25 of the Worst Franchise Investments

Everyone, especially the franchisors, brags about how successful franchising is and how much safer it is for would-be business owners to buy a franchise as opposed to an existing non-franchised business. Blue MauMau's recently released chart of the 25 franchises with the highest SBA loan default rates clearly demonstrates it “ain’t always comin’ up roses,” with the #1 worst franchise investment boasting a 71.1% SBA loan default rate.

According to Blue MauMau, "Some of the perennial worst franchises to buy — hoagie sandwich shops, ice cream stops, and auto repair garages — dominate this year's list. The recession has only helped their failure rates climb."
 

Ed Teixeira of FranchiseKnowHow.com commented on the value of this list.  "Consider that loan defaults don't happen overnight but rather reflect a certain continuum of franchise performance...I'll offer my unsolicited comment that releasing this kind of information is important for the franchise industry. So many of us enjoy and depend upon this industry and it appears that there are always a certain number of franchise concepts that are definitely flawed."

Old Pro and the Cold-Canvas Call

The Old Pro had just returned from his vacation. He was suntanned and ready to go. The summer was over, and it was time to get back to work; so we had invited him into the office to talk to some brand new people we had just recruited.

We had not even finished introducing the Old Pro, when he began, “Selling businesses is tough work, but for those who are willing to pay their dues, it can be very rewarding. There are no short cuts to success, especially in the beginning. Your manager is going to make you learn the hard way —I know, because I trained him.

“He’s going to tell you to go out and talk to the small-business owner. This may not sound like it’s the easiest or most efficient way to get listings,—and maybe it isn’t—but there’s a method to all this. Small-business people...

C-Store vs. Quick Serve Restaurant

We found the following of interest to anyone selling C-Stores. The chart points out the growing popularity for convenience food.

“Reasons for choosing this c-store over other places for purchasing prepared food over even quick service restaurant. Note also that convenient location was very important over quick services establishments.

C-store vs. QSR off-premises, 2009 percent of traffic

Source: The NPD Group as seen in Nation’s Restaurant News, October 18, 2010. www.nrn.com

Introducing the “Old Pro”

For those of you unfamiliar with the “Old Pro,” he is the legendary G. R. “Russ” Wright, a man who introduced many to business brokerage, and whose own career spanned over 50 years. Occasionally, we will include an “Old Pro” story on the blog, often reminding readers of the tried and true basics of business brokerage. The following is from an article I wrote for the January 1987 issue of the Business Broker and offers an introduction to our “Old Pro”.

At the suggestion of a family friend, I moved to California in 1962. That family friend was our “Old Pro,” and subsequently became my mentor. Just before my arrival, three of Russ’s top salespeople had left to form their own business brokerage firm. I should point out that Russ had been in the business since 1935, so by 1962, he was indeed a pro! (I should also point out that Russ eventually became my father-in-law, but quite a few years elapsed before I married the boss’s daughter).

California was a licensed state, so while I was studying for my real estate examination...

Hot Business List -- April 2011

Below you will find the current “hot” business list courtesy of data from Businesses For Sale (www.businessesforsale.com). We asked Businesses For Sale for a monthly ranking of business types based on the number of “hits” on their site. This ranking is not based on the actual sale of businesses.

Top 10 Businesses:

1. E-Commerce Businesses
2. Convenience Stores
3. Miscellaneous Restaurants
4. Bars
5. American Restaurants

Personal Goodwill Revisited

In Darrell Arne's recent newsletter dealing with personal goodwill, Darrell notes that a case tried over 12 years ago is still being cited in recent personal goodwill cases.  He provides a summary of this case, Martin Ice Cream Co. v. Commissioner 110 TC 189 (March 17, 1998), and then goes on to summarize four more recent tax cases that challenged PGW allocations.  Darrell closes his newsletter with five lessons from the court, including what industry makes it harder to argue personal goodwill and what type of agreements support the allocation to personal goodwill. Recommended reading!

To Fee or Not to Fee

My staff and I have worked hard to reach the high levels of competency we have achieved. Between educational and vocational awards, designations and battlefield tested skills we have the scars and medals shared by many of our contemporaries in this occupation we share. Whether it’s practicing as brokers on main street, intermediaries in M&A, valuations for divorce, shareholder actions, estate matters, potential sale, etc., buy-side engagements or arranging financing so that our clients maximize their life dream, we all strive for excellency.

So why do so many in our industry perform for free, sans fee?

We charge potential clients an upfront fee for a strategic options valuation before being engaged to represent the sale of the company. We ask buyers to pay a retainer if they want us to represent them in a business search. We charge a fee to aid a buyer in securing financing and credit back to the buyer if we’re paid an origination fee by the lender.

Sure, it’s argued that we should work on a success fee basis like real estate brokers. They do a comparative market analysis for free and then hope they will get the listing and eventually get the property sold. Many business brokers/intermediaries do an evaluation for free with the hopes of getting the listing. Even if all we had to do was pull BizComps and Pratt’s Stats and present same in a 2-page report, chances are we’d still have 2 to 4 hours of work invested. I’m constantly amazed when I hear of a contemporary in another office working for free. Even if you do not have valuation credentials, are you not more qualified than most to offer an expert opinion of value?

Resolving the Controversy of Franchise Brokers

In a report by Franchise Update Media Group, 57% of the franchisors responding to the survey reported using franchise brokers. Despite the use of franchise brokers by franchisors their use remains somewhat of a controversy. This article explains why.

The use of franchise brokers by franchisors has grown dramatically over the past 10 years. Industry sources indicate that over 50% of franchisors use franchise brokers. By franchisor brokers, I refer to firms with a broker network versus the sole proprietorship. The use of franchise brokers is not limited to a particular size franchisor; franchisors both large and small use franchise brokers.

Start-up franchisors utilizing brokers can receive a boost in starting up their franchise system. The challenge is that many franchise broker firms are reluctant to market franchises represented by a brand new franchisor. In fact, if a franchise broker is willing to include a start-up franchisor in their portfolio one could question the judgment of the broker group since the start-up has no franchise history or performance.

Whenever, I’m asked about using franchise brokers I explain that franchise brokers can be a benefit, however, their service is limited to providing the franchisor a completed application from a qualified prospect. This means that...

Loan Issue Threatens Closing

Hi Tom,

Once again I need your opinion.

Situation:
I have a deal that made it through due diligence and all parties agreed to move to the closing (scheduled for yesterday). In late 2010 the seller had taken a personal unsecured loan and paid off his business equipment loan from 2008 (UCC filed with the state). After weeks of pressure to produce the payoff letter, the seller informed me the second loan was in fact not an unsecured loan as he thought but a restructured loan which still used the equipment as collateral. I have confirmed it is a personal loan, but the UCC is still in place and naturally the bank will not terminate it. The seller refuses to pay off his personal loan with the proceeds of the sale. The buyers are not happy.

Question:
Do you have any suggestions as to how this deal might be structured which will allow the sale to go through and the seller not to pay off the personal loan?

JG

Update on Len Krick's Situation in Nevada

Here’s an update on the issue with the Nevada State Securities Division:

1. I delivered the 200,000 pages of documents plus 2,750 electronic files to the State by the deadline on the subpoena.
2. I am currently in a deal which is scheduled to close escrow this Friday. The parties decided to do it as a stock sale and I backed away at that point. The selling entity is an old C-corp. I have been working on this deal for a year. The commission due is $297,500.
3. The State warned my securities attorney that if I was involved in any stock deals after I received the subpoena, that I cannot conclude them that way. Instead, I need to “turn them into a consulting agreement” and “bill” my client for time at standard rate.
4. They did not indicate that they were unaware of my big deal that I am doing and that, on January 28th, it turned into a stock, but we know that they must be aware because they were emphatic about “any deal since the subpoena”.
5. So, I had my attorney draft the Second Amendment to the Listing Agreement, which I discussed in my last e-mail. I spoke with my client. He said he would sign it if I gave him a discount on my fee (meanwhile it was his idea to do the transaction into a stock deal, not mine). I agreed and sent him the amendment, which is a $52,500 discount from the full fee.

FDA Proposal for Restaurants Food Labeling is Far Reaching

This article from Nixon Peabody in their Franchise Law Alert, outlines key components of proposed food labeling regulations by the FDA.

The Food and Drug Administration has issued two proposed regulations to implement calorie labeling requirement for menus, menu boards, and drive-through menu boards in franchised restaurants and retail food establishments with 20 or more locations. The requirements would include vending machines. Considering that approximately 50% of restaurants are franchise operated, these proposed regulations if enacted, will impact franchisees.

Businesses Startup Rate at 15-Year High

Last year 565,000 new businesses were started every month. That’s 6,780,000 or over 6 and a half million for the year. Another way of looking at it is that every month in 2010, 340 of every 100,000 adults launched a business. And, apparently the numbers were about the same in 2009. Now, obviously the businesses launched weren’t all General Electric or Ford Motor Company. In fact, very few even had one employee. And, we all know that many of them folded in the first two years.

But, the good news for business brokers is that many of them will be successful and eventually be sold – for all of the various reasons known so well. There are many sole-owned and operated businesses; and many others that are just husband and wife owned and operated businesses. Many of these, however, end up to be quite successful. There is a market for them. The government complains that very few (too few, according to it) hire employees. Unfortunately, many small businesses delay, or just won’t expand to require employees because of the cost. By the time one adds all of the taxes and insurance (including health) to a reasonable salary – it just doesn’t make sense. What the government doesn’t figure on is that much of the work that an employee might contribute is being outsourced to another one-person operation. This obviously helps maintain small business. And, don’t forget, a home-based business does not pay rent and can deduct the office portion of the home.

Business brokers should take advantage of this huge increase in small business.

Baby Boomer Bubble???

Surveys have suggested that there will be a flood of new businesses for sale as baby boomers reach the age of 65 and that this will drive down the price of firms.

We do not believe it and see no evidence of it.

The reality is that people are living longer and healthier and see no good reason for retiring just because a certain age has ticked over. Many have no faith in the government looking after them and are unimpressed with the returns from investment in term deposits, shares, property, and (naturally) finance companies.

Of course, every business changes hands eventually, but we are not expecting a sudden flood.

April Market Report from Clyth MacLeod

Business sales are still slow. The main problem is a lack of good listings – saleable businesses with proven profits or genuine potential. Owners are hanging on to their firms.

Yes, we have plenty ofbuyers – immigrants, corporate redundancies, returning ex-pats, and people wanting to fly on their own wings. They are cautious and credit is very difficult to obtain – but they are ready, willing, and able to buy when the right opportunity is presented. We welcome the new financial year and look to many more business sales.

Participate in BBP's Industry Survey for 2010

Throughout the month of May, we are inviting all business brokers and intermediarys to complete our Industry Survey for calendar year 2010.  In appreciation for the time required to complete the survey, participants will receive free Industry Survey Results.

Survey results offer a glimpse of industry averages, changes and trends over time, as well as the general state of the industry. Obviously this "glimpse" is only as accurate as the data entered by those in the profession, so we do ask that participants take the time necessary to provide accurate information.  We so appreciate those who have completed our industry surveys in the past.

If you complete the survey by May 31st, we will make sure you receive a free copy of the results.

Begin the Survey Now

Old Fashioned Values

It is almost 50 years since I sold my first business – a Four Square Store in Otahuhu – and I have been involved in nearly 7,000 business sales since.

Some things don’t change:

• Our Code of Ethics is still the same: “do unto others as you would have them do unto you”.
• Be honest with business appraisals – tell owners what they need to know, not what they want to hear. We don’t “buy” listings.
• People answer our phones – not press #1 or “your call is important”. To us your call really is important.
• Still believe “a man’s word is his bond” (or a woman’s) – but it is prudent to get a signature today.
• Stick to our knitting – we sell and value businesses – not commercial buildings, farms or houses.
• Our fees will be low and be fair – up to 50% lower than some firms – yet providing outstanding marketing and personal service.
• We welcome immigrants – they enrich our country, financially and culturally.
• Integrity is non-negotiable – we will not tolerate any unethical conduct in our team.
• Technology is great (crunching numbers, handling databases, fast communication) but it hasn’t increased productivity and profitability despite our large investment in computers, programmes, etc. People sell businesses.
• We say “NO!” to listing and selling businesses we think are “dodgy”.

Call me “old-fashioned”, but my name is on the company and we plan to be in business for many more years.

Hot Business List -- March 2011

Below you will find the current “hot” business list courtesy of data from Businesses For Sale (www.businessesforsale.com). We asked Businesses For Sale for a monthly ranking of business types based on the number of “hits” on their site. This ranking is not based on the actual sale of businesses.

We are simply trying to provide a glimpse at what buyers are looking at now. We felt that displaying businesses sold would reflect the past rather than the future.

Of the top ten listed below, eight are food and drink type businesses. I include C-Stores as they do sell food and drink. Keep this in mind, that today’s buyer, perhaps more than ever, is a first time-buyer and wants something he or she is comfortable and familiar with. Interestingly, looking at data from many years ago, the top sellers look very familiar.

E-Commerce is also right up there. This category obviously includes a lot of different type of businesses. Since I believe that main street business brokerage is still a numbers business (and I don’t mean necessarily financial numbers). The more fast food businesses the office has listed, the more they have to show a prospecting buyer. Buyers who want something in the easy food line might buy a bagel shop, a sandwich shop or similar business.

Businessesforsale.com is an English company and very good site to place your listings with. But, they break down their lists by country. So, the lists below are based on activity in the U.S.

More from Len Krick in the All-Important Stock vs Asset Issue

I delivered my 200,000 pages of documents plus 2,757 e-files by the deadline, last Friday, to the State of Nevada in response to their subpoena. I also decided to “kiss their ring” and amend my listing agreement on another deal I am doing right now (set to close this Friday or a week from today, to a consulting agreement. This will cost me $52,500 in foregone fee, but I can’t slap the State securities Division in the face right now with another stock sale, now that I am under investigation. I have included the amendment language below that we are doing  to satisfy the State (we hope), until a permanent solution can be found. Note that the State specifically DOES NOT recognize the November 2006 “CBI” No-Action Letter.

I am now soliciting all my friends with the following e-mail. If we can find commercial deals that converted to stock deals, then the State will have to take on the commercial real estate people as well. This would be good for business brokers. Here’s what I am sending out. Note that this is the message to my friends, so they already know who I am, etc.:

Len Krick's Proposal

by Len Krick

Gentlemen:

Obviously I am trying to figure out how to defend myself in the asset sale conversion cases I face. Notwithstanding attaining the ultimate goal of having the SEC address the issue formally through either an exemption or special license, or both, I have an idea to propose for your consideration:

Here are the points:

1. The SEC is asking for actual cases where business brokers were harmed, etc. Based on Mike and John’s e-mails, it appears that they believe that the CBI No-Action Letter should provide sufficient protection.

2. The SEC still believes that any deal where the Seller receives a promissory note, secured by the assets or stock of the business, also should require the Broker to have a securities license. If the SEC actually “ruled” on that, it would have a disastrous effect on the profession of business brokerage, and thousands of business owners would not be able to sell their businesses.

3. I have an action (MSI Case) that alleges, in U.S. District Court, that I am in violation with Nevada State Securities Law.

4. I also am under investigation by the Nevada State Securities Division for possible violation with Nevada State Securities Law. As a result of that investigation, the State is going to uncover at least 8-10 additional transactions that, for different reasons, ended up as a stock sale.

5. Both of these actions are based on “State” law, not Federal.

Records Subpoenaed -- Len Krick's Nightmare Continues

Comment from Tom West:
The issues between the state of Nevada and Len Krick continues. So far, as Len points out, the federal government has not become involved – yet.

So far, this civil case only claims I violated Nevada State Securities laws. It could very easily be expanded, though, to claim I violated Federal laws as well. We are sort of waiting for that shoe to drop.

At this point, the Nevada State Securities has only subpoenaed all my records (which I am reproducing right now); they have not yet indicted me. Obviously, we are hoping that they decide not to proceed. The question is, would I be willing to sign a “Consent Decree,” promising not to do any of these deals in the future? The answer is “How can I promise that when I didn’t create the problem in the first place and am powerless to prevent it in the future? But, my question to you is: Other than showing the SEC that state regulators are starting to deal with this problem on their own, what relevance does the subpoena have to the SEC?

Incidentally, producing confidential records for the State is an issue in and of itself.

IBBA Questionnaire

by Tom West

A recent email from the International Business Brokers Association (IBBA) had a short questionnaire on why deals fell apart. The results were as follows:

My comments:

Unreasonable Seller Expectations
When I initially saw the first reason listed for why deals fell apart, I thought it was a misprint: Sellers had unreasonable expectations? In fact, I was so concerned that I went back to the email and sure enough it was seller expectations.

Broker Licensing Options

by Jack R Sanders, CBA, CBI, CMEA, CM&AA

Today, Business Brokers/Intermediaries have a whole world of new options for legally securing commissions. In the past, most brokers have been licensed as Real Estate Salesman/Brokers in the state they were in or not licensed at all if their state did not require licensing or if there was no real estate involved. That would include a lease to be transferred to the buyer. The lease was a favorite way of requiring brokers to be licensed and to pay a DRE (Department of Real Estate) fee. The place where being properly licensed really becomes an issue is in court when you are trying to collect your fee. That is where the rubber really meets the road.

Not much attention was paid to the business being transferred if it became a stock transaction instead of an asset sale under the Uniform Commercial Code. Attorneys can handle stock transactions but may try to reduce your fee to justify theirs. With the advent of the new FINRA (FINANCIAL INDUSTRY REGULATORY AUTHORITY) Series 79 license there is now an option for handling stock, multi-state, partial interest, equity financing and a whole variety of other transactions we were prohibited from doing as business brokers. Also, currently underway with a big push from several organizations, is another type of license that would permit transactions similar to those described in the SEC CBI (Country Business, Inc) No-Action letter. It has been nicknamed a BrokerLite license and is still under negotiation. It would require limited background check and almost no testing. Opinions vary as to the success of this license being approved.

For the purposes of this discussion, I will limit further comments to the Series 79 license and what is required to obtain one.

Franchise Rules of Thumb -- R to Z

compiled by Tom West

View Franchise Rules of Thumb for franchises from Red Robin to Zoo Health Club.

View the complete Franchise Rules of Thumb list from A to Z on our web site.

More detailed franchise information can be found in our annual Business Reference Guide or on our continually updated online version of the guide -- BRG Online.
 

Franchise Rules of Thumb -- L to Q

compiled by Tom West

View Franchise Rules of Thumb for franchises from La Estancia to Quizno's Classic Subs.

Tomorrow's posting will complete the list of Franchise Rules of Thumb.

Franchise Rules of Thumb -- D to K

compiled by Tom West

View Franchise Rules of Thumb for franchises from Dairy Queen to Kuman Math & Reading Centers. 

More detailed franchise information can be found in our annual Business Reference Guide or on our continually updated online version of the guide -- BRG Online.

Franchise Rules of Thumb -- A to C

compiled by Tom West

View Franchise Rules of Thumb for franchises from AAMCO Transmission to Curves for Women. 

Have you had a franchise resale within the past 12 months?  You can share information about your franchise resale by completing the form at http://bbpinc.com/franchise-resale-form.aspx.

Franchise Rules of Thumb -- Introduction

compiled by Tom West

Throughout this week we will be posting a list of almost 200 franchises with a “quick” rule of thumb, or range, usually expressed as a percentage of sales. For many of the franchises, the information is based on quite a few actual sales; others may have been based on just a few; and in some cases just one where we felt it was appropriate. They can be a good starting point for pricing the business.

Many of the franchises are well known while others are very new with just several units. By the time this information gets published in our print guide, some of the franchises may have folded, sold or merged. We try to keep our information as up-to-date as possible. We could use your help. To contribute to our ever-growing list, just go to our online form, complete the requested information, and click "Save." Also, if you find that a franchise has disappeared or merged, etc, please let us know by emailing tom@bbpinc.com. Obviously the big changes such as Mail Boxes to UPS Store will be caught by us or by our researchers (hopefully).

Keep in mind that rules of thumb are just that. Every business is different and rules of thumb will never take the place of a business valuation or even an opinion of value. But, they will give you a quick ballpark idea of what the business might sell for everything else being equal. A rule of thumb will tell you whether a seller is in the ballpark when he or she tells you what they think their business is worth or what they want to sell it for.

Valuing Assets: Part 4

by George D. Abraham

DETERMINING CONDITIONS

It should be noted that in determining conditions, the appearance of the particular item is important. However, the equipment must be judged on mechanical and electrical working conditions and not just on appearance. Paint, lubrication, and general clean up should be part of general maintenance and should not be used to cover up defective equipment.

The physical condition, deterioration, depreciation or state of repair is a major factor in values. Loss of value due to curable or incurable depreciation is a consideration of market value.

Assuming the current owner paid for leasehold improvements and the local lease market is not providing spaces built to the tenant’s specifications, use the following schedules:

A. Long Lived Improvements (10 to 25 year life)
Walls, electrical wiring and plumbing can be valued at the original cost of installation with no deduction for depreciation. (Inflation rates will compensate for depreciation).

Valuing Assets: Part 3

by George D. Abraham

DEFINITIONS OF CONDITIONS

Care must be taken in assignments of condition ratings to accurately reflect the impact on value

EXCELLENT

New/near new or practically new mechanical condition, extremely low hours of use, no defects, and may still be under warranty.

VERY GOOD

Exceptionally good condition. May have just recently been completely overhauled or rebuilt with new or near new materials and/or has had such limited use that no repairs or worn part replacements are necessary. Very low hours of use.

GOOD

In complete 100% operating condition. No known or obvious mechanical defects but may have some minor worn parts that will need repair or replacement in the near future. May have high hours of use but no defects are obvious.

Valuing Assets: Part 2

by George D. Abraham

When discussing hard assets, there are various categories such as Furniture, Fixtures and Equipment, Vehicles or rolling stock, inventory (both for resale and parts for everyday repairs), Leasehold improvements, as well as Licenses, Patents and Trademarks. Each category of assets has to be analyzed individually and some research is required. Keep in mind that in addition to the fair market value of each item, you may have to arrive at a “Value in Use” of the equipment. “Value in Use” is defined as: “The value of an economic good to its owner/user is based on the production (privacies in income; utility or amenity form) of the economic good to a specific individual. This is a subjective value however, and may not necessarily represent market value.”

When valuing Furniture, Fixtures and Equipment, several things can happen when trying to research the values. For instance, you will usually encounter two scenarios that stand out when calling used equipment dealers, sometimes auctioneers (although you are mainly looking for fair market value, in some cases auction value is the market), and trade association magazine classified ads as well as the owners own estimate and owners of similar businesses; one is that everyone seems to know the value of the various pieces of equipment or that no one can give you a straight answer until they see the equipment and its condition.

You can adjust the equipment on the Balance Sheet by adding to or deducting from depreciation to reflect the fair market value of the assets. This gives you an economic adjustment that is based on fair market value rather than a taxed based value as set forth by IRS schedules that are usually only for tax purposes and probably do not reflect the true value of the equipment.

Valuing Assets: Part 1

by George D. Abraham

Most individuals involved in selling and or appraisal of complete companies usually underestimate the importance of the fair market value of the assets of the business. Many appraisers and intermediaries merely rely on “Book Value” or the owner’s best estimate and even an arbitrary discount or premium based on the type of asset involved. The theory of not really doing a value analysis on the assets is mainly derived by the assumption that the business is worth what the market will pay, or in other words its “Fair Market Value” and that the assets are merely the basis for producing the income stream. It is also a common philosophy that because goodwill is the difference between the assets and the company’s fair market value, that if you are slightly off on the value of the assets, the only factor influenced is that the company will show more or less intangible value, but the fair market value of the complete business is still the same.

If you look into the accepted approaches that are used to value businesses, several aspects begin to cloud the above scenario. For instance, appraisers do, and should use historical as well as projected financial analysis to normalize discretionary net profit. Correctly done, the cost of new equipment to handle future increases in revenues for the business in the projected years and a deduction for true (sometimes called economic depreciation or a capital reserve) depreciation for historical years to arrive at a true earnings picture of the company. If the costs of the assets are off, keep in mind that at a capitalization rate of 25%, every one thousand dollars of discretionary net profit can equal 4 times that amount when capitalizing the income, thereby having a drastic impact on the overall value of the company.

Another aspect that one must consider is that many of the calculations in the various approaches take into consideration the value of the assets. Those that are not directly impacted by methodology involving the assets are still derived from capitalization of the income stream, and as stated above can result in some drastic differences in value.

Why Don’t More Franchisors Disclose...? Part 2: The Options

by Ed Teixeira

Yesterday's blog post discussed Item 19 disclosures for franchisors including some of the benefits. Today's post will explore other options that enable a franchisor to provide important financial data to prospects.

The Options:

Under the amended FTC Rule franchisors can provide prospective franchisees operating cost estimates, such as for labor, ingredients and products, so long as this information is not presented as a percentage of gross revenues. If it is, then an Item 19 disclosure must be made. Additionally, a franchisor can provide the prospective franchisee with a price list for its product line. If the franchisor does provide prospective franchisees with cost and expense information, the information must be consistent with the information contained in Items 5, 6, and 7 of its FDD. Cost information in combination with additional FDD disclosures can enable a franchise candidate to construct financial projections.

In addition, a franchisor can make an Item 19 disclosure for revenue only. By providing revenue figures a prospective franchisee has a basis to develop a break even and cash flow projection.
Some franchisors list franchisee revenue without identifying the franchisee by name or location. This is a rather simple process that a franchisor can follow.

When a franchisor refuses to provide the most basic financial information to prospective franchisees, some consider this to be a red flag. It creates the perception of negative financial results from their franchise network.

Why Don’t More Franchisors Disclose Franchisee Results?

by Ed Teixeira

An Item 19 disclosure is an optional franchisor disclosure made in the Franchise Disclosure Document (“FDD”). It presents the financial performance of the franchisor affiliates, franchisees and company-owned units. It’s been reported that 25-40% of franchisors make a disclosure under Item 19. Based upon various discussions with industry experts I will err on the conservative side and say it’s probably around 30%.
 

There are numerous reasons why more franchisors don’t provide an Item 19 disclosure:

• Difficulty in obtaining consistent and credible data from the franchisees. The fear that some data is not accurate.
• Complexity of gathering, verifying and presenting the data especially on the part of large franchise systems.
• Disclosing financial data that can be viewed by competitors.
• Mixed financial results, whereby some franchisees perform poorly.
• Reluctance to project future financial performance to prospective franchisees.
• Impacting the due diligence process of prospective franchisees, whereby some could be swayed by the disclosure when making a decision to purchase the franchise.

I expect these reasons will continue to play a role in the decision not to make an Item 19 disclosure.

Franchisor benefits from an Item 19 disclosure:

• Can provide credible financial data to franchise prospects (providing it’s verified).
• Sets the franchisor apart from those franchisors that fail to make this disclosure.
• Can accelerate the franchise prospects due diligence process.
• Forces the franchisor to gather franchisee financial results and thus better monitor the network.
• Can boost the sale of new franchises.
• Can be used by the franchise prospect to conduct a more thorough financial analysis.

Disclosing Initial Franchise Fees

by Jeff Fabian

Item 5 – Initial Fees

Item 5 is where franchisors must disclose their “Initial Franchise Fee” and certain other related information. If the franchisor offers different “levels” or “packages”, each of the alternative initial fees has to be disclosed. If the amount of the Initial Franchise Fee is tied to the size of a franchisee’s territory, this must be disclosed as well. Any required pre-opening purchases from the franchisor or its affiliates must also be disclosed in Item 5.
 

Information that franchisors must disclose in Item 5 includes:

• The amount, range or formula for calculating the Initial Franchise Fee
• Whether any “application fees” will be credited toward the Initial Franchise Fee
• Whether full or partial refunds are available (for example, if the franchisee is unable to lease a suitable location within a specified time period)
• Whether the franchisor offers an installment plan (though the franchisor may opt to disclose this in Item 10)

If a franchisor does not offer refunds or installment terms (which is not unusual), it should include a “negative disclosure” to this effect in Item 5 (i.e. “We do not offer full or partial refunds under any circumstances.”).

Item 6 – Other Fees

Franchisors must disclose all fees and other amounts to be paid to the franchisor or its affiliates after the franchisee opens for business in Item 6.

Fees and other payments commonly charged by franchisors include:

The Legal Nightmare Continues...

Fellow Intermediaries and Brokers:

More good news… The State of Nevada may bring a criminal indictment against me in this case.

I have decided to retain the additional attorney who was the State’s first Administrator of the Nevada Securities Division when it was developed to be a real division in the mid-80s. He is considered to be the Nevada Division of Securities “expert.” My regular attorney and I are meeting with him tonight.

Can you spell N I G H T M A R E ?

Len Krick, MBA, SBA, CMEA
Certified Business Intermediary
Merger and Acquisition Master Intermediary

Fellow Intermediaries and Brokers

by Len Krick

First I would like to thank all of you who sent me so many great expressions of sympathy and support.  It’s nice to know that I am not alone out there.  I appreciate that you have “circled the wagons.”
 
Secondly, I can tell you that our efforts, to-date, to get the original claims in the civil suit dismissed have not succeeded, so the legal actions are still on track.  As you can imagine, I am spending a lot of time and more money than I have to defend myself.  No more racing for Len in the foreseeable future, that’s for sure.  I now work to pay legal bills.  It seems ironic since I present a workshop for the IBBA called “Minimizing Business Broker Liability:  An Ounce of Prevention…”
 
Thirdly, yesterday I received the attached subpoena from the State of Nevada alleging violations of state securities law.  While this was, no doubt, prompted by the original case where I was named a third-party defendant in a civil suit, this is much broader.  As you will see, they are asking me to produce all my records since January 2006. Those records will include several deals, in addition to the original transaction, where the listing was for the sale of the business’s assets, but the parties decided, sometimes at the last minute based on tax considerations or continuity of existing contracts, to morph the deal into a stock sale.  So, the State will have evidence of numerous potential “violations” through the years. Each one is identical to the original one:  

From the Desk of Tom West: SEC Suit

by Tom West

The letter to members of the M&A Source from Len Krick (see previous blog entry) should be read by all business brokers. We don’t know how far this will go and more importantly, what the ramifications will be. The unfortunate part of this is that Len is one of the good guys. He is a leader in the profession, always willing to share, works hard, has been very successful, does nothing wrong,...and look what happens.

If this case didn’t have so much importance in the workings of our business, we could say, "Well, these things happen." Of course, in this case, Len had nothing to do with what happened over the past five years. The deal closed that long ago. But, because of the asset sale changing to a stock sale, Len is in the middle. He had no decision in the change and informed all of the parties of the situation and his concern. They went ahead and paid him, and now, due apparently to the poor decision-making of the new owner (the buyer’s son-in-law), the seller, Len, and Len's firm have been sued.

Hopefully this case will die a quick death and court will see what actually happened and dismiss it. But, as Len points out, if it goes further, we may all pay the price.

Dear Fellow M&A Source Members:

by Len Krick 

As most of you know, I have a dual “Main Street” and “M&A” practice in Las Vegas. I try to do things by the books, minimize my exposure to liability, and document everything I do. I have also been involved in the effort to have the SEC address licensing requirements for business brokers for a long time. Back in 2005, when all we had was the IBEC letter, I drafted a document, entitled “Stock Sale Acknowledgment, Notification, and Disclaimer,” to disclose the fact that I didn’t have an SEC license and didn’t intend to structure a deal as a stock sale. This document was based on the IBEC No-Action letter (1986) and I did the things it said I should do, and didn’t do the things it said I shouldn't do; I performed in accordance with the IBEC letter. In every deal I was involved in, which morphed into a stock sale, I obtained the signatures of both the buyer and seller. I never had a party refuse to sign it.

Subsequently, as soon as the CBI No-Action letter came out in the Fall of 2008, I updated the document to reflect the CBI letter “clarified” points. Shane Hansen, the attorney for the Task Force, has reviewed this agreement. Most of you know that I freely give it to anyone who requests an electronic copy; I have a sample in the workshop handout materials for my IBBA workshop “Minimizing Broker Liability.” Countless numbers of business brokers and intermediaries now use this agreement as a band-aid, when an ordinary asset sale turns into a stock sale. However, the SEC laws are still in force and a “no-action” letter is merely SEC staff’s opinion on that specific case.

It’s really no big deal to get a series 7 or 62/63 license; that’s not the point. I took two companies public on NASDAQ and was president of one of them; I simply do not want to get involved in anything that requires more SEC reporting. So, I choose not to get licensed. If I did big deals all the time and they tended to start out or morph into stock sales, maybe it would make sense.

Three weeks ago something occurred that I thought you might want to know about because it might be used as a legal precedent regardless of which “side” wins. If I prevail, then that will be good for all of us. If I lose, I believe that it will be really bad for all of us. That assumes that I am not the only one in the world who was forced to conclude a transaction as a stock sale, unintentionally.

Here’s a quick overview:

62 Reasons for Sellers Hiring Brokers

by Ted J. Leverette

Do you have a response ready for sellers hesitant to use a business broker?  Arm yourself with numerous reasons why using a business broker benefits the seller.

1. Access broker or advisor’s database of potential buyers and investors
2. Advertising run and paid by broker
3. Affiliated brokerage or advisory offices may attract more buyers
4. Assistance during escrow closing
5. Background check on potential buyers run by broker or advisor
6. Broker or advisor can confer with seller, legal and tax counsel about terms of sale
7. Broker or advisor understands and can depersonalize negotiations
8. Brokers and advisors enable buyers and sellers to access a broader pool of potential partners
9. Brokers and advisors have broader third-party prospective from done deals and failed deals
10. Brokers and some advisors know how to sell businesses; most sellers don’t

BizBen’s Busineses Sold in California

from BizBen.com

This list from BizBen.com of small and mid-sized businesses sold in Caliofornia presents a real picture of how the economy influenced the sale of businesses.  See the startling contrast from 2007 to 2010.