7 Due Diligence Steps Before Investing in a Franchise Resale
With recent layoffs in many industries, including pharma, the tech space and even Disney, many franchisee candidates have asked about purchasing an existing franchise resale because they need to replace their income sooner rather than later. We say, absolutely, it is worth consideration. Franchise consultants will have a robust database of existing franchise locations for sale in your market. While there are many benefits to purchasing an existing, open, and operating business, the same level of due diligence is required. Here are seven due diligence steps to take before investing in a franchise resale.
Meet the Executive Team
As a potential purchaser, you would want to be certain you meet the executive team and research who they are and what their background is in running a business, as well as what experience they have in franchising specifically. While having run a business in the past is great experience, another level of expertise is required by the franchisor in being at the helm of a franchise system. In addition to managing the corporate support team, the executive team must be able to provide support and communicate with all the franchise owners in the field across the entire country.
Know the Industry
Once you have checked your boxes on the executive team, you’ll want to review the specific business in your market. To help you further understand why the seller is selling, you’ll want to research the industry in your local market. Is there too much competition? Is there enough business for everyone to go around? Check out the Google reviews of the specific business and the competition. Yu could gain some insight from how the public perceives the business. Is there an ongoing need for the business? Is it an essential business, or was it more of a trendy industry that has faded away? If the industry checks your boxes, move to the next consideration.
Understand the Culture
This may be a bit harder to gauge initially because you will not want the current employees to know that the business is for sale. You don’t want to risk the team leaving, so you might choose to “secret shop” the business. If you want to buy a salon, for example, get a haircut, or if it’s a massage business, get a massage so you can start to understand more about the product or service to learn more about how you can improve upon what needs to be changed to shore up the business to increase profitability. What level of expertise is required by the employees? In other words, do your employees need to hold a specific license or certification, and is the business retaining its staff, or is there a high level of turnover? If there is a high level of turnover, what is the culture like in the business? Maybe the owner isn’t spending the money to provide additional training for the team. Maybe there is no defined career path or an opportunity for employees to be promoted.
Find Out Why They Are Selling
You should ask yourself why the current owner is selling. There are often many valid reasons people choose to exit their business. They or a family member may have health problems. Maybe they have primary employment and are being transferred out of the area and choose not to manage the business from afar. Maybe the business is not as profitable as they expected it to be. Maybe the business is not as easy to run as they anticipated. There are many reasons people may exit a business, and you owe it to yourself to understand what it is to the best of your ability.
Do Your Market Research
Even though the franchisor and franchisee have likely already conducted market research for the area, you should still inquire about the ideal demographic for the industry and confirm the market still meets the ideal criteria.
Consider Funding Options
There could be many opportunities for funding a franchise resale if the seller is motivated. Seller financing could be possible. A leveraged buyout is possible, meaning the proceeds from the existing business will cover the debt service, so there may not be a need for much additional or large cash injection. In addition, the Small Business Administration (SBA) is a likely source of funding. The SBA has a registry of brands they will likely approve funding for as long as the borrower meets the creditworthiness required. The other good news is that you likely won’t need to pay a franchise fee; however, most franchisors do charge a transfer or a training fee (the buyer often pays this).
Look Into Right of First Refusal
It is also important to note that many franchisors reserve the right of first refusal, so even after all your due diligence, they may choose to purchase the units/units for sale. In my experience, most franchisors do not want to own individual units.
Before investing in a franchise resale, understand the business financials, the reason for the sale, and any transfer requirements.