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Westpac - Know What You're Buying
by Westpac, last updated on 11th August 2009
Due diligence is the business term for investigating a transaction such as the purchase of a franchise. If done properly, it should help minimise problems and maximise the health of your new venture. Beverley Barnaby of Westpac provides a guide
In This Article
When a corporate is looking at a business purchase of some magnitude, the due diligence process may take many months and cost tens of thousands of dollars. However, in the franchise world where less money is involved, due diligence needs to be a cost-effective and efficient process. This is especially true as you may undertake due diligence on several businesses before you find the right one.
There are three key areas that you should focus on in deciding if a particular franchise investment is right for you: how the numbers stack up; understanding the legal obligations; and understanding the major risks for the business.
The Numbers
The most important aspect of buying a business or starting a new one is the numbers. Will the profit you reasonably expect to make from the business be worth the time and financial investment?
With an existing business, there is more evidence of what the business is generating. As a result, you should request a minimum of the last two years' financial statements and recent management accounts. Along with this, it is a good idea to ask for GST returns so that the sales figures can be confirmed.
We sometimes see financial statements which do not show the whole picture and have been prepared to intentionally mislead the purchaser. The best person to provide guidance on the integrity of the financial statements is a chartered accountant. If you do not have a good person in mind, your banker will be able to make a recommendation.
For a start-up operation, the franchisor should be able to provide guidance on average figures and ratios. Once you have this, it is vital to get an accountant involved - especially if you do not know the industry well. You, together with your accountant will attempt to determine not only the return on investment and the business's ability to pay debt but how much income you could take home.
The information you should request from an accountant is a review of any historical financial data you have obtained and the preparation of Profit and Loss, Cashflow and Balance Sheets for the next 24 months, including assumptions they have made.
Legal
The contract or franchise agreement forms the basis of the relationship between franchisor and franchisee. The lawyer's function is to advise what the responsibilities of both parties are and, in their experience, whether those responsibilities are fair and appropriate. For this reason, we strongly recommend that all agreements are reviewed by a specialist franchise lawyer such as those listed at the back of this magazine.
A common error is the use of the family solicitor that may have handled a property settlement, family trusts or wills. If they do not have franchise experience, solicitors reviewing an often lengthy agreement may waste time and money or fail to recognise and address abnormal and possibly unreasonable provisions.
Risks and Mitigants
Risk profiling is something bankers always do, so it's a good idea to understand the potential risks involved in your new business before submitting a funding application to them. Most risks are common sense - the challenge lies in finding ways to mitigate them.
If we take a coffee shop as an example, the main risks would typically be those set out in the table below.
Risk | Mitigant |
Franchisee's lack of experience in industry |
The franchise that you are purchasing is well-established and the support and systems in place mean that it is not necessary for franchisees to have previous industry experience. |
Franchisee has no financial management experience |
The franchisee has been trained in the use of the franchise's standard accounting software and has employed an accounts specialist part-time to assist with monthly preparation of profit and loss statements and GST returns. |
Is it the right location and rent? |
For a coffee shop you would normally seek a location that has high foot traffic; however, you need to balance this with the cost of the location. The franchisor is often involved in site selection and usually has a lot more experience than the incoming franchisee. Your franchise banker may also be able to provide some guidance on typical rent-to-sales ratios and advise whether the rent cost is too high.
It is also important to understand the terms and conditions of the lease and ensure that the term available is at least as long as the franchise agreement and bank funding.
|
Competition |
This risk is both an industry risk and a site-specific risk. To use the recent openings of Sylvia Park and Albany Westfield as an example, most well-known coffee franchises have become tenants. It is important to understand what differentiates each concept, which markets they target and who will be the strongest players in that environment.
|
These risks are quite generic when it comes to food and retail. Other common risks in small businesses are associated with: suppliers; major debtors; foreign exchange; transport; technology; out of date stock; theft; environmental / consents; and specific legislation. Each industry has its own issues. Researching these and listing them for discussion with your banker can provide a better understanding of where there may need to be additional focus as you get started.
This article is taken from Franchise New Zealand magazine Volume 17 Issue 1
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