You’ve made up your mind: you’re going to buy a franchise. The franchisor offers you a new or existing franchise location. But what’s the difference and which is better for your situation? 

There are several issues to keep in mind. With an existing franchise, you can look into how it has been performing. On the other hand, a new location allows you to enter into a previously untapped market. This article will explain the different issues you should consider before deciding whether to purchase a new or existing franchise location.

Fees

The most pressing issue for most potential franchisees is the cost. There are many different considerations when it comes to fees and these include: 

  • purchase price;
  • initial franchise fee;
  • ongoing fees; and
  • profits.

Initial Fee

When you are purchasing a franchise, there will be an initial franchise fee that you need to pay to the franchisor. This fee allows you to use the brand and its goodwill.

When you are purchasing a new franchise this fee will be considerably larger than if you were purchasing an existing franchise. For example, a new franchise fee could be $50,000 whereas an existing franchise fee could be $15,000.

However, when you are purchasing an existing franchise, you will need to pay a fee to the existing franchisee for the goodwill that they have built up in that location. Often this fee will be higher than the initial franchise fee. This is because the current franchisee will ideally be running a successful business and you are purchasing the business with this knowledge.

Financials

The main advantage of purchasing an existing franchise is that it allows you to inspect the franchise’s financial records and contact an accountant to value the business. This is a crucial step in purchasing any business. Although it may not be a perfect representation, it can provide a strong indication of the expected revenue.

When purchasing a business, there is no obligation on the seller to provide any documents. However, sellers will want to make the business as attractive as possible and will often offer their financial records. If the seller is unwilling to provide documents showing the value of the business, this should be a warning sign. They are selling the business for a reason and this should be discussed.

Franchise Location

Location is everything. This will be one of the main considerations when purchasing either a new or existing franchise. The main difference is that when purchasing an existing franchise, you will have an idea of the success of the location.

When purchasing a new or existing location you should always inspect the area to determine:

  • the demographic;
  • foot traffic; and
  • any other relevant factors for your business.

Another major issue to look out for is construction plans and rezoning. You should contact the local council to see if there are any major construction plans for roads or the area directly surrounding the shop. If the location is within an existing shopping centre, you should be particularly careful. If the shopping centre is old, renovations may occur in the near future.

It’s a good idea to talk to nearby businesses to get an idea of:

  • the area;
  • the success of nearby businesses; and
  • if there have been any other issues.

Due Diligence

Furthermore, it is important that you understand all aspects of what you are purchasing. You should not just assume you are entering a trustworthy franchise and getting a good deal.

Therefore, when purchasing an existing franchise, you should carry out due diligence

Fitout and Equipment

A benefit of purchasing an existing franchise location is that it already has the fitout in place. Depending on the type of business, these fitouts can be very expensive.

While this can be a considerable saving, you also need to make sure that all the machinery is still functional. An expert should assess this equipment. It would also be helpful to look into any warranties that are in place on the equipment. Although a substantial deal on the equipment may be tempting, this benefit is lost if you have to purchase all new equipment. 

Franchise Term

When purchasing an existing franchise there are two options. You can either:

  1. take over the current agreement; or
  2. enter into a new agreement with the franchisor.

If taking over a current franchisee, the franchisor does not usually have an obligation to renew the agreement. This means that if the current franchisee has a five year agreement and has owned it for three years, you would only have the right to operate the business for a further two years. This should be taken into consideration when deciding the cost. You should be looking to make back your money from the business within the time frame of the agreement.

If you enter a new agreement with the franchisor, this will usually result in a longer term. If the franchisor provides you with both options, you should have a franchise lawyer carefully look at both agreements. It’s possible that a number of commercial terms may have been changed.

Employees

When purchasing an existing franchise, you may be able to include employees in the sale. As these employees understand the business, it can be worthwhile to have them stay on board if they add value to the business.

To make this decision, you should speak with the seller and conduct your own interviews. Additionally, when calculating the sale of business price, any unpaid employee entitlements (i.e. long service leave) should be calculated as this will become your obligation.

Key Takeaways

Overall, when deciding whether to purchase a new or existing franchise, you should consider the:

  • initial franchise fee compared to the price of purchasing an existing franchise location;
  • financial records of the business;
  • location of the business;
  • condition of the fitout equipment;
  • quality of existing employees; and
  • terms of the franchise agreement.

If you would like to learn more about franchising, get in touch with LegalVision’s franchising lawyers on 1300 544 755 or fill out the form below.

Matthew DeRusha
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