Knowing what to look for in a good franchise opportunity requires reading beyond the company-provided sales literature. Understanding what red flags and metrics to look for, along with what entrepreneur development resources are provided, can help investors separate the good from the bad. See the following article from Blue MauMau for more on this.
It is a mine field when it comes to investing in a franchise unit. Good information is very hard to find. And there’s a lot of salespersons who want your money. You’ve read the literature. Buyer be careful. Ask franchisees about the system. But here are the quick metrics and information that I’ve learned from some of the best. These are items that can readily be accessed.
If I were to be interviewed about what I have learned on how to find a good franchise, this would be my list. It is a bit of a contrarian view in that a number of points cannot be found in the prevailing literature.
What are the earnings? I prefer the bottom line to calculate a Return on Investment when buying a new store. But if I have to, I’ll settle for the top line of a franchise system compared to its closest competitors. Sales per store are the easiest to obtain. e.g. What is an average KFC’s sales per store compared to a Zaxby’s? No earnings? No sale.
- How many sold but not open stores are there? In Quiznos’ case there were 3,200 stores that were sold but not opened. In Cuppy’s Coffee, there were two hundred stores not opened compared to less than a hundred that were opened. Too many and its a big bright red danger sign
- Franchise returns. What is the failure rate for paying SBA-backed loans compared to other companies that are in the same sector?
- How does the franchise churning look? The franchise disclosure document provides 3 years of franchise turnover information.
- Franchisee satisfaction. There are surveys of franchisees that can actually put a number on satisfaction, e.g. 94% of franchisees rated their franchisor outstanding in support. Buyers can find real information on a franchise by participating in franchisee associations, where franchisees are more freely able to speak. And there is crowd sourcing on the Internet.
Checks and balances / Entrepreneur Development
- Is there an independent franchisee association with elected offices that franchisees participate in? There are hundreds of franchise systems that have independent associations. If the system does not have an independent association for franchisees, then I’d move on. Inside information is too difficult to get without this. It makes better executives of both franchisor and franchisee. Plus, participation and networking among peers within such an association is very healthy for personal entrepreneurial development. An association provides checks and balances to a franchisor and the franchise system.
- Is there a franchise cooperative where elected franchisee representatives are responsible for system-wide functions such as advertising, purchasing, IT, or the supply-chain? This taps into the drive, operational know-how and entrepreneurial energy of what differentiates a franchise chain from corporate chains — an army of entrepreneurs. It also provides checks and balances to the franchisor.
- Is there a franchisee-to-apprentice mentoring system, and a franchisee-to-franchisee mentoring system?
Red flags (Things that alert me to franchisor problems)
- There aren’t company-owned stores (one show case store doesn’t count). Life is too short to franchise with someone who doesn’t operate and know the business. Without a sizeable amount of company stores, the franchisor is focused on franchising — the business of selling franchise licenses. These types of franchisors say they don’t want company-owned stores to compete with their franchisees. Baloney! Rather than understanding my business, they would only be able to pass on information from one franchisee to another. According to the U.S. Census Bureau, the average U.S. franchisor has 23% of its chain that are franchisor-owned. That’s healthy. Franchisor CEOs with lots of company-owned stores sound different. For example, in a pizza chain, they would be wonks who know and love chatting about the factors affecting the price of cheese and how that has affected sales, or in a tax preparation chain the implications of a new IRS rule with electronic tax filings. So if there are only two company-owned stores in a system larger than ten, I would walk away. I would go down to as few as a baker’s dozen, but no less. (BTW, I didn’t just pull that number out of my hat. More on this later.)
- Young and growing super quickly. Look, growth is good. But when there is hyper-growth it can be one heck of a problem because the structure can quickly outgrow the franchisor’s ability to support it. And the youngest systems are the ones that are highest risk to go bankrupt quickly and easily. Large and long-lived franchise systems are safer investments.
- Crowd sourcing from the Internet clearly identifies where this franchise system has major problems. There are negative blog posts that contain specific and verifiable information. Mud slinging doesn’t count. I would be poking around, asking questions on interactive sites like Blue MauMau’s forums, to get information from industry experts, franchisees and former franchisees.
- The franchisor doesn’t do business in registration states
- There’s a lack of business and franchise experience with the franchisor’s officers
- Does anyone have access to a Lexus-Nexus or WestLaw legal database? How many lawsuits are there? What’s in the FDD? What kind? Anything left out, e.g. Did you catch them in a fib?
If you have considerations that you feel need to be added to this list, let’s hear them.
This article has been republished from Blue Maumau. You can also view this article at Blue Maumau, a small business and franchise news website.