Get Franchise Fit

You finally resolve to get back in shape, so you hire a personaltrainer to help you achieve your goals. At your first meeting, thefitness trainer asks you a series of questions and measures you,weighs you and pinches around to determine your level of body fat.You're at the beginning of a long road. It is vital not onlythat you know where you're starting from, but also that youhead down the right path for you.

It's a lot like the process of buying a franchisebusiness--you cannot afford to make a mistake on such a largefinancial investment. Like working out at the gym, you can get hurtif you're not careful and well-informed about the process. Tolocate and evaluate a franchise that will be a good fit for yourneeds, and to do it right, you have some research and work to do.You'll also be using investigative muscles you've neverused before.

Answering the Tough Questions

Focus your attention on the type of business that interests you.If you plunge into the franchise marketplace without giving somethought early on to the type of business for you, you'll be introuble. Like walking cold into a gymnasium full of complicated,intimidating workout equipment, you won't know where tostart.

Are you intrigued by a conventional retail business, or do yousee yourself working from home? Do you live for food? Do you likeserving the public, or do you want to sell to corporate customers?Do you want to run the business full time or part time?

Obviously, these questions must be answered in the context ofyour interests, your resources and your particular level offinancial fitness. Assess the capital you have immediatelyavailable to you and other likely sources of funds. If you'reabout to sell your $100,000 baseball-card collection or liquidateyour priceless stockpile of Batman paraphernalia, by all meansinclude the proceeds in your calculations. You may want to talk toa local banker about loan programs for which you could qualify (askabout small-business loans backed by the SBA), talk to anaccountant, even visit with your rich Uncle Ned. This personalself-assessment will tell you whether you should be looking at a$700,000 retail franchise or a $40,000 homebased franchise.

Working the Trade-Show Circuit

The internet will throw a lot of options and hype at you; afranchise trade show will let you try out the equipment. Mostcities have one or two franchise and business opportunity tradeshows in a given year. If one comes to your town, take the time toattend. A trade show is a terrific opportunity to see what themarket is offering and speak with knowledgeable franchiserepresentatives.

Let your key research begin here: Ask the right questions of therepresentatives. You know from your personal assessment what typeof business you're seeking, how much cash you have on hand toinvest and how much you qualify to borrow from a lender. So be sureto ask a few initial qualifying questions: Does the company requireprospects to have a certain amount of cash on hand? What is thetotal investment range for the franchise? (They should know therange, since this information appears in the franchise'sdisclosure document, which we'll discuss later.) Are therebusiness-experience qualifications required of prospectivefranchisees? If the answers to these questions pull you out of yourrange, don't waste your time--move on down the line. Make theeffort to find the program that interests you and hits yourinvestment sweet spot.

Plan your time at the show carefully. Expect to pick up a ton ofgeneral brochures and application forms--carrying these around fora few hours will tone your shoulder muscles. Make sure you have afull collection from any franchise booth that interests you, andleave them your complete contact information. A personal businesscard makes the best impression.

Pumping Iron: Lifting the UFOC

Not many franchisors will deliver a disclosure document to youwhen you walk up to the trade-show booth. If you attend a salespresentation or a "discovery session," or speakone-on-one with a sales representative at a hospitality suite orsome other off-site location, most companies will hand you afranchise disclosure document at that time. So just what is thisdocument?

All franchising companies in the United States are required todeliver a complete disclosure document known as the UniformFranchise Offering Circular, or UFOC, to a prospective franchisee acouple of weeks before money changes hands or the prospect signs abinding legal obligation. For anyone researching a franchiseinvestment, this is an indispensable document. As soon as youbecome at all serious about a particular franchise, it's timeto get a copy of the company's UFOC. Franchisors are notrequired by law to give you a UFOC until fairly near the close ofthe transaction, so it's your responsibility to request oneearlier. Some companies wait until you come through headquarters ona visit; others allow you to view the document online. Either way,your goal is to get your hands on the UFOC so you can obtain a fullpicture of the program as early as possible.

Once you have the company's UFOC, read it carefully. Ifyou're an old hand at corporate investing, the document will bevaguely familiar to you--it's based on similar disclosuresrequired under corporate securities laws. If you're new tothese documents or if it's been awhile since you cracked open asecurities offering prospectus, you're in for a pleasantsurprise: All UFOCs are written in plain English and organizedalong the same detailed outline.

Resistance Training: Crunching Numbers

A UFOC is basically broken into three parts: 1) a descriptivenarrative describing 22 various important aspects of the franchiseoffering, 2) a copy of the contracts you sign when you become afranchisee, and 3) a set of the franchisor's audited financialstatements (or those of the company guaranteeing the obligations ofthe franchisor).

Start at the back. An experienced accountant can tell you a lotabout the financial health of the franchising company by reviewingits audited financial statement. Does it have the financial muscleto survive long enough to continue servicing your franchisebusiness, or is it teetering on the edge of a financial abyss? Howmany franchisees paid royalties last year, and what was the roughannual average payment? Did the company make money from itsoperations last year, and how do the numbers compare to theprevious two years? Are any disturbing trends buried in thenumbers? If you're not conversant in number-speak, seriouslyconsider getting professional assistance. You'll probably needan accountant to help with the establishment of your businessanyway, so find one now, and have the UFOC's financialsreviewed.

That brings us to the franchise contracts--everybody'sfavorite mental workout! A word of caution here: Your franchiseagreement is not required to be written in plain English. It'stypically quite long (30 pages of single-spaced verbiage is not atall unusual), and it will strike you as remarkably one-sided,seeming to favor the franchisor at every turn. Let a good lawyerhelp you review it. Find one who has experience working with smallbusinesses, and let the lawyer explain how it affects yourinterests. If your lawyer finds 27 ways she would like to changethe contract before you sign it, arrange a discussion with yourfranchisor representative to find out how the company handlesnegotiated-change requests. Some franchisors insist on theirstandard contract; others will negotiate. Generally, in myexperience, the younger the franchise program, the more willing thefranchisor is to negotiate. In any case, it's always better tohave a lawyer on your team to help you assess the legalsituation.

Shaping Up, One Item at a Time

Now that you have professionals working on the more complicatedaspects of the UFOC, turn to the plain-English narrativedescription. The first few items (Items 1 through 4) tell you allabout the franchise program and the franchisor, its identification,address, range of business activity, history, involvement in otherfranchise programs, its managers' business experience, and itslitigation and bankruptcy background. This is key information forchecking out the depth of the company's experience and thenature of any serious legal problems. Don't be surprised if youfind a few civil cases or arbitration cases against franchiseesdisclosed in Item 3--running to court or arbitration to resolve adispute is an inescapable part of modern business life, andfranchises are certainly no different from other businesses. Infact, the franchise sector is more litigious than most businesssectors.

The next few items in the UFOC (Items 5 through 10) lay out thefees and estimates of the new franchisee's total expenses anddisclose whether the franchisor provides financing for any aspectof the investment. Item 7 is most useful among these items;it's a chart summarizing all the expenses you're likely toincur when you establish a new franchise business. Make sure youraccountant sees this information--it will be useful in yourfinancial planning.

Items 11 through 14 detail the services and rights thefranchisor provides you as a franchisee--everything from assistancewith your grand opening to training to the granting of trademarkand patent rights. Territorial protection, an issue close to thehearts of most franchise investors, is described in Item 12.

Other items worth noting are Item 19 ("EarningsClaims") and Item 20 ("List of Outlets"). Anearnings claim is any statement that conveys how your franchisewill perform financially or how existing franchisees areperforming. A franchisor cannot say, "These businessesgenerate at least $450,000 a year" (even if it's true)without making the statement in Item 19 and disclosing thereasonable basis for the statement and the assumptions thatunderlie the claim. Item 19 disclosures, which appear in anestimated 30 percent of all UFOCs, are therefore eagerly read byprospective franchisees. If the UFOC has no Item 19 statement, youmust rely on the performance information provided by existingfranchisees.

Item 20 lays out a statistical picture of the entire franchisesystem over the past three years. It includes a list of currentfranchisees as well as people who left the franchise system for anyreason in the past fiscal year. Use this vital contact informationwhen looking to interview franchisees about their experiences withthe program.

Just as it takes a little sweat to get in shape, it also takessome hard work to find a franchise business that meets all yourneeds--but the rewards can be well worth it.

The Real McCoy?

The question prospective franchisees ask me most frequently is,"How can I find out if the franchisor is legitimate?"Some people imagine there's some sort of national clearinghousethat can confirm legitimacy on the telephone. There is no suchplace, but there are clues ripe for the picking. Here are fivelikely sources of information to help you answer that all-importantquestion.

1. Even though it may not tell a complete story, the UFOCwill tell you volumes about the franchisor and its background.What sort of business experience do the company's keyexecutives have (Item 2)? What does it say about the company'shistory of litigation (Item 3) and bankruptcy (Item 4)? Is thetrademark registered with the federal Patent and Trademark Office(Item 13)? What do the system numbers (Item 20) say about thenumber of franchises that have opened for business in the pastthree years?

2. Another great source of information: existing and formerfranchisees. Call them (they're listed in Item 20 of theUFOC), and set up interviews. Ask them about their experiences withthe franchise, the training, the investment and how their businessis performing. And ask the ultimate litmus-test question: Would youmake the same investment knowing what you know now? If thefranchise offering is new and there are no existing franchisees tocall, you have no comparable source of information.

3. State agencies can be most useful in your evaluation,particularly if you're in a state that regulates franchisesales. The franchise registration states are California,Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York,North Dakota, Rhode Island, South Dakota, Virginia, Washington andWisconsin. Each of these states requires a franchisor to registerto offer franchises. Find out if the franchise you'reinterested in is registered before getting too serious.

4. The Better Business Bureau provides reports of customercomplaints received. For more information, go to www.bbb.org.

5. The FTC brings legal enforcement actions, large and small,against franchising companies. Look over its recent activity atwww.ftc.gov.

Franchise Fitness Checklist

Muscled up and fit to buy:

• The franchisor is financially strong; your accountant issatisfied.
• Franchisees in the system give their investment decision thethumbs up. Some systems make their franchisee "grades"available online for a modest price (see www.fransurvey.com).
• The business offers a good fit with your interests, andyou're excited to jump into the business. Even better, you haveexperience in this type of business.
• The revenue potential looks strong.
• Market trends are in favor of this business.
• A good location or good customer base is available in your homemarket.
• The franchise system shows steady growth.

Still flabby and needs to step up its regimen:

• There is a load of litigation reported in the UFOC, revealing arough franchisor dispute-resolution style.
• Franchisees in the system say they feel trapped and would notmake the same investment again.
• Franchisees in the system say the training is inadequate.
• Your lawyer says the contract is heavy-handed and poorlyprepared, and your accountant wonders whether the franchisor willbe around in 12 months.
• Your state franchise or consumer-protection agency says thefranchisor is not registered (if required) or that numerouscomplaints are on file.
• The franchisor provides you no UFOC, or the UFOC they give youis out of date, incomplete or not registered (if required).

Andrew A. Caffey is a practicing franchisor attorney in theWashington, DC, area and an internationally recognized specialistin franchise and business opportunity law.