From the January 2007 issue of Entrepreneur

For specific how-to advice from franchise experts and more articles on researching a franchise, visit our Franchise Zone.

When San Francisco software salesman Andrew Lee decided to go into business for himself, he started digging. Interested in a personnel franchise, he called close to 40 franchisees at eight different concepts before choosing Express Personnel in November 2005.

The franchisees were a fountain of information, Lee says. Through them, he learned that a professional recruiting agency might be more difficult to resell than a temporary-employment firm.

By calling competing temp agencies in his city, he learned there was plenty of work to go around. He also heard complaints about unfair competition from chains with company-owned units.

"I tried to call until I found an unhappy franchisee at each company," says Lee, 41. "I couldn't find one at Express."

Unfortunately, franchise experts say stories like Lee's are rare. Too few prospective franchisees conduct even basic due diligence, much less beat the bushes like Lee did.

If you want to know more than the splashy brochures and franchise salespeople will tell you, then roll up your sleeves. You can use a variety of methods to dig deeper and get the real lowdown on a franchisor. The good news: Most of these techniques are cheap or free.

1. Mine franchisees. It seems like an obvious place to start, but few franchise prospects talk to franchisees, even though they're given names in the Uniform Franchise Offering Circular, says Michael Katz, president and CEO of Franchisee Consulting Group in Aurora, Colorado.

"It's a vital [step] that shockingly few people do," says Katz, who is also a franchise lawyer. "They're afraid to ask people questions. Or maybe they talked to one guy down the block."

When you do contact franchisees, choose carefully. Call some franchisees who weren't on the franchisor's recommended list, and if possible, get in touch with some former franchisees. You'll also want to call franchisees who operate in a market and format similar to yours.

When Laura Tanner, 50, was looking into opening a Tutoring Club franchise in Petaluma, California, she called many Bay Area franchisees because she knew they would also have high real estate costs and higher costs of living. Though few shared their financials with her, Tanner was encouraged to learn many were opening additional units.

One of the biggest problems prospects have when contacting franchisees is that they tend to shoot the breeze rather than firing off tough questions, says Mark Siebert, CEO of The iFranchise Group in Homewood, Illinois. Prospects should be extracting nitty-gritty details on revenue, customer counts, ramp-up times, franchisor support, and line-item costs such as labor, rent and supplies. With this data, you can create your own P&L projection.

Franchise attorney Bret Lowell of DLA Piper highly recommends visiting franchisees at their stores, a step many prospects skip. "You can get more information in person," he says. "And it's an opportunity to see the franchise in operation."

2. Dig in to the UFOC. The UFOC furnishes tons of franchisor details, but most prospective franchisees barely give this federally required disclosure document a glance. You should use the UFOC as a starting point for further investigation.

For instance, if the UFOC lists lawsuits against the company, a franchise attorney can usually obtain the actual lawsuit filings. Be aware that the UFOC's summaries of the suits were written by the franchisor, not an unbiased third party. Read the actual court documents to get a better sense of exactly who's suing and what they allege.

Be sure to ask management probing questions about any revenue or earnings figures found in the UFOC. The FTC's guide to evaluating franchise offers notes that such figures may be averages, which aren't necessarily representative of a typical store, or may have been calculated on a small store base rather than across the entire chain.

One thing few prospective franchisees do is obtain the UFOCs of several competitors in their category of interest. Comparing these side by side can reveal crucial differences in cost, royalty rates, marketing or corporate support.

Ramp Up Research

3. Ramp up research. It's easy to learn more about a franchisor and its management team by cruising the internet. For a small fee, you can check an online news database such as LexisNexis for articles written about the company or its managers. You may find past troubles that have been airbrushed out of a manager's resume, or company missteps that a local paper wrote up.

While researching Tutoring Club, Tanner learned through a quick online search that some competing concepts had higher startup costs and required bigger store sites. Her total opening costs were about $100,000.

A word of caution: Be sure to take what you find online with a grain of salt and verify what you learn because many sites, blogs and chat forums have no editors.

Also, business research companies may be helpful in vetting a franchisor. Tanner obtained a positive report on her franchisor from respected research firm D&B before moving forward.

Other good sources for a company reputation check include local Better Business Bureaus and state attorneys general, particularly in the 14 U.S. states that regulate franchising (California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin).

4. Meet the management. Most prospects don't ask enough hard questions of franchisor managers, says Joe Mathews, co-author of Street Smart Franchising. Prospects should walk away from headquarters with a clear sense of just what the company will do for franchisees--and what it won't.

"Ask, 'Who's going to be supporting me?'" Mathews says. "How long have they been here? Will it be a highly skilled business consultant...

or a 23-year-old kid who doesn't know anything?"

To find out how straight management is being with you, franchise consultant Hannibal Myers, owner and president of Atlanta-based H3 Consulting LLC, recommends this litmus test: Ask if they'd be willing to let you out of your franchise contract if you're unhappy. "If they say, 'Oh, sure, that's no problem. We want everybody to be happy here,' they're lying," he says. "They'll tell you anything to get you to sign." Myers looks instead for franchisors that offer extra help to franchisees in trouble, and sales assistance if a franchisee wants out.

Taco Del Mar franchisee Fred Vosloh took an unusual step in getting to know management at the company: Vosloh, 40, first took a job with the Seattle fast-casual, fresh-Mex food chain.

Working at Taco Del Mar headquarters in franchise sales gave Vosloh an up-close look at how the 230-store chain operates. He also got to talk to hundreds of franchisees in other fast-food chains as the company trolled for new prospects, giving him a sense of how Taco Del Mar stacked up against the competition.

Vosloh liked what he saw and purchased a large Taco Del Mar territory in the Gulf Coast with business partner Scott Redlich. They opened their first store in Mississippi in September 2006.

5. Know the market. Most prospective franchisees don't do enough market research to understand how the franchise they're considering fits into the competitive picture, says Siebert. It's essential to learn about current players in the sector, their expansion plans and how many new competitors might be circling.

"Most franchisees aren't thinking about how the market is going to change," Siebert says.

Market research steered Dave Demers of Atlanta to a Five Guys Famous Burgers and Fries franchise. Demers, 48, considered and then rejected the idea of a pizza chain, concluding his market was oversaturated. Less crowded, however, was the upscale-burger niche. After examining several burger entrants, Demers concluded that Five Guys--a perennial Washington, DC, best-burger winner with more than 100 stores--was an affordable ground-floor opportunity in the sector.

Demers' research indicated that burgers would have better repeat-customer patterns than pizza in his market, too. He opened the first Atlanta-market store in the fashionable Buckhead neighborhood last September. Says Demers, "I believe this will have staying power."

6. Get advice. Many franchisees cut their research time by using a broker or consultant who has already researched many franchises. But be aware that few consultants work with every franchise out there. Lee says he worked with several brokers, including Gordon Dupries in San Rafael, California, to get exposure to a broader range of franchise options.

Tanner, on the other hand, ran her franchisor's financials by an SBA accountant, who gave them the thumbs up.

"Hire a good advisor; go to SCORE; find someone with a big-picture view," Siebert advises.

There's no substitute for having an accountant review your franchisor's financial projections, or having an experienced franchise attorney look over the UFOC and franchise agreement. Siebert says spending money on such expertise is well worth it.

"Most franchisees don't know a liquidated-damage clause from a hole in the ground," he says. "They can't make an informed decision. They should hire an attorney to tear the UFOC to shreds."

7. Beat the tom-toms. Many people interact with a franchisor other than the franchisees. These include vendors, corporate store managers, competitors, local media and, of course, customers. All may prove to be good information sources.

Many are easy to find, too. For instance, you can interview customers in stores or read their often-unvarnished opinions online at www.epinions.com and other customer-feedback sites. Talking to an enthusiastic Tutoring Club customer clinched Tanner's decision.

Demers talked to Five Guys' vendors to find out how the company treated suppliers. "I learned they have a very good reputation," he says.

There's no question that doing this much due diligence is a major time investment. Before choosing Express Personnel, Lee worked at researching franchisors full time for weeks. But he says the payoff--knowing he'd gotten a complete picture of his franchisor--was definitely worth all the hard work.

"I had a lot of people tell me I was doing an unusually rigorous evaluation," he says. "But what would you expect? I'm putting my life savings on the line."

Steps

3 Keys to Finding a Great Franchise

  • By all means, use the internet to gather information, but be a smart franchise consumer and see past the hype. Throughout this process, you must be prepared to ask tough questions. A couple of good resources to help you get started are the FTC's Consumer Guide to Buying a Franchise and the International Franchise Association publication Investigate Before Investing by Lewis G. Rudnick and H. Bret Lowell (go to www.franchise.org and click on "Books and Publications").
  • Attend a franchise and business opportunity trade show. Shows come through most cities during the course of the year, and there's nothing quite like seeing the franchise marketplace in person. Before you go, find out which companies will be showing, dig out some basic information online about the ones that catch your eye and plan on visiting with them. Dress in business-casual attire, leave a personal business card with the representatives of programs that look promising, and encourage them to send you follow-up information.
  • Part of choosing a franchise is knowing what you like and what you can afford. Write down your ideas for the kind of business you'd like to be involved in, and go over them with an advisor. Do your homework: Talk to family members, a good banker and an accountant with experience representing franchises. Everyone's situation is different; what kind of resources do you have? Don't waste your time kicking the tires of a business that requires a $600,000 investment if that's simply out of your financial neighborhood.

Red Flags, Green Flags

  • Red Flag: You heard a pitch for a new business, and after 10 minutes, you just knew this was it-the perfect business for you. It may ultimately turn out to be the business for you, but you can't allow yourself to be pulled in by one sales pitch. There is no love-at-first-sight when selecting a franchise.
  • Green Flag: You've visited a good selection of current franchisees, and they've given you favorable information about the franchise. Key questions to ask them: Was the training valuable? Do you enjoy the work? What are the strengths and weaknesses of the business? What were your gross sales last year? And the clincher: If you had it to do over, would you buy this franchise again?
  • Red Flag: You've called on franchisees in the system, and they've uniformly told you the franchise is the biggest mistake they've ever made. They've even tried to dissuade you from it. The franchisees know the qualities of the franchise business better than anyone, and you should consider their independent views on the program. Always value the view from the trenches, especially if you're thinking about jumping into the trenches yourself.
  • Green Flag: You've taken the franchisor financial statements included in the UFOC to an advisor, such as an accountant, and taken the franchise agreement to a good legal advisor, and they've both given you the go-ahead.

Dos and Don'ts of Closing the Deal
Do take your UFOC to an accountant and a legal advisor for review. It may seem like an unnecessary expense, but in a franchise transaction, these advisors will pay for themselves many times over.

Do think about the changes you and your attorney want to see in the franchise agreement. Prepare a short list of suggested changes or questions, and plan to discuss them with a decision-maker at the company. Most franchisors will at least consider your changes, and if your concerns are serious and important, they may offer an amendment or written comments of clarification. Some franchisors will simply tell you they won't make any changes to the contract-that it's a take-it-or-leave-it proposition. As a general rule, I've found that the younger the franchise program, the more willing it is to negotiate on the franchise agreement. It's the marketplace at work-younger companies are usually more eager to address your concerns and sell you a franchise.

Don't put off thinking about a location for your business. Even if you'll be running the business from a home office, think about the equipment you need and other demands on the home office. If you need to find a retail location, it's never too early to start that process. You may even want to complete your market research on a few locations before you commit to the franchise.

Don't close on the franchise transaction assuming that anyone is looking out for your interests just because others have been through the well-packaged process. It ain't so. Have a lawyer in your corner to make sure the document is in good order for your interests.

Don't overextend on the territory purchase. It's natural to want to secure as much territory as possible when buying a franchise, but it can quickly pull you into a debt struggle. One of my client's franchisees recently bought four territories (against the recommendation of the franchisor) because she wanted to own the entire city market, and she and her partner put down a large initial fee. They planned on an SBA-backed loan that didn't come through and quickly ran short of operating capital, jeopardizing their entire investment.

Are They Up in Arms?
Ideally, the relationship between franchisees and their franchisor should resemble a happy marriage. But lately, relations at some of the nation's biggest food-service franchises have been on the rocks.

Dairy Queen, Quiznos and Subway are among the well-known fast-food brands where franchisees have sued their franchisor in the past year. Complaints range from unreasonable requirements to deceptive recruiting to advertising squabbles.

Keep in mind while you're doing your research: Lawsuits will be listed in the UFOC, but they may not be up-to-date. And many franchisee battles are handled through negotiation, which means they can fly under the radar and may not be listed in the UFOC.

So how can you find out if there's a revolt brewing? You can call dozens of franchisees, or try a faster way: Look for a franchisee trade association. These kinds of associations are a growing trend, with the American Franchisee Association counting 15,000 members from a wide variety of franchise types.

The internet offers a wealth of ready information on franchisee gripes. For instance, details of the Dairy Queen franchisees' July 2006 lawsuit can be found at www.dqoa-dqoc.com. An August post contains 20 pages of letters between the Dairy Queen Operators' Association and the franchisor, International Dairy Queen.

Unhappy UPS Store franchisees state their case at www.thebrownboard.com, the site for The Brown Board Owner's Association. Postings include a chat forum, a store-owner survey and even letters from franchisees who oppose the Brown Board's viewpoint. The association has nearly 2,000 members.

Anyone wondering what has some Quiznos franchisees steamed can visit www.toastedsubs.info. The site lists previous and current lawsuits, offers six years of corporate-advertising expenditure reports, and has figures for how many planned new Quiznos stores fail to open within 12 months. There's also an information page aimed at prospective Quiznos franchisees.

It's crucial to learn upfront if franchisees are on the warpath, says C. Everett Wallace, co-founder of the National Minority Franchise Initiative in Durham, North Carolina. "It may be a great brand," he says, "but you really want to find this information out before you sign on."

Of course, you'll want to run anything you discover online about a franchisor back by the company's management, both to hear their side of the story and to verify accuracy.

Carol Tice is Entrepreneur's "Tax Talk" columnist.