Franchising

Going for broker

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Following the recent article Tips for selling an existing franchise, it is worth exploring the topic of franchise sales in more detail, particularly in regards to the role played by business brokers in bringing franchise buyers and sellers together.

Debate often flares within the franchise sector as to the appropriate usage of brokers, who are generally used in franchising for two reasons:

  • To sell new (or “greenfield”) franchises.
  • To sell existing franchises.

Many newer franchise systems will use brokers to sell new franchises, and in most cases will not have been franchising long enough to even have existing franchises up for sale (unless they are company-owned outlets).

By contrast, many (if not most) established and mature franchisors are less inclined to use brokers and often limit their role to franchise re-sales only, and not sales of new greenfield franchises.

New franchise systems frequently appoint brokers (or franchise consultants that provide broking services) to sell their greenfield franchises, primarily because they have ambitious expansion plans (including both unit and master franchising), and will defer to the expertise of others if they themselves have no prior experience in selling businesses or franchises.

Unfortunately, these same franchisors have little or no experience with the consequences of poor franchisee selection practices, do not always have business systems that are sufficiently-developed before franchising, and often have little understanding of working with franchisees in a symbiotic relationship.

This can lead to tension and conflict between franchisors and franchisees in start-up systems where the expectations of neither party have been met from the outset because both sides have relied on an intermediary to coach them through the process.

By contrast, established and mature franchisors are much less likely to use brokers for the sale of new franchises and in the main, prefer to limit their role to assisting with resales.

Established franchisors are more cautious about the role of intermediaries in the franchise sales process. Through experience, they have developed a more comprehensive understanding of the relationship building necessary to ignite a franchise sale, and come to appreciate the costs of poor franchisee selection.

They are also likely to have more refined systems with highly evolved processes, and revised their expansion plans to be less ambitious and more sustainable.

The following table helps summarise the different approach to the use of brokers by new versus established franchisors:

 

New franchisors

Established / maturing franchisors

Enthusiastic & highly optimistic

Enthusiastic but cautious

Willing to try new methods of recruitment

Have definite ideas of what does & doesn’t work

Yet to count the cost of poor selection practices

Have learned from poor selection choices

Ambitious expansion programs

Conservative expansion programs

Advocates of master franchising

Have often bought-back or terminated master franchises

Systems still under development

Highly developed systems

Often lack adequate in-house franchising experience

High levels of in-house franchising experience

Struggle with first round of exiting franchisees

Developing both retention and exit strategies for franchisees

Likely to outsource recruitment

Very limited outsourcing of recruitment

Little unsolicited franchise inquiry

High brand awareness generates unsolicited franchise inquiry

 

 

Other reasons why established franchisors often steer away from the use of brokers for the sale of greenfield sites include:

 

Risk management

A franchisee who is given misleading information during the franchise sales process may have a case to sue the franchisor for misrepresentation. Franchisors, and more particularly, their legal advisers, are aware of this risk and seek to minimise the chances of misleading information being provided by carefully vetting their sales presentations and materials accordingly.

Statements made by brokers can also accrue liability to the franchisor if the franchisee has been misled into buying the franchise as a court may consider the broker to have been an authorised agent of the franchisor. A franchisor has a greater capacity to manage the performance and representations of their own internal staff, than to do so for external brokers.

 

Focus resources on the franchisor’s brand

Recruiting franchisees is expensive, costing up to $20,000 for a retail system in marketing and other expenses per franchise granted. Franchisors that manage their own sales internally are in total control of the portrayal of their brand, and the filtering of all inquiries generated by their marketing.

Brokers will advertise for their franchisor clients, potentially compromising the brand’s integrity in the manner and execution of that advertising. Furthermore, initial inquiries made to a broker in response to one franchise brand’s advertising may result in a sale for an entirely different brand.

 

More immediate and accurate management reporting

A sales process managed and controlled by the franchisor should allow for greater ease and accuracy in measuring and monitoring franchise inquiry rates, as well as ongoing lead management to provide up-to-the-minute reporting and assessment of the relative effectiveness of different advertising media.

 

Ongoing relationship

Franchise brokers rarely, if ever, have a substantial ongoing stake in the relationship with both franchisee and franchisor after a sale is concluded. Franchisors on the other hand have to live with the consequences of their recruitment mistakes, and if they have made a poor selection choice, will not be keen to repeat it by placing greater emphasis on filtering-out unsuitable franchisee candidates in future.

Brokers don’t have the same ongoing relationship with franchise buyers, and are likely to continue to focus on initial sales rather than a whole-of-life approach to the business relationship between franchisor and franchisee.

 

Greater brand knowledge

Brokers can never know a franchisor client’s business better than the franchisor themselves. If a broker is required to constantly refer back to the franchisor for answers during the sales process, it would simply be more expedient and efficient for the franchisor and franchisee to deal direct without an intermediary.

Recruitment personnel who have operated their own franchise for the brand, or otherwise have deep operational knowledge are much more capable of addressing the extensive and often unpredictable questions posed by potential buyers, and will be able to respond with confidence and clarity.

Brokers without such knowledge will interrupt the recruitment process more frequently to seek further information, with the effect that excessive interruptions for often basic information can derail the buyer’s confidence in the proposition before them.

 

Cost and value management

A broker’s fee for the sale of greenfield franchises can be as high as 20% of the total sale price. If for example the total cost of a franchise is $100,000, that means a $20,000 fee to the broker, plus the advertising costs which are also at the franchisor’s expense.

While this fee is essentially a variable cost to the franchisor and is only paid when a franchise sells, it also badly distorts the value proposition of the franchise being sold. For example, if the $100,000 franchise includes $80,000 worth of fitout, equipment and inventory costs, the franchisor is effectively left without an upfront consideration for the use of the system’s brand and intellectual property because the remaining $20,000 of the sale price is paid to the broker for their 20% commission.

The alternative is to load the broker’s commission into the sale price, and increase it by at least another $20,000. At this stage, the franchisor’s offering now costs a minimum $120,000 and may begin to look uncompetitive against rival franchise chains.

Alternatively, inflating the price to include hefty broker’s commissions can undermine the rate of return available from operating the business, and therefore make it less appealing to potential franchise buyers.

While the fixed cost of an internal franchise recruitment position is also expensive, this resource can be utilised in other parts of the business, and their ongoing presence provides some after-sale service and reassure for franchise buyers. Additionally, this resource will be dedicated exclusively to the brand, and be more likely to take a holistic approach to establishment of sustainable long-term franchise relationships, rather than rapid-fire commission-driven sales.

 

Manageable growth

Internal recruitment personnel are better-positioned to match the recruitment needs of the system with the system’s capacity to train, open and support new franchisees as they join. A broker can only introduce buyers and is rarely in a position to consider the franchisor’s wider organisational capacity to absorb such buyers.

 

Inappropriate use of master franchising

Master franchising can be a useful growth strategy for well-developed systems, but unfortunately many new systems attempt to grow via master franchising long before they are ready, and later regret the decision.

Brokers may inappropriately recommend to under-developed franchisors the sale of master franchises, which may then generate higher commissions to the broker compared to the sale of a single franchise.

Unfortunately for under-developed systems, the selection criteria for both single and master franchisees is often so poorly defined at this early stage in their franchising career that any master franchisees chosen rarely have the necessary operational expertise and business skills to both sell and support franchisees themselves. Consequently these arrangements can quickly cause more problems than they solve and lead to time-consuming and costly franchise disputes.

 

The use of brokers for the sale of greenfield franchises is often fraught with unforeseen cost and complications for new and growing franchisors.

For these reasons, as well as for the gravitational attraction of prospective franchisees toward established systems, mature franchisors rarely engage brokers for greenfield sales.

It is not disputed that suitably qualified and reputable brokers have a valid role to play in introducing buyers to sellers of existing businesses. In this environment, and with sensible commissions, brokers can help deliver positive outcomes for vendor franchisees, franchise buyers and franchisors.

 

 

Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. In his spare time, Jason is a passionate collector of military antiques.

 

 

Click here for more Jason Gehrke blogs

 

 

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