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Franchise Buying Guide

Super Sleuthing

Doing your due diligence before buying a franchise involves some detective work. Here's how to uncover what you need to know.
Presented by Guidant Financial
Guidant Financial specializes in helping entrepreneurs purchase new franchises using their retirement funds.

When Chad and Rhone McCall relocated to Austin, Texas, in January 2007, they were looking for a business to buy. The couple, both 36, checked out existing enterprises before finding a franchise opportunity that provided services to senior citizens. Intrigued, they set out to unearth everything they could about two competing franchises with senior-care offerings. BrightStar Healthcare, a relatively new franchisor, had fewer than 30 franchisees--so the McCalls decided they were going to contact them all.

"We talked to all but one or two," says Chad. "The BrightStar franchisees were very interested in sharing the positive experiences they'd had with corporate. That was not the case with the other franchise, where franchisees were less happy and less willing to make themselves available to talk."

The deal was clinched after the McCalls attended both franchisors' "Discovery Days," where they met with managers at the companies' headquarters. At the BrightStar meeting, they visited the corporate office and spent half a day with a full-time salesperson calling actual customers and prospects. The process gave the McCalls a chance to immediately experience a typical day as franchise managers before making their decision. And they learned that their skills from past careers--investment and finance for Chad and health-care sales for Rhone--would be put to good use as BrightStar franchisees. The other franchisor offered no such hands-on opportunity.

The McCalls signed up for multiple territories and opened their first BrightStar franchise this month. And thanks to their extensive research process, they went into business armed with firsthand knowledge from BrightStar franchisees about every detail of their new business: what they could expect to gross, what their break-even point should be, likely real estate and labor costs, what support they could expect from the franchisor and, most important, how much revenue they needed to make a profit that would support them both.

Starting Point
Franchise experts say few franchisees do the type of sleuthing the McCalls did before signing up to own a franchise. Many give only a cursory look at the franchisor's disclosure document, the Uniform Franchise Offering Circular. (A new policy slated to go into effect this July calls for several updates to the document, including a new name: Franchise Disclosure Document. To read more about the proposed changes, check out "A UFOC Makeover.") That's a major oversight, as the UFOC offers key information, such as franchisor financials, lists of current and former franchisees, lawsuits, turnover rates, and in about a quarter of cases, earnings information.

"Often, [prospects] meet a lot of nice people at Discovery Day and say, 'Wow, they're great, they'll take care of me,' and boom, they're in," says Gordon Dupries, a franchise consultant and FranNet franchisee. Prospective franchisees who really want to find out about a franchise need to read its UFOC, ideally with the help of a franchise attorney. Remember, the UFOC represents the franchisor's point of view. The document should be used as a starting point to dig deeper and find out more from franchisees, vendors and customers of the franchise, says Lawrence "Doc" Cohen, past chairman of the International Franchise Association and a Great American Cookies franchisee.

Cohen advocates calling as many franchisees as possible--as well as former franchisees--and visiting several stores if the concept has a storefront. Says Cohen, "The key question [to ask] is, 'Knowing what you know today, would you buy it again?'"

Earnings, Part One: Comparing Apples With Apples
If earnings claims are made in the UFOC, Cohen says, they should be treated with skepticism. Remember, the claims are generally an average figure covering many different franchise types--ones with large and small formats, urban and suburban locations, longtime and new franchisees. What you really want to know is how a new franchisee of your type, and with your past experience, will fare.

That's what San Francisco-area couple Mark and Tina Hoenig set out to learn when they decided to relocate to Maui, Hawaii, in search of a better quality of life. Mark, 50, had a background in software sales, while Tina, 37, was an interior designer. When the pair zeroed in on a Puroclean water-damage repair franchise, Mark says he asked franchisees about their backgrounds to find people with sales and marketing expertise similar to his own. He learned that sales and marketing experience was often more advantageous than other factors such as age, contractor experience or an MBA. Says Mark, "I would talk to those [franchisees] who were like me and ask, 'What did you actually make the first year? [And] the second year?'"

Earnings, Part Two: Comparing Apples With Oranges
Mark compared several franchises in the field, learning that some were large and established with more than 1,000 franchisees, while Puroclean was newer and had fewer than 175 franchisees. The Hoenigs decided they preferred a more ground-floor opportunity. That way, it would be easier for them to introduce new technology.

Cross-comparing franchisors is an often-overlooked but important tool for finding the best franchise opportunity for your needs. Dayna Hess, 35, a franchisee of The Little Gym in Hasbrouck Heights, New Jersey, spent more than 18 months researching kids' gym franchisors and delving into several competitors' models before finally deciding on one she had loved when her daughter was enrolled in it.

A former sales and marketing executive, Hess says she found many differences--from required gym size to mandated color schemes--when comparing franchisors. She went beyond talking to franchisees and created her own cost estimates, researching the business as if she were opening it on her own. She looked into available retail spaces and rental rates, calculated labor costs, then estimated how many birthday parties she'd book and how many children she'd need to sign up to make a profit. When she opened her Little Gym franchise in 2006, Hess says, "I was dead-on with where I expected the numbers to be."

Dupries offers this tip for prospective franchisees looking to suss out costs: Ask the franchisor for a "vanilla shell" financial statement--a blank statement showing all the costs relevant to their business model. "Some people forget workers' comp costs or the water bill or transportation," he says. "So know what items are relevant."

Another way to get a quick rough estimate of franchisee sales is to extrapolate from the royalty income line of the franchisor's revenue statement included in the UFOC, says Mark Siebert, CEO of consulting firm iFranchise Group. If you know the royalty rate and the number of franchisees, and you can factor in the effect of departures and new sign-ups, then team with an experienced franchise accountant to get a back-of-the-envelope idea of average revenue.

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The author is an Entrepreneur contributor. The opinions expressed are those of the writer.

Carol Tice, a freelance writer, is chief executive of TiceWrites Inc. in Bainbridge Island, Wash. She blogs about freelance writing at Make a Living Writing. Email her at carol@caroltice.com.

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This article was originally published in the January 2008 print edition of Entrepreneur with the headline: Super Sleuthing.

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