Franchising Aspiring Franchisees Need an Exit Strategy

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From the day he bought his Homevest Realty franchise in Kansas City, Mo., Robert Rometo was thinking about how he would get rid of it. It wasn't that Mr. Rometo was unhappy with Homevest. He's now on its board of directors and a shareholder. But Mr. Rometo knew he didn't want to be an owner-operator, in the office all day every day, for years.

"I wanted to grow the business in a way that it didn't rely on me, so I could either hire someone else to run it, or sell it," he explains. He worked full time for three years to build the business and cultivate a staff he could trust to run it. Then he managed it from his home in Sarasota, Fla., for two years, returning every few weeks to check in. Eventually he sold the real-estate brokerage to a local investor who had frequently financed the houses the franchise bought, rehabilitated and sold. "Real-estate investing wasn't his full-time job, it was something he did on the side," Mr. Rometo explains. "But I had structured the business in a way that he wouldn't need to be there all the time, so it was perfect for him."

A franchise isn't just another job a person can quit or retire from. It's an investment an owner will one day want to sell, hopefully for a healthy profit. Still, "I bet 99.9% of franchisees don't think about their exit ahead of time," says Tom Feltenstein, a former executive with Burger King and McDonalds, who now consults in West Palm Beach, Fla., for both franchisers and franchisees.

Experts and former franchisees say it's never too soon to think about how and when you'll get out of your franchise. In fact, because it isn't an independent business that you can run any way you want to -- you don't own the brand you peddle after all, and your franchiser will have to approve and train whomever you sell to -- the best time to think about how you'll get out of a franchise might be before you buy in.

Before You Buy
Here are few questions to keep in mind as you talk to the franchiser and current and former franchisees about the investment you're planning to make:

• How easy is it to sell this particular franchise?

Several experts suggest looking into a franchise's recent resale activity. Ask the company what percentage of franchise units turn over in a typical year. "Five percent is a high number," notes Jeff Elgin, founder of FranChoice Inc., a consulting firm in Eden Prairie, Minn.

Then ask everyone from the company management to current and former franchisees how long it usually takes to sell and whether most people sell at a gain or a loss. Even if statistics are hard to come by -- and they probably will be -- enough anecdotal information will provide a clear picture.

Keep in mind, "If lots of people are selling, that could be a good thing," says Eric Karp, a partner with the law firm Witmer, Karp, Warner & Thuotte LLP in Boston, who works with franchisees. "It could mean people are building equity and getting out, like they're supposed to." But if it regularly takes franchisees longer than a couple of months to get a deal done, or if a lot of owners have sold at a loss just to get out, that could signal a poorly managed franchise system. It might also suggest it's a business that's hard to run successfully or doesn't have broad resale appeal.

For example, "some of the carpet-cleaning businesses are quite lucrative, but how many people want to clean carpets, so they can be hard to sell," says Garrett Sutton, a Reno, Nev., attorney and author of "How to Buy & Sell a Business" (Warner Books, 2003).

Another important question: Who's buying the franchises for sale? Your choices are a new franchisee, a current franchisee or the franchiser, if it has company-owned stores. "Your best bet is another franchisee, because they've already been approved by the company," notes Michael Hays, who recently sold a Great Clips Inc. hair-salon franchise in the Reno, Nev., area. Of course, the system can be harder to get into if the majority of buyers are current owners looking to expand. But, experts say, these might be a safer bet than those that rely heavily on bringing in new people.

• Will the parent company help me sell my business? There are two roles a franchiser can play when it's time for you to move on; they can make it easier or more difficult for you to do so successfully.

When Margaret Trapani Packard wanted to sell her Cookie Bouquet store in the New Orleans area, the parent company, MGW Group Inc., in Plano, Texas, gave her a list of people who had contacted the company wanting to buy a franchise. And an employee at headquarters who had owned and sold her own shop offered advice on how to sort the serious buyers from those who were just browsing.

Mrs. Packard had been an employee at the store she bought, and the woman who owned the store and sold it to her was a friend, she said, "so my own purchase was pretty informal." When it was her turn to sell, this time to a stranger, advice from that woman at headquarters to get a deposit and a purchase agreement, "was really helpful."

Mr. Karp says it's smart to ask whether a franchiser has set up a streamlined approval process for U.S. Small Business Association franchisee loans, or if there's a bank that's familiar with the franchise's business and regularly gives loans to its franchisees. "The companies have these arrangements so they can sell franchises, but they'll enhance your ability to sell when the time comes," he says.

Next, read your Uniform Franchise Offering Circular, which every franchiser must provide, looking for rules that could limit your options or drag things out when it's time to sell.

Franchisers sometimes ask for a right of first refusal. This in itself isn't a problem. "Their money is as green as anybody else's," Mr. Karp says. "But, do they have 30 days to let you know, or can they hold up your deal for quite a while?"

If they do have the right to buy your business from you, check to see what kind of formula they use to determine what they'll pay. It might be based on revenue or your customer list. But, "occasionally they'll pay only the depreciated value of your business assets, like any equipment you bought," says Mr. Elgin. "That basically means you'll never sell the business for anything approaching its market value."

• How long will I have to hang in for?
  Susan Kezios, president of the American Franchisee Association in Chicago, says it takes at least three years on average for a franchise to break even. And, according to Mr. Elgin, franchisees typically keep their businesses for eight years, a comfortable margin of time. But turnover and profitability vary by type of business and franchise system. For example, Andrew Sherman, a franchise attorney in Washington, D.C., points out that early-morning hours contribute to a high turnover rate among donut-shop owners. "So buyers coming in need to think they might be in it for the short-term, too, and plan accordingly," he says.

Franchisers will seldom talk about these kinds of numbers beyond the estimates given in the offering circular, so ask former franchisees how long they lasted, and if they were profitable by the time they left. And ask current owners how much longer they plan to stick around, and if they're close to breaking even. If too many people are giving up before breaking even, consider whether you're likely to do any better.

In addition, a franchisee needs to sell before his licensing agreement runs out (your license is one of the primary assets). So Ms. Kezios advises prospective franchisees to make sure they'll be able to keep the terms on any leases or business-related loans shorter than the licensing agreement.

If they run longer, you could wind up renewing a franchise agreement you no longer want to meet those other obligations. Or if you do sell, outstanding leases could make it harder to strike a deal or bring down the price you get. "You want to be able to walk away clean when you're ready to," Ms. Kezios says.

Mr. Hays found this out the hard way. He had taken one of several strip-mall leases that Great Clips had arranged for its franchisees. "It wasn't the deal I would have negotiated," he says, and it was still active when he was ready to move on. "The first buyer I had walked away because he didn't like the lease, either, and the landlord wouldn't renegotiate it.

• How much financial control will I have?
  Mr. Hays returned to franchising after Great Clips. But having done only "OK" on that sale, he didn't want to rely on the exit for making his money back this time. Instead, he says, "I wanted to keep costs as low as I could, to get as much cash flow as possible out of the business while I had it."

Mr. Hays looked for a company with low start-up costs and reasonable exit-related fees. And he avoided companies that had lots of required spending. "Some franchises make you buy everything, even back-office equipment the customer never sees, through them, but they're not necessarily getting the lowest price for you," he explains. He also steered clear of big advertising fees that didn't clearly generate business, or required spending on things like in-store displays.

He chose WSI, a company based in Toronto that provides Internet software and services to local small businesses. The company regularly comes out with new products to drive his business. But it also gave Mr. Hays enough discretion to make him feel in charge of his finances. "It was up to me whether I wanted to set up a retail location or just an office," he notes.

That's not to say a franchiser can't help you improve your finances from time to time. When Mrs. Packard was getting ready to sell her cookie business, someone at the corporate office showed her accounting software the company made available to store owners, but that she hadn't taken the time to learn.

"If I'd been using it, I could have done a better job of watching my expenses and saved more money as I went along, and I wouldn't have had to pay for an accountant," she says. "It would have helped the bottom line."

And after all, whether you choose to hold or sell your franchise investment, it's the bottom-line return that matters most.

-- Ms. Gunn is a free-lance writer in Brooklyn, N.Y., who specializes in management and financial issues

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