A key decision to make when investing in a franchise is whether or not to take over an existing business, as franchise lawyer Kate Sargeant discusses.
So you’ve decided to invest in a franchise. You may have narrowed down the industry that you are looking at and perhaps created a shortlist of possible networks. But there is another key decision to make: Do you buy a resale or virgin territory?
If you buy a resale, you will be taking over an existing franchise business as a going concern, from an existing franchisee. If you choose a virgin territory, you will be the first franchisee in your network to operate in your local territory. This piece considers three key differences between the two.
Time until first pay cheque
If you buy a virgin territory, it will take some time before you are ready to launch the business. You may need to identify and fit out suitable premises, there will be PR campaigns to organise, you will need to set up your IT, admin, stock control and accounting systems and recruit and train your employees. Once everything is in place, it may still be some time before you make your first sales and even longer before those first invoices get paid. Depending on the business, it could take several months or even years before the business is generating enough income to support itself and you.
On the other hand, if you buy a resale, you will hit the ground running. You will take over the existing premises, IT and all of the existing stock and equipment. You will also inherit the existing customer base and any work in progress. There may even be some existing orders in the order book. This means that the business will be generating sales and cash from day one. The business should continue to generate at least the same level of income as it was generating before the sale. Hopefully, you will be able to quickly increase this even more.
If you buy a virgin territory, you will be the first person to operate that particular franchise network in your local area. You can be guided by the performance of franchisees in other territories, but you wont know exactly what the customer demand and specific market conditions in your area will be like until you start operating. Similarly, there may be factors unique to your local market that impact on your profitability, but which wouldn’t be significant in other territories.
For example, if you buy a franchise that involves driving to customers’ homes, a business located in an area with high population density where most of the customers are located in a small area is likely to be more profitable than a business located in an area where the customers are more widely spread and more time is spent travelling between appointments. Add in the cost of fuel and this can have a substantial impact on the bottom line.
Conversely, if you buy a resale, you will have a track record of the actual business operating in your area. As part of your enquiries before you buy the business, you would normally expect to see copies of the accounts for the last three years as well as management accounts for more recent months.
This means there is often greater certainty buying a resale rather than a virgin territory. The current franchisee will have already tested market demand in the local area and will be very familiar with factors such as the local competition, best places to promote the business locally, traffic conditions and location of customers and the other factors specific to that area.
The benefits of taking over an existing business as a going concern do come at a price. It will be significantly more expensive to buy a resale than to buy a virgin territory. This is exactly the same in the world of standalone businesses where it will almost always cost more to buy an established business than to build a new business from scratch.
Having said this, the established business will have an existing customer base, possibly existing orders and will be generating cash and sales from the start. This means that the business may be at least in part, self-funding. The profits that the established business will be generating from the outset may go some way to off-setting the higher purchase price.
Depending on the network you choose, there may be no choice between resale and virgin territory. In established franchise networks, most of the territories will have already been allocated and you will almost certainly have to buy a resale. Conversely, if you are looking at a relatively young network, you will probably have to buy a virgin territory.
Whichever you choose, make sure you research the network thoroughly and completely understand the commitment that you are taking on. Most franchises will involve an investment of several thousand pounds and at least five years of your life, so it is vital that you do your homework before you sign up.