Franchises and Buyouts

Topic 4

Zainon Che Mat

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 Learning Outcomes
• After studying this chapter, you should be able to:
1. Define franchising, and become familiar with
franchise terminology
2. Understand the pros and cons of franchising and the
structure of the industry
3. Describe the process for evaluating a franchise
opportunity
4. List four reasons for buying an existing business, and
describe the process of evaluating a business.

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 What is Franchising?
• A business relationship in which an entrepreneur can reduce risk and
benefit from the business experience of all members of the franchise
system.

• 2 parties involved in the franchising system:

1. Franchisor – the party in a franchise contract that specifies the
methods to be followed and the terms to be met by the other party
2. Franchisee – an entrepreneur whose power is limited by a
contractual relationship with a franchising organization

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 Franchising Terminology
Terminology
Franchise contract
Franchise
Product and trade name
franchising
Business format franchising
Growth Strategies for
Franchise:
Master licensee
Multiple-unit ownership
Area developers
Market Coverage for
franchise:
Piggybank franchising
Multi-brand franchising
Co-branding
Definition
The legal agreement between franchisor and franchisee.
The privileges conveyed in a franchise contract.
A franchise agreement granting the right to use a widely recognized product or name.
A franchise arrangement whereby the franchisee obtains an entire marketing and
management system geared to entrepreneurs.
An independent firm or individual acting as a middleman or sales agent with the
responsibility of finding new franchisees within a specified territory.
Ownership by a single franchisee of more than one franchise from the same company.
Individuals or firms that obtain the legal right to open several franchised outlets in a
given area.
The operation of a retail franchise within the physical facilities of a host store.
The operation of several franchise organizations within a single corporate structure.
Bringing two franchise brands together under one roof.
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 Franchise Organization
Country Entity
Australia Franchise Council of Australia-www.franchise.org.au
Hong Kong Hong Kong Franchise Association-www.franchise.org.hk
Malaysia Malaysian Franchise Association-www.mfa.org.my
Singapore Franchising and Licensing Association-www.flasingapore.org
New Zealand Franchise Association of New Zealand –www.franchise.org.nz
Source: Schaper, M., and Volery, T. (2007), Entrepreneurship and Small Business, 2 nd Pacific Rim Edition, Wiley.

The Impact of Franchising

Provide more jobs for entire industries; durable goods manufacturing, financial
services, construction, tele-communication carriers and others
Reason of growth is that many people entering workforce get their first job in
franchises. With the detailed operation manuals used in franchising, more and more
of entrants will see franchising as a viable business ownership option for their career
goals

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Malaysian Franchise Association
• The Malaysian Franchise Association was formed in 1994 to support the implementation of
the Government program to promote entrepreneurship through franchising.

• MFA will serve as a resource center for both current and prospective franchisors and
franchisees, as well as for media and the public.

• MFA has a unique formula of its membership composition, that are franchisors, would-be
franchisors, master franchisees, would-be master franchisees, government agencies and
authorities, banks, accounting firms, franchise consultants, attorneys, suppliers and vendor of
franchises.

• For that matter, everyone involved and would-be involved in franchising are subservient to
MFA's Code of Ethics of A Professional Conduct of Franchise Practitioners and MFA enforce
this code firmly yet helpfully.

• Through the work of its committee, the MFA is committed to continue advancement of
franchising in Malaysia into the twenty-first century in line with Vision 2020.

• Malaysian Franchise Association

• 1st Floor Wisma Motor, 339 Jalan Tuanku Abdul Rahman
• 50100 Kuala Lumpur, Malaysia.
• Tel : 603-2697 1557, Faks : 603-2697 1559, E-mail : secrtmfa@mfa.org.my
(Source: http://www.mfa.org.my/?about-mfa:background:216K71C99D)

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MFA: VISION AND OBJECTIVES
Vision
(1)
(a) the objective of the Association is to unify the Franchisors, Franchisees and the support institutions in a
spirit of bonding in establishing the good image in the business of Franchise.
(b) the vision of the Association is to be the main promoter and mover representing the Franchise fraternity
towards making Malaysia the Regional Hub for Franchise Development.

Objectives

2) The objectives of this Association are:

(a) to consolidate the effort of the members in protecting their interest.
(b) to encourage and maintain the good image of franchise industry and to encourage ethical business
practice.
(c) to support the government’s effort to encourage the active involvement of Bumiputra in the Franchise
business.
(d) to coordinate the existing facilities and infrastructure for the development of Franchise at national,
regional and international level.

(Source: http://www.mfa.org.my/?about-mfa:background:216K71C99D)

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 MFA Main Functions
1.Set and enforce standards of ethical business amongst members.
2.Act as a registry for information pertaining to franchise business operating or intending to operate
within the country.
3.Coordinate and offer educational programs, seminars and exhibitions specially oriented to franchising
matter.
4.Undertake promotional activities to promote franchising as a successful marketing business concept.
5.Provide input and liaise with government departments and / or agencies on matters concerning
franchising and its application.
6.Serve as a forum for exchange of experiences and expertise amongst members.
7.Establish and maintain affiliations with counterpart organization globally.
8.Develop and maintain affiliations with local industry trade organizations representing distributors,
retailers and service industry generally.
9.Sponsor franchise trade and investment missions to other countries.
10.Host international franchise trade and investment missions and assist in familiarizing them with the
potential in Malaysia.

(Source: http://www.mfa.org.my/?about-mfa:background:216K71C99D)

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The Pros and Cons of Franchising
Pros
• Reduced risk of failure
Cons
• Going into business for yourself, but not by • Misleading or exaggerated earnings claims by franchisors
yourself • Opportunity behavior by which the franchisor becomes a competitive
threat to franchisees
• Use of a valuable trade name and trademark
• Restrictions on franchisees who desire to liquidate their holdings in
• Access to a proven business system favor of alternative investment opportunities
• Management training provided by the franchisor
• Conflicts of interest, such as when a franchisor forces franchisees to
• Immediate economies of scale be captive outlets for other suppliers owned by the franchisor
• A way for an existing business to diversify • Churning: terminating a successful franchise operation in order to
resell it and gain additional franchise fees
• Encroachment: locating a new outlet or point of distribution too close
to an existing franchisee, causing a material loss of sales
• Imposing non-compete clauses on franchisees
• One-sided contracts devised by franchisors
• The imposition of new restrictions as a requirement of contract
renewal
• Franchisor intimidation of franchisees who attempt to form franchisee
associations, seek alternative sources for products, or make other
efforts to create a more level playing field

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The Costs of Being a Franchisee

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 Evaluating Franchise Opportunities
Selecting a franchise – personal observation or awareness to an advertisement in
multimedia
Investigating the potential Franchise – in 2-way effort; franchisor as a source of
information and existing and previous franchises as source of information

Being skeptical of a franchisor who pressure to entered contract without time for proper
understanding and factor to assessing franchise opportunities as a list below;
1.Is the franchisor dedicated to a franchise system as its primary mechanism of product
and service distribution?
2.Does the franchisor produce and market quality goods and services for which there is an
established market demand?
3.Does the franchisor enjoy a favorable reputation and broad acceptance in the industry?
4.Will the franchisor offer an established, well designed marketing and business plan and
provide substantial and complete training to franchisees?
5.Does the franchisor have good relations with its franchisees, and do the franchisees
have a strong franchisee organization that has negotiating leverage with the franchisor?
6.Does the franchisor have a history of attractive earnings by its franchisees?

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Becoming a Franchisor

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Legal Issues in Franchising

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 BUYING AN EXISTING BUSINESS
• Reasons for buying an existing business:
1. To reduce some of the uncertainties and unknowns that must be
faced in starting a business from the ground up
2. To acquire a business with ongoing operations and established
relationships with customers and suppliers
3. To obtain an established business at a price below what it would
cost to start a new business or to buy a franchise
4. To get into business more quickly than by starting from scratch

Buying and Converting is the decision to contract with a franchisor and

convert the companies into units of the larger chain, continue the
business but have advantage on larger corporation resources and
expertise.

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 Finding A Business to Buy
• Matchmakers: specialized brokers that bring
together buyers and sellers of businesses.
• Guidance in finding a business to buy:
– Determine your commitment
– Establish what you can afford
– Figure out what skills you have
– Consider lifestyle impact

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 Investigating and Evaluating Available
Businesses
• Due diligence: the exercise of reasonable care in the evaluation of a
business opportunity.
• Important information to gather during due diligence exercise:
1. Contract and lease agreements
2. Financial statements
3. Tax returns
4. Real and personal property documents
5. Bank accounts
6. Customer lists
7. Sales records
8. Supplier/purchaser list
9. Contracts
10. Advertisement materials
11. Inventory receipts/lists
12. Organization charts
13. Payroll, benefits, and employee pension/profit sharing info
14. Employee roster
15. Certification by federal, state or local agencies
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16. List of owners
 Investigating and Evaluating Available
Business
• Relying on professionals – accountants or lawyers, learn from their experience and
perspective
• Finding out why the business is for sale – a real possibility or any underlying problems
and most common reasons;
 Old age or illness
 Desire to relocate to a different part of country
 Unprofitability of the business
 Loss of an exclusive sale franchise
 Maturing of the industry and lack of growth potential
• Examining the financial data – financial statement and tax return for the past 5 years.
Buyer allowed to share such information and may compare the balance sheet to
actual assets and liabilities.

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 Quantitative Factors in Valuing the
Business
• Fair market value: the price at which the property would change hands
between a willing buyer and willing seller, both parties having reasonable
knowledge of relevant facts.
• In valuing firms, the buyer will have to rely on federal tax returns and state
sales tax statements.
• Should also scrutinize supplier invoices and customer receipts, as well as
the company’s bank statements.
• 3 basic approaches for valuation:
1. Asset-based valuation
2. Market-comparable valuation
3. Cash flow-based valuation

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 Non-Quantitative Factors in Valuing a
Business
1. Market – the ability to support al competing business units. Required
market research, census data or personal observation
2. Competition – the extent, intensity or location of competing business
3. Future community development – zoning changes or any new big project
4. Legal commitments – may include contingent liabilities, missed payrolls
or mortgage and overdue rent
5. Union contracts – conversation with leader’s employee that can help in
determining their job satisfaction and business success
6. Buildings – condition housing of business and there are any restrictions
on access or not
7. Product prices – comparing with others competing products prices in the
locality in order to provide full and fair pricing.

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 Negotiating and Closing the Deal
• Purchase price of a business is determined by
negotiation between buyer and seller.
• Calculated value may not be the price paid for
the business
• Buyer may have the option of purchasing the
assets, rather than the business as a whole.
• A buyers should never go through a closing
without the aid of an experienced attorney who
represents only the buyer.
• A number of documents are completed during
the closing which are bill of sale, certifications as
to taxing and other government regulations, and
agreements pertaining to future payments and
related guarantees to the seller.

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 Comparison of Options
Factor Start Up Purchase Franchise

Market/customer base Unknown Defined Predetermined

Advertising and pricing Unknown Defined Predetermined

strategy
Future growth possibilities Unlimited Unlimited Restricted

Staffing flexibility High Low Moderate

Flexibility in managerial High Moderate Low

decision making
Risk of failure High Moderate Low

Level of initial financial At owner’s discretion Substantial Substantial

outlay
Subsequent financial Nil Nil Yes (ongoing levies and
commitments royalties)
Goodwill costs No Yes Yes

Ability to raise external Poor Moderate Moderate

funds

Source: Schaper, M., and Volery, T. (2007), Entrepreneurship and Small Business, 2nd
Pacific Rim Edition, Wiley.
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The Process of Going into Business

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 Class Discussion
1) Danny Bone understands due diligence. He spent months investigating franchise options,
before focusing specifically on Elevation Burger. Elevation Burger uses the slogan
“Ingredients Matter”, emphasizing its “organically raised, grass-fed, free-range cows and fresh-cut
fries cooked in heart-healthy olive oil.”

•The company had been in business three years when it started franchising in 2008. Danny’s brother
Dennis brought franchising experience to the company from his days of managing their parents’
Dunkin’Donuts franchise. Danny and Dennis began their franchise agreement with Elevation Burger in
the spring of 2008, intending to open their Austin Texas, location by the end of that year.

•What Danny hadn’t counted on was the recession. Financing suddenly tightened, and forecasts for
restaurant sales were especially negative. Nevertheless, Danny and Dennis remained confident and were
convinced that they understood how to run a cost-efficient operation. The brothers were committed to
opening three Elevation Burger restaurants in the Austin area.

•Question 1: Should the Bone brothers have anticipated an economic downturn as part of their due
diligence investigation?

•Question 2: What steps would you take to attract customers to your franchised restaurant when they
are trying to save money?

•Question 3: What can the Elevation Burger franchisor do to help franchisees during a recession?

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2) You are applying Loan of RM100, 000 from
MARA but required to;
• Compare and contrast the start a business
from scratch and franchising (5 marks)
• Evaluate whether the amount of RM100, 000
is enough to start a business from scratch or
franchising. Support your answer.
(15
marks)

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 References
• Petty, J.W., Palich, L.E., Hoy, F., and Longenecker, J.G. (2012), Managing
Small Business: An Entrepreneurial Emphasis, 16 th edition, South-Western,
Cengage Learning.
• Scarborough, N.M. (2014) Essentials of Entrepreneurship and Small
Business Management, 7th edition, Pearson.
• Schaper, M., and Volery, T. (2007), Entrepreneurship and Small Business,
2nd Pacific Rim Edition, Wiley.

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