Franchise Buying Guide

Now You're Cooking

Read the Labels
Presented by Guidant Financial
Guidant Financial specializes in helping entrepreneurs purchase new franchises using their retirement funds.

You have an advantage over most other investors. As a prospective franchisee, you'll receive a detailed, extensive report about the franchisor, the franchise being offered and the franchise system. This document is known as the Uniform Franchise Offering Circular, or UFOC.

The UFOC is one of the most detailed ingredient labels you'll ever come across. Like food packaging labels, the UFOC's format is established by federal law, and it's designed to deliver key information about the franchise investment. You'll find 23 items of information, all of which are important to your investment decision. If there's one piece of advice you shouldn't ignore, this is it: Read this document carefully. Sure, it may read like an insurance policy in places, but it's a treasure trove of details for alert investors. The good news: All UFOC documents must be written in plain English. No Latin phrases. No "hereinafters" or "whereinbefores." No run-on sentences only a lawyer could love.

Pay special attention to key UFOC sections that describe the franchise program. Some sections give you information about the franchisor, its financial standing and litigation background; some outline the franchise investment itself; and others fill you in on the network of existing franchise owners. Taking all three areas into consideration is crucial when making your investment decision.

1. The franchisor. Items 1, 2, 3 and 4 tell you who the franchisor is, how long it's been in business, its key executives' experience, its litigation or arbitration history, and whether there are any bankruptcies in its background. The key information here is the litigation background. If the company is involved in numerous lawsuits with its franchisees, find out why.

You also want to know about the financial stability of the franchisor. Item 21 requires a franchisor to attach three years of audited financial statements to the UFOC. This gives you a great snapshot of the franchisor's recent financial history. You want to know if this company is going to be around for the long haul; after all, your franchise agreement can run 20 years or longer. Its value as an investment is greatly diminished if the franchisor is on shaky financial ground.

The same can be said about the principal trademark licensed to you. Confirm in Item 13 whether the mark is federally registered with the U.S. Patent and Trademark Office and whether the franchisor will stand behind you if the mark is ever challenged by a third party. If the mark isn't federally registered or if you're not entirely comfortable with the legal obligations in the event of a challenge, talk to your attorney (an important advisor in this process) and know the legal risks going into the situation.

2. The franchise investment. Items 5 and 6 lay out the fees you must pay the franchisor. Usually, franchisees pay a substantial initial fee plus ongoing royalties expressed as a percentage of the business's gross sales. Initial fees typically range from $10,000 to $30,000, royalties from 3 to 6 percent. Look for other fees as well, such as a marketing or advertising fee, which adds approximately 1 to 2 percent to the monthly royalty payment. Item 6 lists other incidental fees, such as transfer fees, renewal fees, audit expenses and additional training fees.

Item 7 is very important in a successful franchise recipe. It presents, in chart form, the franchisor's best estimate of the total expenses involved in opening a franchise. Equipment costs are estimated, as are real estate and build-out cost ranges. Use this item to compare the real costs of the program to your budget. If you find a total investment range of $150,000 to $375,000, you'll know roughly how much you'll have to spend or raise if you want to get one of these franchise recipes off the stove and onto the table.

Other disclosure sections tell you about the restrictions placed on your product supply sources (Item 8), your obligations under the franchise agreement (Item 9), any franchisor financing programs available to franchisees (Item 10), and the franchisor's contractual obligations to provide services, training and assistance (Item 11).

If your first question is "How much money can I make with this franchise?" you'll find an answer (if the franchisor chooses to offer it) in Item 19. Most franchisors don't provide performance data. They leave it to would-be franchisees to make their own projections and assumptions about the potential of the business.

Anyone seriously considering buying a franchise should interview as many existing owners in the system as possible. You'll find a list of owners in Item 20. Ask them how their units perform and whether they're satisfied with the training program and their business's performance. Not only will this information provide an invaluable reality check, but it will also help you with your business planning and financial projections.

3. The network. Turn to the charts and lists shown in Item 20 for a systemwide snapshot of the franchise program. The charts are designed to reveal a three-year summary of the growth--or contraction--of the national franchise system and the franchisor's expansion plans during the coming 12 months.

Generally, two lists are attached to Item 20. The first is a list of existing owners, organized by state. The law requires merely that the franchisor list at least 100 franchisees in your state and adjacent states. Also attached to Item 20 is a list of the names, addresses and telephone numbers of franchisees who have left the system for any reason in the past year. Talk to these former franchise owners to find out why they left and whether it was related to shortcomings in the program.

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This article was originally published in the January 1999 print edition of Entrepreneur with the headline: Now You're Cooking.

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