Putting The Franchisor Under The Microscope Lloyd Shears Most of us would like to own our own business. We talk about, think about, and dream about it. And for most, this is as far as the dream ever goes. Despite all our best intentions and desires, most of us will never own our own business. WHY? There are a number of reasons. Let's begin with money and courage, as we need both to go into business. Money and courage are inversely proportional to each other. I have yet to meet anyone without money who did not have incredible courage. In fact, if we have nothing to lose taking a chance is easy. This changes however, when we have something to lose. When we have equity in a home, a pension fund, or savings. The courage to invest is frequently defeated by the fear of losing. For most the decision to invest, is governed by what we could lose, not by what we could gain. And, let's not forget ego. It's hard not to give thought to what family and friends will say should we try and fail. At this point, most people will not even investigate business ownership. I have the privilege of speaking to hundreds of people annually who are interested in owning a franchise. In seminars, I sometimes ask the question, "Would you jump off a building if I asked you to?" Almost without exception I receive laughs and a resounding "No!" Rarely does anyone ask, "How high is the building?" The building could be the tallest in Canada. It could also be one inch high. Without facts we are being guided by perceptions. Few of us would have an issue with jumping off a one-inch high building. So too with going into business; many let perceptions, not facts, be our guide. It's OK to have a good look at a business and decide it's too big a risk. It's OK to decide the building is too high. However, only investigation can reveal this. Only with the Franchisor under the microscope will we know the risk … the height of the building. Only then is our decision an informed one. Just as we don't buy the first and only house, car, or shoes we look at, it is a good idea to have an in-depth look at a number of good quality companies. "Shop" for your franchise by comparing it to others in the industry, and perhaps other industries. Wherever possible, buy the industry leader. The industry leader will have a proven track record and a system that is duplicatable with predictable results. In other words, they know what they are doing. Buying the industry leader has a second benefit. It is easier to compete as the industry leader rather than against the industry leader. The same logic that serves us well in other parts of our life will also serve us in looking at a franchise. Few of us would feel comfortable lending our car to a niece or nephew who got their driver's license last week. However we would not think twice in lending it to a friend or relative who has been driving for 30 years. The difference is experience. It is the same in business. The franchisor who has been in business l5 years and has 300 franchises is almost certain to be a safer investment than the company which went into business five months ago and has 3 franchisees. The latter still has a lot to learn and the former has learned a lot. It doesn't mean that you should not buy a franchise from a new franchisor; simply that you do it knowing the facts and being prepared for the greater risks. Comments like "Someone had to buy the first McDonalds", while accurate, do not tell the whole story. For every company that made it big, there will be many that did not make it at all. In Canada we are constantly aware that many of the big name franchises that dominate our cities are American. In the United States and the province of Alberta there are very specific laws governing franchising. The other 9 provinces of Canada have no specific franchise legislation. Should the franchises you are looking at be in operation in any American state or the province of Alberta, the franchisor will make available to you a document, called a Uniform Franchise Offering Circular commonly referred to as a UFOC. Note the first word "uniform". It means that everyone signing the agreement in any given year is signing the same agreement, and getting the same deal. The agreement will not change in any material way. The franchisor will not charge you more money or less money. Also the document clearly spells out much of the information you need, to begin to examine the franchisor to decide if the company is right for you. Should the company not currently operate in Alberta or the United States they may not have the UFOC document prepared. This simply means that the information is not contained in a nice neat package. You still need the information to make your decision and will be asking the franchisor for it. Not all franchisors are created equal. There are young franchisors and old franchisors, smart franchisors and stupid franchisors, big franchisors and small franchisors. Research will set out the differences. HOW LONG HAS THE FRANCHISOR BEEN IN BUSINESS AND HOW MANY FRANCHISEES DO THEY HAVE? As discussed earlier in the chapter, it is a safe assumption that the company in business l5 years with 300 franchisees, will be further along their learning curve than the 5 month old company with 3 franchisees. NEVER make the mistake of assuming all franchisors are created equal. The "holy spirit" of franchise knowledge does not descend on a new franchisor overnight and endow them with the knowledge they need to be successful for years to come. This does not mean that you should not buy from a new franchisor. It simply means you make sure you have done your homework. FRANCHISEE FEE Every franchisor will have a franchise fee. This is a one-time, up-front amount of money we pay to the franchisor, to cover their cost of getting us into the business. This will cover the cost of training, the early on "hand holding" we will require, and, if it is a "site sensitive" franchise, the cost of assistance with site selection. While the franchise fee will vary, $20,000 to $25,000 are pretty standard. Ask the Franchisor what you will receive for your money. ROYALTIES Franchisors will also charge a royalty. This is usually a percentage of gross sales (although there are franchisors who charge a flat monthly fee). The royalty has to be high enough to support the franchisor (after all, we are buying a franchise to receive the long term support of the franchisor so we need them to be financially strong), but not so high as to make it difficult for us to be profitable. The amount of the royalty will vary depending on the industry. However, make your decision based on what you will keep, not pay to the franchisor. For example, a l0% royalty on first glance may appear high, and a l% royalty may seem like a great deal. Should investigation reveal that the company with the l0% royalty gives extremely good support and the average franchisee is able to achieve a net profit of 50%, it may seem like a bargain. The company with the l% royalty could prove to have tight margins and struggling franchisees. Only research will reveal the facts. TERMS The franchise agreement you will sign is a legal document. It has a day that it begins and a day that it ends. Be certain to know the length of the contract. Ten years is a very standard length but I have seen everything from 3 years to 20 years. Just as important as the length the franchise has been granted for, is what your franchise agreement says about renewing the contract for additional terms. This renewal could be automatic and simply require your signature on documents. It could also be more involved, and include a renewal fee and additional training. In the increasingly competitive food industry you may well be required to renovate your premises to the current look of the newer franchises. While costly, this could also be necessary to remain competitive. ADVERTISING The franchise contract will normally set out the amount the franchisees will contribute to advertising. Again, like the royalty, it will usually be a percentage of gross sales. In addition to checking the amount be sure to understand how the funds are presently being spent, and what the plans are for the future. Remember it's your money so be sure you have a voice in how your money is spent. PROPRIETARY EQUIPMENT AND SUPPLIES Ask the franchisor if you as a franchisee will have any equipment or product which is exclusive. If so, where will this product come from? TERMINATION The franchise agreement will normally have a termination clause. This is a clause which sets out the conditions under which you can terminate your agreement with the franchisor, and the conditions under which the franchisor can terminate their agreement with you. It is rarely used but it's there and you want to be familiar with it. Ask the franchisor if the termination clause has been used and, if so, what the circumstances were. TERRITORY Does the franchise agreement clearly give you the right to an exclusive territory. Remember, if it does not, that means the franchisor has reserved the right to sell additional franchises in your area. You will want an exclusive territory, perhaps protected with a radius clause. TRAINING This is a really important part of buying a franchise to most people. Often we are buying the franchise and are relying entirely on the franchisor for their training. How long is the training? Where will it take place? How many people do they train at a time? Will they train several people (perhaps a family) from a single franchise. EARLY ON HAND HOLDING How much "on site" assistance will I receive when I open the business? How much extra support can I expect to receive in the beginning and from whom? LITIGATION Is the franchisor involved in any litigation or have they been in the past l0 years? What is the outcome of any litigation that has taken place? This will tell you how the franchisor handles disputes. SELL OUT The reason we buy a business is as a wealth-building strategy. We buy it to make money. Usually a portion of the wealth building we are planning on will be realized when we sell the business. The franchise agreement will give us the right to sell the business and set out the conditions of that sale. It is standard, and in your best interest, that the franchisor reserves the rights to approve and train every new franchisee entering the system. After all you do not want another franchisee selling their business to someone who clearly cannot run it properly and thus cause problems for the whole franchise system. When we sell the business the franchisor will want money to cover their costs, of training the new franchisees, early on hand-holding of the new franchisee, and legal costs. Most franchisors require a flat fee be paid to cover these costs. In some cases it could also be a percentage of the sale price. Be certain before you buy that the costs of exiting the system are acceptable to you. SITE SELECTION If the franchise you are considering buying is location sensitive, in other words a portion of the success of the business will depend on the right location, be sure to know what assistance the franchisor will be rendering with regard to finding that location and negotiating the lease. Be sure to check with other franchisees to be certain they have been satisfied with the franchisor's efforts in that area. ON-GOING SUPPORT Things change in business. We either belong to a franchise which leads or follows. We are "Number 1" or we aren't. We rely on the franchisor to keep us out in front. How will the franchisor demonstrate to us leading the industry? BUYING POWER How does the franchisor use its buying power to increase the profitability of the franchisees? MARKETING EXPERTISE Does the franchisor have a marketing department and have they been successful in creating winning market strategies to increase sales? FINANCIAL STATEMENT Remember, the reason you are buying a franchise is to get the long term support of the franchisor. To be in business long term to support you requires that the franchisor be solid financially. The financial statements of the franchisor (available in every UFOC) are how you check the foundation of the franchise. Think of it much the same way as checking the foundation of a house prior to buying it. Without reviewing the financial statement, you have no idea how stable the company is. We should also expect the franchisor to request our financial statements. Supplying these to the franchisor is how we indicate that we are serious and capable. MANAGER POLICY Does the franchisor permit absentee ownership or do they require owner operators? DOES THE FRANCHISOR HAVE A VISION? The problem with aiming at nothing is that it will probably be reached. Have the franchisor share their vision with you. Is the vision realistic and is it a vision you wish to be part of? Once we have had the majority of our questions answered, regarding the documentation, it is time to begin speaking with the existing franchisees. This is where we find out how the people operating the franchises are doing. The UFOC will provide a complete list of franchisees and in the absence of a UFOC the franchisor should be happy to supply you with a list. Just as you have never had a job where everyone was happy and performed at the same level it is unlikely to find a franchise system where everyone is happy and performing at the same level. Speak to Franchisees who are happy and unhappy, successful and unsuccessful. Determine whether you identify with and will run your business like the successful or the unsuccessful franchisees. Speak to franchisees of different generations; those who have been in the system weeks, months and years. If you want to know what the franchise is like after a year, three years or five years, speak to franchisees with this amount of time in the system. Only they can tell you. Be sure you have set goals, and be sure you are buying a system where your goals can be reached. If it is your goal to work part time in five years, be certain you are buying into a business where other franchisees experience shows this to be possible. Think of the business you are buying as the vehicle to get you to your destination. Before you buy, make sure you like and understand the destination. Most franchisees are going to be cooperative, however direct questions such as "How much money do you make?" may not produce the desired results. Perhaps taking a more consultative approach such as "Is it realistic that I would achieve sales of $250,000 (or some realistic amount) in my first year and have a profit of 25%?" will open up the subject. Asking it directly will close the subject. Remember to ask if they consider their experience with the franchisor to be positive and if it's a relationship they would enter into again. Before you make a final decision to buy, meet with the franchisor. This is your opportunity to make sure you like the people you will be dealing with. Think of buying a franchise much the same as a marriage. You want to be compatible with your partners. Deciding whether to invest your hard earned money into a franchise requires planning and hard work. It will take 20 to 30 hours of investigating over a four to six week period to decide if a franchise is right for you. When you begin, set a date by which you plan on having a decision made and work towards it. If, after investigating, you do not have the information to say "yes" then you have automatically said "no". It's OK to say no. It's OK to go the edge of the building, look and say it's too high to jump. "No" is also a business decision. Being in business in general, and franchising in specific will not be right for everyone. In conclusion I must tell you that it's impossible to investigate everything. However, do set goals. Set a destination, and buy the best franchise in your investment range, with a proven track record of assisting franchisees to reach these goals. Please accept my best wishes for a prosperous future. <