Consider this scenario: A small dealer isn’t looking to expand its business when an opportunity arises. A well-known-brand franchise in the area is up for sale. The franchise’s owner is losing money but the small dealer’s owners think they could turn the dealership around. New car sales are strong and financing is currently attractive. Should this motivated entrepreneur buy the business?

What Manufacturers Might Require

When considering a second franchise, you’ll want to take a close look at what the manufacturer will require. Is your existing manufacturer offering the second franchise? If so, it might allow you to stay in the same facility but require you to build a separate showroom or segregate your showroom area for the two brands.

Some dealerships are able to solve the dual franchise problem by hiring a receptionist to direct customers to separate showrooms as well as separate customer waiting and service areas.

If your manufacturer thinks you lack sufficient space, it may require you to open a second facility. It also might require you to dedicate one or more salespeople to the additional franchise and may try to make changes to your current sales and service agreements that you might not agree with.

If the second franchise represents a different manufacturer, the plot will thicken. The second manufacturer — or your existing factory — may have a long list of requirements that necessitate opening a new facility and running the new franchise separately.

Purchasing a second franchise is one of the biggest moves a dealer can make. Here are six steps to take in the decision-making process.

1. Choose the Right Franchise

Is the brand you’re eyeing likely to sell in your market? Just because you’ve always liked, say, Lincolns — and several of your customers have expressed interest — doesn’t mean they’ll sell well for you. Base your decision on solid data, not on instinct.

Consider whether the franchise is high-quality, is on the rise and matches up with your area’s demographics.

The manufacturer can provide sales projections and even assist in (and possibly pay for) market research. Don’t stop there: Seek hard data, including the failure rate, from objective third parties. Some financial analysts, for example, track auto manufacturer franchises, and your Dealer 20 Group may have additional information.

2. Determine if the Price is Right

The price of the franchise will probably be the deal maker or the deal breaker. As you evaluate the price, you’ll need to account for your short- and longer-term costs, including:

• Altering or expanding your store, or building a new facility (see the right-hand box for some possible requirements from the manufacturer).
• Adding to your sales force and back-end staff, and
• Training staff on the new brand and manufacturer’s procedures.

One word of warning: A new franchise normally will operate under working capital constraints. Be sure that you won’t be strapped with too much debt service as a result of overspending.

Additionally, what is being purchased matters — that is, assets or stock. Asset-based purchases are more common for dealerships, but corporate stock purchases still exist. Future federal tax expense becomes a crucial consideration when determining how the deal is structured. An asset sale can favor the purchaser because costs can be recaptured more quickly through depreciation.

But the seller may prefer a stock sale because the tax paid on the gain often is levied at a lower rate. That means the seller may be willing to accept a lower price for a stock deal than for an asset-based transaction. For the buyer, a lower price might make up for missing out on the depreciation advantages of an asset sale — but the buyer also needs to be concerned about future unknown liabilities that could arise with a stock purchase.

Consult with your tax adviser about your situation so the best tax results are achieved.

3. Project Profitability Carefully

You should be able to find out the current franchise owner’s record of profits — or losses — fairly easily. But bring your financial adviser into the analysis to help identify any hidden losses or exaggerated profits. Annual losses, however, aren’t as much of a yardstick as you’d think, because the business is likely to be run very differently under your ownership.

What is extremely important when calculating profitability is the franchise’s purchase price and the value of its goodwill and potential sales volume. Is there enough opportunity for change in the business’s operations to achieve the profitability you’re projecting?

4. Assess the Impact on Your Franchise

If the second franchise is a standalone business, its profits and losses will be calculated separately from those of your first franchise. But if you’re putting both franchises together in the same corporate structure, you’ll need to assess whether the newcomer franchise will add value and profitability to your existing business.

Or will the second franchise rob your first franchise of sales? Be sure to estimate the retail impact of this “in-house” competitor carefully.

5. Weigh in on Staffing

You’ll likely have to hire additional staff for your new franchise operation. An exception: If you’re housing both franchises under one roof and can dedicate one or more salespeople from your current staff to the new endeavor. But you’ll still need to consider how the new line of business will stretch your management team, your back office and every other part of your operations.

6. Bring in an Expert

Your CPA can be a crucial peg in your decision to add a franchise. He or she can assist in:

• Determining whether the franchise price is fair;
• Performing due diligence to authenticate that what you’ll receive is what’s being represented; and
• Conducting a sound business evaluation of all the factors mentioned above to determine whether the second franchise is a good idea or a bad one.

Last but not least, your CPA can assist in the submission of paperwork to the manufacturer for the approval of the sales and service agreement.

Opportunities and risks: Adding a second franchise is a way for capable entrepreneurs to take advantage of market opportunities and expand their businesses. But a second franchise carries just as much risk as any other investment, and you need a proven business strategy to make it all work.