Buying a Foreign Franchise

Researching a franchise based outside the United States? Before you buy in, here are five questions you need to ask.

learn more about Jeff Elgin

By Jeff Elgin • May 5, 2006 Originally published Jun 6, 2005

Opinions expressed by Entrepreneur contributors are their own.

For many years, U.S.-based franchise companies have been"exporting" their brands and franchise concepts to othercountries all over the world. The opposite trend began a number ofyears ago and has been accelerating recently: foreign-basedfranchise companies that are bringing their brand and operations toour market.

This is an exciting business dynamic, as it gives franchisees afantastic way to take advantage of business concepts that may notexist in the domestic market or that have a unique twist. Thatsaid, this dynamic also raises a number of questions in the mindsof many prospective franchisees.

Some of the most common questions we hear in relation toforeign-based franchises coming to the United States include:

"How safe is investing with a foreign-basedfranchise?" The same disclosure requirements that apply toa domestic franchise also apply to any foreign company that comesinto the United States to offer franchise opportunities. Thefranchise must provide you with a UFOC disclosure documentcontaining information on key mandated factors. They are alsosubject to the same consumer protection rules in terms of theirbehavior during the process of selling their franchise. Also, youcan use the internet to find out information about any companyanywhere in the world. Most prospective franchisees don't findany significant difference in the research process of aforeign-based franchise company compared to any other, so the factthat they are foreign-based should not, in and of itself, affectyour risk in a negative way.

"What corporate structure do foreign-based franchisestypically use in the United States?" Most successfulinternational franchising, in either direction, uses a "masterlicensing" arrangement. In this scenario, the franchisor findsa domestic partner that they contractually agree will develop thefranchise in the selected country. In the case of foreign-basedfranchises, this is the most typical structure we see. Theforeign-based company will research the franchise business in theUnited States, then interview and select a master licensee thatwill own and control the franchise rights in this market. Theforeign-based company may own some percentage of this entity or maysimply require the entity to pay it fixed or variable fees inexchange for the development rights. The most common alternative tothis structure is for the foreign-based company to create awholly-owned subsidiary in the new country and then hire localemployees to run the operation.

"What extra research do I need to undertake?"It's always a good idea to check out the track record of anyfranchise company in relation to their past results. In the case offoreign-based franchises, you effectively have two companies youshould research: the U.S. master licensee and the foreign-basedmain franchise company. In relation to the U.S. master, you want tomake sure you have a track record of performance sufficient todemonstrate that they know what they are doing and can help you besuccessful. You also need to know that they are strong enoughfinancially to last and support your efforts long term. In relationto the foreign-based franchise company, you may want to gatheradditional information about the franchisor's operations inother foreign countries to see how well they follow the standardsand values we're used to in the United States. Also check onthe financial strength of the parent company in case the masterlicensee in the United States encounters difficulty and needs to besupported in some manner by the parent company.

"What if I am the first U.S. franchisee?"There's an old adage used in relation to smart money investingin franchises: "When in doubt, send a scout." The simplefact is that being the first franchisee, or even part of the firstgroup of franchisees, in any system under any circumstances alwaysinvolves far more risk than waiting until later. No matter how muchexperience a franchisor has elsewhere, each country they go into isdifferent. Until they are tested in the real world, the companysimply doesn't know how well their operating systems,marketing, training and brand are going to work. If you do decideto be a test subject for them in their new U.S. operation, oneadvantage you may have relates to bargaining power. The very leastyou should do is negotiate for some form of an early bird discountof costs, such as the initial franchise fee (or even better--alarge special marketing test allowance paid for by the franchisor).This approach will help you, but it still doesn't change thefact that you will be entering the business with a fair degree ofuncertainty.

"What are the red flags I should be on the lookout forwith a foreign-based franchise company?" There is reallyjust one, and that involves the transition of their opportunityinto a different culture. There are many examples of U.S.-basedfranchises that have struggled when they brought their conceptsinto a foreign country because of cultural or language barriers.Make sure you have taken this into consideration prior to makingany investment. If the company has not been operating in thedomestic U.S. market long enough to prove the effectiveness oftheir concept, you have exactly the same risk as with any otherstartup franchise--you don't know for sure that it's goingto work well and should therefore be cautious.

Investing in a franchise concept that has been developed andproven in another country before entering the U.S. market can be awonderful opportunity ... or a train wreck. The only way to knowfor sure is to conduct a complete and thorough investigation of thefranchise. This includes researching the people operating thefranchise, the capital structure of the U.S. entity offering thefranchises and the track record of success they've achievedwith other U.S. franchisees.

One final piece of advice: When in doubt about anything, ask thefranchisor. Don't be bashful about this, since they haveprobably been asked the same thing by many others before you andshould have the answers to your tough questions all ready to go.Research thoroughly, take the time to do this right, and you shouldbe fine.

Jeff Elgin

Jeff Elgin has almost 20 years of experience franchising, both as a franchisee and a senior franchise company executive. He's currently the CEO of FranChoice Inc., a company that provides free consulting to consumers looking for a franchise that best meets their needs.

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