Last time, I suggested that you mystery shop the store you want to buy before formally meeting with the seller, and interview key people from the Home Office, the Master Franchisee, and other franchisees in the territory to help you determine the true condition of the store for sale.

Now, you are ready to move on to the next stage of the due diligence process.

5. Examine the Lease Carefully

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One of the most important assets you gain when buying an existing franchise is the current lease agreement. You are purchasing the sum total of all the business assets and goodwill that was built over time in that specific location. You need to make sure that you can continue operating in that location uninterrupted to justify the multiple you are paying to buy the store.

Read the contract very carefully to make sure there are no restrictions on your ability to assume the lease under the exact same terms currently enjoyed by the seller.

Verify the number of years remaining in the life of the lease. Keep in mind that if there are only a few years left on the lease, there’s a serious risk that the landlord may raise the rent significantly upon renewal. Remember that there is no such thing as rent control when it comes to commercial leases.

It’s possible that the seller was able to negotiate more favorable terms when the rental agreement was first signed (for example, if it was signed at the height of the recession). You need to consider the possibility that these terms may change upon renewal.

If the current lease has an option to renew, check if the rent amount (and subsequent increases) during the new term is still subject to negotiations, or if the rent amount is fixed. Of course, you would prefer the certainty of a fixed amount upon renewal.

5. Ask the Home Office about Recent Sales Nationally and Within the Territory

To assess whether the asking price is reasonable, you need to know the multiple used in recent transactions across the country and particularly, within your territory. Were the selling price based on a multiple of sales, multiple of owner’s cash flow, or some other basis — and in any case, what specific multiples or basis were used?

Determining the right selling price is obviously not an exact science. It’s simply what the buyer and seller ultimately agree upon as the fair price. Each store has its own unique strengths and weaknesses so it’s not realistic to simply follow a fixed formula or multiple. But you need to have a baseline to serve as the starting point of your negotiations.

To be continued…