Buying into a franchise is a big commitment and prospective franchisees should consider as many sources as possible before signing on the dotted line, particularly if one of their prime sources for information is the seller. There are many things a franchise seller likely won’t say in response to hard questions, so buyers should seek answers elsewhere. Good questions to ask include how much profit you’ll make if you perform at the average level, what are the real chances for failure, what is the structure of the franchise network and, finally, how fair is the contract. For more on this continue reading the following article from Blue MauMau.
I was emailed by an industry leader who asked me, along with probably many others, what the best piece of quick advice I would give to someone who was considering a franchise. What should have taken a minute or two for a short phrase of wisdom, such as "analyze" or "be careful", took hours. These three ideas have been swimming in my head of things I seldom hear on buying a franchise that we need to hear from franchise consultants or their books.
Here are uncommon but critical points of franchise investing that I hope one day will be common sense.
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ROI: The first question is — How much EBITDA (profit) from a franchised unit can you expect if you were just average? What are the Years to Simple Payback (Avg unit investment/EBITDA) for a return on your investment? In short, you naturally want to know how much money you can make.
Some months ago, a franchisee who owned a children’s learning center, told me that she hadn’t made a single cent in profit in the seven years she had busily been in business, had no positive cash flow, nor had been able to even pay herself a salary. She had essentially volunteered her services free of charge. "I guess at least I contributed to the welfare of the many children in our community," she rationalized out loud as she contemplated how she could no longer support her money-pit of a school. With life savings long since depleted, she and her husband, with his years of former franchise experience in another sector, were forced to consider losing the last of their personal assets – their home and cars as they both reached their retirement years.
Such selfless acts of charity are best left for charity.
If a franchisor won’t give information out about store profits, he either doesn’t want to give it out or doesn’t know. Both are alarming. If the franchisor does not know what store level profits are, he cannot understand the impact of his business decisions to the store. How can a blind man to profits direct you on what business activities your store needs to do? If he says he wants to tell you what are the average store profits but is prohibited by law, then count your lucky stars. There is no such law. You’ve just caught him misleading you and can rule out investing in a store under that franchisor. Move on to the next brand. After all, you don’t want your business format franchise dictated in all its aspects by those who are dishonest or at best, just clueless.
RISK: What’s the chance of failure in this particular brand compared to competitors?
(Please, dear seller. No generic and bogus industry figures to support your lemon of a franchise brand because supposedly 90 percent of all franchises of every brand succeed versus 30 percent for independent stores. First, that’s not true and second it’s not even specific to a brand. Government and academic statistics say that although the store property may remain and be sold to someone else, the actual franchised business behind the four walls of the store fail at the same rate or even higher than independent ones. Start-up franchisors also have similar rates of failure for their own new franchising firm.)
ORGANIZATION: Franchise systems come in many different forms. First, how is the network structured and second, what is the power culture like for a franchisee? Is it despotic or collaborative? Is it built for slow learning or fast? Is knowledge passed top down or front lines up? Does the franchisor have many company-owned stores to learn for itself or do its managers have to pass on second-hand information from franchisee to franchisor employee back to another franchisee? Those are structural indications about how a franchise system is built to learn from the point where initiatives meet customer – the stores. A franchisor will learn better from its own multiple stores and having skin in the same game that franchises are in.Read more of The Franchise comic
Another question is what’s the power structure? In this network, would you be a North Korean citizen, who has the simple duty to put up, shut up and follow orders — or else? Having said that, despotic systems can provide a strong sense of order, comfort and security to its citizens. And dictators are tolerable if franchisees are comfortable. They are downright cuddly if franchisees see wealth. As long as their leader(s) can stay a step ahead of competitors, the system can thrive.
Or, can you participate in advisory councils, where franchisee lords and barons dish out advice to a franchisor king and his ministers — if they are in a good mood to take the suggestions.
Or, would you be the franchise equivalent of an American citizen in this brand, who votes on where the brand heads? When the collective wish of franchisees are not carried out, there is a changing of the chief and guards. The American, investor and business analyst in me likes that republican model because I think it makes me better. The system is better for it too. Hardware store, hotel and some quick service restaurant owners have a propensity for that franchisee cooperative model.
Categorize which company is the franchise equivalent of North Korea or America. North Korea isn’t set up like America. North Korean citizens may utter how happy they are under their benevolent leader when you visit. Likewise, almost all brands give lip service on how collaborative and wonderfully benign they are. Some might even show you some sort of paper on how satisfied their franchisees are. One place to look for reality is how the organization is actually set up and aligned structurally for franchisees and franchisor to collaborate.
Here’s one last item that I did not put in my uncommon list because many books and sellers already speak about it but I’d be remiss if I didn’t mention it.
LEGAL: How legally abusive is the contract, manual and unwritten word? Is there evidence of abuse? As a successful business owner, you’ll be in this business for years, likely seeing franchisor leaders and owners come and go. If new franchisor leaders decide to milk you, how much abuse could it legally give you? Could you get out or could it easily take your business for nothing and then sell it to another at a big profit?
Find a specialized franchise attorney on this. Don’t scrimp. It’s worth paying $5,000 or so to have a top-notch franchise attorney highlight the problems and then negotiate with a hard headed franchisor over a few important clauses. There are unscrupulous tricks in the franchise agreement crafting trade that you and a general business attorney would never have thought of. The franchisor’s initial posture in negotiating will likely be that the contract is a take it or leave it proposition. For most, that probably is the case. But in the future your family may be grateful that you hired a top legal expert to bring the contract slightly in your direction to protect your $300,000 investment. Do it.
This article was republished with permission from Blue MauMau.