A Guide to Assessing Franchising Opportunities
Jim Denney faced a common choice: buy a franchise or start an independent company?
He was an experienced business owner in Scotia, N.Y., near Albany, who had spent a year investigating a promising franchising opportunity — a business that raised sunken concrete slabs by pumping cement slurry beneath them, a technique sometimes known as mudjacking.
The franchise brought many advantages: brand recognition, a 60-year history as a successful company, a proven business model and systems already in place for operations, training, equipment and safety — all of which would allow Mr. Denney to shorten the learning curve and grow faster.
But he and his partner had reason to be wary. They already owned another franchise business and had grown frustrated by the lack of support they received from their franchisor. How could they be sure their new franchisor would do better?
Buying a franchise demands caution — especially in the current economy. At best, franchising can ease the path to self-employment by allowing a franchisee to buy a packaged concept with a proven business model and brand recognition. At worst, it can turn the dream of business ownership into a nightmare and saddle franchisees with debt and exploitative relationships with their franchisors.
The credit crunch has made it more difficult for would-be franchisees to obtain financing. On the bright side, franchisees have more leverage in bargaining — but only if they follow proper due diligence and ask the right questions.
“In this current economic situation, be extra careful, because franchisors are even more hungry to sell franchises,” said Don Sniegowski, editor of Blue MauMau, a franchise news site. “Once they’ve got you in their sights, they’re under a lot of pressure to sell that franchise. It’s a buyer’s market, and if you’ve got money right now, you can pick and choose what you want. And you better be very choosy.”
Here are nine questions every would-be franchisee should ask:
Who Are You?
Buying a franchise requires considerable due diligence — more on that below — but before analyzing the business, aspiring franchisees should scrutinize themselves. Nick Bibby, a franchise consultant in Shreveport, La., said his first advice to clients comes from an ancient Greek aphorism: “Know thyself. Decide first if you’re made for entrepreneurship.”
Unfortunately, many people become enamored with the dream of business ownership and fail to ask simple questions that determine whether franchising is a good fit. “People don’t want their dreams shattered,” Mr. Bibby said. “People don’t want to know the truth.”
He compares this step to marriage counseling. By asking hard questions in advance, people can minimize the danger of being blinded by passion and entering a relationship doomed to failure.
What are your interests? Where can you leverage your existing skills? Are you the sort of person who likes to follow a system, or do you prefer to do things your own way? Do you want to manage people or work independently? Are you ready to pull 16-hour days, or do you need a part-time gig that allows you to keep your day job?
And of course: What kind of business is right for you? Franchise opportunities run the gamut, including retail, business-to-business services, in-home businesses, child care, education, home improvement, construction, real estate, wedding planning and fast food.
Should You Hire Experts?
Now hear this: You need help. Franchising is full of sad stories of people who sign agreements without fully understanding the implications. Often, these people lose their savings, homes and happiness. Even experienced businesspeople need to hire experts.
“A prudent businessman will start this process with a franchise dream team — a financial adviser you trust, a legal adviser you have confidence in and a business broker who’s working for you,” said Robert Purvin, chief executive of the American Association of Franchisees and Dealers. “You also need to start with a psychological adviser to identify what type of business makes sense for you.”
Mr. Sniegowski of Blue MauMau recommends that would-be franchisees hire experts in three areas: marketing, accounting and legal. Make sure you hire experts who specialize in franchising, not generalists. Many franchises, he adds, aim at people from outside the industry like recently laid-off corporate employees who might not know much about coffee or doughnuts or whatever the franchise sells.
“Don’t go to the neighborhood attorney, your brother-in-law attorney or your sister who’s an accountant,” said Mr. Sniegowski. “Go to someone who really understands franchising.”
A franchise broker may help steer you to a franchise that fits your needs. But be aware that brokers often receive commissions from franchise chains for signing up new franchisees and thus may have an incentive to steer you to certain companies.
What Is the Best Business Opportunity?
Even if you are buying a franchise, you need a business plan. Franchisors often provide information that can be inserted into your plan, but you should not rely on the franchisor to do your homework for you. You need to analyze your own market and consider enlisting professional help.
Does your business satisfy a need or a trend? How many potential customers live in your area? What is the competition? By the end of this process, you should have a business plan that is supported by hard data. This plan also is essential for obtaining financing.
Mr. Denney, the businessman in Scotia, spent six months investigating his market before satisfying himself that he had a viable business opportunity for his concrete-raising franchise. He looked at census data, information on the housing stock and talked to people throughout the industry. Mr. Denney is an investor who felt confident doing his own research; he suggests that people who lack such experience hire market research professionals.
“People spend more time evaluating whether they want a Wii or a PlayStation than buying a franchise,” Mr. Denney said. “It really is kind of scary.”
Who Is your Franchisor?
There are more than 3,000 franchises in the United States, and a vast majority are unknown to the average consumer. Mr. Bibby, the franchise consultant, puts it bluntly: “Most — I’ll say a minimum of 70 percent of all franchises — are not worth the powder it would take to blow them up.”
Investigate your potential franchisor thoroughly. This may be one of the most important business decisions you ever make, and you should treat it accordingly.
What is the business model? Is the product or service unique? Is the brand established? How is this franchise different from competitors? How will it provide lasting value? Is the business model based on royalties or does it rely on signing up more franchisees and collecting fees? Does it have hidden profit centers, like rents or annual meetings?
Does the franchisor provide support like marketing and training? Does the company have a history of litigation? How many franchisees are there and what is their failure rate? What is the background of top management? How long have they been in the business? What is their reputation, and have they had any personal bankruptcies or litigation?
“Not all franchises are created equal,” said Jim Coen, president of the Dunkin’ Donuts Independent Franchise Owners. “It’s incumbent on the franchisee to really drill down and figure out the potential to make money. Sometimes potential franchisees fall in love with the concept and find out too late the business model is not sustainable”
What Do Other Franchisees Say?
In addition to crunching numbers and enlisting professionals, you need to investigate with your eyes, ears and gut. Talk to other franchisees. Hang out in their businesses and observe. Get a job or volunteer in another franchise.
Treat these visits like an ethnographic study; you want to immerse yourself in the culture of the business. For example, you may discover that franchisees all work 16-hour days, seven days a week. If you can’t imagine yourself racking up such hours, that franchise probably is not a good fit.
Track down franchisees who have left the system and ask about their experiences. If you are fortunate enough to find a chain with a franchisee association — there are only a few hundred in the United States — make it a resource. Visit the company headquarters and meet with the people you will work with.
Use the Web. In a world of social networking, it’s not hard to find out what other people are saying about a franchise.
Can You Afford It?
By law, the franchisor should provide you with a disclosure document that specifies the initial investment. But take these estimates with a grain of salt: they may be averages, and may vary by region. Ask other franchisees how their costs compare to the franchisor’s estimates.
Reporting earnings is optional and only a fraction of franchisors do so. Again, you and your business advisors must do your own analysis.
Many first-time franchisees make the mistake of underestimating working capital requirements and buy a franchise at the upper range of their affordability. One old adage bears repeating: It will cost twice as much and take twice as long.
“It’s not uncommon at all for a store to open and still be struggling a year or two later,” said Peter Birkeland, a small-business consultant in Chicago and author of “Franchising Dreams” (University of Chicago Press, 2004). “You have to have a lot of working capital.”
The credit crunch makes financing harder to obtain. Lenders have become more wary, and home prices and investment accounts have sunk in value. Some franchise chains have come up with creative financing packages to help franchisees. Scrutinize these packages carefully with your financial advisers.
One other thought: You can sometimes buy an existing franchise for less than it would cost to open a new one. And banks are more likely to give you financing for a location that already has cash flow. Of course, an existing franchise that’s up for sale can be a nice opportunity — or a red flag.
What Are the Legal Terms?
Federal and state laws require franchisors to provide prospective franchisees with two crucial legal documents: the franchise agreement and the disclosure document, often known as the Uniform Franchise Offering Circular.
By law, you must receive the disclosure at least 14 days before signing any contract or making any payment to the franchisor. Take these documents to the lawyer — again, one who works for you and specializes in franchisees — and review them in detail.
Could You Do Better as an Independent?
Before you sign an agreement, stop to consider whether you’d be happier as an independent.
Franchising can offer many advantages, but the quality of support varies widely. Moreover, franchisees must follow procedures and pay fees and royalties. Will the franchise provide continuing value for the life of the franchise agreement? If not, consider starting an independent business.
In the 1990s, Timothy Bates, a professor at Wayne State University, studied a sample of more than 20,000 new businesses that started between 1984 and 1987; by 1991, 35 percent of franchise units had gone out of business compared with 28 percent of independents.
Can You Negotiate?
Mr. Birkeland, the small-business consultant, said that in the current economy, franchisees should be emboldened to negotiate on items like franchise fees, larger territories or deals on multiple units. “I would push hard for the bargain,” he said. “A franchisor may put on a stern face and say, ‘Take this deal or we’ll find someone else’ — I wouldn’t believe it before, and I definitely wouldn’t believe it now.”
Terms may be less negotiable with strong franchises, especially on items that might dilute the integrity of the brand and or create inequalities among franchisees. Some franchisors flatly refuse to budge from the standard template.
But it never hurts to ask. Mr. Denney suggests that aspiring franchisees ask their franchisor a simple question: Are you willing to negotiate the franchise agreement?
“If the answer is no, walk away,” he said. “No franchise agreement that I’ve ever seen is ever going to be acceptable on the first go-around. There has to be some back and forth. If it’s not negotiable, they’re going to own you.”
Mr. Denney and his partner eventually signed their agreement — but only after negotiating numerous changes and almost going independent. In the end, he believes it was a good deal for both sides, and in the first three months his franchise with Concrete Raising of America has generated substantially more business than he would have as an independent.
“Yes, franchising does offer some turn-key aspects, but there is still a huge amount of work that goes into it,” he said. “You’ve got to do that due diligence.”
