Purchasing a franchise opportunity has become a popular means of pursuing a new business venture. The idea of joining an established group and utilizing a recognized brand can offer an added level of comfort when going into business. However, this golden slipper does not fit everyone and needs to be carefully considered. To assist in sorting through various aspects of franchise opportunities, the Federal Trade Commission (FTC) publishes “A Consumer Guide to Buying a Franchise” and offers other assistance found on its website or by calling toll free 1-877-FTC-HELP.
This information can be very helpful and is made available free of charge to protect those willing to seek and use it.
Consider Doing It Yourself
In working with clients viewing these opportunities, I try to provide certain practical advice. The first question I generally pose is – why not do it yourself? That is, why use limited resources to acquire and operate a franchise if you can do basically the same thing under your own mark or design. The hope is that the synergistic effect of joining a franchise group will enhance the likelihood of its success. In considering a franchise opportunity, I suggest you make a list of the benefits desired in being part of the franchise system. Doing so should cause you to consider whether it will help fill the gaps in your business skill set and is worth the cost of franchise, royalty and other fees. If the list is short, you may want to consider going it on your own. On the other hand, if your list is long, your weaknesses should be supported by the strengths of the system. This mental process is helpful not only in considering the basic question but also in determining if what you believe you are obtaining from the franchise system will actually be delivered through the franchise agreement and your relationship with the franchisor and the other franchisees.
Review the FDD
As a result of an FTC rule and certain state agency regulations, franchisors are required to disclose basic information, typically set out in a Franchise Disclosure Document (FDD). The FDD should be delivered to you in advance of making any formal commitments and includes an abundance of useful information concerning the franchisor and the franchise opportunity conveyed in plain english. While this document is often long and detailed, it contains many important facts and is provided to give the prospective franchisee a basis for making an informed decision.
I am often asked to review the FDD for red flags that might significantly affect the decision to join a franchise system. There are many that should raise potential concerns regarding the franchise opportunity. Here are a few for your consideration:
- New system – no history of developing the brand
- Undeveloped Operating Aspects – purchases, software, or advertising to be considered in the future
- Few franchised units – limited experience in operating multiple units
- Use of affiliates – capturing various levels of profits may create conflicting interests
- Limited products or services – less room for economic error
- Weak financial statements – limited ability to weather tough times
- Limited management experience – no history of capable assistance
- Limited rights to expand – may not provide the desired economic dynamics for your investment
- Litigation or bankruptcy history – uncertain past
Understand the Franchise Relationships
Without a doubt, one of the most important aspects of a franchise is the relationship it establishes among the franchisor, the franchisee and the other franchisees. It is hoped the benefits of the relationship will help the system (and each franchisee) grow and prosper. I suggest you take every opportunity to meet and talk with management of the franchisor and the other franchisees. Your gut reaction to them will be a good barometer of whether the relationship advantage will be realized through your participation in the program. The FDD provides names and contact information of franchisees, both current and those that have recently left the system. Contact current franchisees to determine their view of the system. If possible, also try to speak with franchisees that have exited the system; it can be even more informative to see what problems they encountered and why their experience did not result in continuing participation.
Modify the Franchise Agreement
The FDD will also contain a copy of the franchisor’s form Franchise Agreement. This document will contain the terms of the legal relationship that will exist if you decide to become a franchisee. It is important that the franchise document be reviewed by legal counsel and you have a good understanding of the requirements of that document.
A fundamental question that often arises at this point in the process is whether to request changes to the Franchise Agreement. While each franchisee would like to tailor the Franchise Agreement to its individual needs, a well advised franchisor will not want to make any changes. One of the main strengths of a good franchise system is the consistent and uniform approach to its operation, and a franchisor will work hard to maintain this benefit. In reality, a franchisor is not going to grant many concessions, and spending the time and resources to assert a comprehensive list of requested changes will probably be a futile effort. It is more productive to compile a short “wish list” of items particularly important to you and see if they can be agreed upon. In most events, a franchisor will only consider changes in areas that do not have system-wide impact. Here are some topics to consider:
- Additional Support – help fill skill gaps
- Modification of protected territory size – fit the size to the desired area
- Opportunity to open additional units – take advantage of economies of scale
- Extend periods (e.g., opening, training) – tailor to needed time table
- Installment payments of franchise fees – provide cash flow relief
- Limits on personal guaranties – restrict individual legal exposure
- Maintain royalty percentage on transfer – obtain benefits for full term of agreement
- Terminate covenant not to compete or limit damages on franchisor default – franchisor should not benefit from its breach
- Right to terminate with notice/payment – help limit exposure in new system
Franchisors will sometimes agree to amendments or to current consents/waivers of requested actions. To justify these potential changes, a prospective franchisee may be able to, for example, assert the small size or newness of the system, or highlight what the franchisee is bringing to the table and offering the system, such as the willingness to participate in a new system or develop multiple units.
These are just a few of the topics to be considered by a prospective franchisee. When determining if a franchise is the right fit for you, be realistic about your expectations, and understand the true costs and benefits of the franchise approach. The wealth of information available should be considered and of significant assistance if you will take the time to utilize it in the process.
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