Labor of Love
A pregnant elephant gestates for more than a year. Yes, I know that for all good things, you must wait, but imagine feeling pregnant for over a year but not knowing if you're actually going to have a baby. That is precisely where Jack and Diane have been for the past year, after purchasing their fast-change oil-center franchise. Their "baby" is their business, but right now all they have to show for their investment is a signed franchise license and a written purchase offer for a great site. The venture must be financed, and more obstacles stand in the way. If everything falls into place, they might open their newborn business in six months.
Having a life-changing event looming on the horizon has affected Jack and Diane's everyday existence. They both express a sense of resignation about their limited leisure time, and they know when the store opens, a vacation will be out of the question. Jack entertains his psyche by visiting his potential site-imagining the day when the cash register sings a happy song. Those dreams flicker into the background as he heads for his "real" job.
Big purchases have also been forsaken, as they need to save money and paint a pretty picture for the bankers. Diane, an independent contractor in the software industry, frets about having gaps in her employment. Everything in their lives is pointing in one direction: the fulfillment of the dream of owning their own profitable business. The next decision is a hard one. To rent or to own?
After a series of false starts, Jack was able to find a developer to purchase the land, build the oil-change center and then lease it back to him. This is known as a build-to-suit, an investment vehicle that typically preserves the franchisees' cash for other purposes. However, when Jack received the developer's letter of intent, fees were included that lead me to believe the developer smells blood. For example, the developer has decided to charge a development fee of $50,000 and expects Jack to cover his other soft costs, such as legal work, travel and other contingencies-estimated to run $12,000. Furthermore, the rent is scheduled to increase 2.5 percent every year for the initial term of 15 years. The default clause is burdensome on the lessee, and at the end of the term, Jack and Diane will own nothing but their equipment, which is not attached to the building in any way. The developer, who admittedly must take the risk of building a single-use structure (oil pits don't rank that high as an amenity), will make off like a bandit, while Jack will have to show up and make things happen every day.
Typically, a franchise license is really no more than a cash-flow machine unless you own the real estate. If you can go into a business that is located in a mall or strip center, the landlord will generally provide you with an allowance to make many of your improvements. When only a shopping center will do, it makes sense not to own the real estate. You can also expect the landlord to give you about 90 days of free rent with which to finish your construction if you sign a five-year lease. This does save you considerable money upfront. However, when you are working with a freestanding building, wouldn't it be nice if you could someday sell that prime piece of commercial real estate to fund your retirement? All it takes is money, or perhaps a little resourcefulness.
Jack is pursuing his alternatives and has discovered that his franchisor has cut a deal with a major oil company that will front him $50,000 if he limits his oil sales to their brands. The oil company gets guaranteed distribution, and Jack pays back the advance by paying 8 cents a gallon more for his oil over a seven-year period. Group buying power and existing vendor relationships are strong advantages to joining a franchise chain. Unfortunately, some franchisors will negotiate favorable pricing, then retain the benefit for themselves. As a prospective franchisee, you can discern how your franchisor behaves by paying attention to Item 8 of the Uniform Franchise Offering Circular. In essence, a franchisor is required to disclose the consideration they receive from approved or designated suppliers. If the franchisor has not developed any relationships with approved vendors, you will be required to do considerably more work in arranging for supplies.
Meanwhile, the due-diligence period specified in Jack's real estate purchase offer is about to expire. He needs an extension, and the seller has no legal obligation to grant one. Think quick, Jack. Your future depends on it.
*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 firstname.lastname@example.org.