2. After studying this chapter, you should be able to…
Define franchising, and become familiar with franchise terminology.
Understand the pros and cons of franchising and the structure of the industry.
Describe the process for evaluating a franchise opportunity.
List four reasons for buying an existing business, and describe the process for evaluating a business.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3. What Is Franchising? Franchising Franchisor Franchisee
A marketing system involving a legal agreement, whereby the franchisee conducts business according to the terms specified by the franchisor.
Franchisor
Party in franchise contract that specifies methods to be followed and terms to be met by the other party.
Franchisee
An entrepreneur whose power is limited by a contractual agreement with a franchisor.

4. Franchising Terminology
Franchise Contract
The legal agreement between franchisor and franchisee
Franchise
The privileges conveyed in the franchise contract

5. Franchising Options Types of Franchising Arrangements
Product and Trade Name Franchising
Area Developers
Business Format Franchising
Piggyback Franchising
Types of Franchising Arrangements
Master Licensee
Multi-Brand Franchising
Multiple-Unit Ownership
Co-Branding

6. EXHIBIT 4.1 Economic Impact of Franchising
Economic Activity in Franchised Businesses
There were estimated to be 901,093 establishments in franchise systems in the United States in 2010.These businesses directly provided
• million jobs • output worth $868.3 billion.
These businesses accounted for approximately 3 percent of all U.S. business establishments. During the economic turmoil in the United States from 2007 to 2010,employment in eight of ten lines of franchise business activity increased. The two exceptions were Commercial and Residential Services and Lodging.
Economic Activity Because of Franchised Businesses
According to the most recent economic impact study by PriceWaterhouseCoopers, the economic significance of franchising is greater than indicated by the activity in franchised businesses alone, for it stimulates still more activity and causes growth in many nonfranchised businesses. Counting economic results both inside and outside of franchising, franchised businesses in the United States were the cause of
• 21 million jobs, or 15.3 percent of private-sector jobs • $660.9 billion of payroll, or 12.5 percent of private-sector payrolls • $2.31 trillion of output, or 11.4 percent of private-sector output.
Sources: PriceWaterhouseCoopers, 2010 Franchise Business Economic Outlook (Washington, DC: International Franchise Association, 2010); and PriceWaterhouseCoopers, The Economic Impact of Franchised Businesses, Volume II (Washington, DC: International Franchise Association, 2008).
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. The Pros and Cons of Franchising
Advantages
Probability of success
Proven line of business
Pre-qualification of franchisee
Training Support
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

8. Reduced risk of failure
EXHIBIT 4.2
Advantages of the Franchise Model
Reduced risk of failure
Going into business for yourself, but not by yourself
Use of a valuable trade name and trademark
Access to a proven business system
Management training provided by the franchisor
Immediate economies of scale
A way for an existing business to diversify
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

9. EXHIBIT 4.3 Government Concerns About Franchising
Misleading or exaggerated earnings claims by franchisors
Opportunity behavior by which the franchisor becomes a competitive threat to franchisees
Restrictions on franchisees who desire to liquidate their holdings in favor of alternative investment opportunities
Conflicts of interest, such as when a franchisor forces franchisees to be captive outlets for other suppliers owned by the franchisor
Churning: terminating a successful franchise operation in order to resell it and gain additional franchise fees
Encroachment: locating a new outlet or point of distribution too close to an existing franchisee, causing a material loss of sales
Imposing noncompete clauses on franchisees
One-sided contracts devised by franchisors
The imposition of new restrictions as a requirement of contract renewal
Franchisor intimidation of franchisees who attempt to form franchisee associations, seek alternative sources for products, or make other efforts to create a more level playing field
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

10. EXHIBIT 4.4
An Estimate of Investment Costs and Benefits by Oreck Clean Home Center
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

11. 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

12. Evaluating Franchise Opportunities
Selecting a Franchise
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. EXHIBIT 4.5
Evaluating Franchise Opportunities
Is the franchisor dedicated to a franchise system as its primary mechanism of product and service distribution?
Does the franchisor produce and market quality goods and services for which there is an established market demand?
Does the franchisor enjoy a favorable reputation and broad acceptance in the industry?
Will the franchisor offer an established, well-designed marketing and business plan and provide substantial and complete training to franchisees?
Does the franchisor have good relations with its franchisees, and do the franchisees have a strong franchisee organization that has negotiating leverage with the franchisor?
Does the franchisor have a history of attractive earnings by its franchisees?
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

14. EXHIBIT 4.6 Profile from International Franchise Association (2010)
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

15. EXHIBIT 4.6 Profile from International Franchise Association (2010)
Source: accessed October 26, 2010.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

16. EXHIBIT 4.7 Top 10 Fastest Growing Franchises for 2010
Name/Rank Startup Costs (2009)
1. Jan-Pro Franchising Int’l. Inc. Commercial cleaning $3,145–50,405
2. Subway Submarine sandwiches and salads $84,300–258,300
3. Stratus Building Solutions Commercial cleaning $3,450–57,750
4. Dunkin’ Donuts Coffee, doughnuts, baked goods $358,200–1,980,300
5. Anago Cleaning Systems Commercial cleaning $8,543–65,406
6. McDonald’s Hamburgers, chicken, salads $1,057,200–1,885,000
7. CleanNet USA Inc. Commercial cleaning $6,655–92,950
8. Bonus Building Care Commercial cleaning $9,020–41,919
9. Liberty Tax Service Individual and online tax preparation $56,800–69,900
10. Vanguard Cleaning Systems Commercial cleaning $8,200–38,100
Source: Entrepreneur's 2010 Fastest-Growing Franchises Rankings (Top 10) with Start-Up Cost Ranges in 2009 from accessed October 29, Reprinted with permission of Entrepreneur Media, Inc. © 2010 by Entrepreneur Media, Inc. All rights reserved.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

17. Becoming a Franchisor Franchisor Considerations The Business Model
Financial Considerations
Required Assistance
Franchisor Considerations
Operations Manual Development
Government Regulations
Adding Long-Term Value

18. Becoming a Franchisor Benefits Drawbacks
Reduction of capital requirements
Increase in management motivation
Speed of expansion
Drawbacks
Reduction in control
Sharing of profits
Increase in operational support costs

19. 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

20. Franchise Disclosure Requirements
Rule 436 of the Federal Trade Commission
A rule that prescribes that the franchisor must disclose certain information to prospective franchisees
Franchise Disclosure Document (FDD)
A document accepted by the Federal Trade Commission as satisfying its franchise disclosure requirements
Investment requirements
Conditions that would affect renewal, termination, or sale of the franchise

21. Buying an Existing Business?
Reduction of Uncertainties of Startup
Acquisition of Ongoing Operations and Relationships
A Bargain Price
A Quick Start

22. Finding a Business to Buy
Determine your commitment.
Establish what you can afford.
Figure out what skills you have.
Consider lifestyle impact.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

23. Pros and Cons of Buying an Existing Business
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

24. Finding a Business to Buy
Due Diligence
The exercise of the prudence expected of a reasonable person in the careful evaluation of a business opportunity.
Matchmakers
Specialized brokers that bring together buyers and sellers
Relying on Professionals
Accountants
Attorneys
Other experienced business owners

25. EXHIBIT 4.8 Due Diligence for Purchasing a Business
Once you’ve found a business that you would like to buy, it’s important to conduct a thorough, objective investigation. Look into every aspect of the business, verifying whether the owner’s stated reasons for selling are legitimate and double-check every detail for accuracy. The following list includes important information you want to include when researching the business you want to buy.
Contracts and lease agreements
Financial statements
Tax returns
Real and personal property documents
Bank accounts
Customer lists
Sales records
Supplier/purchaser list
Contracts
Advertisement materials
Inventory receipts/lists
Organization charts
Payroll, benefits, and employee pension/profit sharing info
Employee roster
Certification by federal, state or local agencies
List of owners
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

26. Finding Out Why a 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.

27. 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 (fair market value).

28. Valuing the Business Asset-Based Valuation Market-Comparable 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.

29. Nonquantitative Factors in Valuing a Business
Competition
Market
Future community development
Legal commitments
Union contracts
Buildings
Product prices

30. 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

31. product and trade name franchising business format franchising
franchisor
franchisee
franchise contract
franchise
product and trade name franchising
business format franchising
master licensee
multiple-unit ownership
area developers
piggyback franchising
multi-brand franchising
co-branding
churning
encroachment
Franchise Disclosure Document (FDD)
Franchise Rule
matchmakers
due diligence
nondisclosure agreement
fair market value
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.