From the October 1997 issue of Startups

Franchising is big business, and there are thousands of different franchises from which to choose. "Franchising is responsible for 40 percent of all retail sales in the United States," says Mark Siebert, president of Francorp Inc., an Olympia Fields, Illinois-based franchise management consulting firm.

In recent years, there has also been a proliferation of low-investment franchises that appeal to entrepreneurs who are either on a tight budget or are trying to minimize their risk. These types of franchises usually require start-up investments of anywhere from $5,000 to $20,000 and include opportunities from auto check-up services and direct-mail advertising to house-sitting services and video photography.

In fact, the most difficult part of buying a franchise may be selecting one. Once you've done some research, it's a fairly simple task to analyze a franchise and make a decision. But selecting one that will be of interest to you and meet all your criteria is a difficult task.

First of all, you need to recognize your strengths and weaknesses from both a personal and professional standpoint so you can determine what type of business you want to own and operate.

After you've listed all your goals and objectives, your next order of business is to investigate your options. What types of franchises are on the market that will enable you to fulfill those objectives? Which franchise concepts and categories are currently growing at a healthy rate?

Analyzing the Franchise

Once you've selected a franchise, the next step is to analyze it thoroughly to determine whether it is really worth buying. This can be done in several steps, beginning with contacting the franchisor and requesting its Uniform Franchise Offering Circular (UFOC) and its franchise agreement to find out more about the franchise's inner workings. State and federal laws require that the franchisor give you these documents at least 10 days before taking your deposit and signing you on as a franchisee.

The UFOC contains 23 standard items that disclose information regarding the franchise. Keep in mind, however, that the UFOC is merely a starting point. In order to protect yourself, thoroughly investigate the information in the UFOC. Before ever sitting down with the franchisor or any current franchisees, you should examine the information in these documents carefully, preferably with legal as well as financial counseling. Don't allow yourself a false sense of comfort because the documents appear to comply with the Federal Trade Commission rules or various state filing requirements. Most of those regulations only require the franchisor to make complete and full disclosure of specific types of information in the document. As long as the disclosure is made in the proper manner, the franchisor can draft the terms and conditions of its franchise and its obligations to you as a franchisee in almost any manner it wishes.

Interviews with the Franchisor

Once you've received all the documents from the franchisor, you will enter a preliminary negotiation stage before you sign. This is the most critical period in your dealings with the franchisor. At this point, you'll meet a representative of the franchisor in order to evaluate the franchise package. This provides an opportunity for both you and the franchisor to form first impressions and determine whether negotiations will proceed any further.

The representative of the franchisor may be one of three people: the franchise owner or company president, an in-house salesperson or a franchise broker (an outside salesperson retained by the franchisor to act as a representative). No matter which one of these people you meet, he or she will want to know more specific information about you, including your financial status, your business experience and your general background. If the franchisor doesn't ask these questions or show any interest in your previous background, that should be a danger signal to you. When they do ask you questions regarding these topics, however, don't feel they are prying into your personal life. They aren't. They are just protecting their interests.

Be prepared with questions of your own about the company. You might even want to have your attorney present or have your attorney highlight areas of the franchise agreement and UFOC that should be questioned. Don't leave until you've been supplied with all the information you need. This could take anywhere from a few hours to all day. The primary goal here is to satisfy all your doubts so that you feel comfortable with the data supplied by the franchisor.

Throughout your meeting with the franchisor, you'll be discussing specific subjects that will affect your decision to purchase a franchise. Those subjects will be covered in both verbal and written form. Take notes and, after the meeting, date those notes, detailing who gave you the information, their title and so on. Do this with any phone conversations you have with the franchisor as well. This will help you in the future, should any problems develop.

During your interview, concentrate on some key areas that will help you determine the strength of the franchise. Here are some important questions to ask:

1. What are the pretax net profits of existing operations? Compare this figure against the earnings statement that the franchisor has already supplied you.

2. What, specifically, is included in the training program, field assistance, store design, facility construction, site selection and feasibility studies?

3. How will the initial franchise fees and investment be segmented?

4. Will there be additional working capital required after the initial fee and investment and, if so, how much?

5. How will the franchisor arrange for the supply of product to the business? Ask to see a current price sheet.

6. What, exactly, are the territorial restrictions and protections?

7. How many franchises have been sold to investors in the state you will be operating in during the last twelve months, and how many have opened a franchised business in that time?

8. Does the company have any plans for further expansion in the state? Has it identified any locations it plans to develop?

9. Will the franchisor allow you to see the operating books and records of the business for the past two years?

10. What type of support will the franchisor provide once your franchise has opened its doors?

11. Have any franchisees been terminated? If some have, ask the franchisor to detail the reasons. Have any franchisees failed or gone bankrupt?

12. What kind of financing is available from the franchisor, if any?

13. Are there are any lawsuits pending against the franchisor? Have them elaborate on any past judgments.

14. How are disputes between the franchisor and franchisees settled?

15. Will the franchisor assist in site selection? It will be of enormous help if it does. Regardless of whether it does or not, do your own demographic study so you're familiar with the profile of the audience within the market area.

During your interview, keep these points in mind:

  • Don't be afraid to ask questions. And don't be afraid that you'll appear foolish, because very few people understand the franchise agreement or the UFOC in full. Primarily, you're trying to pinpoint any problems that may exist in a franchise.
  • If you run across a franchisor who is reluctant to pass along a list of current franchisees, makes promises of earning a fortune on a limited amount of money invested, insists on deposits for holding a franchise unit, tries to convince you to sign before someone else does or is full of empty rhetoric when answering your questions, head for the door. These franchisors are probably trying to cheat you out of your money.
  • Cross-check all the information supplied. Are the franchisor's claims backed by performance? Are the advertising claims applicable at the store level? Are the profitability claims justified? You can check this information by contacting as many franchisees as possible.

Interviews with Franchisees

Some franchisees will be very supportive; after all, they were once in your shoes. However, some people may feel their business is none of yours. This could also be a danger signal. If a franchisee doesn't want to talk to you, that might be an indication that the franchise isn't doing nearly as well as expected.

Do all you can to convince franchisees to talk to you. Stress that the conversation will be kept confidential and be as candid as possible to establish a good rapport. Remember, franchisees aren't required to provide any information. The more amiable and upfront you are with them, the better your chances of obtaining information. However, if a franchisee continues to be uncooperative, just move on to the next franchisee. Someone else will surely talk to you.

Ask the franchisees questions that will let you know whether or not the franchisor has been upfront with you. Here are a few questions that work well:

1. Is the franchisee happy with their investment, the support from the franchisor and ease of entry into the business?

2. If a second franchise became available in their market area, would they purchase it?

3. Were they well-trained for the challenges of the business?

4. What are their income and expense figures? Compare them against the sample earnings statement provided by the franchisor. Find out if they have any cash-flow problems.

5. What are sales patterns like? Are they seasonal? Ask them to describe the busy season.

6. What type of ongoing assistance have they received from the franchisor?

7. Are their advertising fees reflected in the marketing support (for example, co-op advertising) received?

8. Are the franchise and royalty fees fair and competitive with other franchises in the same industry?

9. Is local market penetration in line with national figures?

10. Were equipment, signage, logos and the like provided for free, or at an additional cost?

11. Were there any hidden costs?

12. What degree of autonomy are franchisees allowed? How tightly regulated are they by the franchisor?

13. Is there a franchise owners' association? Are there any disputes that are the subject of discussion among franchisees?

14. What are the actual costs of the products, and are they competitive in the marketplace?

15. Have they had any problems with product supply?

16. Do they have any complaints about the franchisor?

17. What were their initial start-up costs? What major hurdles did they experience during the first few months of start-up? How did they finance the business?

18. How long have they been a franchisee and will they renew?

19. Have franchisees encountered clauses in the franchise agreement that have caused them problems?

20. How long are their workdays and do they take vacations?

You'll gain much invaluable information from franchisees, but don't stop there. You should also check out all the bank references the franchisor supplies to determine the solidity of its financial situation. Run a credit check on the company. Check out any references supplied by the franchisor. Call the Better Business Bureau to find out if any complaints have been lodged against the company. Have Dun & Bradstreet deliver a status report on the firm through its subscriber service.

After you've completed a thorough evaluation of the franchisor, you can make a truly informed decision and enter serious negotiations. Remember that you can negotiate items within the franchise agreement. That's why you've gone through a complete analysis of the company. Finally, when negotiating with the franchisor, make sure your attorney is present.

New Biz On The Block

Buying a new franchise is a bold endeavor that requires a certain kind of personality; If you're a risk taker with a drive to create and a "vision" of what you want your business to become, then purchasing a new franchise may be the way to go, according to Andrew A. Caffey, a franchise attorney and former general counsel of the International Franchise Association.

Getting in early gives you the opportunity to truly shape the future of the franchise and to reap the financial rewards of success. A creative person with lots of ideas can innovate and improve the original business concept (within the parameters of the franchise agreement, of course) to make it even more profitable. Your ideas will become the basis for the handbooks and guidelines that will shepherd future franchisees. Unfortunately, because you're essentially helping to write the rules as you go along, you'll receive less guidance and training from the franchisor than the purchaser of a more established franchise would. Caffey points out that, in this way, buying a new franchise is a bit like building a machine from scratch. "When you build it yourself," Caffey says, "you know just about everything there is to know about that machine."

In fact, you'll probably get to know more than any manual or training video could have ever taught you-but you might have to learn it the hard way. In Caffey's experience, quality training is one of the most important features of successful franchises. Although some new franchise systems may provide outstanding training to their franchisees, many will not have the resources to do so. Caffey warns that lack of training must be weighed among the other risk factors involved in purchasing a new franchise.

Prepare yourself for what lies ahead by investigating every aspect of the franchise before you buy. Talk to as many other franchisees as you can about their experiences, even if there have only been a few before you. "Read the UFOC very carefully, and ask questions about anything you don't understand," Caffey says. "Pay special attention to Item 11, which details the training offered, and Item 19, which provides information about the company's earnings. Any absent or unclear information should prompt you to dig a little deeper and ask for more documentation or explanation." Purchasing a franchise whose concept has not yet been fully tested is risky business, but the rewards-should the franchise succeed-make this risk worthwhile for some adventurous souls.

Contact Sources

Andrew A. Caffey, 3 Bethesda Metro Ctr., #300, Bethesda, MD 20814

Reprinted with permission from Entrepreneur Magazine's Guide To Buying A Franchise, Business Guide 1807. To order, call (800) 421-2300.