CHAPTER 4 Franchises and Buyouts

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. PowerPoint 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. 4 2

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. 2008 Cengage Learning. All rights reserved. 4 3

The Pros and Cons of Franchising Advantages Probability of success Proven line of business Pre-qualification of franchisee Training Franchisor-provided Financial assistance Franchisor assistance Operating benefits Franchisor-aided Limitations Franchise costs Initial franchise fee Investment costs Royalty payments Advertising costs Restrictions on business operations Loss of independence Lack of franchisor support 2008 Cengage Learning. All rights reserved. 4 4

Franchising from the Franchisor s Perspective Benefits Reduction of capital requirements Increase in management motivation Speed of expansion Drawbacks Reduction in control Sharing of profits Increase in operational support costs 2008 Cengage Learning. All rights reserved. 4 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. 4 7

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

Franchising Agreements Franchise Contract The legal agreement between franchisor and franchisee Franchise The privileges conveyed in the franchise contract 2008 Cengage Learning. All rights reserved. 4 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. 4 10

Evaluating Franchise Opportunities Selecting a Franchise Opportunity Personal observation Advertisements Investigating the Potential Franchise Information sources Independent, third-party sources Federal Trade Commission Internet Franchise consultants Franchisors themselves Disclosure documents Existing and previous franchisees 2008 Cengage Learning. All rights reserved. 4 12

Franchising in South Africa The Franchising Association of South Africa (FASA) has released the results of its 2015 FASA survey, providing some remarkable facts about the franchising industry in South Africa. According to Ethel Nyembe, Head of Small Enterprise at Standard Bank, 2016 will see increased activity within the franchise sector, particularly the fast food franchises. This comes as international brands that announced their entry into the market this year look to establish operations around the country in the New Year. Following Burger King s successful launch in 2013, South Africa has opened its doors to many new international brands, including Krispy Kreme, Paul bakeries, Dunkin Donuts and Starbucks, which will start operating in 2016. However, the sector won t be without its pains. With South Africa moving closer to a recession and possible credit-rating downgrade to junk and as investors lose faith in our struggling economy, the franchise sector will have to dig deep to weather this latest storm, FASA said. Survival in these tough times will have to be a collective effort between all stakeholders, it said. 2008 Cengage Learning. All rights reserved. 4 13

Franchising is a massive contributor to the South African economy. FASA has released these stats showing just how big the industry is: Franchise contribution to GDP is now at 12.5%, in monetary terms the franchise market is worth an estimated R456 billion; There are 17 business sectors through which franchising contributes to GDP; Quick Service Restaurants and Restaurants (24%), Retail (12%), and Building, Home & Office Services (11%) remain the largest contributing sectors; There are 627 franchise systems/franchisors in South Africa; There are 39,119 franchise stores, most of these are operated by the franchisees, who form the backbone of the franchise industry. The Majority of these outlets are located in Gauteng, Western Cape and KZN; From a satisfaction perspective, 80% of franchisees reported good relations with franchisors, and 73% are satisfied with their suppliers; More importantly, 72% of franchisees reported an optimistic outlook about the future in the face of economic challenges 2008 Cengage Learning. All rights reserved. 4 14

Evaluating Franchise Opportunities Finding Global Franchising Opportunities High growth potential in overseas markets Need for added expertise in unfamiliar cultural contexts Sources of Information U.S. government publications International newspapers Web sites of foreign countries 2008 Cengage Learning. All rights reserved. 4 16

Considering Legal Issues in Franchising The Franchising Contract Signed with legal counsel present Contains a termination and transfer provision Contains statement of rights to renew contract 2008 Cengage Learning. All rights reserved. 4 17

Pros and Cons of Buying an Existing Business Pros High 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 2008 Cengage Learning. All rights reserved. 4 19

Investigating and Evaluating Available 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 2008 Cengage Learning. All rights reserved. 4 20

Finding Out Why the Business Is For Sale Owner s Reasons for Selling Old age or illness Desire to relocate in a different section 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 Beware of sellers who may have cooked the books to make the business more attractive. 2008 Cengage Learning. All rights reserved. 4 21

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 overstated/understated Income underreported Unrecorded debts Adjust asset valuations to reflect the true state of the business. 2008 Cengage Learning. All rights reserved. 4 22

Valuing the Business Asset-Based Valuation Estimates the value of the firm s 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. 2008 Cengage Learning. All rights reserved. 4 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. 4 24

Negotiating and Closing the Deal Terms of Purchase Assets purchase or total entity Indemnification clause Payment in full or partial payments over time Closing the sale Best handled by a third party Bill of sale Tax certifications Payment-to-seller agreements and guarantees 2008 Cengage Learning. All rights reserved. 4 25

Key TERMS franchising franchisee franchisor franchise contract franchise product and trade name franchising business format franchising master licensee multiple-unit ownership area developers piggyback franchising disclosure document Uniform Franchise Offering Circular (UFOC) matchmakers due diligence 2008 Cengage Learning. All rights reserved. 4 26