Thinking of buying an existing franchise? While franchise resales are often touted as a fast track to business success, the road to franchise ownership can be fraught with hidden pitfalls and unexpected hurdles if you’re not careful. We’re sharing 10 common challenges in franchise resales that affect buyers and sellers, and giving you the insights you need to make confident, informed decisions.
1. Franchise Resale Pricing
The price of a franchise resale is primarily determined by the operating income the location is currently achieving. This income-based valuation reflects the business’s actual performance and profitability, making it a key factor in negotiations. For buyers, understanding the franchise’s financial statements and verifying income claims is crucial.
Check out our guide to understanding cash flow to learn more about business sales, expenses, and growth.
2. Maintaining Brand Value in Franchise Resales
Franchisors have a vested interest in ensuring that franchise resale prices do not dip too low. A low resale price can negatively impact the perceived value of the franchise brand as a whole. To prevent this, franchisors often set minimum price thresholds and actively monitor resale transactions to maintain brand integrity and value.
Due to the franchisor’s guidelines and controls, franchisees may have limited ability to independently determine the resale prices of their franchises.
3. Franchisor’s Role in the Franchise Resale Process
Buying a franchise involves significant franchisor participation in the sale process. The franchisor typically drives the sale process, requiring potential buyers to undergo a thorough vetting process. This vetting ensures that the new owner is financially stable, experienced, and capable of maintaining the franchise’s standards.
4. Demand for Significant Down Payments
To promote financial stability and reduce risk, franchisors may require buyers to make a substantial down payment, sometimes up to 50% of the purchase price. This down payment ensures that the buyer has a significant financial stake in the business and is less likely to be over-leveraged with debt, which could jeopardize the franchise’s success.
To help you get started, we’ve put together a short guide on how to finance buying a franchise.
5. Franchise Fees on Transfers
Franchisors usually charge a franchise fee on the transfer transaction. This fee can vary but generally covers the costs associated with transferring ownership, including administrative expenses and the cost of training the new owner. Buyers must factor this fee into their overall budget.
6. Working Capital Needs for Buyers
In addition to the purchase price, buyers need sufficient working capital to cover operational expenses, inventory, and unforeseen costs during the transition period. Having adequate working capital ensures that the business can continue to operate smoothly and meet its financial obligations from day one.
7. Mandatory Upgrades Before Closing
Before a franchise resale transaction closes, the franchisor may require completing necessary upgrades to the location. These upgrades ensure that the franchise meets current brand standards. If these upgrades are not completed, the franchisor can opt to withhold estimated upgrade costs from the sale proceeds to ensure compliance.
8. Closing Documents and Funds For Franchise Resales
To protect their financial interests, franchisors might require closing documents and funds to flow through their lawyer. This ensures that outstanding fees or debts owed to the franchisor are settled before the seller receives the sale proceeds. This step helps maintain financial clarity and accountability.
9. Full-Time Franchise Owner/Operator Requirements
Franchisors often prefer that the new owner be a full-time operator. They look for individuals with relevant skills, experience, and a commitment to running the business hands-on. This approach helps ensure the new owner is fully engaged and can drive the franchise’s success through active management and leadership.
10. Adherence to the Franchise System
New franchisees must adhere strictly to the established franchise system. This includes following operational procedures, marketing guidelines, and other franchise-specific protocols. Compliance is critical to maintaining brand consistency and avoiding potential legal disputes with the franchisor.
Navigating the intricacies of franchise resales requires a keen understanding of both the franchisor’s and franchisee’s perspectives. As a business broker, my goal is to help buyers and sellers understand these nuances and facilitate smooth, successful transactions. By being aware of the franchisor’s requirements and preparing accordingly, potential buyers can confidently step into ownership, ready to take the franchise to new heights.
If you’re considering buying or selling a franchise, contact me for expert guidance tailored to your unique situation.