The arguments in favor of a franchise are formidable.  With a franchise you should get immediate name recognition, awareness, and acceptance.  You get training in running your business.  You get complete policies and procedures manuals.  You get national contracts with suppliers which allow you to buy for less than you could arrange for yourself locally.  You also have access to a franchise owner's group which will give you people you can talk to about problems you are having with the operation of your business.

The primary argument against franchises is the control that the franchisor exercises over your daily operations.  The franchise company's area manager will make spot inspections to check your quality of goods and services and to make sure that you comply with their rules and procedures.  Some owners find this intrusion into their business to be onerous.

Some people think that franchise fees are too expensive.  Franchise fees and royalties should be neutral to your bottom line.  Increased business due to the name recognition of the franchise and decreased cost of supplies due to national contracts should offset the cost of the franchise.  If it weren't so, franchisors would have little to sell.

The last thing that needs to be mentioned is that the franchise company will intrude on the sale of the business.  When you buy an existing business that has a franchise, you need to apply to them and pay a franchise fee.  Then when you want to sell the business you will need their permission, maybe you will have to give them a "right of first refusal" which might interfere with a sale that you have negotiated with a ready, willing, and able buyer.  You just might lose that buyer while the franchisor decides whether they want the business or will let you sell it.

The independent business owner has the flexibility to do things his own way.  He can succeed or fail because of what he does or does not do.  As that independent business owner if you want to grow your business, you just go out and do it.  You don't need permission from some franchise company.  Maybe if you are really good, you will become your own franchise company, There are no limits on what you can achieve.

Lease or Own the Real Estate

In an ideal world this question wouldn't come up.  You would own the real estate.  However, in the real world there are many reasons to lease:

Somebody else already owns the location where you want to be, such as a prime corner or in a mall.

You don't have enough money to buy the property but you can manage a lease.

You don't want to be a landlord; you just want to run your business.

But the reasons to own are very persuasive:

When you rent you are just working for the landlord. Rents will average 10-15% of sales and they could even reach 30%.  Rents will increase on a regular basis.  Rents will be greater than net profits.

When you own the real estate, rents (mortgage payments) are virtually fixed and eventually the mortgage will be paid off.

You can open any hours that you choose, not those set by the landlord.

You can remodel, change your signage, and even sell your business without the landlord's permission if you own the property.

Many large retailers make more money from their real estate than they do from the operation of their stores.

How to Pay for Your Business Purchase

We will get into how much to pay for your business later, but right now we need to address HOW to pay for your business.

Many of the characteristics of buying a business parallel buying a house.  The sale is handled by a real estate broker, the closing is handled by an escrow company or attorney (depending on your local laws and customs) and the purchase money is provided by a lender.

Buyers have the notion that they need 10-20% down like they would when buying a house.  Even though this is possible, in almost all cases the buyer needs at least 50% cash down and maybe even 100%.

You have heard about the Small Business Administration (SBA) and you probably think that they will lend you the money to buy or start your business.  In almost all cases the SBA DOES NOT lend money, they simply guarantee a portion of the loan that a bank makes, similar to the way the FHA guarantees a home mortgage.

SBA loans and SBA-like loans are what they call "cash flow" loans.  This means that the lender makes the loan on the basis of the business's ability to repay the loan, not on the assets of the business.  They will consider the assets when they are determining how much to loan but not on whether to make the loan.

Because it is a cash flow loan the major determinate of the value of the business is its ability to generate profits.  This is "Goodwill".  Hard assets may be as little as 10% of the value.

If you default on the loan, the bank will repossess the business just like they would if you default on your car payments or your house payments.

If the bank repossesses your house or car they can sell them and recover all or most of the funds they lent you, but if they repossess your business its value is as a going business not its hard assets.  When they repossess the business in most cases it is or will be shut down.  It has no going business value.  If they are able to sell it at all it will be for pennies on the dollar.  The SBA guarantee covers a portion of this loss, but not all of it.  The bank will lose money if they take your business.  The bank doesn't want to lose money, therefore they (most banks) will require dollar-for-dollar collateralization in order to make an SBA or SBA-like loan.  In order to get dollar-for-dollar collateralization they want you to pledge sufficient assets (other than the business) to cover their exposure.  It is also an SBA rule that if you have any assets you must pledge ALL of those assets in order to obtain an SBA guaranteed loan.

Another aspect of SBA loans is that they are very expensive.  The normal interest rate is prime plus 2-3/4% and the loan is made for only 7-10 years, which results in high payments.

If you are going to borrow the money to buy the business and the bank is going to require a pledge of all of your assets, which generally means your house, but also includes all of your other real estate holdings, plus all your stocks, bonds, money market accounts, retirement plans (other than trusts) and anything else of value that you have, wouldn't it make more sense to borrow the money against your house or some other asset directly?

This will get you the money at a lower interest rate (usually) with a longer time to repay which will result in a lower payment. Plus you won't tie up all your other assets.

Example:

        $400,000.00  @  10.5%  for 10 yrs pymt = $5,397.40

        $400,000.00  @    6.5%  for 25 yrs pymt = $2,700.83

You should go to a bank that makes SBA loans to talk to a banker.  You can verify what I have said and you can pick up an SBA loan application package.  In the package you will find a blank Pro-Forma Profit and Loss Statement.  Make copies of this form.  You will need it for analyzing businesses which you will consider to purchase.

Be sure to ask the banker how much the loan application fee is and whether it is refundable if you don't get the loan or you don't even proceed with the loan application process.

Another source of purchase money is Seller Financing.  The argument that your broker will use with the seller to convince him that it is in his best interest to carry a note for part of the purchase price is that he can get more for his business if he helps with the financing.

For example, if two identical businesses were offered for sale, one for ALL CASH and one with 50% owner financing, which one would you buy?

Or as another example, one business is worth $500,000.00 and the seller wants all cash, and the other business is worth $1,000,000.00 but the owner will accept 50% down and carry the balance.  Which one would you buy? Remember that value of the business is primarily a function of its profitability.  The million dollar business is probably going to make twice as much profit.

Would you pay a little extra for the business if the seller helped with the financing?

If the seller helps with the financing it generally means that he believes in the business and wouldn't be afraid to have to take it back.  It also means that he will be there to help you and won't disappear into the night with your money and leave you to your own devices.

When you buy a business you want to maintain contact with the seller because he is the keeper of the "Knowledge Base" for your business.  There are going to be questions that you will want him to answer even long after the purchase transaction is completed.

part 1                                                       

part 2

More to come. Stay tuned.