Before Buying A Franchise...Read This

 The financial projections are a significant factor in your decision to invest in a franchise or not. You need to ask the following questions to determine if the information that the financial numbers were based upon, match those numbers with the numbers associated with where you will locate your franchise.

For example, lets ASSUME that the franchisor (company selling the franchise) based their financial projections on there being 200,000 people within a 5 mile circle of the franchise location. Now, you want to locate a franchise in your town and your town has a population of 100,000 in a 5 mile circle of the franchise location. The franchise in your town will not be as profitable as the franchise in the town that has 200,000 people in a 5 mile circle. 

 Here Are The Questions That You Need To Ask:

 1. What are the number of households (A person or group of people occupying a single dwelling) or the population of the area that is needed to reach the financial projections that the franchisor is showing you? If the franchisor cannot answer this question, then that is a major red flag!!! You may want to go to a different franchise.

 2. How close do those households need to be to the location of the franchise? 3 mile circle? 5 mile circle? 10 mile circle? 15 mile circle?

 3. Go to the local Chamber of Commerce and ask them how many households or the population that is in the area where you plan to locate your franchise? Number of households or population within a 3 mile circle? 5 mile circle? 10 mile circle? 15 mile circle? Do your best to match the franchise answer to questions #1 and #2 above.

 4. Compare the Chamber of Commerce numbers with the number(s) that the franchisor gave you. If the franchisor number of households or population is higher than the Chamber of Commerce number, then the franchise fees and/or marketing fees that you will be required to pay the franchisor will leave you with no profit and possibly losses.  In other words, you will not be able to sell the franchise for what you paid for it!!  If the franchisor population or household numbers are lower that the actual population or household numbers you received from the Chamber of Commerce, then your franchise should match the franchisor numbers. It is important to compare numbers that are the same distance from the franchise location.

 5. In conjuction with the population or household numbers, you need to ask the franchisor what is the median income for that population or household numbers that they based the financial projects upon. Again, go the Chamber of Commerce and ask them what is the median income for the population that live within your franchise location. If the franchisor's median income is higher than where your franchise will be located, you will not match the franchisor's financial projections. If the Chamber of Commerce median income number is higher than the franchisor's median income number, then you should match the financial projections or do better.

  6. Will the franchisor assist you when you decide to sell your franchise? If the answer is no, then you will be competing with the franchisor to find a buyer for your franchise business, when you decide to sell. If yes, “What costs will you be responsible for? How long does it normally take to sell an active franchise? How much do you need to pay them if they sell your franchise?

 7. What is your geographic territory? Is your geographic territory in writing and included in the purchase contract of your franchise? Can the territory boundaries be changed? If so, by Who? When? How Often? What is your recourse if you do not want to lose a portion of your geographic territory?

 ESTIMATED Math for Selling a Franchise

 You need to look at both the beginning and the ending of an endevour to have a complete picture on which to basis your decision.

Let’s start by looking at “The 3 Basic Items A Buyer Expects When He/She Buys A Business?”

1. The buyer expects a salary that will be used to pay the buyer’s personal expenses or the expectation of receiving a salary within a year or two max.

2. In addition, income from the business will be used to make the monthly payments on the loan that was used to buy the business or to have a return on the buyer’s investment that is greater than the current interest rate on a commercial loan.

3. The business will continue to pay all of the expenses associated with the business as it has done in the past.

 Now, that you have the basics lets move forward. The franchisor will provide you with all of the financial information needed for you to make a decision to buy their franchise except the following;

 How many years do you need to work before you can sell your franchise and breakeven on your initial investment (get back the money you spent)?

 You will need two pieces of information to do an estimated ball park calculation. They are your total initial investment and the estimated or projected annual sales/revenues from the franchise financial projections. The total initial investment is all costs associated with the purchasing of the franchise, inventory and equipment. Also included is the expense of the improvements you made to your rented franchise space (hereinafter called leasehold improvements).

The last item is “What is the selling percentage of annual sales as used in the Business Reference Guide?” The Business Reference Guide is a professional publication that supplies information about the sales of businesses in previous years. This number varies from 25% of annual sales (Atlanta Bread Company) up to 125% of annual sales (Ace Cash). The majority of the franchises fall in the 40% to 60% range. For illustration purposes we will use 50%.  You can call me at (912) 667-7355 to request the selling percentage of annual sales for the franchise you are thinking of buying. I can be reached at (912) 667-7355. AGAIN, THIS IS AN ESTIMATE.

THE MATH:

Step #1: You will calculate your net initial investment (N.I.I.). This is done by the following formula;

 Total Initial Investment as explained above    $

(highlighted in green)

Less: Leasehold Improvements                     -$

Less: Invemntory                                        -$

Plus: Additional investment in Year 1            +$

Plus: Additional Investment in Year 2, et.      +$

                                                                 --------------------

NET INITIAL INVESTMENT (N.I.I.)                   $

 Step #2    Now, you divide the N.I.I. by the selling percentage of annual sales.

N.I.I. divided by 50% (.5) = the Annual Sales that represent your breakeven point (get back your initial investment). You locate the Projected Annual Sales numbers for future years in the franchisor’s financial projections and then match the Projected Annual Sales number with the Annual Sales number generated by the above calculations. The year that the projected annual sales number comes closest to your calculated annual sales number is how long you will need to work to breakeven on your initial investment. Is this something you want to do?

 Here is an example:

The initial investment was as follows, franchise fee and cost to purchase the franchise was $35,000 - Leasehold Improvements was $14,000 - Inventory was $8,000 and Equipment was $13,000 - Additional first year investment was $25,000 - Additional second year investment was $10,000

 Total Initial Investment as explained above $ 70,000

Less:Leasehold Improvements - $ 14,000

Less: Inventory - $ 8,000

Plus:Additional investment in Year 1 $ 25,000

Plus:Additional Investment in Year 2, etc. $ 10,000

--------------------

NET INITIAL INVESTMENT (NII) $83,000

 $83,000 divided by the selling percentage of 50% = the annual sales number of $166,000. You will review the projected annual sales numbers supplied to you by the franchisor and see what year's projected annual sales number comes closest to the $166,000 number. Then, that is the estimated number of years you will need to work to breakeven (recover your money that you put into the business.).

 Another option is to purchase an on-going business. You can contact me at

(912) 667-7355 or by emailing me at leomckittrick@yahoo.com if you want to explore the possibility of purchasing an on-going business.

My next blog article will be "Perspective Matters".  This article explores the perspectives of the buyer of a business and the seller of a business and how that influences the negotiations. 

In your opinion, What other questions should be asked?

Leo McKittrick

McKittrick and Associates

Business Broker

Commercial Realtor

(912) 667-7355