Buying a business is a nerve-wracking process. I know – I have done it myself (or, rather, I have bought a share in a business) and I have assisted many people with the purchase of a business, be it a franchise or a non-franchise business. The one common factor is that there is never any certainty as to how a business will perform.

And for most people, if the purchase of a business goes wrong it is disastrous, because of the amount of money involved. If you buy a pair of shoes or some clothes that don’t fit, you can always replace them. If you buy a business that doesn’t fit or doesn’t work there is probably going to be a significant impact on you, your family and your finances.

It follows therefore that it is of the utmost importance that proper due diligence is carried out before deciding to purchase a business. The time, effort and money spent on performing proper due diligence is always worth it.

So, having established that buying a business is a nerve-wracking process, the degree of anxiety is far greater if you are going to buy a brand new or greenfield franchise. The purchase of a greenfield franchise is fraught with more difficulty than the purchase of an existing franchise.

Lack of financial data

A greenfield site is a new site or territory rather than an existing franchise. Once there was not a franchise on the site or in the territory (it was a ‘green field’) and now there is.

The most obvious difficulty in purchasing such a franchise is the lack of financial data. When you purchase a business that is already trading from a franchisee, or when you purchase an existing site or territory from a franchisor, you have historical financial data for that location. It is of course true that when you purchase the site or territory the future performance of the franchise might be very different to the past performance. This could be because of changes in economic conditions, product mix, operator and many other reasons. But at least you have a starting point when you buy an existing business.

The biggest unknown when purchasing a franchise business – greenfield or not – is usually the sales. If you know what your sales are going to be, then it can be relatively easy to put together an expense budget.

Items such as cost of sales, franchise royalties, marketing levies and often even wages, can be fairly readily determined if sales are known. They all vary to some extent with sales and some can be calculated as a percentage of sales. Some costs such as rent are likely to be fixed irrespective of what the sales are.

So if sales are known, the rest of the budget is easier (but not necessarily easy) to prepare. This article focuses only on sales and not on expenses

Tips for sales predictions

So how do you determine sales for a greenfield franchise?

The franchisor may provide some estimates as to likely sales. The franchisor does not have to do this, but if it does, it is likely that you will be provided with a range of possible sales. You should make enquiries of the franchisor as to how its sales figures were determined. Increasingly today franchisors use sophisticated techniques to help them make decisions about site selection and territory planning. Often this includes financial modelling and detailed demographic analysis. Make enquiries and find out what work your potential franchisor has done in determining your site or territory. It may provide useful guidance to you to in predicting your sales.

If the franchise system you are buying into has many existing franchisees but your proposed business is a greenfield, then you should find out which other franchises in the system are most similar to yours. When you have identified similar franchises, try to obtain financial information – and particularly sales information – for those businesses. The source of your information could be the existing franchisees or could be the franchisor. Whatever your source, great care needs to be taken in identifying similar franchises within the franchise system; factors such as demographics, population density or location can mean that two franchises that on the surface appear very similar are in fact very different.

If the franchise system you are investing in is relatively new and does not have many franchises, or many franchises similar to yours, look at other franchise systems that operate in the same industry. For instance, if you are the early purchaser in a new bakery franchise, there are existing bakery franchisors to turn to. If you are the early purchaser of a new franchise in the printing sector, there are comparable existing businesses.

Do some homework. Try to establish which franchises in those other systems are similar and then try to obtain financial information, and particularly sales information, for those franchises.

Benchmark data

Finally, if there is there is no data available for franchises in the particular industry, there will be data available for non-franchised business in that industry. Various bodies produce business benchmarks for a wide range of industries  – from A for accountants to V for video libraries –  and almost certainly for the industry in which the franchise system you wish to buy into operates.

Clearly the reliability of the information you obtain will vary in inverse proportion to how closely it relates to the franchise you are buying. As a buyer of an existing franchise, you will find the historical data for that franchise is a great starting point. If you are buying the first franchise in a new system in an industry in which no franchises operate, the data you get may bear little relation to how your franchise will perform.

The reliability and accuracy of the data you obtain affects the risk, and accordingly the reliability and accuracy of the data should be taken into account when deciding whether to purchase the green field franchise, and if so, how much to pay.