1. PowerPoint Presentation by Charlie Cook The University of West Alabama Longenecker Moore Petty Palich © 2008 Cengage Learning. All rights reserved. CHAPTER 4 Franchises and Buyouts Starting from Scratch or Joining an Existing Business Part 2

2. © 2008 Cengage Learning. All rights reserved.4–2 Looking AHEAD 1.Identify the major pros and cons of franchising. 2.Explain franchising options and the structure of the industry. 3.Describe the process for evaluating a franchise opportunity. 4.List four reasons for buying an existing business and describe the process of evaluating a business. After you have read this chapter, you should be able to:

3. © 2008 Cengage Learning. All rights reserved.4–3 Franchising  A marketing system revolving around a two-party agreement, whereby the franchisee conducts business according to the terms specified by the franchisor. Franchisee  An entrepreneur whose power is limited by a contractual agreement with a franchisor. Franchisor  The party in the franchise contract that specifies the methods to be followed and the terms to be met by the other party.

4. © 2008 Cengage Learning. All rights reserved.4–4 The Pros and Cons of Franchising Advantages  Probability of success  Proven line of business  Pre-qualification of franchisee  Training  Franchisor-provided  Financial assistance  Franchisor assistance  Operating benefits  Franchisor-aided Limitations  Franchise costs  Initial franchise fee  Investment costs  Royalty payments  Advertising costs  Restrictions on business operations  Loss of independence  Lack of franchisor support

5. © 2008 Cengage Learning. All rights reserved.4–5 Major Pluses and Minuses in the Franchising Calculation 4-1

6. © 2008 Cengage Learning. All rights reserved.4–6 Franchising from the Franchisor’s Perspective Benefits  Reduction of capital requirements  Increase in management motivation  Speed of expansion Drawbacks  Reduction in control  Sharing of profits  Increase in operational support costs

7. © 2008 Cengage Learning. All rights reserved.4–7 Franchisor Controls on Franchisees Restricting of sales territory Requiring site approval and imposing requirement on the outlet’s appearance Restricting the goods/services that can be sold Requiring specific operating hours Controlling advertising

8. © 2008 Cengage Learning. All rights reserved.4–8 An Estimate of Investment Costs by Wing Zone 4-2 LowHigh Franchise fee$20,000$25,000 Leasehold improvements 50,000 80,000 Equipment (excludes sales tax) 48,000 53,000 Signs 6,000 8,000 Computer P. O.S. system 18,000 Office equipment/phone system 3,000 3,500 Drop safe and lock 1,000 1,500 Digital security system - 3,000 Initial inventory 4,000 Start-up marketing 3,000 Grand-opening fund 5,000 Insurance (down payment) 3,000 3,500 Initial training expenses 2,000 3,000 Uniforms 1,000 Utility deposits 1,000 2,500 Architectural plans 5,000 8,000 Real estate cost 4,000 7,000 Working capital 15,000 20,000 Total Investment$189,000$249,000

9. © 2008 Cengage Learning. All rights reserved.4–9 Franchising Agreements Franchise Contract  The legal agreement between franchisor and franchisee Franchise  The privileges conveyed in the franchise contract

10. © 2008 Cengage Learning. All rights reserved.4–10 Franchising Options Product and Trade Name Franchising Business Format Franchising Piggyback Franchising Area Developers Master Licensee Multiple-Unit Ownership Types of Franchising Arrangements

11. © 2008 Cengage Learning. All rights reserved.4–11 The Structure of Franchising 4-3

12. © 2008 Cengage Learning. All rights reserved.4–12 Evaluating Franchise Opportunities Selecting a Franchise Opportunity  Personal observation  Advertisements Investigating the Potential Franchise  Information sources  Independent, third-party sources –Federal Trade Commission –Internet –Franchise consultants  Franchisors themselves –Disclosure documents  Existing and previous franchisees

13. © 2008 Cengage Learning. All rights reserved.4–13 Profiles from the Franchise Opportunities Guide (2005) 4-4 Source: International Franchise Association, 2005, http://www.franchise.org, August 2, 2007.

14. © 2008 Cengage Learning. All rights reserved.4–14 Entrepreneur’s 2007 Fastest-Growing Franchises Rankings (Top 20) 4-5 Rank Franchise 1 Subway 2 Jan-Pro Franchising Int’l. Inc. 3 Dunkin’ Donuts 4 Coverall Cleaning Concepts 5 Jazzercise 6 Jackson Hewitt Tax Service 7 RE/MAX Int’l. Inc. 8 CleanNet USA Inc. 9 Bonus Building Care 10 Jani-King Rank Franchise 11 Liberty Tax Service 12 Cold Stone Creamery 13 Cartridge World 14 Coffee News 15 (tie) Budget Blinds, Inc. 15 (tie) Edible Arrangements 17 Brooke Franchise Corp. 18 Choice Hotels International 19 The UPS Store/Mail Boxes Etc. 20 Century 21 Real Estate LLC Source: “28th Annual Franchise 500,” Entrepreneur, January 2007, p. 255. Reprinted with permission from Entrepreneur Magazine, January 2007, http://www.entrepreneur.com.

15. © 2008 Cengage Learning. All rights reserved.4–15 Evaluating Franchise Opportunities Finding Global Franchising Opportunities  High growth potential in overseas markets  Need for added expertise in unfamiliar cultural contexts Sources of Information  U.S. government publications  International newspapers  Web sites of foreign countries

16. © 2008 Cengage Learning. All rights reserved.4–16 Considering Legal Issues in Franchising The Franchising Contract  Signed with legal counsel present  Contains a termination and transfer provision  Contains statement of rights to renew contract

17. © 2008 Cengage Learning. All rights reserved.4–17 Franchise Disclosure Requirements Rule 436 of the Federal Trade Commission  Uniform Franchise Offering Circular (UFOC)  A document accepted by the Federal Trade Commission as satisfying its franchise disclosure requirements. –Litigation and bankruptcy history –Investment requirements –Conditions that would affect renewal, termination, or sale of the franchise.  http://www.ftc.gov/bcp/franchise/netrule.htm

18. © 2008 Cengage Learning. All rights reserved.4–18 Buying an Existing Business? Reduction of Uncertainties of Startup Acquisition of Ongoing Operations and Relationships A Quick Start A Bargain Price

19. © 2008 Cengage Learning. All rights reserved.4–19 Pros and Cons of Buying an Existing Business Pros  High chance of success  Less planning  Existing customers/ suppliers  Necessary equipment  Bargain price  Experienced employees  Existing business records Cons  Existing problems  Poor quality of current employees  Poor business image  Modernization required  Purchase price based on inaccurate data  Poor business location

20. © 2008 Cengage Learning. All rights reserved.4–20 Investigating and Evaluating Available Businesses Due Diligence  The exercise of prudence, such as would be expected of a reasonable person, in the careful evaluation of a business opportunity. Relying on Professionals  Accountants  Attorneys  Other experienced business owners

21. © 2008 Cengage Learning. All rights reserved.4–21 Finding Out Why the Business Is For Sale Owner’s Reasons for Selling  Old age or illness  Desire to relocate in a different section of the country  Decision to accept a position with another company  Unprofitability of the business  Loss of an exclusive sales franchise  Maturing of the industry and lack of growth potential Beware of sellers who may have “cooked the books” to make the business more attractive.

22. © 2008 Cengage Learning. All rights reserved.4–22 Examining the Financial Data Review financial statements and tax returns for the past five years. Recognize that financial data can be misleading.  Assets overvalued  Expenses overstated/understated  Income underreported  Unrecorded debts Adjust asset valuations to reflect the true state of the business.

23. © 2008 Cengage Learning. All rights reserved.4–23 Valuing the Business Asset-Based Valuation  Estimates the value of the firm’s assets; does not reflect the value of the firm as a going concern. Market-Comparable Valuation  Considers the sale prices of comparable firms; difficulty is in finding comparable firms. Cash-Flow-based Valuation  Compares the expected and required rates of return on the amount of capital to be invested in the business.

24. © 2008 Cengage Learning. All rights reserved.4–24 Nonquantitative Factors in Valuing a Business Competition Market Future Community Development Legal Commitments Union Contracts Buildings Product Prices

25. © 2008 Cengage Learning. All rights reserved.4–25 Negotiating and Closing the Deal Terms of Purchase  Assets purchase or total entity  Indemnification clause  Payment in full or partial payments over time Closing the sale  Best handled by a third party  Bill of sale  Tax certifications  Payment-to-seller agreements and guarantees

26. © 2008 Cengage Learning. All rights reserved.4–26 Key TERMS franchising franchisee franchisor franchise contract franchise product and trade name franchising business format franchising master licensee multiple-unit ownership area developers piggyback franchising disclosure document Uniform Franchise Offering Circular (UFOC) matchmakers due diligence