Franchises

Franchising Insight

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Purchasing a franchise is a big investment, so be sure to get your questions answered before taking the plunge. Our columnist addresses the concerns of readers.

Readers have almost as many questions about franchising as there are franchises to buy. Here are answers to recent questions.

Question: I'm interested in buying a fast-food franchise. But I'm not sure that I have enough saved to cover the entire transaction. Is it possible that a franchiser will help finance my purchase of an outlet?

-- Joseph, Columbus, Ohio

Joseph: First the good news. More and more big franchisers offer financing to those who would buy their franchises.

And the bad news: It's tough to qualify for those financing deals as a first-time franchise buyer.

The good news about franchiser financing stems from the fast growth of the franchising industry. Estimates vary, but as many as 7,000 companies are selling franchises in the U.S. alone, says one source, with a few thousand more overseas firms attempting to break into the U.S. market. In order to distinguish themselves from the competition and attract the best franchisees, many franchisers are now financing the sales of their units.

Andrew Sherman, a partner in the law firm McDermott, Will & Emery in Washington, D.C., represents franchisers and advises them on growth strategies. "The lion's share still don't provide direct financing, but it's on the rise," he says. "Given the competitive landscape, I think you'll see more heading in that direction."

For most people, coming up with the initial fees, licenses and startup costs is a significant investment. Count on spending a minimum of $50,000 and up to $200,000 to cover those costs. Whether franchisers will lend to a first-time buyer of a franchise depends on many things, including how much you invest and your track record as an entrepreneur. Any bruise on your personal credit history will likely disqualify you, says Mr. Sherman.

Mary E. Tomzack, president of FranchiseHelp Inc. of Elmsford, N.Y., estimates that about one-third of franchisers offer some form of financing. Some franchisers have relationships with third-party finance companies and banks that specialize in lending to their franchisees. Those include some of the biggest, such as Burger King, Taco Bell and Wendy's, according to FranchiseHelp, which offers strategic advice to franchisees and franchisers.

When you research a franchise, you can find out in Item 10 of the Uniform Franchise Offering Circular (the UFOC), a document that a franchiser must file with the Federal Trade Commission and make available to prospective franchisees.

For the franchiser, how much to lend franchisees is a tricky question. "It's a difficult balance," says Mr. Sherman. If a franchiser is too aggressive in its financing, it could saddle some of its franchisees with debt that may be too difficult to repay, which is in no one's interest.

Mr. Sherman has advised his clients to draw a line between lending for "hard" and "soft" costs. For instance, it might make sense to finance a franchisee's acquisition of real estate, he says. But franchisees who seek funds for the initial license fee or employee training probably will be too strapped to make the enterprise work. "If they are qualified, they ought to at least have that much [to put] down," Mr. Sherman says.

Other good news on the borrowing front: Since franchising has experienced such a boom, the industry has established a track record that raises the comfort level for mainstream banks and the U.S. Small Business Administration. Both Mr. Sherman and Ms. Tomzack say that bank lending to franchisees rose smartly in the 1990s.

Some of the biggest financial players in the U.S. are now specifically pursuing business with franchises. For example, GE Capital, CIT Group Inc. and the National Cooperative Bank have franchise-lending arms. "That's significant," says Mr. Sherman. "It's indicative of trend. Years ago, none of the big players were in this area." Those big lenders are much more likely to work with experienced franchisees who may be financing the purchase of additional units.

If you're a first-time franchise buyer, you'd best have sterling credit and a nice nest egg to qualify for these programs. Otherwise, if your heart is set on buying a franchise, you may have to save a while longer.

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Question: What are the common issues that franchisees overlook when reviewing a franchise contract?

-- Mark, Henniker, N.H.

Mark: Just like in life, it's not what we anticipate and fret over that gets us. It's the odd banana peel that throws us into a skid as we run for the bus.

In acquiring a franchise, most people thoroughly examine the fees, the long hours and the financial commitment required, looking at those issues from all angles. But rarely do they give sufficient attention to the terms of ending the franchise agreement. "That's always the one thing they don't think about," says John P. Hayes, a franchise-marketing consultant in Dallas (his Web site is www.howtobuyafranchise.com), who advises would-be franchise buyers.

This isn't like planning your divorce before you get married. There are all sorts of legitimate reasons for franchisees to end their relationships with their franchisers. They may just want to sell the business after a good run. A health issue may arise, or a spouse receives a job offer in another town, or they may decide that they've made a horrible mistake and just plain hate what they're doing.

When the time comes to end things, you might find yourself obliged to pay fees even after you've shuttered your business, or endure other unpleasant and unexpected terms.

Here are some things to watch out for, says Mr. Hayes. Beware of an agreement whereby the franchiser has the right to buy your franchise under a predetermined formula. You might do far better selling it on the open market.

Another scenario: You've paid all your current fees to the franchiser for three years, but now want to end a five-year contract. Even if you're closing your business, you may owe the franchiser for the fees covering the remaining two years on the agreement.

Some of these issues are negotiable going in, depending on the franchise. One rule of thumb: the bigger, better-known and generally more desirable franchises typically have fairly standard, cookie-cutter-type contracts that leave little room for negotiating these terms. Meanwhile, it's buyers of newer franchises who tend to have more leverage to draft the language addressing their exit.

Need we say this aloud? You must find a reputable attorney in the franchise field, one who is knowledgeable about these issues and will ensure you understand and can live with the terms of ending the franchise agreement. Get referrals from the local bar association and other franchisees.

Another area Mr. Hayes points to as troubling for neophyte franchisees as they execute their purchase agreement: an overemphasis on territory. Very often, a franchisee feels greedy about territory, assuming the bigger, the better.

Actually, the opposite is often the case. With more franchises already operating in a given city, a market presence likely exists for your business before you invest your first marketing dollar. Many have cost-sharing plans for advertising that give you a bigger bang for your advertising dollar. "Fast-food franchises have proven this," Mr. Hayes says. "You can do well with one block of New York City."

Don't forget to look beyond the contract, Mr. Hayes advises. Take your time and interview as many franchise owners as you can. "Some of my clients say, 'I don't want to call someone and ask them how much money he makes,' but that's not the point at all," he says.

Instead, ask questions like: "Knowing what you know now, after several years with the franchise, would you do it again?" and "What surprised you after you purchased your franchise?"

"If it takes you three weeks to do that, so what?" says Mr. Hayes. "If you're investing $200,000, it's worth it." Consultants can do this research for you, should you desire, but it's best if you to get this information firsthand and write a report for yourself about what you find, looking for trends. "At the end of this process, you have very useful information," he says.

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Question: Are you aware of any regional or national franchises that specialize in selling and servicing home multimedia-networking products and services?

-- Paul, Scotts Valley, Calif.

Paul: The short answer is no, not exactly that.

But Malcom Gordon of FranChoice Inc. of Eden Prairie, Minn., which represents about 80 separate franchises and tracks others, is intrigued.

"I've never heard of anything like that," Mr. Gordon says, as he clicks through databases and records. This means you may have hit upon a juicy niche. "It sounds to me like there may be quite an opportunity there for starting a franchise," he says.

I agree with Mr. Gordon. Even I, an avowed technophobe and proud Luddite, have a wireless home network, with my family using other computers on the same network. I can tell you that the installation by a major U.S. computer maker was less than satisfying. My 10-year-old daughter does a better job than they did, so now I generally rely on her for technical support.

Interestingly, more industries, including service businesses far afield from fast-food and auto-transmission shops, are seeing explosive growth in franchised businesses.

Many unlikely businesses have found franchising to be the best way to distribute their product. Marc Shuman, for instance, launched a business installing custom garage fixtures, a spin-off from a family business that made department-store fixtures.

When it came time to launch GarageTek of Syosset, N.Y., he decided that franchising was the perfect model, because he could maintain stronger control over the quality of the installation, as opposed to distributing the product through, say, big home-improvement stores. He believes this decision has led to happier customers and a stronger business. He sold his first franchise two years ago, and now has franchises in 29 states.

So, what's involved with franchising your business? A well-regarded book on the topic is "Franchising & Licensing, Two Ways to Build Your Business" by Andrew J. Sherman (Amacom, 1999), now in its second edition. Very briefly, if you decide to pursue this, you'd have to contact a franchise attorney and draft a Uniform Franchise Offering Circular, which must be filed with the Federal Trade Commission. And, of course, you'd have to have your business up and running in such a way that it lends itself to being franchised. You'd need financing and relationships with suppliers, as well as systems for screening franchisees.

If you see yourself more in the role of franchisee than franchiser, you might want to check the International Franchise Association's lengthy list of franchises at www.franchise.org . The IFA now lists more than 75 different industry categories of franchised businesses.

Given your interests, here are a few to review. We aren't endorsing any of these, of course. But they might be considered in the same broad category that has sparked your interest.

  • LifeStyle Technologies may be the closest to what you're seeking. It describes itself as a home-entertainment and technology company that helps builders and homeowners with their audio/video, home-theater, security and home-automation needs. It's now in Charlotte, N.C., and Atlanta.
  • Geeks on Call, Norfolk, Va., offers on-site computer services, including repairs, networks and one-on-one training. Founded in 1999, the company has franchised "98 new Geeks since May 2001," its Web site says.
  • Computer Troubleshooters of Decatur, Ga., "provides on-site computer support to small business and home users around the world," according to its Web site. It has 104 franchised units.
  • Expectec Technology Services, Aberdeen, S.D., offers "on-site, high-level technology services to commercial and consumer customers." Its franchisees offer computer repair, business-phone systems, retail-information systems, Web services, networking and outsourced information-technology services.

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Question: I've made a deposit on a pizza franchise. The franchiser has 40 stores in Tampa, St. Petersburg and Clearwater. It wants to expand into Orlando, and I'd be the first one there. Is this a good idea?

-- Athar, Orlando, Fla.

Athar: You sound a bit ambivalent about the fresh territory, which is understandable. Franchise buyers generally regard territory in one of two ways.

One is that the best territory is a big and lonely expanse, a sort of Louisiana Purchase view of the world. You plant your flag and declare dominion over all you survey, proclaiming all of Orlando's pizza lovers are mine, mine, MINE!

Other franchisees prefer the safety-in-numbers approach. You join a battalion of pizza purveyors sharing turf as well as your advertising costs and marketing presence. Together you impart a sense of scale, marching in lockstep to conquer the world with your many convenient locations.

If you buy the franchise in Orlando, you belong to the first group. If you buy in the Tampa area, you are in the second example.

Franchises differ in how they address territory, of course. Some offer "protected territory." Under these agreements, the franchiser promises that you have a certain specified turf to yourself. It could be defined by geography, demographics or other parameters.

For companies that sell franchises, it's one way to attract franchisees. A recent study by the Institute for Operations Research and Management Sciences, Linthicum, Md., a trade group that studies management, found that 91% of successful new franchise chains granted exclusive territory for their franchisees. "Usually, protected territories are considered a plum," says William Repack, a franchise consultant and a professor of entrepreneurship at Robert Morris University in Moon Township, Pa., outside of Pittsburgh.

Others scatter their franchises or crowd them where they like. It's been a subject of litigation over the years, often with franchisees suing to keep their parent franchise from opening a new store down the street.

You're in an interesting spot. Judging by its expansion in the region, your franchiser appears to have done quite well in the Tampa-St. Pete area. Whether this translates into happy franchise owners you must discern from your own research. You've done that, right? Including talking to other franchisees?

Dr. Repack believes that you may be in a fortuitous position. "If the franchiser is very interested in expanding, and I assume it is, it's going to want to help the first franchise in a new market," he says.

To a great extent, the success of the franchiser in a new market depends on your success. So don't be shy asking for help. Sometimes that may come in the form of financing, perhaps, or negotiating your lease. "These are things you'd like to negotiate" with the franchiser, he says.

One issue for a franchisee in your position to address is the advertising and marketing agreement. Typically, the franchisees kick in a percentage of revenue toward advertising. Will you be paying to advertise in Tampa? Will the Tampa stores be paying for advertising in Orlando? Or are there regional advertising buys that help all?

Either way, Tampa and Orlando, as markets go, aren't so far apart, with significant traffic between the two, so you may arrive with more of a market presence than you would expect in a virgin territory, Dr. Repack believes.

Maybe you are just far enough away to make it worthwhile for the franchise owner to take special care of you. And you may be just close enough to bask a bit in the chain's success in Tampa.

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Question: What are some franchises that are good for absentee owners?

-- Marcy, San Fernando Valley, Calif.

Marcy: I can only imagine you, commending your employees for the spike in profits over the speakerphone while you loll poolside, pina colada in hand. Maybe we should all look into this.

If you are searching for a franchise that is more of an investment than a lifestyle, they are out there. It depends on the franchise. For some franchises, it's entirely possible, and, for others, it doesn't make economic sense or is expressly forbidden.

This is an important issue for franchise chains, and it doesn't take a genius to see why. A business can only benefit by on-site ownership. No one has a stronger incentive in the success of the business, after all, than the owner with his own capital at risk. Many franchises have become well-known for the long hours required to run their businesses -- rising at 3 a.m. to make the donuts--a far cry from the distant oversight you envision.

For that very reason, many franchises demand an on-site owner, and make it a condition of franchise ownership. McDonald's Corp. franchises, for instance, are famous for turning away passive investors and corporate owners, instead requiring owner-managers. With people lining up for a chance to buy a McDonald's, it can afford to be picky in the selection of its franchisees.

Michael Fisher is a Tampa Bay, Fla., consultant who helps businesses franchise their concepts, and says most strongly prefer owner-operators. "It's tricky," he says. "A franchiser selects franchising as a method to expand the business in part to have someone share the risk, and to have an owner with the vim, vigor and vitality to grow the business." Unlike the owner, he says, the typical manager can too often say: I'm off the clock, that trash on the floor is someone else's problem.

Yet, Mr. Fishman has had some success owning--as a mostly absentee owner--a few Fantastic Sam's hair salons in Bradenton, Fla., and sold them a few years ago at a nice profit.

Mr. Fisher's advice: Look for exceptionally strong systems and effective marketing plans, factors that you wouldn't control even if you were hovering like a nervous mom over the premises every day. Look to well-established chains that have worked the kinks out of their systems. Someone else is going to be following these blueprints, and the more specific, the better.

Mr. Fisher thinks that food operations are poor candidates for absentee owners, because the detail work and interaction with customers is so important. On the other hand, an absentee-owner might do well with, say, brake or muffler shops, or hair salons, as he did. He cites a tobacco retail operation, which he says has outstanding automated systems related to cash flow, inventory control and others. "The better the systems, the more it runs itself," he says. That frees an owner to rely on a manager.

An absentee owner requires an excellent manager, of course, someone with a track record of integrity and results. Less important, says Mr. Fisher, is that the manager has experience in that particular franchise. If you are part of a good franchise system, an experienced manager can follow the plan.

Economies of scale also come into play. A small franchise, especially in its early phase, may not throw off enough cash to support a strong manager with profits left for you. It's likely to be a different case, though, for the owner of several franchised units, all operating under one manager. So, going into this, you'll require a reasonably good sense of sales and profits, which only a few franchised operations will project. You're likely to discern this important information only by talking to other franchise owners in the system.

You still will have to figure out a way to stay close to the business, whether it's reading through the data generated by automated reports or talking frequently to your manager. Nothing substitutes for the unannounced drop-ins. It's the best way to detect dirty floors or rude employees before those issues translate into anemic sales.

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Question: I am looking into opening a coffee house. Would it be best for me to buy a franchise or open an independent store of my own making?

-- Samantha, New York City

Samantha: By coincidence, Steve Siegel was recently kicking around a similar question posed to him by a young friend. Mr. Siegel has a particular point of view, as an owner of 35 Dunkin Donuts franchises and chief operating officer of a new florist franchise out of Boston called KaBloom.

"Certainly, there are plenty of independent coffee houses that are very successful," Mr. Siegel says. "If you have someone who has the vision to build a business and the ability to execute it all, then go for it," he says.

Those are big ifs.

When he sat down with his young friend who was planning an independent coffee house, Mr. Siegel fired questions at him over several hours. How did the young man envision the design of the coffee house? Where would he get his products? Will it be a sit-down place? Just a counter? Will there be food? What kind of food? How will you price it? How fast will service be? Who will the competition be? How will he train employees? Where will he find them? How will he finance the shop?

Those were just a few starters, and Mr. Siegel's friend ran out of answers before Mr. Siegel ran out of questions. The friend ultimately went on to do something else.

Buying a franchise answers many of the questions that a business start-up must address. The entrepreneur simply executes the vision of the franchiser. For many, that is challenge enough. "Not everyone is entrepreneurial enough to build out his or her dream and execute it," says Mr. Siegel, who is also the past president of the International Franchise Association. "Franchising can be a nice place to be."

Of course, for all the questions franchises address for new entrepreneurs, they raise plenty of their own. The fit between the franchiser and franchisee may be bad. Can you play by the franchise's rules? They call the shots on the products you carry, your suppliers, your internal recordkeeping. And of course, you'll be paying the franchise fee, in the ballpark of 6% of gross sales.

Many a deal between franchiser and franchisee falls apart after the papers are signed. Profits may be disappointing. The franchise may demand a lifestyle that one didn't quite anticipate--long hours, early rising. Costs may be higher than anticipated, leaving the entrepreneur stretched. Franchise consultants often cite $200,000 as a very rough estimate for the investment that a franchisee should expect in start-up costs for a respected franchise.

If there is a franchise you are considering, cut no corners doing the research. The most meaningful part of it is calling other franchise owners, and chatting about their business, just as Steve Siegel's friend did. What do they know now that they wish they'd known before they bought? Has the workload been what was anticipated? How about the earnings?

Franchise consultant William Repack says to factor in your level of experience in the business. You might have greater success on your own, he believes, if you've been, for example, an assistant manager at Starbucks. "If you know the ins and outs, maybe you know enough to save the franchise fee," he says.

But, he also points out that if you're contemplating independence in order to avoid franchising fees, you may want to reconsider. Whatever the franchise fee is, he believes, you reap in management help. You also get coffee, paper goods, pastries and other supplies at reduced prices due to the clout of the franchise buying power.

Those savings can make it tough for independents to compete. Mr. Repack fondly recalls a cozy coffee shop in Moon Township, where he operates, that lasted about four years. It was a bohemian place, dimly lit, with beads in the doorways and 50-year-old furniture. "It was reasonably successful," he says. "But after Starbucks arrived across the street, she was gone."

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