Growing and maturing franchisors place a great deal of emphasis on recruiting new franchisees, but as the franchise terms for their initial recruits come to an end, management resources and attention needs to be focused on the process of renewing or transferring franchises.
The average term of franchise agreements in Australia is five years, with an option usually available for a similar term on renewal. In theory, this means that after franchising for nearly five years, a franchisor will be faced with a growing number of renewals, but often franchisees may wish to sell or renew in a shorter timeframe, and franchisors must be prepared accordingly.
Franchise Agreement Renewals
Franchise agreement renewals provide an opportunity for both franchisor and franchisee to recommit themselves to the franchise business relationship for a further term. For franchisees, the renewal process can be daunting, primarily because it requires them to consider what they will do with the next five years or so of their lives. On the other hand, franchisors can use the renewal process as a way of introducing necessary change and updates to the franchise business and to the prevailing franchise agreement.
Franchise Agreements Transfers
Franchise agreements transfers are a different matter. When a franchisee sells his or her franchise, the buyer is often new to the franchise business. This means the buyer must go through the same or an updated version of the franchisee selection process applied when the original franchisee joined, as well as undertake the franchise training program and any other induction requirements.
At the end of this process, the franchisor has a new franchisee operating an existing franchise business. The franchisor has interviewed, trained and inducted this franchisee, generally spending a considerable amount of time and effort in the process, but the outcome of which is that the franchisor’s network remains the same size as it was before the franchise was transferred. In other words, the work required to manage a franchise resale is often the same as for the sale of a new franchise, but without the benefit of increasing the size of the franchise business group.
Sale of a Franchise
Franchises are assets that can be bought and sold by franchisees. The sale value of a franchise business is usually determined as a multiple of the business’ net profit, so the greater the profit, the higher the sale price. Business owners can make money out of their franchise businesses two ways – from profits generated as a going concern, and from selling the franchise business at a higher price than they paid for it.
The best price will be achieved by demonstrating the highest possible franchisee profitability, however many small business owners often include extra expenses in their businesses so as to reduce profits and therefore reduce the tax payable on those profits. While this may provide a greater economic benefit to the business owner in the short term, it reduces the potential for a significant capital gain on the business on sale because the profit multiple will result in lower overall value.
Determining sale values is not a function of the franchisor, but occasionally franchisors are required to intervene and veto a sale where the sale price is so high and the circumstances of the buyer are such that the buyer would inevitably run into severe financial distress due to loan over-gearing. For this reason, franchisors often take an interest in the franchise resale process for the long-term overall health of the franchise business network.