Speed Bumps

Last month, Jack and Diane* stoically survived a bout with buyer's remorse— nagging feeling their recent franchise purchase might have been a mistake.

It's been a year since these first-time franchisees started their journey, yet they are still about 190 days from opening their quick oil-change location. Now that the land has been selected and leased, Jack is working fervently with his architect to create the construction drawings. However, a new issue has arisen. Jack's location is sandwiched between a coffee shop and a gas station, and the property is so tight that the oil-change customers will have to wait in the property owned by the coffee shop. Accordingly, the entrepreneur operating the coffee shop has decided to seize upon Jack and Diane's need and, in keeping with the axiom that there's no such thing as a free lunch, has demanded to be paid for this privilege. Jack says of the unexpected expense: "I'm going to have to pay the coffee shop a $2,500 one-time 'maintenance fee,' since my customers will be using his infrastructure more than his customers will be using mine."

By my calculation, after reviewing the franchisor's earnings claims in Item 19 of the Uniform Franchise Offering Circular (UFOC), Jack will have to perform 712 oil changes to recover this new expense. The average oil-change center is estimated to handle 42 cars per day, so it'll take almost 17 days of work to make up for this new cost. And there's another hidden cost tied to the easement issue; namely, the fact that an easement should be prepared and recorded in the real estate records. Jack's attorney should be involved here.

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These types of charges show why even the most thorough financial projections should have an expense line item set forth as "other costs" or "miscellaneous" to protect yourself when unanticipated costs come knocking. The second moral to this story is to understand how important ingress and egress are to a retail business. I've seen restaurants fail merely because it is too difficult for customers to make a left-hand turn against traffic. Jack obviously understands this and is wisely willing to pay the price.

On a brighter note, Jack has also learned that in his region, waste-oil recycling companies will pay him for the oil he drains from his customer's vehicles. However, to fully capitalize on this opportunity, Jack needs to buy an oil-filter crusher that squeezes the remaining oil from a filter. While the franchisor does not require this piece of equipment, Jack calculates it would pay for itself very quickly if they invest the money upfront to get one. Chalk that cost under "miscellaneous."

Now that Jack has secured the land, his franchisor is becoming much more involved in assisting him with his pre-opening preparations. For the first time since purchasing the franchise, Jack was able to sit down with his franchise advisor to go over a six-page checklist of action items. Jack will be responsible for such tasks as hiring the staff, finding a vendor for uniforms and laundry, establishing bank accounts, setting up his accounting records, selecting a payroll company, and sourcing credit card machines. Fortunately, this franchisor wants to create a turnkey operation for Jack, which means the franchisor will handle ordering the lubrication equipment, computer consoles, tools, security equipment, signs, oil, filters, storage tanks and other operating supplies. This franchisor func-tion can save franchisees a tremendous amount of research and investigation that they would have to undertake if they were independent business owners. In addition, franchise chains often negotiate better pricing and terms for goods and services than sole proprietors can wrangle.

However, many franchise relationships do have a catch: Franchisees typically may only buy from approved suppliers. In some instances, the franchisor may be the only approved supplier, and an unscrupulous or greedy franchisor could make an excessive profit here. Item 8 of the UFOC should disclose the intent of your system, as it requires franchisors to disclose the restrictions on sources of products and services and the types of benefits they receive from these suppliers.

In Jack's case, the franchisor states: "We have not, up to this time, derived any income from markups on the prices charged to our franchisees for goods. If we designate suppliers in the future, we may derive income through license fees, commissions, promotional fees, advertising allowances, rebates or other monies paid by these approved suppliers." Obviously, this is pretty open-ended, and if this franchisor starts marking up costs in the future, Jack has been forewarned and may have trouble crying foul.

You might be surprised to know how often required purchase issues come up in franchising. To be fair, franchisors are entitled to develop revenue streams in addition to receiving monthly royalty fees and also need to preserve quality control. On the other hand, if you are a restaurateur, for example, and you could buy beef from your brother-in-law for half the cost but aren't allowed to, you'll be frustrated. The penalty for using unapproved suppliers can be termination of the franchise agreement.

Before you purchase a franchise, make sure you understand the procedures and requirements necessary to get a new supplier approved. This information is often buried in the operations manual, so if you see a reference to the manual in the UFOC, it's fair game to request a copy of the standards before you buy the franchise.

*The franchisees' names have been changed.

Todd D. Maddocks is a franchise attorney and small-business consultant who is founder of Franchisedecision.com. You can reach him at yourcounsel@attbi.com.