In last month’s article, I discussed the basic terms and definitions associated with franchising, the influence franchising has in the U.S. economy, and how to perform a cost/ benefit analysis of a franchise purchase. This month’s article of our 3-part series will talk about analyzing yourself and how to evaluate the franchise after narrowing your search.
When you are looking at a franchise, remember that you might spend the next 10 -20 years of your life in this franchise. Prior to making the commitment to devote this amount of your life to this business, you need to do some personal inflection, look inside yourself; talk with your family and discuss this with friends or trusted colleagues to determine if this franchise is for you.
Self or Inner-Evaluation
The first answer you need to know is whether you want to work on the business as an owner/ operator or are you looking for a franchise where you can hire someone to manage it in your place. Many franchises require that you be an “owner/operator” which means that not only do you own the business, but you are required to work full-time within the business. This can also mean being required to attend training and annual conventions, besides dedicating your working hours to the business. In the alternative, there are some franchise systems that allow you to hire someone to be your manager. This option is commonly called “absentee ownership”. If you are looking for the absentee owner type of franchise, remember that in almost every franchise you will have to guarantee the performance of the franchise which means you should be very careful about who you hire to run your franchised business. Additionally, realize that if your Manager goes on vacation, quits or heaven-forbid, you have to fire them, you will most likely have to step in to run the business until you hire a replacement manager and get them trained. If this could pose a problem with your work week schedule, one option is to always have at least 2 managers, or a manager and an assistant manager who is cross trained. This will greatly reduce the possibility of you having to step in to run the business temporarily.
Another important question to ask yourself and those close to you is: “how well do I work with others?” This can feel like handing someone a clip loaded with bullets, when they already have a gun in their hand, but you need to know the utmost truth. This must be the 2nd question you get answered. Most of the franchises that people are exposed to, such as restaurants, and all other retail type locations, have many employees and a lot of face-to-face interaction. However, if that is not your strong suit, you need to own up to it, so you are not setting yourself up for failure, or stress filed days. There are many franchise systems that allow you to work from home, have customer interactions via phone calls or even to email customers. Regardless of your social skills or preferences surrounding customers and employees, there is a franchise that will fit you perfectly.
Another part of your self-discovery, is asking yourself, “why do I really want to own a franchise?” During the various seminars that I give to franchisees nationwide, usually called “A to Zee – your 5 Steps of Due Diligence” I pose this same question to the attendees. Most prospective franchisee entrepreneurs give one of three general answers: 1) I want to be my own boss, so I am willing to buy myself a job, 2) I want to buy a business that I can control how much money I make; or 3) I want to create a legacy situation, where I can build up the business and then leave it to my kids, or favorite charities, etc. These are all great answers, but they only touch upon a few of the reasons. Those that people will not talk about out loud are that they recently were fired, right-sized, down-sized or whatever the politically correct term is this year, and they do not ever want to experience that trauma again. Or possibly they have retired yet are bored, or they have reached a certain age where they are too young to retire and just old enough that it is harder for them to find a different job that excites them. Whatever your reason, you should know and understand it before you move forward with a franchise purchase to ensure you are making the right decision and that the franchise system you choose supports and allows your choice. For example, not all franchise systems allow you to leave the business to your children. These are factors you must consider when doing your due diligence.
One question that franchisees fail to ask many times is whether the franchise will work in their market. An over exaggerated example of this is that a snow removal business would not make a lot of money in Miami, but a bathing suit retailer might. Many franchises are for sale in areas that the product or service may not work well in, but franchisors will typically leave it up to you to determine that. As the potential business owner, you should research whether this business has competitors or similar concepts in your target market and whether those businesses are doing well. One way you can determine that is to have your franchise attorney do a competitor analysis for you. Or a layman trick is to obtain the competitors FDD, and peruse the Item 19 disclosure section for any financial performance representations, or if that system does not have an Item 19 disclosure in their FDD, you can look at the list of franchisees associated with Item 20 (although it is usually in an attached exhibit in most FDD’s) and then call the franchisee close to your target market and ask them financial questions. If you can spend a little extra money, it is also great to hire a marketing company to perform research into your area about the “leakage” for your proposed industry. Leakage in a marketing report reflects the amount of competitors in a given area as compared to the number of buyers for that product or service, and the distance the consumer is willing to travel for such services or products. This may cost a little more, but it could be well worth it in the end.
Another big question to ask is whether your family and friends will support your decision to buy a franchise. This is a very important question to ask because statistically a family-owned and operated franchise is more successful because each member of the family has a vested interest in the success or failure of the business. Additionally, without support of your loved ones, you will have no outlet for your frustrations, concerns or celebrations.
Next Step – The Numbers
So now you have looked at different franchised businesses and thought about who you are and what your goals and support structure look like, but what should happen next? Next, you should read and re-read the Franchise Disclosure Document. If you do not understand the Franchise Disclosure Document and the Franchise Agreement, then how can you expect to successfully follow the franchisor’s model?
When evaluating the franchise, most buyers look straight to the total investment which can be very deceiving. Item 7 of the Franchise Disclosure Document lists the total initial investment required to purchase the franchise; however, this Item gives a range for the franchise investment, and only covers the opening of the business plus the first 3 months of business. In some franchises, this range can include costs for running the business from your home to leasing commercial space which can vary greatly. Also, there are many franchises that require you to have a specific vehicle which can greatly change the total investment if you do not have the vehicle already or if your financing terms are not exceptional.
Every franchisee is concerned with the fees. The 3 main questions that I get regarding fees are: 1) Is the franchise fee too high?, 2) What am I getting for the royalties I am paying? and 3) What is the franchisor doing with my marketing fee? Of course, everyone asks if they can negotiate the fees, but that will be addressed in our third part of the Journey to Franchise Ownership series next month.
The franchise fee is not likely a profit center for your Franchisor, it represents your ticket to get into the system, and cover the franchisor’s costs associated with locating you, training you and helping you get opened for business. Depending upon the franchise, you can expect to pay between $19,000 and $50,000, with the average franchise fee being around $35,000 now. This franchise fee is what the franchisor uses to rent space to train you, pay trainers, cover printing expenses and costs of meals during your training, pay sales people or franchise brokers’ commissions, etc. Most franchisors expect this fee to be used almost entirely on the above expenses and as a payment to cover the costs associated with finding you.
The next expense franchisees ask about are the royalties. Royalties are always an area of contention between franchisors and franchisees. Every franchisee at some point argues that they are paying high royalties and not getting enough support for it. It is best to think of a royalty as your association dues, the payment to continue using the franchise name, buying power, reputation, and support system. Admittedly, there are franchisors that charge high royalties and give very little in return, but most good franchisors have evaluated their royalties and charge an amount that is reasonable based on the services, research and development, they give in return. When someone buys one of the popular fast food franchises, they know that people will come and buy food based solely on the name; however, what most franchisees will not acknowledge is that the famous fast food chains have spent a lot of money negotiating with suppliers of the various food products to reduce prices to the franchisees to save them money. Good franchisors will look for ways to make the lives of their franchisees better and more profitable in order to earn that royalty.
Another type of fee that franchisees look at many times is the two typical but separate marketing fees. These are the local marketing fees and the national marketing fees. Almost all franchisors require a national or regional marketing fee, aka Business branding fund fee, which funds reside in a separate bank account that the franchisee pays typically between 1-4% of gross sales in to for marketing on a nationwide or regional scale. Many times franchisees will not see their bottom-line increase and therefore argue that they are not getting any benefit from the national or regional marketing. If the franchisee is the sole franchise owner in a state then this may be true, but in most instances’ franchisees will experience some exposure in their general area from the national or regional marketing fund. A national or regional marketing fund should be supplemented with your local marketing efforts. Franchisors will often require that franchisees spend a minimum amount in their local territory. These amounts can vary from franchise system to franchise system, but normally run between 3-10% or in some franchises can be a flat monthly, quarterly, or annual amount. Local marketing can be used in many different ways including sponsoring local sports teams, tv commercials, radio, newspapers, door hangers, and even combined with other franchisees to create a cooperative advertising budget where franchisees all operating in a particular area pool their funds and buy a bigger ad that names all of the franchisee’s locations. Franchisees should always talk with the franchisor, other franchisees, or marketing companies to determine what type of local marketing works best.
There are many other areas of the FDD and other fees that could be explained, and in next month’s conclusion to the Journey to Franchise Ownership series, I will discuss who to talk with about these fees, some tips for negotiating, and what you can do to finance some of the initial investment.
Shelton Law & Associates additionally works with entrepreneurs buying franchises by assisting with Business Creation, Industry Evaluations, Franchise Disclosure Document Review, Fairness Factors, Opinion Letters and Negotiations.
For more information or to schedule a customized consultation for your business you can write to franchising@SLA.Law or call (866) 99-FRANCHISE.