Franchising offers many benefits for those looking to become business owners. Most importantly, you are buying a tried and tested business model. If you are looking to enter a franchise network then there are two alternative methods to do this.
The first option is to buy a franchise directly from the franchisor; whereby you develop a new territory or a new location (often referred to as a “greenfield franchise”). With a greenfield franchise, you set up the new franchise business from scratch and build its reputation and customer base.
Alternatively, you can purchase an existing franchise business as a going concern from a franchisee with the rights to operate the franchise (known as a “franchise resale”). Usually, the business has been trading for at least two years and a significant amount of goodwill has been developed.
Emily Shingler, a solicitor in Darwin Gray’s Franchising team, explores the benefits and risks of buying a greenfield franchise against buying an existing franchise.
- Lower entry cost v instant cash flow
Generally, purchasing a franchise direct from a franchisor allows for a lower entry cost compared to buying a franchise for resale. You will normally pay a premium for buying an existing franchise; particularly if the seller has built a strong reputation and has a good sales history. With a greenfield franchise, you pay the franchisor an initial franchise fee and usually some training and set-up costs.
However, depending on the business model, a new business may take several months before it starts to make a profit. With a franchise resale, your business is already trading which can be beneficial if you are looking for instant cash flow.
- Untapped market v established customer base
Where the franchise has not yet operated in a particular area, then it’s a great opportunity to tap into a wealth of potential customers. Unlike buying an existing franchise business, you have the benefit of starting from fresh without being hindered by any past poor performance of a previous franchisee.
However, as the territory or location is untested, there is less certainty as to the demand for your products/services compared to an existing franchise business that has already established a strong customer base in a proven area. With a franchise resale, you can benefit instantly from the goodwill and brand recognition already attached to the business.
- Freedom to negotiate v ready to go
If you purchase a new franchise, you are generally at liberty to negotiate agreements and arrangements with suppliers and contractors. If your franchise business requires premises, then, subject to any requirements in your franchise agreement, you are able to find suitable premises and negotiate a deal with a landlord. As you are not already locked into a lease, you may be able to negotiate a rent-free period or secure other favourable terms.
However, sourcing out suitable premises and negotiating a lease can be both time consuming and expensive. You will also need to complete any fit-out works and purchase relevant equipment to operate the franchise. Depending of the franchise model, a large amount of initial investment may therefore be required before you can start trading.
With an existing franchise, the initial work will have been completed and the business will already be up and running. However, you may still have to replace equipment that is no longer in good working order. You may also have obligations to refurbish any premises under your franchise agreement and/or lease. Before purchasing any business where property is part of the deal, it is prudent to carry out due diligence on such premises and obtain professional advice to fully understand your obligations under an existing lease.
- Potential for significant growth v predictable revenue
As the entry costs for a new franchise are likely to be lower, there is an opportunity to grow a successful business and make a considerable profit in the future on the sale of the business. This may be appealing for someone who has spotted a gap in the market for the franchise in a particular area. However, as a new franchise will require time to establish, there is less certainty on the potential future profits.
With an existing franchise business, provided you carry out financial due diligence, you are able to get a good indication of expected profits. You can normally get a better understanding on your likely return on investment. This makes securing lending generally easier than if you were setting up a new business.
Concluding thoughts
There are clear advantages and risks associated with both buying a new franchise and a franchise resale. The right option for you will often depend on a number of financial and commercial factors along with your own personal circumstances. Regardless of what option you take, you will need to undertake thorough due diligence investigations. This is to enable you to decide whether the proposed acquisition represents a commercially sound investment. It is also good practice to speak with some existing franchisees to get an insight into how the franchise is likely to work out for you.
For more legal advice related to franchising, contact Darwin Gray’s franchising team: www.darwingray.com/franchising.
