Buying a franchise is an exciting opportunity for prospective business owners. It allows you to join a community of business owners, operate under an established brand and benefit from a tried-and-tested system. However, there are two different ways to enter a franchise network. Your first option is to buy directly from the franchisor. Via this method, you own a new store or territory, known as a ‘greenfield’ franchise site. Alternatively, you might like to buy an existing or established franchise. This article will explore the pros and cons of buying a greenfield franchise rather than buying an existing franchise.

What is a Greenfield Franchise?

A greenfield franchise is a new opportunity. You buy the franchise directly from the franchisor and: 

  • establish a new store; or 
  • develop a new territory. 

You will set up the new franchise and begin running the business from scratch. It will be a brand new business and you will be responsible for ensuring its success from the beginning.

A retail goods franchise will involve opening a new store location where there is no other store close by. Alternatively, a service-based franchise will require extending into new franchise territory that is not currently serviced by the franchise network.

Greenfield opportunities are advertised on the franchisor’s website. The ‘greenfield’ label is applied to distinguish the location from existing franchises. Whether the franchise is a greenfield or existing franchise should be made clear in the disclosure document provided to you by the franchisor.

What is an Existing Franchise?

Existing franchises are premises or territories that past franchisees have already established. You will buy the store or territory from an existing franchisee who wants to sell their business. In some circumstances, you can buy a corporate store from the franchisor and begin running the venue as a franchise. 

Existing franchises have a history and are often ready to start doing business immediately. There are numerous advantages offered by an established franchise. However, there are risks and you should do your due diligence before finalising the deal. 

Pros and Cons

Greenfield Franchise

Pros

Cons

Value

A greenfield franchise presents an interesting opportunity to open up a previously untapped market. A great business owner can set up a strong foundation for a store, build its reputation and then on-sell the business for a profit. 

Risk

With an untapped market comes the higher risk associated with an unproven territory or site. Unlike an existing franchise, you cannot rely on sales figure history or business goodwill. It may also take longer to develop a client base.

Lower Entry Cost

When you purchase a franchise from a franchisor, there will be an initial franchise fee that you pay for the right to become a franchisee. However, when you purchase an existing franchise, you will need to pay the sale price to the vendor for the reputation they have established in that location. Often the sale price adds a premium to the cost for existing sites or territories, meaning that a new franchise allows for a lower entry cost.

Missed Opportunity to Buy Poor Performing Franchises

In some circumstances, a greenfield franchise does not necessarily allow for a lower entry point. Certain existing sites that are performing poorly could be sold for less than the cost of the fit out. Franchises which have been improperly managed can also be easier to turn around and succeed than a fresh new location.

Profit Margin

Given the entry cost is likely to be lower, there is an opportunity to make a reasonable profit when you are ready to sell the franchised business.

Long Term Game

A new franchise may require more time to establish. You need to successfully operate the franchise, build goodwill, and demonstrate decent profit margins. Often new franchisees need to operate the business for around two years before realising a return on their investment. You also need to ensure you have sufficient working capital to sustain the start-up costs, business expenses, and personal finances until the business makes a profit.

Find a Lease that Perfectly Suits Your Needs

A new business allows you unlock the potential of a fresh and exciting new location or territory. You are able to fit out the store in exactly the way you would choose, with your franchisor’s approval. Further, you can obtain the benefits of a landlord contribution for the fit out, as you are building the site from scratch.

You Bear the Burden of the Leasing Process

You are required to search, gain approval and negotiate a new lease. Remember to inspect the area to determine the demographic, foot traffic, construction plans, rezoning requirements and prosperity of nearby businesses. This process can be time consuming and expensive. Then you need to plan and purchase a brand new fitout and equipment.

Existing Franchise

Pros

Cons

Benefit from the Goodwill of the Existing Business

If you are keen to buy an existing business, you probably want to buy the good reputation that the business holds. You will analyse the profitability of the business, meaning that you will have a good general understanding of the business’ likelihood of success. Importantly, you may pay more for an existing franchise because you will be paying for the goodwill of the business, in addition the cost of the fitout and equipment.

You May Suffer from Poor Goodwill

While goodwill of an existing franchise can be an advantage, you should carefully evaluate the outgoing franchisee’s relationship with the local community and the standard of customer service provided. Poor service experiences in the past may be detrimental to the success of your business and take some time to improve. 

Past Financial Records to Indicate Expected Revenue

Buying an existing franchise will give you the opportunity to inspect the franchise’s financial records and consult with an accountant. This will give you a better indication of your expected revenue and return on investment.

Existing Financials Records Might be Misleading

It is critical that you carefully check and understand all records and aspects of the sale. Sometimes it can be difficult to verify sales. Financials might be enhanced or outgoings might be downplayed by the vendor, to boost the sale price. You should carry out due diligence and not assume you are getting a good or trustworthy deal.

There is a risk that even when you complete as many checks as possible, you uncover the actual sale figures or costs after the purchase takes effect. Making a claim against the vendor can be difficult to enforce after the sale has completed.

Less Risk

If you carefully conduct your due diligence, you should be able to get a good understanding of the business’ history. You can ask both the franchisor and vendor for financial information to help you make your decision. This means that you assume far less risk than if you were to purchase a greenfield franchise and establish your business from scratch. 

Higher Sale Price to Buy the Franchise

While the initial franchise fee will be lower, you will generally have to pay a significant premium for an operating business compared to a new business. You may have to pay between two and four times the business’ earnings on top of fit out, equipment and stock to acquire an existing franchise. The reason for the premium is justified by the knowledge you have of the reputation, goodwill and success of the established business.

Fit Out and Equipment Is Already Organised

Buying an existing franchise often enables you to avoid finding and fitting out the appropriate premises to run the franchise. Depending on the business type, fit outs can be very expensive. Further, you may be able to purchase the business cheaply with a depreciated fit out and equipment. You should assess whether the fitout and equipment is still functional, or whether the franchisor will require the fitout and equipment to be replaced. You should ask the franchisor to inspect and advise on the state of the equipment.

Locked into an Existing Lease

Avoiding the search for a location is a benefit of an existing franchise. However, you must carefully understand the terms of the lease you are agreeing to. Purchasing a more established store might mean that the lease is due to be renewed in the near future. There is no certainty that the lease will be renewed or that the rent will remain at its current rate. When renewing the lease the landlord might increase the rent or require an expensive refurbishment. You should carefully consider your potential obligations under the leave before purchasing any business involving premises.

Keep on Existing Employees

Often the employees of a business being sold are happy to continue working for the new owner. Good quality employees can be valuable to keep to assist with the transition because they understand the business well. You should discuss this decision with the vendor and personally interview the employees.

Assume Employee Obligations

Remember to consider any unpaid employee entitlements (e.g. long service leave) in your calculation of the sale of business price. These entitlements will become your obligation after settlement. 

Franchisor Approval and Fee

In most franchise systems, the franchisor must be informed of and approve the transfer of a franchise from a vendor to a purchase. It is helpful to enquire with the vendor and the franchisor if possible as to what criteria you need to fulfil to enter the franchise network. Franchisors may require that you: 

  • have business experience; or 
  • are of good financial standing. 

Many franchisors will charge a transfer fee and some will ask you to pay for your required training. Certain franchisors necessitate that you complete a lengthy and expensive orientation prior to being approved by the franchisor. You should ensure that you have some legal instrument which allows you to depart from the sale if you are not approved.

Key Takeaways

Whether you buy a greenfield franchise or an existing franchise, you need to do your due diligence. Do your best to confirm the investment is a good choice for you and make sure you know:

  • how the initial franchise fee compares to the purchase price of an existing franchise;
  • whether the location of the existing franchise is advantageous, considering any potential renovations or construction in the area;
  • what the condition of the existing fitout and equipment is;
  • whether you are happy with the performance of existing employees?;
  • whether the financial records indicate that the business is likely to continue to be successful; and 
  • what the terms of the franchise agreement are.

If you would like legal advice about whether to purchase a greenfield franchise or an existing franchise, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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