Part 2 Starting from Scratch or Joining an

Part 2 Starting from Scratch or Joining an Existing Business CHAPTER 4 Franchises and Buyouts Longenecker • Moore • Petty • Palich © 2008 Cengage Learning. All rights reserved. Power. Point Presentation by Charlie Cook The University of West Alabama

Looking AHEAD After you have read this chapter, you should be able to: 1. Identify the major pros and cons of franchising. 2. Explain franchising options and the structure of the industry. 3. Describe the process for evaluating a franchise opportunity. 4. List four reasons for buying an existing business and describe the process of evaluating a business. © 2008 Cengage Learning. All rights reserved. 2

Franchising • Franchising Ø A marketing system revolving around a two-party agreement, whereby the franchisee conducts business according to the terms specified by the franchisor. • Franchisee Ø An entrepreneur whose power is limited by a contractual agreement with a franchisor. • Franchisor Ø The party in the franchise contract that specifies the methods to be followed and the terms to be met by the other party. © 2008 Cengage Learning. All rights reserved. 3

The Pros and Cons of Franchising • Advantages Ø Probability of success Proven line of business v Pre-qualification of franchisee v Ø Training v Franchisor-provided Ø Financial assistance v Franchisor assistance Ø Operating benefits v Franchisor-aided © 2008 Cengage Learning. All rights reserved. • Limitations ØFranchise costs v v Initial franchise fee Investment costs Royalty payments Advertising costs ØRestrictions on business operations ØLoss of independence ØLack of franchisor support 4

4 -1 Major Pluses and Minuses in the Franchising Calculation © 2008 Cengage Learning. All rights reserved. 5

Franchising from the Franchisor’s Perspective • Benefits Ø Reduction of capital requirements Ø Increase in management motivation • Drawbacks Ø Reduction in control Ø Sharing of profits Ø Increase in operational support costs Ø Speed of expansion © 2008 Cengage Learning. All rights reserved. 6

Franchisor Controls on Franchisees • Restricting of sales territory • Requiring site approval and imposing requirement on the outlet’s appearance • Restricting the goods/services that can be sold • Requiring specific operating hours • Controlling advertising © 2008 Cengage Learning. All rights reserved. 7

4 -2 An Estimate of Investment Costs by Wing Zone Low High $20, 000 $25, 000 Leasehold improvements 50, 000 80, 000 Equipment (excludes sales tax) 48, 000 53, 000 6, 000 8, 000 18, 000 Office equipment/phone system 3, 000 3, 500 Drop safe and lock 1, 000 1, 500 - 3, 000 Initial inventory 4, 000 Start-up marketing 3, 000 Grand-opening fund 5, 000 Insurance (down payment) 3, 000 3, 500 Initial training expenses 2, 000 3, 000 Uniforms 1, 000 Utility deposits 1, 000 2, 500 Architectural plans 5, 000 8, 000 Real estate cost 4, 000 7, 000 Working capital 15, 000 20, 000 $189, 000 $249, 000 Franchise fee Signs Computer P. O. S. system Digital security system Total Investment © 2008 Cengage Learning. All rights reserved. 8

Franchising Agreements • Franchise Contract Ø The legal agreement between franchisor and franchisee • Franchise Ø The privileges conveyed in the franchise contract © 2008 Cengage Learning. All rights reserved. 9

Franchising Options Product and Trade Name Franchising Piggyback Franchising Area Developers Types of Franchising Arrangements Business Format Franchising Master Licensee Multiple-Unit Ownership © 2008 Cengage Learning. All rights reserved. 10

4 -3 The Structure of Franchising © 2008 Cengage Learning. All rights reserved. 11

Evaluating Franchise Opportunities • Selecting a Franchise Opportunity Ø Personal observation Ø Advertisements • Investigating the Potential Franchise Ø Information sources v Independent, third-party – Federal Trade Commission – Internet – Franchise consultants sources v Franchisors themselves – Disclosure documents v Existing and previous franchisees © 2008 Cengage Learning. All rights reserved. 12

4 -4 Profiles from the Franchise Opportunities Guide (2005) Source: International Franchise Association, 2005, http: //www. franchise. org, August 2, 2007. © 2008 Cengage Learning. All rights reserved. 13

4 -5 Entrepreneur’s 2007 Fastest-Growing Franchises Rankings (Top 20) Rank Franchise 1 Subway 11 Liberty Tax Service 2 Jan-Pro Franchising Int’l. Inc. 12 Cold Stone Creamery 3 Dunkin’ Donuts 13 Cartridge World 4 Coverall Cleaning Concepts 14 Coffee News 5 Jazzercise 15 (tie) Budget Blinds, Inc. 6 Jackson Hewitt Tax Service 15 (tie) Edible Arrangements 7 RE/MAX Int’l. Inc. 17 Brooke Franchise Corp. 8 Clean. Net USA Inc. 18 Choice Hotels International 9 Bonus Building Care 19 The UPS Store/Mail Boxes Etc. 10 Jani-King 20 Century 21 Real Estate LLC Source: “ 28 th Annual Franchise 500, ” Entrepreneur, January 2007, p. 255. Reprinted with permission from Entrepreneur Magazine, January 2007, http: //www. entrepreneur. com. © 2008 Cengage Learning. All rights reserved. 14

Evaluating Franchise Opportunities • Finding Global Franchising Opportunities Ø High growth potential in overseas markets Ø Need for added expertise in unfamiliar cultural contexts • Sources of Information Ø U. S. government publications Ø International newspapers Ø Web sites of foreign countries © 2008 Cengage Learning. All rights reserved. 15

Considering Legal Issues in Franchising • The Franchising Contract Ø Signed with legal counsel present Ø Contains a termination and transfer provision Ø Contains statement of rights to renew contract © 2008 Cengage Learning. All rights reserved. 16

Franchise Disclosure Requirements • Rule 436 of the Federal Trade Commission Ø Uniform Franchise Offering Circular (UFOC) v. 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. v http: //www. ftc. gov/bcp/franchise/netrule. htm © 2008 Cengage Learning. All rights reserved. 17

Buying an Existing Business? Reduction of Uncertainties of Startup A Bargain Price © 2008 Cengage Learning. All rights reserved. Acquisition of Ongoing Operations and Relationships A Quick Start 18

Pros and Cons of Buying an Existing Business • Pros • Cons Ø High chance of success Ø Existing problems Ø Less planning Ø Poor quality of current Ø Existing customers/ suppliers employees Ø Poor business image Ø Necessary equipment Ø Modernization required Ø Bargain price Ø Purchase price based on Ø Experienced employees Ø Existing business inaccurate data Ø Poor business location records © 2008 Cengage Learning. All rights reserved. 19

Investigating and Evaluating Available Businesses • Due Diligence Ø The exercise of prudence, such as would be expected of a reasonable person, in the careful evaluation of a business opportunity. • Relying on Professionals Ø Accountants Ø Attorneys Ø Other experienced business owners © 2008 Cengage Learning. All rights reserved. 20

Finding Out Why the Business Is For Sale • Owner’s Reasons for Selling Ø Old age or illness Ø Desire to relocate in a different section of the country Ø Decision to accept a position with another company Ø Unprofitability of the business Ø Loss of an exclusive sales franchise Ø Maturing of the industry and lack of growth potential • Beware of sellers who may have “cooked the books” to make the business more attractive. © 2008 Cengage Learning. All rights reserved. 21

Examining the Financial Data • Review financial statements and tax returns for the past five years. • Recognize that financial data can be misleading. Ø Assets overvalued Ø Expenses overstated/understated Ø Income underreported Ø Unrecorded debts • Adjust asset valuations to reflect the true state of the business. © 2008 Cengage Learning. All rights reserved. 22

Valuing the Business • Asset-Based Valuation Ø Estimates the value of the firm’s assets; does not reflect the value of the firm as a going concern. • Market-Comparable Valuation Ø Considers the sale prices of comparable firms; difficulty is in finding comparable firms. • Cash-Flow-based Valuation Ø Compares the expected and required rates of return on the amount of capital to be invested in the business. © 2008 Cengage Learning. All rights reserved. 23

Nonquantitative Factors in Valuing a Business • Competition • Market • Future Community Development • Legal Commitments • Union Contracts • Buildings • Product Prices © 2008 Cengage Learning. All rights reserved. 24

Negotiating and Closing the Deal • Terms of Purchase Ø Assets purchase or total entity Ø Indemnification clause Ø Payment in full or partial payments over time • Closing the sale Ø Best handled by a third party v Bill of sale v Tax certifications v Payment-to-seller agreements and guarantees © 2008 Cengage Learning. All rights reserved. 25

Key TERMS • • franchising franchisee franchisor franchise contract franchise product and trade name franchising business format franchising • master licensee © 2008 Cengage Learning. All rights reserved. • • • multiple-unit ownership area developers piggyback franchising disclosure document Uniform Franchise Offering Circular • (UFOC) • matchmakers • due diligence 26