Franchising is the most successful device for small-business ownership ever invented. One person invests his or her own capital and builds a retail concept using the trademark and proven business systems of the franchisor, all while tapping the power of group purchasing and advertising. This uniquely American concept is now being exported to the far reaches of the globe--McDonald's recently announced that in the first six months of 1999, it opened 523 restaurants outside the United States and that its restaurant in Gibraltar marked 117 countries now spanned by the Golden Arches. Truly, there's no end in sight. Franchising is minting new millionaires both in the United States and abroad at an unprecedented clip.
The franchise method of distribution has been adopted in virtually every category of small business you can imagine. What started with the great American hamburger is now found in service industries throughout the booming economy.
How can you get in on the action? Buying a franchise is a complicated investment, every bit as challenging as starting an independent business. With a franchise, though, you have the benefit of receiving training and assistance from an experienced organization that has gone through the process many times before.
The first step is to recognize there is an information challenge. There's no way around it--buying a franchise takes research.
Andrew A. Caffey is an attorney in the Washington, DC, area, and an internationally recognized specialist in franchise and business opportunity law. You can reach him at email@example.com
The Entrepreneur Meets The Library
We Americans have several factors working against us as we approach franchise investment decisions. We tend to be trusting, relatively wealthy and pressed for time--and that's a dangerous combination. To protect ourselves when buying a franchise, we need to exhibit patience, skepticism . . . and the research skills of a librarian.
The first step is to assess your own skills--the talents you bring to your work--and think about the type of business that would best capitalize on those skills. If you love being around people, consider a retail operation, like a restaurant, that rewards strong people skills. If you're most comfortable around corporate offices (perhaps you've had a long career in big business), then consider a business-to-business services franchise. If you enjoy mind-melding with a machine, look for a franchise in computer repair or automobile services. Go with your strengths; doing so can determine your success in business.
You should also consider your financial resources in great detail. You can bet they'll be tested when you start any business, regardless of whether you buy a franchise. Look beyond your personal bank account and retirement savings; consider what kind of support you might draw from family and friends. If your rich Aunt Mildred once told you to go into business for yourself, now is the time to talk to her about investing in your future. Be prepared to offer Aunt Mildred what any investor is looking for in return for cash: a promissory note with a definite payback period and a stated rate of return and/or an ownership interest in the business.
Early in your planning, you should meet with an accountant who has experience representing small-business owners. Rely on his or her expertise in matters related to raising money, promissory notes and the like. A good accountant can also prepare a detailed projection of your business finances, enabling you to identify your break-even points and the amount of cash you need to start and run the franchise.
Expect a flurry of paper when you begin your investigation of a franchise purchase. Set up file folders early on to help you keep the information organized and easy to retrieve.
For each company you evaluate, create folders labeled as follows: "Promotional Materials," "Notes On Meetings & Phone Calls," "Correspondence," "Franchisee Interviews," "UFOC," "Contracts" and "Miscellaneous."
Be disciplined when these materials are created or sent to you or when you return from a business meeting or trade show. Immediately drop the papers in the appropriate files, and keep them organized. If you don't, the pile of papers will overwhelm you.
You're now ready to begin contacting franchisors. Attend a trade show, do some franchise shopping on the Internet and write to companies with franchise programs that peak your interest.
Unidentified Flying Circulars
You're offered a tremendous advantage as a prospective franchisee. Franchising law requires all U.S. franchisors to deliver a UFOC to prospective franchisees, at either the first personal sales meeting or at least 10 business days before a contract is signed or money changes hands, whichever comes first. This prospectus is a sandwich of three separate documents: a sample franchise agreement; three years' audited financial statements of the franchisor; and a 23-item narrative describing the franchisor, the franchise system and the franchise offered.
Here are some of the key program descriptions in the UFOC:
- The franchisor's background, the experience of key executives and the company's litigation and bankruptcy history (Items 1 through 4)
- All the fees charged by the franchisor (Items 5 and 6)
- An estimate of total investment in establishing the business (Item 7)
- Restrictions on the purchase of products to be used and sold in the unit (Item 8)
- Financing that the franchisor makes available (Item 10)
- A summary of the services, such as training and site selection, that the franchisor provides in relation to the franchise program (Item 11)
- Territorial protections (Item 12)
- The status of the trademarks, copyrights and patents associated with the program (Items 13 and 14)
- A description of how well the franchises perform financially (Item 19)
- System statistics and lists of franchisees and former franchisees (Item 20)
Overcome your inclination to toss this imposing document aside. Read it! Highlight any statements you don't understand or that raise questions in your mind, and plan to follow up with the franchisor's sales rep or your advisors.
Reading the UFOC is only the first step in your investigation. There's much important information that can't be found in the UFOC, and the only way to ferret it out is by asking a lot of questions. This step--taking the time to look behind the paperwork--separates the casual, clueless investors from the real entrepreneurs.
The other information you need to find out includes:
- Is the market for the product or service of the franchise program strong, or is it declining?
- Is there an independent franchisee association in the system?
- How does the franchisor handle competition issues between its franchisees?
- What were the typical store sales last year, and what is the range of sales?
- What process has the company put in place for the governance of the system? Do franchisees have a say in the development of new products or services?
Taking It To The Franchisees
Without question, the best place to track down independent answers to these questions is from existing franchisees in the system. You'll receive a list of franchisees in Item 20 of the UFOC, so use it. In person or on the phone, talk to as many franchisees as you can. Don't limit yourself to a few names the franchisor gives you; these owners may not be representative of the system. Unlike a franchisor, franchisees aren't restricted by franchise laws in what they can say to a prospective franchisee, and most will be happy to speak candidly with you.
Pepper the franchisees with questions. Was the training worthwhile? Have their businesses met their expectations? Is the business seasonal? What's the market like? Who are the major competitors? What do they consider the keys to success in this business? What are the hot issues that franchisees are talking about in the system? Is encroachment by the franchisor a problem? If they had the decision to make again, would they purchase this franchise?
You'll find other sources along the way in your franchise evaluation. The Internet is a surprisingly good source of gripes and complaints, some of them actually enjoying a basis in fact. See what you can find, but verify any Internet information with the company and with the franchisees you meet.
The Better Business Bureau (you can find it in the Yellow Pages) is a reliable source of information about businesses and their standing in your community. Check out whether any negative reports have been on the franchisor.
State consumer protection agencies and/or your state's attorney general's office can be helpful. If you live in one of the 14 franchise registration states, check with authorities to make sure the company is registered to offer franchises in your state. If the franchisor is slow to deliver a UFOC, you may be able to get a copy from your state agency. The franchise registration states generally make all registered documents available to the public. Those states are California, Hawaii, Illinois, Indiana, Maryland, Michigan (filing state only; no UFOCs on file), Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin.
Finally, the FTC provides some information about investing in a franchise and reports of enforcement activity against errant franchisors on its Web site (http://www.ftc.gov).
If your pursuit of happiness includes owning a business, by all means look into investing in a franchise. Once you have found the right business for your interests, marshaled your financial resources and investigated the opportunity, you'll be well on your way to a real declaration of independence.
For more information on franchising, log on to http://www.entrepreneur.com
The biggest challenge most people face in purchasing a franchise is finding the money necessary to build the business. Here are some starting points:
- SBA-backed loans. This lending program has launched more franchises than any other in history. Talk to your bankers about whether you qualify to secure an SBA-backed loan for your franchise.
- Family equity. Even if you locate financing, you'll need to inject a slug of "equity" into the business. Check your own resources. What do you need to pay your bills every month? Do you have friends and family willing to invest in the venture?
- Venture capital. Venture capitalists have been busy the past few years trying to keep up with Internet start-ups. If you approach a venture capitalist, be prepared to provide every last detail of your proposed business and business plan, and be willing to give up as much as 50 percent of your business in return for the investment.
- Angels. An angel investor is a wealthy individual who is not a professional venture capitalist. He or she has investment money in hand and is looking for a financial home run, or at least a better return than can be expected from the stock market. Angel investors look for annual returns of at least 25 percent. They're often patient, long-term investors who have witnesses the birth of thousands of entrepreneurial ventures.
- Incubators. Be on the lookout for incubator programs in your community. They're typically privately owned or sponsored and underwritten by a university. An incubator program offers inexpensive office space and services, as well as introductions to the venture capital marketers, who are often seeking an equity position in return.