Guide to Buying Another Franchise: Study the Resale Opportunities

Expanding your franchise portfolio by purchasing an existing franchise location can be a strategic and efficient way to grow your business. By leveraging resale opportunities, you gain access to established operations, a built-in customer base and the potential for increased value through strategic acquisitions. But while resale opportunities provide unique advantages, they also provide some specific challenges that prospective buyers need to navigate. 

Advantages of Franchise Resales

Overall, franchise resales offer a significant head start compared to starting a new location from scratch. 

"If you are looking to expand the business as a franchisee, look at resales," said Jessica Fialkovich, co-owner of Transworld Business Advisors and founder of Exit Factor. "There are a couple of opportunities that resale provides over starting a brand new location. If you look at a brick-and-mortar, it's all ready to go, and it already has an established book of business. It is a really great way to grow."

Fialkovich also highlights the potential for increased value through strategic acquisitions. 

"Private equity firms roll up businesses together to increase the value of the corporation all the time,” said Fialkovich. “When you are in a franchise community, you can do that on a micro-level within your own brand.” 

For example, if a franchise owner owns a location that produces $250,000, they may get a valuation multiple of two to three times their annual profit when they decide to sell, Fialkovich says. If they produce $500,000 in earnings, though, the valuation multiple could be as high as four.

“When you look at valuation, there are tiers when you jump up in multiples,” said Fialkovich. “To grow your business organically to reach that new tier, it might take 10 years or might not be possible with one single location. However, if you acquire resale locations, you can jump to that next tier almost immediately. Overall, this is one of the biggest benefits of being part of a franchise that is often overlooked.”  

Key Considerations in the Due Diligence Process

So, how do you find these resale opportunities? Well, that is where a franchise system can come in handy. “Networking with your fellow franchisees can be really helpful in this regard,” said Fialkovich. “Attending national conferences and franchise advisory committee meetings can also help, especially within larger brands. If you stay within your brand as a franchisee, the due diligence should be much easier.”

Once a resale opportunity is identified, it's time to do your homework. There are several critical factors to consider when evaluating the business. 

“While you are buying an existing business, you must still evaluate the franchisor, the franchise agreement and conduct validation by talking with other franchisees in that system,” said David Busker, founder of Franchise Vision. 

This process includes reviewing the Franchise Disclosure Document (FDD) and understanding the franchise agreement, which often requires signing a new 10-year contract upon purchase.

“Part of the process is the same as buying a new franchise — namely, the discovery process, FDD review, validation, etc.,” said Busker. “The other part, however, makes it more dynamic and more difficult — namely, having three parties all agree on the transaction, including the buyer, seller and franchisor.”

Similarly, Fialkovich underscores the importance of understanding the financials and operations of the existing business. 

“You do need to have a mindset shift — you are going to value those resale companies differently than a new franchise,” Fialkovich said. “If you were just adding a new location, you’d be looking at franchise fees, build-out costs, etc. But with a resale, you are going to value the multiple of revenue of that location. There is an education process for how those deals are structured and how you value those companies.”

Fialkovich recommends bringing in a CPA to determine if the businesses’ finances are legitimate and check the books and records. She also says it’s important to meet with the current owner, ask the right questions and learn about the day-to-day of the business.

Common Pitfalls and How to Avoid Them

Several common pitfalls can derail a franchise resale transaction. Busker points out that not adequately reviewing financials, especially Seller's Discretionary Earnings (SDE), can lead to overpaying or misjudging the business's profitability. 

“Many small businesses including franchises may have a number of overlapping costs between personal and business use, such as multiple family members on the payroll, company cars and other costs that will reduce the operating cash flow, but may not be there under your cost structure,” said Busker. “If you are not confident to complete a deep dive on the financials, hire a professional accountant or advisor to help you review the financials and ask the right questions.”

Another pitfall, Busker says, is relying solely on the seller’s disclosures for basing the buyer’s decision. “Ask for a customer list and permission to interview customers and get direct feedback on the business, personnel and service levels,” said Busker. “If possible, interview all key employees and managers. This can help you understand not only where any potential problems may lie, but also what opportunities there may be to grow the business that aren’t currently being pursued.”

Fialkovich adds that the dependency on the current owner can also pose a significant risk. 

“There is a lot of risk — if businesses aren't prepared for exit, the financials can be a mess, and the business can be very owner-dependent,” she said. “If the relationships are dependent on that specific person, there can be a big transition risk when someone steps into the role. I find that businesses that are better prepared and have gone through an exit strategy program are higher value companies. If the company has fewer risk factors, it is valued higher; if it is a risky transaction, it should be valued lower.”

Busker recommends clarity on all commissions and fees involved in the transaction. 

“If the buyer is being procured by the franchisor or a franchise consultant that works with the franchisor, the seller will be required to cover those costs,” he said. “In some cases, the franchisor may charge a commission if the seller agreed to have the franchisor market their business for sale and handle due diligence for any prospective buyers. If the seller has engaged a business broker to market their business for sale, those agreements are typically exclusive and would require they get paid a commission also.”

One last factor to keep in mind, Fialkovich says: everything is negotiable. “Price is always negotiable,” she said. “You can also change your terms and conditions to protect your risk and downside without arguing over the price.”

The bottom line? Expanding your franchise portfolio through the purchase of an existing location can be a strategic move that offers significant advantages over starting from scratch. However, navigating the due diligence process carefully is essential to avoid common pitfalls and ensure a successful transaction. 

Check out some similar articles on 1851 Franchise:

• Buying Existing Franchises: How to Navigate the Resale
• Where Can I Find Which Franchises Are For Sale?
• Evaluating Franchise Opportunities: 10 Key Considerations