circumstances as well. Make sure you understand not only the business you are buying but also the term of the franchise rights you are receiving. Obtaining a full new term of franchise is usually an advantage that may also allow the seller of the business to ask for a higher purchase price, because you will be getting an extended time to amortize your investment.