Chapter 14: Investigating Franchising -Reading Between the Lines and Listening

Learning Objectives:1. Understand franchising’s impact

on the economy, employment, and our daily lives

2. Explore franchising as an alternative doorway into business ownership

3. Gain an overview of how the franchise system works

4. Evaluate the pros and cons of being a franchisee

5. Review what the franchisor and franchisee receives

6. Develop techniques for examining franchises and performing due diligence

7. Understand the purchasing process

8. Learn how to evaluate the franchise disclosure document

9. Understand risk – reward factors in buying into a “ground floor” opportunity or an established franchise for sale

10. Review and recognize why franchising may be the right doorway for some and absolutely the wrong doorway for others

11. Recognize the advantages of owning multiple locations and explore the opportunities to enter the franchise market with smaller locations

12. Realize why the true entrepreneur is always the franchisor.

13. Explore multilevel marketing

Franchising’s Reach

Franchising is big and includes many industries More than 3,000 franchisors in the US Over 300 lines of businesses and 750,000 franchisees Over 200 new firms offered franchises during the

past year Almost $800 billion of economic output in 2012 Half of franchise employment is in restaurants

Proceed with caution Less than 20% of franchisers last 20 years 25% of 200 new franchise systems established each

year fail Ask yourself if it the right fit for you

Franchising Information & Courses

Start your research with the SBA’s “Consumer Guide to Buying a Franchise”

IFA’s Franchising Basics Course: How franchising works and questions to ask Laws and regulations & Pros and cons Companies & types of businesses available Additional resources & information

AAFD “Roadmap to Selecting a Franchise” Contact your local SBA/SCORE for formal

workshops

Action Step 57: Explore Franchising on the Web

Take an online franchising quiz at FranchiseHELP What are your results? Do you agree or disagree?

Jump start your search with other sources Check out articles on what interests you

Which franchises are hot? Which ones are growing the fastest? Where are the happy and profitable franchises? Do not get lost – keep a list of goods ideas

Find a few franchises you are interested in and explore additional resources

What did you learn? What surprised you?

Exploring the Third Doorway

Determine if you are franchisee material You are buying a business and a lifestyle Review your financial goals Do not invest more than 25 – 50% of your net worth Franchising Basics:

Start with answers to frequently asked questions Acquire some of the specialized vocabulary Check out the FTC’s website for unbiased information Franchising is a very litigious business Attend a franchise exposition

Global Village: A Franchise Overseas?

Action Step 58: Franchise Information Packet

Request info from franchisors that fit your needs Some packets are available online Some franchisors prequalify potential buyers

before sending packets Study your desired franchise and their main

competitors Summarize what you have learned

Focus on the need for the product & its uniqueness

What are the advantages of the franchise format? Beware of fads – look forward 5 to 10 years

Start to formulate questions

Action Step 59: Visit a Franchise Exposition

Look online for expos in your area Go to the expo and talk with exhibitors Learn what you can from sales presentations Attend free workshops Collect literature and select franchises worth a

second look Usually small and new franchisors exhibit at

shows Salespeople work on commission – do not be

persuaded; you are not yet ready to buy

Beware of Scams as You Begin Your Search

The Rented Rolls-Royce Syndrome The Hustle The Cash-Only Transaction The Boast The Big-Money Claim The Couch Potato’s Dream Location, Location, Location The Disclosure Dance The Registration Ruse The Thinly Capitalized Franchisor

1. .

What the Franchisee May Receive

Brand-name recognition & Brand-loyal customers Support, Training, Money, Planning & Bargains Psychological handholding & field visits Assistance in site selection & layout and design Standardized & pretested products Promotional materials, Operations manuals & Software Area or master franchises & Territory protection Assistance of a store-opening specialist Sales and marketing assistance & Advertising

Ranges from $3,000 to well over $1.5 million Usually covers 5-10 and up to 20 years

Royalty fees Average fees are 3-6% of gross sales

Advertising & Promotion fees Payable even if you are not profitable 2-5% of gross sales

May profit on items sold to franchisees May make additional income from training materials, computer systems & fees for training classes

.

What the Franchisor Receives Initial nonrefundable franchise fee

Ranges from $3,000 to well over $1.5 million Usually covers 5-10 and up to 20 years

Royalty fees Average fees are 3-6% of gross sales

Advertising & Promotion fees Payable even if you are not profitable 2-5% of gross sales

May profit on items sold to franchisees May make additional income from training

materials, computer systems & fees for training classes

Additional Franchise Issues & Concerns

Intense competition & oversaturated markets that cause encroachment

Multilevel distributorships & pyramid sales schemes Best opportunities are seldom offered to outsiders Termination clauses may be ambiguous May be many disgruntled or unprofitable franchisees Litigation should be looked at closely Brokers have the franchisor’s best interest in the

forefront Legal recourse against the franchisor may be difficult Royalties are based on gross sales, not net profits –

franchisor imposed specials can be financially challenging

Additional Franchise Issues and Concerns

Franchisor may discourage association among franchisees

Non-compete clauses may be part of your contract In most states franchisees must go to the

government if the franchisor violates FTC rules Beware of “ground floor” opportunities – it is risky to

be an early franchisee Many services and product to not transfer easily to

other parts of the country Voluntary chains may be more desirable as there are

no royalty or franchise fees Management and owners should be thoroughly

investigated

Action Step 60: Investigate Franchisors and Franchisees

Franchisors – interview at leastthree: What is included in the franchise

fee? Terms of the agreement? Top performers vs. lower

performers? Failing franchisees?

Long-term goals and plans? Social media? Training &

services? Royalty fees & assessments? Terminated franchisees?

Territories? Turnover rate? Major changes? Advertising & Promotion? Skills needs? Opportunities to

own multiple franchises?

Franchisees – as many as possible and a variety of types:What do you wish you had known before you purchased? Major problems? Happy with support & training? Helpfulness of franchisor? What would you change if you could?Territory issues? Strongest competitors? Employees? Turnover? How many hours a week do you work – first year and now?What does it take to be successful?Start-up costs? Time to profitability?Is income what you anticipated?Would you do it again?

Process Involved in Purchasinga Franchise

Complete your Due Diligence Try to read between the lines Ask questions Work with the franchisor to find the

best spot Get the advice of your accountant,

attorney, other franchisees & banker Negotiate to complete the sale

Action Step 61: Summarize Your Insights & Research

What do you like about franchising? What do you dislike about franchising? What additional information do you need? Which franchise if for you? Why? Can you make the money you desire from one

franchise? If not, could multiple locations provide it?

What will you like most & least about owning this franchise?

Can you raise the funds you need? Will you like running the business? Are you still in

love with the idea of being your own boss?

Action Step 61: Summarize Your Insights & Research

Where do you see this franchisor in five years? Where do you see yourself and this franchise

in five years? Will you be able to easily sell this business? Which franchise if for you? Why? Will you be able to hire a manager if desired? Can you grow in this business? How responsive has the franchisor been to

changes in the marketplace? Are you creating wealth or just replacing your

job? What questions still remain?

Buying An Existing Franchise or Buying into a New One

Existing Franchise Likely a new agreement – approval may be required Expect a transfer & possible training fees Upgrades may be required – find out in advance Shorter time to full operations and no opening

expenses Positive cash flow could come much sooner Existing employees may be a positive or a negative

Buying into a New Franchise Consider a system less than two years old very

carefully Return on investment may be longer Training and support may not be effective or in place

The Other Side of Franchising: Reasons for Not Purchasing

1. I know the business as well as they do2. My name is as well known as theirs3. Why pay a franchise fee?4. Why pay a royalty fee and advertising fee?5. My individuality would be stifled6. I don’t want others to tell how to run my

business7. I don’t want a ground-floor opportunity

were I’d be the guinea pig8. It felt like I would have been committed for

the rest of my life

The Other Side of Franchising: Reasons for Not Purchasing

9. There were restrictions on selling out10. If I didn’t do as I was told, I would lose my

franchise11. The specified hours of business did not

suit my location or desires12. The franchisor’s promotions and products

did not fit my customers’ needs or tastes13. I don’t want a ground-floor opportunity

were I’d be the guinea pig14. I would not be in control of my business

Can You Franchise Your Idea and Become the Franchisor?

The odds do not favor success Fewer than 1% of franchise ideas get off the

ground Ask yourself these questions:

Can someone learn to operate your business in three months or less?

How profitable are you? To attract high-quality franchisees need to generate $500,000 in annual revenues and at least 15% income to owner

Not all ideas are transferable to other locations Former Marine and Army Reservist Change Path

Home Instead Senior Care

Franchising Trends and Final Franchising Thoughts

The best opportunity may be a young franchise that has proven its concept

Does the franchisor change & update the product to meet the changing marketplace?

Explore the possibility of an area franchise Consider multiple franchises under one roof Major legal changes may be forthcoming Another alternative may be network

marketing

Network Marketers: Pros or Cons?

Several successful companies exist but Internet growth has led to an increase in pyramid schemes

Low entry cost encourages scam artists: Make sure there is a solid product or service Confirm that commissions are supported by sales Don’t pay more than $500 in initial buy-in costs Beware of high earnings claims Don’t participate unless the company is willing to

buy back inventory Find out if the marketer has a DSA number & how

long the company has been in business Do your due diligence

Think Points for Success

Avoid ground-floor opportunities. Talk to franchisees, especially those who have left the system. Franchisees may receive a finder’s fee and not be totally honest. You are purchasing a job, and you have to do it their way, not

yours. The franchisor always gets a percentage of gross sales. Consider if you really need the security blanket of a franchise. Read the proposed agreements carefully. They are air-tight, favor

the franchisor, and are usually nonnegotiable. Can you be comfortable relinquishing your independence? If you like to break rules, be creative, and stretch things to the

limit, do not buy a franchise – you will very likely end up in court.