The following excerpt is from Rick Grossman’s book Franchise Bible. Buy it now from Amazon | Barnes & Noble | iTunes | IndieBound
Franchising your business doesn’t have to be difficult and expensive as long as you have a well-planned franchising roadmap and realistic expectations. Franchising your business can also be very lucrative as you take your already successful business model and duplicate it to build a thriving enterprise that can be worth big money in the future. Following is some information that can help you succeed.
1. Can you afford the franchising process?
Franchising your business doesn’t have to be terribly costly if you budget correctly and have a game plan. You don’t want to waste money unnecessarily or spend money that can be differed until you have revenue coming in from franchise sales.
You should be able to get a pretty good idea of the project costs when you interview franchise attorneys and franchise development consultants. Be sure you’re talking to experienced individuals who have active franchise practices. Standard business (and not franchise-specific) advisors can lead you down the wrong path or dissuade you from franchising due to their lack of experience or comfort with franchising. The franchise industry is very unique and has many elements that may not align with general business models, so choose your consultants and advisors wisely.
2. Impounds and deferred fee-collection stipulations
If you’re in a registration state and the attorney for the state examining your application for franchising determines you don’t have sufficient capitalization to open the franchises you plan to open, the applicable state agency may still grant you a permit to sell franchises. To do this, however, you must open an impound account in a bank chartered in that particular state for the direct deposit of all franchise fees. In essence, an impound is a trust account: The franchisor is required to have the franchisee write a check to the designated depository bank, to be held in trust until the franchisee provides a written declaration to the registration state that his or her franchise is open and that the franchisor has performed all of their opening obligations under the franchise agreement.
Once this declaration is received, it’s filed with the appropriate state registration agency; if the agency approves the declaration, it will prepare an order allowing the franchisor to remove the franchisee’s funds from the bank. The franchisor then submits this order to the bank, and the bank pays that particular franchise fee to the franchisor.
Unfortunately, not too many banks are familiar with these trust account procedures, and most escrow accounts are extremely expensive -- $1,000 to $2,000 in some cities for each franchisee escrow account. In some instances, your franchise attorney may be able to convince the state authority that you’ll provide in your franchise agreement a statement that you will defer, or not require payment of, the initial franchise fee until the franchisee has opened his or her store and advised you that he or she agrees you have fulfilled all your opening obligations under the franchise agreement. Many registration states will allow this type of provision in lieu of impounds.
3. Multistate franchise taxes and accounting
You’ll want to interview accounting firms that have an active franchise practice just like the attorneys and franchise-development consultants mentioned earlier. Discuss the various business entity types and corresponding advantages and disadvantages so you set it up right the first time. You’ll also want to talk to them about taxes in your home state as well as other states that you’ll be doing business in as a national franchisor. They will advise you on your federal taxes as well.
4. Franchise discovery process
Good franchise owners tend to be people who can follow a system, so it’s good practice to create a step-by-step discovery process for prospective owners to follow. This allows them to learn as they go, which is more effective than trying to absorb all the information at one time. This also enables you to track their progress and commitment level as they move through the steps.
5. Franchise brochure
Following a prospective franchisee’s initial inquiry, you should send them an informational brochure. Brochures can cost anywhere from a few dollars to thousands of dollars to prepare. Depending on your personal taste and budget, it may be preferable to use a simple franchise brochure stating many of the items that are in the disclosure, featuring a nice overview of the attributes of the particular franchise system.
In California and a few other states where registration is necessary, the brochure, like any advertisement, must be submitted to the appropriate registration authority for prior approval anywhere from three to seven days before publication, with a duty upon the agency to disapprove it within such time or the ad is deemed approved.
6. Franchise candidate application
In addition to sending a brochure, you should make an attempt to find out if the franchisee is financially qualified to buy a franchise. Therefore, the first document forwarded to the franchisee should be a franchise application seeking the franchisee’s background information and net worth. This application should be tailored to your needs and reviewed by your legal counsel.
7. Franchise disclosure documents and receipt
After a prospective franchisee has completed the background application and net worth financial form, use the document to assess their suitability to your franchise by checking out every disclosure that you can. If you determine a franchisee to have the necessary qualifications, the next step is to forward your disclosure document to the prospective franchisee or meet with him or her and present the franchise disclosure document. The prospect acknowledges receiving the disclosure by signing a document called a receipt and returning it to you, the franchisor. Always prepare two receipt forms -- one copy for the prospective franchisee to keep and the other to sign and return to you.
It’s good practice to provide the potential franchisee with the required disclosure document before any discussion about it. If the franchisee is out of state and the franchise is to be operated in your registration state, the disclosure document to be sent to the prospective franchisee would be your in-state disclosure document. However, if the franchise is to be operated in another state, you will be required to register in the other state before offering your franchise.
8. Franchise fees, royalties and other fees
Many franchisors fail because they expect to immediately profit by charging high initial franchise fees, high royalty fees and high advertising fees. However, if you look at what’s happening in the American market, you’ll find that discounters who charge lower fees and bank on volume to make profits have overtaken the retail market. Most franchisees cannot handle high initial franchise fees and even higher royalty fees based on their gross sales. So keep your expenses to a minimum while maintaining a high level of services to the franchisee. The franchisee is the marketing arm of the franchisor; if the franchisor can set up a franchisee by breaking even, he or she has already accomplished a great feat.
Always make detailed projections regarding how much profit you can make with a minimum amount of franchise fees and royalties, taking into consideration the profit you will make from the sale of your products and services to your franchisees. It will be time well spent.