Should You Buy an Existing Business or Franchise?

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It’s an important question that can excite and intimidate you all simultaneously. The decision itself entails careful consideration of various factors, but one thing is certain: purchasing an existing business or franchise can streamline the initial planning process. In any case, this guide can help you decide which path best aligns with your goals and circumstances.

The Case for Existing Businesses

As the name suggests, an existing business is one that is already operational with established customers, processes, and revenue streams. When you purchase an existing business, you acquire its assets, liabilities, and operational history. This option is appealing because it allows you to step into a functioning enterprise with a proven track record, providing immediate benefits and potential gains.

Advantages

• Immediate Cash Flow: Since the business is already operational, it generates revenue from day one. This can provide financial stability and reduce the initial risks of starting a new venture from scratch.
• Established Customer Base: This means you don't have to start from scratch to attract clients. It will save you time and marketing expenses and allow you to focus on maintaining and expanding customer relationships.
• Proven Business Model: The processes, products, or services of an existing business have already been tested in the market. This reduces the uncertainty and risks of a new business and puts you in a good position to be profitable.
• Pre-Existing Supplier Relationships: More often than not, existing businesses have established relationships with suppliers. It can result in better credit terms, reliable supply chains, and potential cost savings.
• Trained Staff: You don’t have to worry about hiring and training new employees since the existing business may already have trained and experienced staff. They can provide continuity and help maintain the operational efficiency of the business.

Challenges

• Hidden Issues: These can include outdated equipment, unresolved legal matters, or poor employee morale. Thorough due diligence is key to uncovering and addressing these problems before finalizing the purchase.
• High Initial Investment: The initial cost of purchasing an existing business can be high, especially if the business is well-established and profitable. This may require significant upfront capital or financing, which can be a barrier for some prospective buyers.
• Cultural Integration: Integrating the existing company culture can be challenging for a new owner. Some employees may resist changes, and adapting to the established business methods can take time and effort.
• Limited Flexibility: Since you are inheriting its existing processes, systems, and culture, your ability to make big changes or implement new ideas is limited. It can even be challenging to shift directions if the existing systems are deeply ingrained.

The Case for Franchises

A franchise is where an individual (franchisee) is granted the rights to operate a business using the name, branding, and business system of an established company (franchisor). In return, the franchisee pays an initial franchise fee and ongoing royalties.

Advantages

• Established Brand Recognition: Franchises benefit from the marketing and reputation of the parent company, which can attract customers and generate sales more quickly than starting a new, unknown business.
• Proven Business System: The franchisor provides a detailed operations manual, training, and ongoing support to help the franchisee run the business successfully. This reduces the trial-and-error phase often associated with startups.
• Marketing and Advertising Support: National or regional marketing campaigns can drive customers to your business without requiring you to invest in marketing activities. This can help you reach a broader audience and increase your revenue.
• Easier Financing: Franchises often have an easier time securing financing. Lenders are more likely to fund franchise purchases because of the established business model and the franchisor’s support, which reduces the perceived risk.

Challenges

• Initial Franchise Fee and Ongoing Royalties: Buying a franchise involves paying the franchisor an initial franchise fee and ongoing royalties. These fees can be substantial and impact your profitability.
• Limited Control: If you prefer a high degree of autonomy and creativity, a franchise may not fit you best. Franchisees are required to follow the franchisor's established systems and procedures.
• Restrictions and Obligations: Franchise agreements often come with strict restrictions and obligations. These can include limitations on your products or services, geographic territories, and operational hours.

Making the Decision

Financial Considerations

Purchase Costs

The cost of buying an existing business can vary widely based on various factors, the industry, location, and profitability. In most cases, the purchase price includes the value of the assets, inventory, and sometimes goodwill. Although buyers should be prepared for significant upfront costs, there may be more room for negotiation.

Franchises usually have a fixed initial franchise fee set by the franchisor. This fee grants the right to operate under the brand name and access the business model. Additionally, franchisees must invest in the initial setup, including equipment, leasehold improvements, and inventory.

Return on Investment (ROI)

An existing customer base and established revenue streams can provide a more immediate ROI. Evaluating the ROI of an existing business involves analyzing past financial performance, including financial statements, tax returns, and other documents to assess profitability.

For franchises, the ROI is often influenced by the success rate of the franchise brand. The brand's reputation and market presence can significantly impact the ROI.

Ongoing Costs and Fees

Franchises have specific ongoing fees, including royalty fees (a percentage of revenue) and advertising fees. These fees are outlined in the franchise agreement and can impact profitability.

Owning an existing business involves operating expenses like rent, utilities, payroll, and inventory costs. Additional costs may include marketing, maintenance, and insurance. These expenses can fluctuate based on business performance and market conditions.

Financing Options

For existing businesses, a purchase can be made through various means, such as personal savings, bank loans, and seller financing. Traditional bank loans often require a solid business plan and collateral. However, if banks are hesitant, seller financing—where the seller provides a loan to the buyer—may be another alternative.

Franchises often have established relationships with financial institutions. Some franchisors offer in-house financing or partnerships with lenders specializing in franchise loans. Additionally, Small Business Administration (SBA) loans can be a valuable resource for franchise financing.

Legal Considerations

Obligations and Liabilities

Inheriting the legal obligations and liabilities is part of buying an existing business. Conducting thorough due diligence can uncover potential legal issues that could affect it. These can include existing contracts, leases, employee agreements, and pending lawsuits.

On the other hand, franchisees must comply with the franchisor's operating standards and policies. The franchise agreement outlines the legal obligations, including adherence to the brand's operational guidelines and quality standards.

Contracts and Agreements

When it comes to existing businesses, a careful review of all contracts and agreements is a must. This includes leases, supplier agreements, and customer contracts, to name a few. To prevent future complications, ensure these contracts are transferable and favorable.

As mentioned earlier, the franchise agreement governs the relationship between the franchisor and franchisee and details the rights and responsibilities of both parties. This involves the duration of the agreement, renewal terms, and conditions for termination.

Case Studies

Buying an Existing Restaurant

John, an aspiring restaurateur, decided to buy an existing restaurant in his hometown. The restaurant had a loyal customer base and a history of profitability. John conducted thorough due diligence, including reviewing financial statements, inspecting the property, and interviewing staff. He discovered that the kitchen equipment needed upgrading, but the overall potential outweighed the initial costs. John successfully negotiated a fair purchase price and took over the business. With his passion for food and strong management skills, John maintained the restaurant’s reputation and increased its profitability.

Purchasing a Franchise Coffee Shop

A business professional, Lisa wanted to enter the coffee shop industry but lacked experience. She decided to buy a franchise coffee shop from a well-known brand. The franchisor provided extensive training, marketing support, and a detailed operations manual. Lisa appreciated the brand recognition and the established customer base. Despite the initial franchise fee and ongoing royalties, Lisa found the franchisor’s support invaluable. Her coffee shop quickly gained popularity, and she plans to open additional franchise locations in the future.

Main Takeaway

Deciding between buying an existing business or franchise involves careful consideration of various financial, legal, and operational factors. Although both paths offer opportunities for success and growth, the right choice will depend on your personal preferences, skills, and goals. Do your research and seek professional advice to make an informed decision.

If you’re still undecided or unsure where to start, our business formation experts at NCH are here to help. From helping you evaluate potential business opportunities to guiding you through the process of forming an LLC or corporation, we will guide you every step of the way.

Call us at 1-800-508-1729 to schedule your complimentary consultation!

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.

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