Whether to buy-in or start-up

Should I buy a franchise or an established business?

Buying a franchise

Many people get a business loan or other type of business finance and rush into buying franchises, believing it is a quick way to get independence and an income. But remember; a franchise is not a business, but a way of doing business.

Franchising is a way to distribute goods and services through one marketing concept, by the building of a business relationship between the originator (and ultimate owner) the franchisor, and the distributor of the goods and services (the one at the coalface), the franchisee.

The franchisor develops a business concept then licenses the use of that concept to franchisees, for a fixed period of time. The selling point to the franchisee is that the hard yards are already done in areas such as branding, marketing, processes and systems, business plans, buying power, management systems, governance and consistency.

For the franchisor, it can well be a way to become wealthy. They have smartly (and legally) sold their concept to those who wish to run a business, while maintaining control over the total franchise operations. As a bonus, their developed business system earns them financial rewards. The franchisees pay the franchisor for the licence at start-up, with ongoing franchisee fees. On the surface, and if the franchisor excels at choosing outstanding franchisees, it would seem to be a win-win situation for franchisors.

For the franchisee, the end result could prove to be less rewarding. As with all business start-ups, franchising is equally a gamble. Notably, you never own the business. You are only “leasing” it for a fixed period of time. Franchisor policies will play a very major part in the operation of your business … on everything from pricing and marketing to fiscal robustness. When there is an economic downturn, revenue might fall, but the fixed costs you pay the franchisor can stay the same.

Most importantly, the package being sold as a franchise can be quite difficult to score and judge as a good or poor investment. And how will you know if it is worth what you paid for it? In terms of worst-case scenario, if the business is not what was promised, can you on-sell the business?

The trick is in choosing the right franchise.

Source: Kathleen Bowden, director of Kathleen Bowden Consulting

Researching franchises

Trade shows are a good initial source of information on potential franchise options. You will be able to quickly and easily gather information on a wide array of businesses, enabling you to compare the merits of each option. If you decide that franchising is the correct business choice for you, then you must thoroughly research the business that you are seeking to invest in. Find out:

• What is the franchise profit margin?
• What fees will you have to pay to the franchisor?
• Does the franchise provide training and support?
• Does the business have a strong reputation?
• Is there demand for the franchise’s products and services?
• You should speak to existing franchisees of the business to learn from their experiences.

The franchising industry is regulated by a mandatory code of conduct under the Trade Practices Act by the Australian Competition and Consumer Commission. Before you buy a franchise, you should read The Franchising Code of Conduct and the Franchisees Guide to the Franchising Code of Conduct – both available free of charge from the ACCC. (www.accc.gov.au)

Buying an established business

Buying an established business may sound like a way of avoiding set up costs and hassles, but you must thoroughly investigate why the business is for sale.

Before seeking a business loan or business finance, you need to ensure that the business is commercially viable and not for sale due to the failure of the current management. The current business owner should be able to supply you with a report on the businesses finances, trading and prospects.

What factors have led the current business owner to sell? They may claim they are simply retiring or are unable to continue operating the business due to health factors; your accountant must be able to verify these claims.

One market indicator to be aware of is the number of similar businesses currently on the market. This is often an indication that the industry is suffering a significant downturn. Other important questions include:

• Have changing demographics in the area reduced the business’s turnover?
• Are there new products or businesses about to launch in competition with the business?
• Are there new legislations that will come to affect the business?

You will be asked to agree on a separate price to purchase the business’s current stock of products. You are under no obligation to buy this stock, as you may have identified poor stocking as a problem with the business.

Be extremely cautious about taking on the businesses debts as you will be unable to claim unrecovered debts as you were not involved in the sale that led to the debt.

When drawing up the contract to buy the business, you should seek to include clauses that will protect you from misleading information given to you by the existing business owner. You should include:

• Certification of the previous three years’ financial statements.
• Details of all business assets.
• Details of the business’s employees positions, salaries, working hours, super entitlements and leave.
• Details of tax, both paid and owing.
• A covering clause that allows you as the purchaser to revoke the purchase, within a certain time frame, if the business details prove to be incorrect or fraudulent.