What is a Franchise Resale?
A franchise resale is the purchase of an existing franchised business from a franchisee. A franchisee is given the right to operate a franchise from a franchisor during a specified time period within a specified geographic area as outlined in a franchise agreement. This contractual right (along with obligations on the part of the franchisee) is transferred to the buyer in a franchise resale from the franchisee (or seller) with the approval of the franchisor. The contractual rights of a franchisee granted by the franchisor include the right to operate the franchised business using the brand, franchised name, and business model created by the franchisor. In return, the franchisor imposes obligations, standards, royalties, and qualifications on the franchisee.
Advantages of Franchised Businesses
- The main advantage of owning a franchise is having the right to use an established brand that is known to the public and gives instant credibility for the franchisee.
- A strong brand usually means that the franchisees are more successful than other similarly situated non-franchised businesses because they generate more sales with higher customer traffic as a result of their superior brand and business model.
- This allows the franchisor to charge higher franchise fees while imposing stricter obligations and qualifications on the part of the franchisee.
- Another advantage of franchised businesses is the training and support offered by the franchisor to its franchisees.
- New business owners in particular often need and desire this training and support in order to properly run and grow their business.
- Lastly, a major advantage of a franchised business is the lower supply costs that a franchisee frequently obtains due to group price discounts.
- Lower supply costs means higher net margins and a stronger business model for the franchisee.
Disadvantages of Franchised Businesses
- The main disadvantage of owning a franchised business is paying royalty fees to the franchisor.
- Royalty fees typically range between 5-10% of gross sales, and may also include ‘advertising fees’ if the franchisor is paying for national advertising on behalf of its franchisees.
- Such fees seriously cut in to the overall profits that a franchisee may be expected to earn, and often are due even if the franchisee is losing money.
- The fees are typically paid monthly, and its terms are detailed within the franchise agreement between the franchisor and franchisee.
- Another major disadvantage with owning a franchised business is the restrictions imposed by the franchisor upon its franchisees regarding how they can operate the franchise.
- Such restrictions may limit the products or services that the franchisee may offer to the public, restrict the geographic territory in which the franchise may operate, or require that any employees of the franchisee to be qualified and trained by the franchisor.
- Lastly, a franchisor may also impose mandatory attendance on the part of its franchisees for training seminars and conventions.
- While such training and networking may be useful, it is not for everyone and comes with significant travelling costs.
Franchise Resale Must be Approved by Franchisor
In virtually any franchise resale, the franchisor has the right to approve or disapprove the potential buyer as the owner of one of its franchises. The procedure by which the franchisor will approve or disapprove of potential buyers in a franchise resale is outlined in the franchise agreement between the franchisor and original franchisee. The franchisor typically desires successful and longstanding franchisees, and thus will want franchisees with sufficient business experience, education, or the right ‘personality.’ They will not want franchisees with criminal backgrounds, past bankruptcies, or lacking specific business experience that some franchisors require.
Franchise Transfer Fee
In addition to having the right to approve of all potential buyers in a franchise resale, the franchisor also may impose a franchise transfer fee when a franchise resale occurs. This transfer fee is specified in the franchise agreement between the original franchisee and franchisor. A typical transfer fee is around $10,000. The payment of the fee is negotiable between the buyer and seller, but is usually paid by the seller (or original franchisee). Often times, a seller who is in good relations with the franchisor may succeed in negotiating a reduction in the transfer fee.
Franchise Training Fee
A franchisor often provides up to two weeks of full time training at the franchisor’s headquarters for all new franchisees. This specialized training teaches the franchisee about the franchise’s particular industry as well as how to specifically implement the franchised business model. The training provided by the franchisor is often crucial to a franchisee’s future success. Because of the time and resources dedicated by the franchisor in conducting the training, they will invariably charge the buyer in a franchise resale a training fee in order to cover the training costs. As with the transfer fee, the training fee is also outlined and described in the franchise agreement (or later addendums) between the original franchisee and franchisor.
Franchise Disclosure Document
The Franchise Disclosure Document (FDD) is an absolutely crucial document that every potential purchaser (including of course in franchise resales) of a franchise should read and thoroughly understand as a part of their formal due diligence process. A franchisor must – by federal law – disclose information and financial statements to those seeking to invest in their franchise. This information includes the number of past and present franchisees with relevant contact information, financial statements revealing information about the health of the franchisor and of its franchisees, history of litigation, information regarding the franchised territories, the systems and business plan which the franchisees will implement, and the obligations expected from franchisees. In a franchise resale, it is helpful for the seller to obtain the most recent copy of the franchise’s FDD so that all potential buyers may receive it as a part of the business prospectus.
Franchises make excellent business investments when the value and brand that the franchisor brings is greater than the costs of royalties, fees, and obligations imposed upon franchisees. In a franchise resale, buyers and sellers must also be aware of the transfer and training costs, as well as the rights of approval retained by the franchisor.
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