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Franchises and Buyouts

Part 2 Starting From Scratch or Joining an Existing Business


PowerPoint Presentation by Charlie Cook The University of West Alabama
Copyright 2006 Thomson Business & Professional Publishing. All rights reserved.

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
Copyright 2006 Thomson Business & Professional Publishing. All rights reserved. 43

The Pros and Cons of Franchising


Advantages
Probability of success
Proven line of business Pre-qualification of franchisee

Limitations
Franchise costs
Initial franchise fee Investment costs Royalty payments Advertising costs

Training
Franchisor-provided

Financial assistance
Franchisor assistance

Operating benefits
Franchisor-aided

Restrictions on business operations Loss of independence Lack of franchisor support

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Major Pluses and Minuses in the Franchising Calculation

Exhibit 4.1
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Franchisor Controls on Franchisees


Restricting of sales territory Requiring site approval and imposing requirement on the outlets appearance Restricting the goods/ services that can be sold Requiring specific operating hours Controlling advertising

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Estimate of Investment Costs by Great Clips

Note: This is an estimate only of the capital needed to open and operate your salon during the initial 12 months after you open for business. Great Clips cannot guarantee that you will not have additional expenses starting the business.

Source: http://www.greatclipsfranchise.com/investment.htm; April 27, 2004.

Exhibit 4.2
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Franchising Agreements
Franchise contract
The legal agreement between franchisor and franchisee

Franchise
The privileges conveyed in the franchise contract

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Franchising Arrangements
Product and Trade Name Franchise
Grants the right to use a widely recognized product or name

Business Format Franchise


Provides an entire marketing system and ongoing guidance from the franchisor

Master Licensee
An independent firm or individual acting as a sales agent with the responsibility for finding new franchises within a specified territory

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Franchising Arrangements (contd.)


Multiple-Unit Ownership
The holding by a single franchisee of more than one franchise from the same company

Area Developers
Individuals or firms that obtain the legal right to open several franchised outlets in a given area

Piggyback Franchising
The operation of a retail franchise within the physical facilities of a host store

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410

The Structure of Franchising

Exhibit 4.3
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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
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Franchising from the Franchisors 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

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Legal Considerations in Franchising


The Franchising Contract
Signed with legal counsel present Contains a termination and transfer provision Contains a statement of rights to renew contract

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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/franchise/netrule.htm

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Buying an Existing Business?


Acquisition of Ongoing Operations and Relationships A Quick Start

Reduction of Uncertainties

A Bargain Price

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Buying an Existing Business


Reasons for Buying an Existing Business
To reduce some of the uncertainties and unknowns that must be faced in starting a business from the ground up To acquire a business with ongoing operations and established relationships with customers and suppliers To obtain an established business at a price below what a new business or franchise would cost To begin a business more quickly than starting from scratch

Copyright 2006 Thomson Business & Professional Publishing. All rights reserved.

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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

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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

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Finding Out Why the Business Is For Sale


Owners reasons for selling the business
Old age or illness Desire to relocate to 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.
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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.


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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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Nonquantitative Factors in Valuing a Business


Competition
Market Future Community Development Legal Commitments Union Contracts Buildings Product Prices

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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

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