It can be difficult to start a business from scratch. Starting a business from scratch can be challenging. The good news? You don’t have to start from scratch to have your own business. Consider franchising or buying an existing business.
Differences between franchising and buying a business
Before deciding if one of these options is right for you, make sure you understand the basics of franchising and buying an existing business. The main difference between franchising and buying an existing business is the level of control you will have over your business.
The franchise gives you more guidance but less control
A franchise is a business model in which a business owner (the “franchisor”) sells the rights to its logo, name and business model to an independent entrepreneur (the “franchisee”). Service-oriented restaurants, hotels, and businesses are commonly franchisees.
Two common forms of franchising are:
- Product franchise / trade name: The franchisor owns the right to the name or trademark of a business, and sells the right to use that name and trademark to a franchisee. This style of franchise typically focuses on supply chain management. Products are typically manufactured or supplied by the franchisor and delivered to the franchisee for sale.
- Franchises in business format: The franchisor and the franchisee have an ongoing relationship. This style of franchise typically focuses on managing broad-spectrum businesses. Typically, the franchisor offers services such as site selection, training, product delivery, marketing plans, and even help obtaining financing.
When you buy a franchise, you have the right to use the name, logo and products of a larger brand. You will also benefit from brand recognition, promotions, and marketing. But, it also means that you have to follow the bigger brand’s rules on how you run your business.
Buying an existing business gives you more control but less guidance
Buying an existing business is exactly what it sounds like. Generally, the buyer takes over all ownership of the business. The biggest advantage is having an existing blueprint that can include important factors like an established customer base, defined operating expenses, and fully trained employees. Regardless of the type of business, almost any type of business can be bought or sold.
When you buy an existing business, you usually get full control over its direction. However, without a fixed vision, infrastructure and outside guidance, your business could struggle to find the best way to run things.
Consider 3 Factors Before Franchising or Buying a Business
Although business models differ, there are three common steps to take to help you determine whether you should franchise or buy a business.
- Quantify your investment: Take a look at your financial picture and decide how much you are willing to spend to buy – and ultimately run – the business. This will help you determine what types of businesses or brands are best for your budget.
- Consider your talents and lifestyle: Be honest about your skills and experience, as they can help you weed out unrealistic deals. For example, if you prefer practical assistance, then the franchise may be the best for you. Conversely, if you are an experienced business owner, you may want to consider purchasing an existing business.
- Check out the big picture: Take a look at the existing infrastructure and make sure you understand everything that comes with the purchase. Don’t be afraid to ask questions about contracts, leases, existing cash flow, and inventory. The more you know, the better equipped you will be to make a good decision.
Choose the right franchise or custom business that exists for you
Once you know whether you want to franchise or buy a business, you will need to evaluate each specific opportunity. In short, it comes down to this: do your due diligence.
Your research should help you understand the business both financially and in the big picture.
If you are interested in franchises, you should explore the following:
- All existing reports: Now is the time to put on your detective hat. To get started, get a Uniform Franchise Offering Circular (UFOC). This form contains vital details about the legal, financial and personal history of the franchise.
- Rules and associated regulations: Every franchise is different. Confirm that you will have the right to use the franchise name, trademark, and do business in a protected area from other franchisees. You can also find out if you will receive training and administrative help from the franchisor and will be able to use the franchisor’s experience in marketing and advertising.
- Contracts: The contract between the two parties generally benefits the franchisor more than the franchisee. The franchisee generally needs to meet sales quotas and purchase equipment, supplies, and inventory. Make sure you understand everything before signing.
If you are interested in buying an existing business, here is what to consider:
- Licenses and permits: You will need to obtain the necessary licenses and permits from the current owner or apply for them yourself. Find out what federal, state, and local permits and licenses you will need to run your business.
- Zoning requirements: Zoning requirements can affect your business. Make sure your business follows all the basic zoning laws in your area.
- Environmental concerns: If you are buying real estate in conjunction with the business, it is important to check the environmental regulations in the area.
- The value of the business: There are many different methods of determining a fair price for the sale of the business. These are some:
- Capitalized profit approach: This method refers to the return on investment that the investor expects to obtain.
- Excess gain method: Like the capitalized profit method, except that it separates the return on assets from the rest of the earnings.
- Cash flow method: This method is typically used to determine the amount of a loan that the company’s cash flow can support.
- Tangible asset method (balance sheet): This method values the business for tangible assets.
- Specific intangible asset value method: This method compares the purchase of a desired intangible asset versus its creation.
Prepare to buy your franchise or business
Once you have found a franchise or business to buy, it is important to conduct a thorough and objective research.
At this stage, you will probably want professional help. Consider hiring a lawyer and an accountant. The tax rules surrounding franchises in particular are often complex. A specialist in franchise law can help you evaluate the franchise package and tax considerations. An accountant can help you determine the total costs of buying and operating the business, and can even help you estimate potential profits.
A lawyer and an accountant together can help you create and evaluate important documents. Typically that includes:
- Letter of intent
- Confidentiality agreement
- Contracts and leases
- financial statements
- Tax returns
- Sales contract
- Purchase price adjustment
Be sure to visit the Federal Trade Commission’s Bureau of Consumer Protection for a wide range of resources and guides to help you buy a franchise.