Franchise vs Existing Business: Which Is Safer?

This is a transcript from Episode 18 of The Franchise Champion Show. Listen to the full episode on Apple Podcasts, Spotify, or YouTube.

Welcome, everybody. Good to see some new faces here and some familiar faces as well.

Since we're streaming here, I know we got some people that are going to be trickling in. That's all right. We're just going to go ahead and get started though. So I am Alan Regala and I'm the owner of Athlete to Owner Franchise Coaching. We're going to dive a little bit into a quick history of my story for those that don't know me, didn't hear this before. I was an undergrad at Cal Poly, played tennis.

Division 1 tennis there. Ended up working for a year in the corporate world before deciding, ah, this isn't for me. I'm not ready to move on. I got my master's at Stanford in mechanical engineering. Was a consultant at IDEO for a couple of years. And that's when a guy from the accounting department handed me Rich Dad Poor Dad and said, hey, you should really own a business. And after reading through that, I was like, you know what? I think you're right. I'm young, and I really feel like business ownership makes a lot of sense, so why not give it a shot?

So I ended up inventing my own product and wrote my own patents, had it made overseas, blah, blah. Got into Entrepreneur Magazine, which was pretty cool. And then the iPhone came out and I was like, my product is no longer going to be useful in this world. So I went through the ups and downs of entrepreneurship and basically had my first failure, actually my second failure behind me.

And so we decided to move to Seattle for my wife's work, where I ended up utilizing a franchise coach to help me find a business. And through that process, I ended up starting ShelfGenie of Seattle, which is a home improvement franchise. And over the years, over the period of 14 years, I built that up and I had a great team in place and I was able to go and do things with my family, with my kids. I never missed any games. We went on some great vacations together. I even traveled the world playing tennis, which was pretty amazing. And this business allowed me to do that. So I had that lifestyle component to it. It also brought in a great amount of money. So I was able to pay for my kids' colleges and buy a new house.

And it also brought me purpose, which I realized going through the business that that was a big part of what I was doing. And part of why I was successful is incorporating purpose into my work. I decided last year after 14 years that it was time to sell and move on to the next thing. And so I did that. And then came full circle and decided to become a franchise coach myself so that I can help other people that are interested in taking control over their financial and lifestyle goals.

So that's what I do now. A couple of weeks ago or last month, we had our first workshop where we talked about four different career options: working in corporate and buying a business, starting an independent business and buying a franchise. And I won't go over all this right now, but basically what it comes down to is, you know, owning a business has its advantages in that you're building an asset over time. When you're working, you're creating an asset, you've got major tax benefits.

So from a financial standpoint, it can be very, very advantageous. And also, you know, having control over your time and the autonomy is another important aspect of that as well. So today we're going to be focusing on buying an existing business and buying a franchise and what the differences are, pros and cons of each of those.

What Are You Actually Buying?

So what are you actually buying when you're buying an existing business? Let's hear some. What are you guys buying? You're buying a name? Yep, the brand. Existing contracts. Yep, cash flow, right? You're buying cash flow, essentially, right? You've got also inventory and equipment, things of that nature, the reputation. And hopefully, to some degree the owner's knowledge, whatever they can transfer to you.

And so the cost of a business—there's different ways of establishing the valuation of a business and there are different models, different ways of looking at it. But typically, you take the profit of the business or what is often called seller discretionary earnings, which is basically all the positive stuff that comes from the business. So that can be a salary plus the actual profit from the business plus whatever perks people might be running through the business. And then it's generally a multiple of that. And that could be anywhere from three to five times that multiple, or it could be less, could be more, just depends.

You know, just as an example, so a business is making $300,000 in seller discretionary income, which could be like $100,000 in their salary plus $200,000 in profit. We'll say that could sell for, let's say, $900,000 to $1.5 million, just as an example.

So there's different types, obviously, of businesses that are available on the market. You've got some mainstream businesses, oftentimes the ones that are at this kind of price range, $100,000 to like $500,000, you might find, say, a small coffee shop. And generally speaking, these are kind of—it's kind of like a job, right? It's usually a very small, few amount of people. It's maybe the owner just themselves working this particular business. Maybe they got a little bit of help. And then typically as you get higher and higher up in the size of the business, the cost of the business, you usually have more employees, a bigger team. And eventually, you've got managers in place and other people in place so that the business can run a bit more on its own.

The Acquisition Timeline

The process for buying a business can be anywhere from four months to over a year. It really depends on what it is you're looking for, how much money you have, and how things just kind of tend to line up.

Pooja, have you been looking at existing businesses? You have? OK. How long have you been in that process?

I've been thinking about it for probably a year or two.

Year or two. Okay. Yeah. Yeah. So the entrepreneurship through acquisition is a big thing. And it really comes down to like, can you find the right thing? What's the timing of that? Right? What you're looking for and what becomes available and getting it before someone else.

I find a lot of owners typically—it's their baby, so they overvalue it.

Yeah, exactly. Is this really worth it?

Right, right, right. Yeah, I definitely see people that don't really understand the true value of their own business because it's their baby, and so they think it's worth way, way more than it actually is, more than other people are willing to pay anyways.

So, you know, obviously you have to find the business, right? Some initial screening happens. If you end up finding something that is desirable, you would have a letter of intent that says, hey, I'm willing to pay X amount of money for this. And really, at that stage, if they agree to that, the due diligence process is what takes the longest. And this is where most deals tend to fall apart, is once you start looking into the business and you find out that, oh, this is not what I thought it was.

Then you've got financing and closing as well. And so part of that due diligence process, people tend to find things which end up making the deal fall apart. Red flags such as the seller not providing their detailed financials. Maybe they say their business is making $300,000 a year in profit, but they can't show you the books to prove it. Or maybe they show you tax returns and it shows they're only making $100,000, not $300,000. So there's inconsistencies.

Another red flag is declining revenue or customer loss. If you're looking at the last three years and the revenue is going down, down, down, that's not a good sign. There could be lots of different reasons for that. Maybe the market's changing. Maybe competition has moved in. Maybe the owner has kind of checked out mentally and is no longer doing the things that need to be done in order to continue to grow the business or maintain the business.

Operational issues or legal problems. Maybe there's some lawsuit that's going on or maybe there's just operational issues that need to be fixed. Maybe the equipment is old and outdated and needs to be replaced, which is going to cost a lot of money.

High customer or employee turnover. If customers are leaving or employees are constantly leaving, that's a sign that there's something wrong with the business.

Over-reliance on the owner. If the entire business is dependent on that one owner and their relationships and their expertise, once they leave, the business could fall apart. So you need to make sure that the business can run without that owner, or at least understand what it's going to take to replace that owner's contribution to the business.

Undisclosed debts or liabilities. Maybe there's some debt that they haven't told you about or there's some liability, some lawsuit that's pending that they haven't disclosed.

And unclear reasons for selling. If someone says, "Oh, I'm just ready to retire," but they're only 45 years old and they seem perfectly healthy and capable of continuing to run the business, that might be a red flag. Why are they really selling? Is there something wrong with the business that they're not telling you about?

So these are all things that can come up during due diligence that will make a deal fall apart. And this is very common. Most deals do fall apart during this stage.

The Challenges of Going Solo

But at the end of the day, what makes it really challenging is that you don't know what you don't know. And so there are things that you probably should be looking for, but you don't know to look for or to ask. You're spending a lot of money. This is a big investment. So it's something that is really difficult, scary, to do on your own.

The other option is you can use a coach. I use the word coach, but also in the industry, it's called a consultant or a broker or advisor. I like the word coach because that's how I operate, like a coach. So ideally, you're using a coach because they know the intricacies of franchising. You want to use a coach who has ideally done what you want to do and who has your best interests in mind.

Pooja had a great question. Are all coaches like fiduciaries? Are they looking out for your best interests? And they're not. I mean, there's a lot of them out there. And I can tell you that there's a lot of them that have never owned a franchise, never been in business for themselves. This coaching, brokerage, consulting can be a good career. And so the bar is relatively low to get into doing that. So I just recommend you work with someone that you can trust and someone that has these qualities.

One of the best parts about working with a coach is that there's no cost associated with it. It's similar to working with a real estate agent on the buying side, where if you end up purchasing a franchise, then a coach will get a referral fee from the franchisor. So there's no cost to you in the meantime to use their services.

So the only real downside is if you work with a bad coach, someone who's not looking out for your best interests.

Why Athlete to Owner?

So why Athlete to Owner? That's my company, obviously. Well, I have the experience. I owned and operated my own business, operated at $4 million, multiple units for a period of 14 years. I was a top performer in my system. I had a great team, built a solid team. We had about 20 people on my team, and I was a semi-absentee owner in the end. And I had a successful exit last year, which was great.

As I mentioned before, I'm really into the education part of this business. So it's not just about trying to sell franchises. I don't sell anything. All I do is educate, and I work with my clients on understanding their needs and their goals, and then educating them so that they can make the best decision possible. And so these are the eight principles of high performance that I figured out through the years and through training, high performance training through tennis and applying those to business to find success there. And so these are some of the things that I teach as a framework with my clients. I have a podcast which has been super fun. Really, again, I bring in high performers from different brands and interview them to showcase both the franchisee and what it takes to be successful as well as the brand itself.

The Franchise Exploration Process

So the process, if you are interested in learning more and exploring: it starts with an introduction call to get to know each other a little bit, understand your needs. I do a deep dive interview where we really understand what those goals are financially and lifestyle-wise and understand your skill sets and what your hobbies are, all those sorts of things, so that we create a profile.

So that we can then match you with an appropriate franchise that'll really be optimal for your success. I'll introduce you to franchisors and funding specialists at the beginning of the process. The funding specialist part is important—to talk through it with someone who can make sure that you're going to have a high likelihood of being approved for a loan if that's the direction you want to go, or if you have money for the ROBS, if you choose to use retirement funds and those sorts of things. And with the franchisors, this is the start of the journey and learning more about those brands.

While you're going through that process, this is what we call the due diligence process, where you learn in detail from these franchisors. I'll provide ongoing coaching and education so that, you know, I'm providing what questions to ask and when you have questions throughout that process, being able to answer those.

That due diligence process is going to be guided by the franchise development person. So every franchisor has a person that works with candidates. Sometimes those franchise development people work for the organization itself. And sometimes they work for an outside organization that helps them to sell franchises. But either way, they're going to walk you through the process. They'll provide you with the franchise disclosure document.

The Franchise Disclosure Document (FDD)

I mentioned this briefly earlier—it's required if you're a franchise, you have to have a franchise disclosure document. And it has 23 items in it that talk about various things like the founders, financial performance, investment costs and all those sorts of things.

They'll talk about unit economics. So with this specific business, what are the different types of expenses you can expect and all things related to owning a business, owning one of their franchise businesses. The territory map. So it might be certain zip codes. What does that look like for your business? Usually they have some sort of exclusive area.

Not all franchises have an exclusive area. Some of them are like business coaching. For example, there's no one area. You can have other people next to you, but you can also service people all over the country, all over the world.

Validation Calls: The Most Important Step

And the most important part of this, which we talked about earlier, is doing these validation calls and not just relying on the document like that franchise disclosure document for some numbers, but actually talking to the owners. This is the most important part of the process because you're really going to get a better sense of what it's like, what kind of support does the franchisor provide. This is with existing owners, validation calls. This is where I provide you with a list of questions.

Questions that you can ask, including like, how much are you making? What's your revenue look like? What are your expenses like? What kind of startup capital did you actually need? Here's what they're telling me, but what do you recommend? Would you do this again? All sorts of questions that you're going to want to ask existing owners.

And I did validation calls as a ShelfGenie franchisee for other people trying to get into the ShelfGenie system. And so I got a range of different people asking me questions. And it was really interesting from my perspective, because some of them never asked me about money. I was like, okay, I thought that would be like one of my top things—asking people about money, right? But you don't start off with that, right? You kind of lead into that.

You have to, because it's a sensitive subject, right? And so I was very forthcoming. I mean, if someone's getting into this business, they should know what they're dealing with, like the real ins and outs.