Buying A Franchise Business – The Good, The Bad, The Ugly!

Once Ray Kroc figured out how to duplicate the success of one single hamburger stand, the franchise concept changed small business forever. Franchising has provided countless entrepreneurs with the ability to achieve their dreams of business ownership. It has also changed the way we conduct our daily lives. I once heard that a new franchise opens up every eight minutes in America and franchising is exploding internationally. Take a look around next time you’re in the car; and you’ll realize how significantly franchising has impacted our economy. This is especially true as we have shifted from a manufacturing base to a service economy.

As you can imagine, whenever there is an uptick in a certain market segment, there’s always pros and cons associated with it, and the usual con artists who somehow manage to take advantage of a burgeoning situation. There are horror stories about naïve people losing their investments, false and misleading representations being made by franchisors, and the other usual nonsense. On the whole however; past wrongs have been addressed and the government has done a semi-reasonable job of cleaning up and monitoring the franchise industry. So too has the franchise industry itself.

Personally, I’m a big fan of franchises for the right individual. Notwithstanding this, there are several factors you must consider before jumping head first into one. Your success is definitely NOT guaranteed when buying a franchise; not even close!

The Good

I love the franchise concept. In fact, if done right, the very core behind franchising can be a tremendous strategy to employ in any business, even if there’s no desire to open up additional locations. The heart of franchising is to follow a proven recipe, to put policies, procedures, marketing strategies and systems in place that can be duplicated in additional locations and will allow a broad range of people to operate the business successfully. The foundation to the model itself is the philosophy that when the business plan is implemented and followed, it will produce results.

Perhaps the best part of franchising for the prospective franchisee is that you can evaluate other franchise locations under the same banner to determine how they are performing. As such, a good part of your research and due diligence can be done on similar businesses and this is a huge advantage compared to buying a non franchised business. You can speak to other franchisees and ask them:

• If you had to do it over again, would you make the same decision?
• Did you buy your franchise from the franchisor or was it a resale?
• Does the franchisor appear to have adequate funding to continue to expand and support the franchisees?
• Has the franchise met the expectations that you were promised or had hoped for?
• How effective and frequent is the training?
• Do they train management and employees?
• How frequently do they visit your premises?
• How quickly do they respond to inquiries?
• Did the franchisor help you with financing?
• How thoroughly did the franchisor investigate you? Not that you have anything to hide; rather, wouldn’t you feel more confident knowing that they have rigid guidelines in who they sell franchises to? This ensures that their brand will be protected and cherished. In other words, are their criteria for selling you as strict as your guidelines for buying from them?
• How supportive are they with advertising materials, systems, marketing, etc.?
• Would you encourage others to buy this franchise?
• Is the business profitable?
• What is the single most important thing that drives the business (i.e. advertising, location, marketing, product, customer base, customer service)?
• What is the biggest complaint you have about the business and the franchisor?
• If the master franchisor has delivered on all of the promises that they made in their sales materials, how sales are trending, what they would do differently, how easily additional locations can be opened, etc.

The big pitch made by franchisors is that when buying a new franchise, you “should” have far less potential downside than other business ventures; especially a raw start up. Because their business model has been tested elsewhere, you may avoid the usual start up obstacles.

Sounds good so far?

The Bad

Franchisors will not guarantee your results. I have found that some of the slickest salespeople work in this industry.  They will paint a beautiful picture for you: they will show you demographic studies that state: IF the traffic patterns and buying habits prove right, IF you follow the prescribed formulas, IF other franchisee results are duplicated, and IF you don’t try anything new, then you can possibly, probably, and potentially, be successful. Pretty non committal isn’t it?

Personally, I view new franchises as being one rung above a start-up. In fact, the only difference is they have a formula that has proven to enjoy some degree of success elsewhere. By no means does this assure your location of achieving similar results.

A new franchise is a model. The upside is limited. You will not become a millionaire owning one outlet. On this note, you have the courage and entrepreneurial fire inside, then you may want to consider one that has far fewer existing franchisees. If the franchise itself is not mature, you may be able to negotiate better terms in the agreement, a larger territory, and concessions on the franchisee fee, extra marketing funds, and the ability to open up additional locations. This is the only way for you to truly make a lot of money as a franchisee.

You also need to consider your personality. Franchises are good for those who may lack experience or confidence operating a business. Above all, you must be the type that can take orders because the franchisor dictates how you run the business. You must be willing to follow guidelines that put the franchise brand and not your own interests first. This is the only way that a franchise can be successful on a mass scale. The brand must always be protected and enhanced.

The Ugly

One of the biggest concerns you need to address is how the franchisor can impact your business. Unlike the old days when franchisees could negotiate huge territories, today, an established franchise will attempt to severely limit any exclusivity or territory size. As such, they can actually become your competitor if they open up other locations that impede upon your client base. While you may get some protection, do not expect it to be broad. On the other hand, with a new concept, you may have some negotiating room, but here the downside is that the concept itself is less proven.

Prior to July 2008, a franchisor would provide the prospect with a Uniform Franchise Offering Circular (UFOC). That has now changed to a Franchise Disclosure Document (FDD) which is a better document in general, but by no means is it bulletproof. The FDD must be provided to prospective franchisees before any money changes hands, and it forms the basis of your agreement with the franchisor. All franchisors must provide you with this document. There are strict rules about what can and cannot be claimed, and before signing a franchise agreement you should have the FDD and any franchise agreement reviewed by a competent and experienced franchise attorney. Get a specialist in the field.

The franchise agreement can have stringent rules that may come back to haunt you. Some have clauses that bind you to a guaranteed royalty amount based upon the length of the deal. As an example, if you’re on the hook for $100,000 in franchise fees over the next ten years, and decide to sell the business after five, but your total fees paid at that point are $60,000, you may be on the hook for the other $40,000.

Or, you may be restricted from selling the business, a transfer fee may be involved, the franchisor may have the right of first refusal to buy it, certain penalties can hurt you if you do not follow all of the rules of the agreement. And so you must read, and fully understand what you’re agreeing to and get professional input.
In any event, the lesson is simple: engage competent counsel to assist you.

It’s Ultimately Up To You

Just like anything else, there’s good, bad (and ugly) in the franchise world. Naturally, you have to do extensive research, but in the end, the decision has to fall to you. As you meet with franchisees, pay attention to the individual and not just their story. I have found that many franchisees go into these with an attitude that it’s a money machine and that is not the case. Yes, there is a formula in place and yes, certain processes have been tested elsewhere, but that does not mean you can just sit back and the money will roll in. A business, regardless if it’s a franchise or not needs to be worked! If you do not pay attention to it, chances are it will disappear.

The Suggestion

Obviously, the franchise industry would not exist if it were all bad. Clearly, there are some wonderful opportunities to get into a franchise business and for the right individual; they can present the ideal scenario. That being said, I fundamentally believe that you should buy a franchise resale versus a new location whenever possible.

A franchise resale offers you the opportunity of marrying these best of a franchise with all the benefits of an existing business.

• You can access the true historical data of an ongoing enterprise with a track record to back up its asking price.
• You won’t have to deal with the hassles of building a new location, which is an exercise in frustration on its own.
• Everything is in place, including inventory, customers and suppliers, so you will be operational very quickly. (By the way, it can take up to one year from the time you purchase a new franchise until you open your doors for business.)

A resale allows you to eliminate the guesswork that comes with trying to predict how a new franchise will perform.

You will of course have to be approved by the franchisor, and may face some prior contractual issues, but as long as you’re a good candidate, you will be approved. You should review the current franchise agreement in place to understand the ramifications of a sale. You may need to sign a new agreement altogether as opposed to having a simple transfer of the existing one. Once again, have it reviewed.

If you want to pursue a franchise resale, be sure to get a copy of our guide on buying a business which covers franchise resales extensively. You can learn more by visiting www.diomo.com

Comments

[David E]

I have a more negative view of franchises, having met with countless franchisees and business owners first-hand. I used to be in the commercial property management business, acting on behalf of the landlord to collect rent, triple-net (CAM) expenses, dealing with leasehold improvements and build-outs, etc, etc. Almost all of them answered your first question, regarding if they had to do it over again, negatively. The franchise fees killed their return on investment, and they all felt they were not getting their money's worth. The sole exception was owners of McDonald's. I have also witnessed a few franchise owners wanting to sell out upon retirement, and their efforts hampered by the franchise companies, who changed their eligibility criterion for new buyers--one of them requiring $1,000,000 in verifiable liquid assets--making retirement for the seller nearly impossible. This is a veiled attempt at the franchise company wanting to take over the business of the franchisee, and taking an unfair advantage of the situation by artificially lowering the market value of the business, thereby acquiring the business for next to nothing.

[The Franchise King]

Richard, You have written the most complete article on franchising that I have seen in a long time.

Thank you for adding value to our industry!

The Franchise King

[Selling a Business]

Very thorough article. I think that a lot of buyer only see 'the good' when approaching the franchise situation, it's good to keep a balanced perspective. Thanks.

[Buying a franchise business]

Great article, Buying a franchise business is simple. But what is not simple is choosing the right kind of franchise business. Before buying a franchise business, you must first make sure you clearly understand the dynamics of the franchise business, what a franchise business really is, and how it works.

[Business Opportunities]

Good job. This is a veiled attempt at the franchise company wanting to take over the business of the franchisee.

[Jon Franz]

Thanks for a great article Richard! I agree with your comment, "I fundamentally believe that you should buy a franchise resale versus a new location whenever possible".
GoingFranchise.com