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Dealer Insights - September/October 2012 - What to Consider Before Buying a Second Franchise

Joel wasn’t looking to expand his business when an opportunity arose: A franchise in his area — with a brand he admired — had come up for sale. The previous owner was losing money, but Joel thought he could turn the dealership around. New car sales were strong, and financing was attractive. Should this motivated entrepreneur buy the business?

Purchasing a second franchise is one of the biggest moves a dealer may ever make. Here are some key steps to take in the decision-making process.

CHOOSE THE RIGHT FRANCHISE

Is the brand you’re eyeing likely to sell in your market? Just because you’ve always liked, say, Lincolns — and several customers have expressed interest — doesn’t mean they’ll sell well for you. Base your decision on solid data, not instincts. Consider whether the franchise is high-quality, is on the rise and matches up with your area’s demographics.

The manufacturer can provide sales projections and even assist in (and possibly pay for) market research. Don’t stop there: Seek hard data, including the failure rate, from objective third parties. Some financial analysts track auto manufacturer franchises, and your Dealer 20 Group may have additional information.

DETERMINE IF THE PRICE IS RIGHT

The franchise’s price will probably be the deal maker or the deal breaker. As you evaluate the price, account for your short- and longer-term costs, including:

  • Altering or expanding your store, or building a new facility (see the sidebar “What the manufacturer may require”),
  • Adding to your sales force and back-end staff, and
  • Training staff on the new brand and manufacturer’s procedures.

One word of warning: A new franchise normally will operate under working capital constraints. Don’t get strapped with too much debt service as a result of overspending.
 
Additionally, what is being purchased matters — that is, assets or stock. Future federal tax expenses are a crucial consideration. Asset purchases are more common for dealerships and can favor the purchaser because costs can be recaptured more quickly through depreciation.

But the seller may prefer a stock sale because the tax paid on the gain often is levied at a lower rate. That means the seller may be willing to accept a lower price for a stock deal. For the buyer, this might make up for missing out on an asset sale’s depreciation advantages — but the buyer needs to be concerned about future unknown liabilities that could arise with a stock purchase.

PROJECT PROFITABILITY CAREFULLY

You should be able to find out the current franchise owner’s record of profits — or losses — fairly easily. But bring your CPA into the analysis to help identify any hidden losses or exaggerated profits. Annual losses, however, aren’t as much of a yardstick as you’d think, because the business likely will be run very differently under your ownership.

What is extremely important to consider is the franchise’s purchase price, the value of its goodwill and the potential sales volume. Is there enough opportunity for change in the business’s operations to achieve the profitability you’re projecting?

ASSESS THE IMPACT ON YOUR FIRST FRANCHISE

If the second franchise is a standalone business, its profits and losses will be calculated separately from those of your first franchise. But if you’re putting both franchises together in the same corporate structure, you’ll need to assess whether the newcomer franchise will add value and profitability to your existing business.

Or will the second franchise rob your first franchise of sales? Be sure to estimate the retail impact of this “in-house” competitor carefully.

BRING IN AN EXPERT

Your CPA can be a crucial peg in your decision to add a franchise. He or she can assist in:

  • Determining whether the franchise price is fair,
  • Performing due diligence to authenticate that what you’ll receive is what’s being represented, and
  • Conducting a sound business evaluation of all the factors mentioned above to determine whether the second franchise is a good idea or a bad one.

Last but not least, your CPA can assist in the submission of paperwork to the manufacturer for the approval of the sales and service agreement.

OPPORTUNITIES - AND RISKS

Adding a second franchise is a way for a capable entrepreneur to take advantage of market opportunities and expand his or her business. Just remember that a second franchise carries just as much risk as any other investment, and you’ll need a proven business strategy to make it all work.

SIDEBAR: WHAT THE MANUFACTURER MAY REQUIRE

When considering a second franchise, take a close look at what the manufacturer will require. Is your existing manufacturer offering the franchise? If so, it might allow you to stay in the same facility but require you to build a separate showroom or segregate your showroom area for the two brands.

Some dealerships solve the dual franchise problem by hiring a receptionist to direct customers to separate showrooms and service areas.

If your manufacturer thinks you lack sufficient space, it may require you to open a second facility. It also might require you to dedicate one or more salespeople to the additional franchise and try to make changes to your current sales and service agreement that you might find harmful.

If the second franchise represents a different manufacturer, the plot thickens. The second manufacturer — or your existing factory — may have a long list of requirements that necessitate opening a new facility and running the new franchise separately.

 

Dealer Insights - September/October 2012 Issue 

 

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