Finding the Right Franchisee
Prospective franchisors often ask me about the most difficult aspect of franchising. "Is it franchise sales?" "Is it ensuring franchisee success?" "Is it quality control?"
And my answer never ceases to surprise them: "No, it's turning down a check for $25,000."
Perhaps the single biggest mistake made by novice franchisors is to sell franchises to candidates who are not truly qualified to run them.
It's easy to understand why this mistake gets made. A new franchisor, who has spent perhaps $100,000 preparing to franchise, finally begins offering franchises. The low close rate typical of franchise sales, combined with the long sales cycle, makes it feel as if that first franchise sale will never take place. Doubt creeps in. "Will I ever sell a franchise?" Then, a prospect the franchisor knows is marginal indicates he wants to sign the franchise agreement and pay his initial fee.
So what do you do?
Importance of Choosing the Right Franchisee
Before you take that check, the first thing you need to remember is that you're in this for the long run-you can't be a successful franchisor unless your franchisees are also successful in their own businesses.
Underperforming franchisees require much more support than strong franchisees, so they cost you more. At the same time, they generate lower revenues and therefore pay less in royalties. And, of course, failed franchisees don't pay royalties at all, and are much more likely to bring litigation against the franchisor.
You should also remember that every one of your franchisees (and every one of your lawsuits, should you have any) is disclosed in your offering circular. A sharp franchise candidate will always speak with these franchisees as part of their due diligence process.
Suppose you accept a franchisee who is unqualified, undercapitalized and lazy. Do you really think he's telling prospects, "Frankly, the reason I am failing is that I am unqualified, undercapitalized and lazy. This is a great franchise, and the franchisor is wonderful"?
Not likely. Regardless of whether you are to blame in actuality, imagine how the franchisee is portraying your franchise: "It costs a lot more to do this than you think. And it's a lot harder than the franchisor lets on. I never get enough support. And now I've lost my life's savings investing in this. My wife has left me. My kids are gone. And I may lose my house..."
Well, I can pretty much guarantee you that anyone who talks to that franchisee isn't likely to sign a franchise agreement with you anytime soon.
So what's the tradeoff? Increased support costs, increased litigation, reduced royalties and a reduced ability (or maybe no ability) to sell franchises on one hand, versus a check for $25,000 on the other. The bottom line: Sometimes you have to walk away.
Sorting the Wheat from the Chaff
So how do you identify franchisees who will be successful? Some criteria are easily identified. For example, some specific skill sets may be necessary for success: mechanical expertise, food-service experience, etc.
These "hard skills" questions are among the first the new franchisor should address. Are you better off with experienced prospects, or should you look to train your franchisees from scratch? To answer that question, you should first figure out the following:
- What resources do you have to train and support new franchisees?
- Do you have an adequate value proposition to sell people who already have experience in your industry?
- How important is prior experience in terms of the franchisee's ability to become profitable in their first year?
A related question is whether you should allow for "passive investors" as opposed to owner-operators who work onsite. The tradeoff here is fairly basic: Owner-operators, if properly selected, typically have better unit-level performance (both from a quality and from a financial perspective)-they're more attentive to details and more concerned with quality and customer satisfaction than most managers. On the other hand, opening the franchise opportunity to passive investors can mean faster growth and a larger pool of prospective franchisees from which to draw. One possible solution to this question is to require investor groups to designate an "operating partner" who holds some equity in the franchisee's company and also brings the skills you're seeking to the franchised business.
Perhaps the single biggest factor to consider when choosing a franchisee is capitalization. Inadequate capitalization is the most common reason for franchisee failure, so every new franchisor should closely examine liquid net worth, net worth and the candidate's credit score.
Depending on the nature of the business, your franchisee may be able to finance a portion of the franchisee's initial investment. The amount financed is a function of what's being financed (equipment is easier to finance than working capital, for example) and the creditworthiness of the franchisee. That said, you should be sure to take a conservative approach to each franchisee's ability to service debt-and should walk away from franchisees who are going to be too highly leveraged. In terms of single-unit operators, most franchisors will look for a minimum of 30 percent of the investment in liquid net worth, 100 percent in net worth and FICO credit scores of 700 to 725 or better.
Of course, none of this is carved in stone. Franchisees with a working spouse may need lower working capital requirements. Alternatively, franchisors with a longer startup period or greater working capital requirements may want to take a more conservative approach.
As you continue the evaluation process, you should also assess criteria such as intelligence. While franchisees may be looking for a "no-brainer" of a business, the truth is that most businesses do require intelligence to run. And you can't coach "smart." Since most people will tell you they're smarter than average, it's incumbent on you to determine whether they're good judges of their own talent. Short of intelligence tests, measures such as a candidate's work history, academic achievements, vocabulary and general presence help to provide clues.
Likewise, most businesses require hard work, and franchisees expecting an easy go of things may wash out early. So when measuring work ethic, look for the way a prospect conducts his life. Ask prospects about their "average day" and their hobbies. If it sounds like a 40-hour week will wear them out or they brag about their two-handicap on the golf course, you can pretty much figure they'll spend too much time away from their franchise after they join your system.
Soft skills can be equally important to a franchisee's success. Depending on the franchise, sales and/or management skills may be a franchisee's most important asset. Relationship factors, such as honesty, personality and compatibility, also play a part-after all, you'll be living with this franchisee for perhaps the next 20 years.
One of the often-asked questions in the area of franchise qualification is whether a franchisee should be entrepreneurial. Generally speaking, we recommend that franchisors avoid highly entrepreneurial candidates. Entrepreneurs tend to have several definable characteristics: They tend to have moved from job to job and have frequently already started at least one business of their own. They tend to drive fast cars, have lots of traffic tickets and are frequently divorced. True entrepreneurs tend to be rule breakers-and that is the last thing a franchisor should want. In fact, we identify entrepreneurs by the simple formula that they "never saw a rule they didn't want to break."
While you may not want to exclude entrepreneurs outright, franchisors are better served targeting straight-A students with long-tenure to their corporate jobs. They tend to drive the family car through the right lane of life.
In order to assess these soft criteria, franchisors are increasingly using more sophisticated assessment tools to "benchmark" the "job" of their franchisees. These tools are then used by franchisees to determine their compatibility for the role. But regardless of whether you use these tools or not, assessing the job of the franchisee-and ultimately doing what you can to assure the franchisee's success-is the most important and the most difficult job of every franchisor.