Avoid the Pitfalls of Existing Franchise Locations

When it comes to choosing between buying or building a new franchise location, or buying an existing franchise, I always recommend the latter. Buying new or building from the ground up poses far too many risks for a new franchisee. Buying an existing location is the safer bet, but there are still many dangers that you’ll want to avoid. Be well armed with the following information before you buy.

Negotiations

Negotiating with a seller might be the single-most important negotiation you make as you enter the world of franchising. That’s why it is crucial for you to first understand what the sales picture is, and by sales, I mean documented sales.

• Get the sales reported on the seller’s financial statements;
• Get the sales reported to the franchisor;
• Get the sales reported on the federal and state income tax returns;
• Get the sales reported on the sales tax returns;
• Get the sales reported for the past 3 years.

Examine each of these reports carefully and note any discrepancies. Grill the seller on any differences until you understand them completely.

If the seller is claiming that the sales are actually higher than the reports indicate because of some business process that the seller is employing (i.e., taking cash under the table), assign a value to this unreported amount using the following formula:

Seller’s claim of unreported income "X" plus adjustment factor of 0.00 equals value of unreported income.

Sales Trends

Asking good questions about a franchise’s sales trends will also help you get a sense of its overall financial picture, what problem areas you should be prepared to address immediately, or whether you should just walk away. Here are a few questions that’ll help get you started:

• What has been the sales trend over the past 2 to 3 years? Is it up, down, or sideways? What is the stack-ranking of your location compared to others in your market? What does your trend research tell you about the likelihood of sales increasing or decreasing?
• What is the cost of goods sold? What are the trends? In mid-2008, the dramatic increase in fuel prices affected the underlying cost of nearly everything in the supply chain, from food to plastics, to transportation. Has pricing been able to keep up with rising costs of goods? (Again, match the reported cost of goods sold from the seller’s financial statements to the tax returns, and understand any discrepancies.)

Looking at Labor Costs

Analyze your projected labor costs very carefully.

Understand how real estate, employment, governmental, national, local, and franchisor trends are going to impact your labor costs. (See and for more information.) Do not apply a simple "rule-of-thumb" percentage. Create or examine an actual labor schedule and factor in the increasing cost of your labor, adjusted especially by anticipated future regulatory costs. Be sure to account fully for the hours you will work in the business and the amount the seller is working in the business.

Be sure to find out if the seller is employing family and paying under the table, therefore under-reporting the true cost of labor. Is the spouse doing all the books, are the children working, etc.?

Also, do you plan to work LESS in the business than the current owner does? If so, you obviously need to increase your projected labor costs AND adjust projected sales down, and increase your cost of goods.

There is no one who will care about customer service, sales, and cost of goods, as much as the owner.

If you plan on working MORE than the current owner, do NOT agree to revalue the net income stream for the improvements to sales and cost of goods you may achieve. If the current owner is an absentee owner, and you plan on working 50 hours a week in the business, it is OK to assume that your labor cost will go down, but not by the full 50 hours. Assume you may be able to eliminate labor on 50 to 75 percent of your time on the schedule.