Buying a Franchise: how to choose the right franchise
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What (good) franchisees want - By Rod Young
Franchising however is not a guarantee of success. Like all businesses, franchises can, and do fail from time to time. When this happens, franchisees blame the area or territory, the location, their competitors, the franchisor or some other factor beyond their control. Rarely will franchisees admit that "I failed to understand my business before I invested and if I had done my research I would never have bought it". In the future, don't be surprised to see businesses, including established franchises fail. Blaming external factors or the economy for failure is glossing over the deeper issues of why the business failed. Good businesses should be able to withstand and weather the ups and downs that many businesses experience over the years including the financial challenges that the world goes through from time to time.
The average tenure of a franchisee in many networks is between seven to eight years. It is hard to find a period in history when we have gone seven years without some form of economic turmoil. Why then are people prepared to invest their life savings into a business which they should have known would not survive if revenue dropped by, say, 10%?
Avoiding failure in any business, franchises included, begins a long time before you sign an agreement and commit to a contract for a significant period of time. It begins when the idea of owning your own business first enters your mind. Given the financial and contractual nature of the franchising relationship, it is crucial that prospective franchisees thoroughly evaluate the business opportunity and the franchisor before committing to buy into a franchised business. Just because the anecdotal evidence strongly suggests that franchising is not as risky as an independent business where you are on your own should not be considered a guarantee of success.
Step One: Set Your Limits
Assuming you have an open mind on the particular type of franchised business you would like to operate, the two key considerations in buying a franchise are:
- What size of investment can you afford?
- What are your criteria and industry/area of interest?
Other criteria to consider include:
- Where will the investment funding come from?
- What is the level of debt and the cost of debt service and principal repayment?
- How much income do you expect in return for your investment?
- In what geographic area should the franchise be located?
- How many days will your franchise trade?
- How many staff are you prepared to employ and manage every week?
- How many days/hours are you prepared to commit per week?
- How many years are you expecting to be involved?
- Do you have the support of your spouse or partner and what role, if any, will they have in the operation of the franchise?
You must reduce your list of potential franchises down to a manageable level - say, three or four. Take a good look at the list. Do you really see yourself operating any of those businesses for a period of years?
Ask yourself these questions:
- Does the business present well to you as a consumer?
- Do you understand the business?
- Have they proven their ability to secure quality locations or operate in multiple regions?
- Are current franchisees profitable?
- Are they seen in the media and portrayed well?
- Are current franchisees happy?
- What is the marketing and advertising program like?
- Do they have strong relationships with the banks?
- What is the quality of the management and leadership team?
- Do they have company owned operations?
- Do they listen to and learn from their current franchisees?
- Do they have a clear vision and growth plan?
- Do they have a good, solid growth history?
- How good is the induction and training program, especially if you are a novice in the product, service and/or business?
- How well developed are their management information systems?
- Do they have an operations and procedures manual?
- What level of ongoing support is provided?
Most franchisors will ask you to submit a formal application form. Be wary of those who don't - it's a sign they don't care about who becomes a franchisee or they may not fully understand the business of franchising. Take your time with any application. If you have to hand write it, do so carefully. Be honest and forthcoming with information, it's not in your best interests to mislead anyone about your ability to operate or fund the franchise.
A constant recurring issue for prospective franchisees is underestimating the amount of finance and working capital that is available. You should live within your means and invest within your means as an undercapitalised business is difficult to make successful.
You may be asked to pay an application fee of some kind. Make sure you receive a receipt for the fee and a written assurance that the amount is fully refundable until you sign a Franchise Agreement.
Step Four: Talk to Franchisees
There is perhaps no more telling test of a franchise system than to speak with a range of current franchisees. The validation of the franchise system by the current franchisees is a key test of the success of a franchised network. Don't just limit yourself to those suggested by the franchisor - they will undoubtedly pick the happiest franchisees.
Speak to a range of franchisees and ask them:
- Are they satisfied with their investment and the business?
- Would they recommend this franchise to their friends and family?
- Would they sign up again knowing what they know now?
- What support does the franchisor provide?
- Is the franchisor reasonable?
- Is the franchisor willing to listen?
- What problems are other franchisees experiencing?
- What would they change?
- Are the marketing campaigns delivering customers?
Let's assume for a moment that you're the type of person who can tolerate a reasonable level of risk and as such, you're prepared to venture into a new Greenfield franchise where the franchisor has not operated from a location in the area or within the territory. What should you look for, what are the questions to ask and how do you arrive at a commercially sound decision?
Some of the benefits of taking on a new Greenfield franchise include:
- No goodwill is payable to a previous franchisee
- It is a brand new operation and the local reputation of the business can be established as desired
- If it is a site based franchise, the landlord may be prepared to make a contribution toward fit out and/or negotiate the lease terms to link rental to sales levels.
As an alternative to a Greenfield franchise, an established business enables you to take some comfort in the proven trading history so, in effect, it is generally perceived as a lower risk option. However, you may have to deal with the history of the previous franchisee. If the premises or vehicles are looking a little tired, a refurbishment or upgrade can restore the appearance. Don't forget the current franchisee's reputation in the market - which could be good or bad. Similarly, existing employees could be a positive or a negative influence. A key issue to consider is the potential for further growth of the business; is there more growth to be had or has it reached its peak?
There is no substitute in business for having detailed and accurate historical financial information for the performance of a business. The quality of the numbers is crucial and frankly, some examples defy belief - they lack detail and in some cases, any semblance of accuracy.
Step Six: Do Your Own Due Diligence
By this stage you should have contacted and met with your target franchisors and secured a first meeting or, hopefully, some financial details about the offer. You may be asked to sign a confidentiality agreement.
Regardless of the information the franchisor provides, you must develop your own view of the financial aspects of the business. There is no substitute for a thorough understanding of the establishment costs, revenue potential and operating expenses.
Choose an accountant who is experienced in small business and franchising. Discuss how he or she can assist you in reviewing the financial information and advising you on the potential of the business.
Your assessment should be conservative - err on the side of understating revenue and over-stating expenses to gain a conservative view of the business. Ask yourself:
- Are my assumptions reasonable?
- Do any other franchises in the network achieve the levels of patronage I think I can achieve?
- Are businesses close by achieving the level of patronage I think I can achieve?
- Do my rental and wages expenses include ancillary costs like rates, utilities, employee benefits, holiday pay and health insurance?
- Is my cost of goods assumption realistic and consistently achieved by other franchisees?
- Are the accounts of the existing operations accurate?
- If it is a mobile or service franchise, are the running costs of a vehicle adequate for the territory?
Step Seven: Establish Finance
Some franchise systems are accredited with major banks. This means the banks have done their due diligence of the franchise system and may be prepared to finance part of your establishment costs against the business. Be careful. You don't want to exceed the limit you set for yourself originally. Test the financials again to see if the business can sustain the loan repayments required to fund the initial capital costs
Step Eight: Use a Specialist Lawyer
You will most likely be provided with a pro-forma copy of the franchise documentation. If you receive only a summary of the franchise agreement ask for a full copy. No reasonable franchisor should refuse this request. A franchisor that won't provide a full copy of the franchise agreement should ring warning bells. If the franchisor refuses to provide one - walk away.
The franchisor should provide you with a copy of a Disclosure Document as well as the Franchise Agreement. The purpose of a disclosure document if to provide information on the sector the franchise operates in, outline the history of the business of the franchisor, who the directors and shareholder are, the business history of the franchisor's directors and key officers including any previous history of business failure they may have been associated with, the number of units granted, opened and the units that have closed or been terminated and importantly details of the capital costs including working capital needed to establish the franchise and the profit and loss model based on the performance of current franchisees. The contents also should include items such as the intellectual property being licensed.
You should engage a specialist franchise lawyer with experience in both business and franchising to review the proposed agreement, disclosure document and any other documentation the franchisor provides. There is no value in engaging a non-specialist to review the Franchise Agreement because such agreements are, by their nature, substantially different to ordinary business contracts. A specialist advisor is a must. It's a worthwhile investment and importantly saves you the investment of paying a lawyer to learn franchising at your expense.
Step Nine: Keep Asking Questions
A quality franchisor will be willing to answer all your questions and provide you with enough information on which you can make a fully informed decision. Don't fail to ask simply because you think the question is stupid - ask it anyway. You must be comfortable with every aspect of the business, so ask, ask, ask and keep on asking until you are satisfied.
Only after you have completed all these steps should you contemplate signing a Franchise Agreement. So, in summary:
- Set your limits - know how much you can comfortably afford
- Make sure the franchise meets your criteria
- Ask the right questions - use key questions to shortlist three or four potential franchises
- Make your application - complete it as thoroughly and accurately as you can
- Talk to current franchisees - they are an excellent source of information about the franchisor and the business
- Do you own due diligence - err on the conservative side and use an experienced accountant
- Establish finance - evaluate the various banks with whom the franchisor is accredited
- Use a lawyer with extensive franchise experience - only a specialist should review your legal documentation and advise you
- Question - ask all the questions you want until you are satisfied you understand everything
Understand the franchisor is not responsible for your success or failure. That obligation rests with you as the proprietor of your own franchise. It will be your job as a franchisee toensure your franchise is profitable. If you cannot accept that responsibility you are not yet ready to make the transition to being your own boss!
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What (good) franchisees want - By Rod Young
About the Author: Rod Young
RSS for Rod's articles - Visit Rod's website
Rod, as founder and Executive Director of dc strategy, is recognised as one of the world's leading franchise and channel strategy experts. He has over 30 years experience establishing and developing successful networks and brands in Australia, Europe, China, South East Asia, India and the United States.
Rod's specialist areas are:
As a key advisor to leading Australasian companies, Rod has transformed many smaller businesses into national and international chains. He is also currently on the board of several national and international franchise networks.
Click here to visit Rod's website.
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