Cheap Sheet

How Much Will You Make?

The most vexing part of research is finding business performance information. Any rational investor wants to know how much money he or she will make and how the franchise will perform financially. It's vexing because franchisors are restricted by law from providing any performance information (known as "earnings claims") unless it is disclosed formally in Item 19 of the UFOC. About two-thirds of all franchisors have no such disclosures and so, at least according to the rules of the game, give no earnings claims information. So where do you turn for answers to this vital question?

Your primary research source is franchisees. They aren't restricted in any way by the franchise laws and are free to share information with anyone. When you gather information from franchisees, note it carefully and use it as one factor when working with your accountant to prepare a conservative set of financial projections. Many factors affect how those numbers relate to your business performance.

Also ask your accountant to help you examine the franchisor's audited financial statements in the UFOC. Sometimes the presentation will break out royalty revenue from franchisees and may (if 100 percent is collected), with some simple math, give you an idea of the average franchisee's revenues.

If your franchisor is among the one-third of franchisors that provides earnings information, examine Item 19 and pay attention to the data qualifications and limitations discussed in the footnotes. There is always a wide range of performance levels in a franchise system-some locations are unbeatable, but some owners are fantastic managers and operators, and there are weaker locations and poorer performers among us all, franchisees included. Keep this in mind as you review the performance information in Item 19.

The action at the lower investment levels of franchising is white-hot, no question about it. Since the mid-1990s, the power of the PC has allowed many businesses to become homebased, dramatically lowering overhead and opening up a remarkable array of business franchise concepts that don't require the investment expense of a built-out retail location.

Even if it is a relatively low investment, you still need to take the time and spend the effort necessary to thoroughly research the opportunity. Read the UFOC, talk to current franchisees, call a few former franchisees, and ask tough questions. You'll form a clear picture of the company and its franchise program very quickly, and you'll be able to make the franchise investment with confidence.

For more information on low-cost franchises, visit Entrepreneur's FranchiseZone.

Franchises Are Your Friends

Your best sources of information are existing owners in a franchise system-talking to them is a must. A good approach and a sensitive discussion makes all the difference. Remember:

  • Owners are sympathetic. They immediately identify with you; they were in your shoes before they bought into the franchise. They want to help.
  • Respect the franchisee's time. Don't show up at lunchtime and try to get a restaurant supplier's attention, and don't expect to get a franchised magazine publisher's attention when an issue is approaching deadline. Make an appointment for a convenient time before or after a busy period when you can meet in person and have a focused discussion.
  • Ask about training value. In any franchise, training is a large part of what you pay for. With a low-cost franchise, you want to make sure the training is rock-solid. Ask current owners what they thought of the training and whether it equipped them well for operating the business.
  • Confirm franchisor support. Just because you haven't sunk half a million dollars into a franchise does not mean the franchisor should be weak on support. Ask owners if they think the franchisor has sufficient resources to provide the support franchisees need to be successful. Is there someone who's knowledgeable at the other end of the line when you need help?
  • Explore business success. An important question to ask when you're interviewing a franchisee is whether the business has been successful in the owner's eyes. It's all right to ask a business owner what his or her company's gross sales were in the past year. Then pop the ultimate question: "If you had the chance to do it over, would you invest in this franchise?"

Take Your Money and Run

Keep an eye out for these warning signs that the franchise system is not healthy or the program isn't working well for investors.

  • High turnover rate: Item 20 of the UFOC shows you the number of franchisees who have left the system in the past fiscal year, as well as their names and addresses. Is the turnover figure more than 20 percent? Ask why those people left: Did they sell their businesses for a tidy profit, or did they fail in the business and close their doors? Talk to several people who left. A high turn-over rate caused by business failure or franchisee unhappiness is a reason for concern.
  • An aggressive franchisor dispute resolution style: If the franchisor has a history of suing its franchisees to collect fees or enforce the terms of the franchise agreement, it will be revealed in Item 3 of the UFOC. When you see a large number of disclosed cases, ask the franchisor and franchisees what it means.
  • Disappointing franchisee reports: When you talk to franchisees, what do they say about their experiences with the program? If they are discouraged, not making money or mad at the franchisor for some reason, you need to understand the problem. Do not be quick to conclude that the same problems can't happen to you-they can.
  • Little or no track record: Some of the most promising low-cost franchise investments on the market are new and don't have much of a track record. That's not fatal, but it should alert you to an elevated risk.

Andrew A. Caffey is a franchise attorney in the Washington, DC, area; an internationally recognized specialist in franchise and business opportunity law; and former general counsel of the International Franchise Association.

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This article was originally published in the February 2005 print edition of Entrepreneur's StartUps with the headline: Cheap Sheet.

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