How to Research a Franchise Opportunity
Your assignment: Buy a franchise. Step 1: Take our crash course in finding the right franchise for you.
Settle down, class. Today we're going to explore how tolocate and evaluate a good franchised business. Not all of you willwant to hold down a job for your whole working life. Let's havea show of hands: Who's dreamed of owning your own business? OK,that's most of you. Buying a franchise is one way to get there;some even say it's the easiest way. So take notes, askquestions, and for goodness' sake, please stay awake!
Lesson No. 1: Is It in You?
Not everyone who raised his or her hand will be happy as afranchisee. Owning a business is tough work, and most franchiseshave to be run according to a very detailed, strict set ofguidelines. If you're a high-spirited entrepreneur who wants todo it your way without following somebody else's rules, you maywant to look for an independent business to start or purchase;owning and running a franchise may frustrate you. So the firstthing to do is to know what you want out of a business and whetherit will bring you fulfillment. If you like the idea of running abusiness where you deal with customers at your own counter orprovide services to businesses, or if you love sales or havewriting skills, then keep these skills and preferences in mind whenyou start looking through franchise ideas. They'll help youzero in on the right business for you.
Whether the business you get into is a franchise or not, ittakes money to make it happen. Make a list of your resources,relatives you can approach to be investors, your savings and yourinvestments. Then go talk to a few bankers. You'll find thatsome banks will lend you money for a business as part of a federalprogram where the government promises to pay back most of the moneyto the bank if your business goes toes up and you default. Bankslove this; it lowers their risk when they lend money to newbusiness owners. Ask the bankers about SBA loans-read about theSBA's loanprograms, and take a look at a registryprogram where franchisors and the SBA have teamed up tostreamline the application process.
Lesson No. 2: Get Your Feet Wet
One of the best ways to find out about the types of franchisesavailable to you is to attend one of the franchise and businessopportunity shows that appear regularly in most U.S. cities. Thebig ones can have up to 400 exhibitors. Attending one of theseshows is well worth your time. You can kick tires, ask questions,gather brochures and try on ideas.
The Internet is also a tremendous source of information. Asstudents, you're experts at using the web, so you know that thehype-to-fact ratio will run on the high side. What's that?Well, you're right, that's also true of franchise tradeshows, but at least you can talk to real people at a show.
Lesson 3: Information, Please
A big part of the challenge of looking into a franchise isgetting your hands on information. I've got some good news: Thefranchisor is required to package the key investment informationand hand it to you in a document called a Uniform FranchiseOffering Circular (UFOC). It spoon-feeds you some basic informationabout the franchise investment.
The first thing to understand about the UFOC is that it'sactually three documents sandwiched together: 1) a 23-itemnarrative about the franchise offer, 2) up to three years ofaudited financial statements of the franchisor, and 3) the form offranchise agreement you'll be asked to sign. If you'reserious about a particular program, you should carefully read thisdocument. It's amazing how many franchise investors don'tbother. It's required by law to be written in plain English, sodon't be intimidated. I can tell you that every studentwho's completed this class has read the UFOC and understandsits limitations and strengths.
First, look at the UFOC's attachments. You may have noexperience reading a commercial contract or a set of financials,but these will be indispensable to your professional advisors. Takethe contract to a good business attorney; let your counselor lookthrough it and explain it to you. If you and your attorney concludethere are points you can't live with, explore negotiating withthe franchisor.
Take the financial statements to an accountant trained toevaluate all those numbers. Your basic questions: Does thefranchisor have the financial wherewithal to meet its commitmentsunder the franchise agreement? And will it be around for a while?Your accountant can also use Item 7 information to advise you onyour own financial planning for the investment.
Lesson 4: Breaking Down the UFOC
Now turn to the meat of the coconut, the narrative descriptionof the offering. This front portion of the UFOC is designed toelicit all the important information you need to make an investmentdecision, and it's organized into 23 separate items. Itprovides information about the franchisor, the investment itself,the franchise system, and the rights and obligations of thefranchisor and the franchisee in the program. Let's break itdown:
- Items 1 to 4 address the franchisor and its background.You'll find a description of the franchise in Item 1, thebusiness experience of the key franchisor managers, as well as thelitigation (Item 3) and bankruptcy (Item 4) backgrounds of thefranchisor and key affiliates. Go over this information with yourattorney so you can keep any litigation disclosures in perspective.They can tell you a lot about the company's dispute-resolutionstyle.
- Items 5 to 7 are the money sections. They lay out thefees you pay the franchisor for the right to participate in theprogram as a franchise owner (initial franchise fee, continuingroyalty payments, advertising contributions and any other fees).Item 7 details the franchisor's estimates of your totalinvestment. Item 7 is presented in chart form and usually containsdollar ranges for categories of expenses. You may find more thanone chart in Item 7 if the company offers different types or sizesof franchised businesses.
- Item 8 describes restrictions regarding the products andservices you can buy and sell through your business. Though youmay not think so when you first read this item, it's of theutmost importance to your business. It gives you an idea of howmuch of your operation must meet the franchisor'sspecifications and informs you of arrangements with approvedsuppliers and whether you're required to purchase inventoryfrom the franchisor.
- Item 10 tells you if the franchisor provides anyfinancing. Be aware that very few franchisors do so.
- Item 11 details the obligations of the franchisor under thefranchise agreement before and after you open. Zero in on thedescription of the training program. The mark of all goodfranchisors is a well-thought-out, thorough training program.Training is the biggest service you're buying with your initialfranchise fee; get your money's worth.
- Items 12 to 14 list the intangible rights you'll receivewith your franchise package: territory rights, trademarks,patents, copyrights and confidential information. Make sure youunderstand the territory rights. Is your territory exclusive? Canthe franchisor or other franchisees compete with you in yourterritory? You'll find the answers in Item 12. Check Item 13 tosee if the main trademark licensed by the franchisor is federallyregistered. If not, ask your lawyer if that poses any risks toyou.
- Items 15 and 16 tell you if you must participate personallyin the franchised business, as opposed to hiring a manager, andwhat restrictions are imposed on the customers you can serve or theproducts and services you can offer.
- Item 17 is a lengthy chart summarizing the keyprovisions of the franchise agreement that relate to renewal,termination, transfer and dispute resolution.
- Item 19 is an important disclosure item. A franchisorisn't required to provide earnings information to a prospectivefranchisee, but if it does, it must reproduce the statement in Item19. This would answer the first question you might ask afranchisor: "How much money does one of these franchisesmake?" or "What were the average gross sales in yourstores last year?" These are loaded questions. You may besurprised to learn the law restricts how they can be answered. Mostfranchisors aren't in a position to answer these questionssince they don't have earnings information in Item 19 of theirUFOCs. My estimate is that about one-third of franchisors providesome sort of earnings statement in the UFOC. Read it with a carefuleye, and make sure you review it with your accountant.
- Item 20 is a statistical picture of the franchisor'ssystem that tells you how many franchisees joined the system inthe last three fiscal years of the company and how many left.You'll also find the contact information for currentfranchisees and those who left in the past year. Call as manyfranchisees as you can; visit several as well. Ask them how theylike being a part of the program, how much money they grossed lastyear (only a franchisor is restricted from answering this), andwhether they would make the same investment decision if they had itto do all over again.
Someone Get the Lights
The sharp-eyed among you will notice that I've left out afew items from my discussion. These are lesser disclosure itemsthat will speak for themselves when you crack open the UFOC.
There's the bell. Thank you for your attention to thisimportant topic. I wish you all success in your entrepreneurialventures.
- Visit the FTC's Web site. The FTC maintains a useful Website where you can read general guidelines about buying a franchiseand catch up on FTC enforcement activity.
- Check the Franchise Registry. This innovative programcan smooth the way for borrowing money under the SBA loan guaranteeprogram when you come to purchase franchise rights. You can findout if a particular franchisor has registered with this program bylogging on to the Web site.
- Find out if there are veterans' benefits. Manyfranchisors offer special financial incentives for veterans. Readabout the VetFran program here.
- Get franchisee evaluations. Prospective franchiseescan get survey results from an online service that asks existingfranchisees for their opinions about their franchise programs.
- Get help from franchisee associations. There are threenational trade associations of franchisees: 1) the International FranchiseAssociation in Washington, DC, which is a trade group offranchisors and franchisees; 2) the San Diego-based American Association ofFranchisees & Dealers, which publishes the Fair FranchisingStandards; and 3) the Franchisee Association in Chicago.
Andrew A. Caffey is a franchise attorney in the Washington, DC,area and an internationally recognized specialist in franchise andbusiness opportunity law.
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