5 Things You Must Know Before Buying a Franchise
“Retired” too early, RIFfed, laid off, sick of your job or just ready for something new? Maybe you’re just ready for a transition in your career and you’re convinced you have the business savvy, education and have even managed to save up some money…Now What? It must be time to chase the American dream and go into business for yourself.
Buying a franchise can be a much safer investment than starting your own business. In theory franchises offer business systems proven out over time with strong leadership, great economic models, well financed R&D and experienced support teams…in theory. How can you be sure?
For many people, buying a franchise could be one of the largest financial commitments in their entire lives and it will be a very emotional experience. Friends will say they read something bad about what you plan to do on the internet. Spouses will doubt you. You will doubt you! A little self-doubt can be motivating. You need to ask yourself, “What evidence do I have that I can’t do this?” Then ask yourself, “What evidence do I have that I can do this?” Doubt is just a lack of information. So how do you find a great franchise and get the information you need to overcome the doubt?
Most people pull out their darts and throw them into the franchise cyberspace hoping to hit that great franchise bulls eye; this looks good, that looks good, Oh, how about this one, my friend told me this one was good, never really having any idea if those franchises are really what they are looking for.
The internet will offer some good marketing pieces and flashy sales literature for sure, even some carefully worded FAQs. All of that will certainly work as a decent brand introduction. But then it’s just like when buying a new home, would you ever buy a new home just looking at the sales literature without ever going inside the front door? Of course not! Looks good on the outside, as do many franchise systems, but what about the foundation, the utilities, the roof, the schools or the neighbors? You’ve got to get more information.
You may hire an independent home inspection company, a pool management company, a landscape architect, have a chat with the neighbors and even hire an appraiser all in an effort to learn as much as possible before spending your hard earned money. So why wouldn’t you do the same research on a franchise you are thinking about buying?
I typically tell all of my clients that until they can answer 5 critical questions about a franchise system, they will not have enough information to make a decision. The 5 questions are:
- Do the unit level economic model proven?
- Does the franchisor offer a strong value proposition in exchange for the fees they charge?
- Does the industry have broad appeal…trendy?
- What are people saying about the brand?
- Are you a culture fit for the system?
Many of my clients say, “I just want to do some independent research” before I schedule a live call. This is probably one of the most destructive and self-defeating things you can do if you are serious about finding a great franchise.
The franchisor is not in business to deceive or “sell” the franchisee prospect. The franchisor is in business to successfully and quickly grow their brand. Trust them. If they are not trustworthy it will show soon and it will be evident over the course of discovery and validation.
The answers to these simple questions can all be found but you are going to have to open many doors to find them. Read closely, here is the golden nugget in this post…The information you need to make an informed and educated decision on a franchise will not be found online on a public access web site! Believe me on this one!
So where are the answers?
Of course some online research is necessary…but don’t believe it all. Many of the answers can be found in the Franchise Disclosure Document…if you can get one and know how to read it. They can be found in determined validation with the existing franchisee base…if you can get their contact information and know which questions to ask. And can be found by meeting with the franchise leadership and support teams…if you can get an invitation to the corporate office.
Let’s review each question:
1. Do the unit level economics work?
This is usually the first question every prospect asks…what’s in it for me? What are the chances that my investment will make me money?
Every franchise must have a federally required Franchise Disclosure Document (FDD). But of all the information that is required to be in this document by the Federal Trade Commission, a financial proforma or financial modeling information is NOT required. Unfortunately that is true. And if the FDD does not contain that information, then, anyone from the corporate office involved in selling the franchise cannot provide the information even if they have it! So where is it found? By talking with the existing franchisees! The FDD must contain the contact information for every current franchisee and the contact information for all franchisees that have left the system over the past 12 months.
The franchisees are not legally restricted from divulging any information they are comfortable sharing. Ask questions! Every franchisee will have a different story, but if you speak to enough of them, the true story will emerge.
Great systems will have strong financial models with greater than a 1:1 ratio of first year sales to development costs, the ability to net a good six figure income, and the ability to repay your initial cash investment quickly.
2. Does the franchisor offer a strong value proposition in exchange for the fees they charge?
Here is where a franchise system will succeed or fail and where the great franchisors set themselves apart from the pretenders. This is where the royalties and fees are earned!
Every franchise will charge a royalty fee and many have additional “brand development” or “national marketing fund” fees.
Royalty fees will typically run from 4-7% of gross sales. A few are less and some are more mostly it depends on the industry. But the support package that is offered is the great differentiator among franchise systems and where the franchise system builds its value. The good ones earn their fees.
Brand Development or National Marketing Fund fees typically run 1 or 2% of gross sales and can only be used for marketing programs that can affect all franchisees equally. This piece is essential and should be charged. This is a bonus for the system and like a high tide raises all ships it will help all units in the system grow. If it is not being charged, ask why and when they plan to implement it. It is some of the best money spent!
Where will the answers be found…in validation calls with existing franchisees and in visiting the corporate office. Call the franchisees and be diligent in your efforts. Remember, the franchisees are busy people. Be well prepared in your questioning and respect their time. They will be your best resource for accurate information.
Visit the corporate office, ask questions and take notice of the scenery. The strong franchise systems are resourced ahead of the curve. They have the technical and human resources in place and are prepared for growth. Strong franchise systems should offer support virtually from the first introductory call through opening and throughout the term of the franchise agreement. Make sure the people and tools are in place.
To earn their royalty fees great franchise systems will offer site selection criteria and assistance, lease negotiation assistance, design assistance, preferred vendor arrangements for cost containment, IT systems for payroll, accounting, data management and security. They will also have tried and proven marketing programs, web sites and operational and administrative support. This is the backbone of the “system”; if these are not in place the system will not be able to support the franchisee.
3. Does the industry have broad appeal…is it trendy?
We all remember the growth and crash of the “froyo” craze; Frozen Yogurt. The early adopters did quite well and then the competition grew in location and brand, diluted each market and now it’s hard to find one still open.
Make sure the industry is based on solid, historical data. How long has it been around? Is this just a new variation on an old theme? This will take some research and some intuition…being trendy won’t last but solid industries will evolve and grow. What are people saying about the brand?
With social marketing these days, this research is easy. Go to the Facebook page of the brand; see if they have a LinkedIn profile, Twitter feed, Yelp reviews. But remember, most people will only comment on social media if the experience was less than expected. Expect some negative but look for the positive. Great brands will show it.
4. Are you a culture fit for the system?
This is the hardest question to answer, but possibly the most important.
Franchise agreements typically run from 7-10 years. They are very difficult to get out of and even if you can, you can bet it will cost thousands if not hundreds of thousands of dollars to terminate the agreement. This I can GUARANTEE, at some point in the term of the agreement you will have a conflict with your franchisor…GUARANTEED. You need to have a good feeling for how the franchisor will handle the conflict.
There will be hints to this:
- How does the franchisor handle “negotiation” on the franchise agreement?
- Are you even allowed to “negotiate”?
- How many terminations in the system (some are expected and even good) and is there litigation connected with the terminations?
- What type of communication style does the corporate office have with the franchisees?
- What is the cultural feel in the corporate office?
- How do the franchisees feel about the corporate office?
Another indicator of culture is in how the employees interact in the corporate office, the “musak” in the background, the branding on the walls and the overall feel of the atmosphere. How the franchisor manages their office is a great indicator of how they will manage the system.
These questions must be answered before the franchise agreement is signed.
A franchise agreement is not to be entered into flippantly or without a thorough understanding of the agreement and the franchisor.
Just like a real estate agent can open the front door on a new home and show you around, the franchisor should open the door to completing and facilitating the proper due diligence in researching their franchise system.
Many franchises look the same from the outside and even in some of the services and products they offer. Successful businesses will always be imitated. The real difference between franchise systems may not be seen from the outside, it is in their commitment to the franchisee’s success. If the franchise system has the necessary components in place and is well resourced, most likely the franchisees are happy and successful. If you are searching for a franchise, it is imperative that you do the research necessary to answer those 5 critical questions and validate the system.