Cheap Sheet

Stumped by the task of finding the perfect budget-friendly franchise? We've got all the answers you need to do your homework right--and spend your money wisely.

By Andrew A. Caffey

Opinions expressed by Entrepreneur contributors are their own.

Low-cost franchises have become hot commodities. Prospectivefranchisees know that if they can choose wisely and startbusinesses without the heavy front-end investment of a retaillocation, they can increase the potential return on their money.It's a well-known numbers game. For example, the typical newrestaurant build-out, including franchise fees, can run you$400,000 or more. That means some serious lender financing for mostpeople, as in signing a 30-year personal note and putting yourhouse on the line. You'll find similarly sobering numbers whenbuilding out a franchised muffler shop or a convenience store.These businesses ratchet up the franchise investment to a levelthat puts it out of reach for mere mortals trying to make the jumpinto business ownership.

That's where low-investment franchises come in. Thiscategory includes perfectly robust businesses that can be run frominexpensive office spaces or executive suite arrangements, or evenfrom home offices. Maid services, in-home care services, magazinepublishing, trademarked product distribution, interior decorating,auto-mechanic tool distribution and a variety of mobile, van-basedrepair services are just a few of the categories. If you can getinto the business for a total investment in five figures, considerit a lower-end franchise investment.

As with all franchises, however, it pays to assess the stabilityof the program and the financial risks you're undertaking. Justbecause the level of investment is manageable doesn't make itlow-risk; being able to swing a $45,000 investment doesn't meanyou can afford to lose it all. So here is a nugget of franchiseadvice that's worth its weight in pink slips: in a word,research.

With a modest amount of diligent research, you can lower many ofthe risks inherent in a franchise business investment. Don'tlet the idea discourage you--this is rather enjoyable research,gathering information that will make you better at running yourfranchise. It's asking people the right questions-and it'san organized way to investigate a serious investment.

Do Your Homework

Start with the quality of your search. Attending a franchisetrade show is a great way to get your feet wet. Held in largecities nationwide, these shows allow you to meet dozens offranchise representatives, all eager to convince you that theirprograms are tailor-made for you.

Go with an open mind, but before you go, spend a few minuteswriting down what would best meet your financial expectations andinvestment level. Know how much you have to spend on a franchisebusiness and what type of business would excite your interests. Areyou good at selling and do you want to deal with the public? Or doyou see yourself involved with other businesses? Getting yourthoughts straight before you arrive on the trade show floor willsave you time and aggravation. If you're looking for alower-level investment, you don't want to spend your valuabletime talking to restaurant franchisors about $500,000 investments.Also, jot down a few qualifying questions so they're at the topof your mind when you approach a booth: "Can you tell me thetotal investment range for your program?" "What are yourinitial fees?" "Are there other franchisees in mytown?" "How long have you been in thisbusiness?"

You should come back from a franchise trade show with basicinformation about a sampling of qualified programs. Follow up bywriting a letter or e-mail requesting more information from theones that interest you.

The internet provides a flood of information about franchising,and you should put it to work for you. The ratio of hype to fact israther high, but there is no better way to shop for ideas and toget a sense of the programs available in the market. New,sophisticated tools that will help you search are showing up on thenet. For instance, for a modest price, www.fransurvey.comprovides a collected survey of franchisee opinions about their ownexperiences in a growing number of franchise systems.

Federal and state enforcement agencies are also helpful researchsources. The FTCregulates franchise sales nationally and has a useful website thatgives you a sense of the actions recently taken against franchisorsthat have not been playing by the rules.

If you live in one of the 14 states that also regulatesfranchise sales, you should check with the regulating agency tomake sure a franchisor is registered in your state to actuallyoffer and sell you a franchise. The registration states are:California, Hawaii, Illinois, Indiana, Maryland, Michigan,Minnesota, New York, North Dakota, Rhode Island, South Dakota,Virginia, Washington and Wisconsin. Contact the state attorneygeneral or securities commissioner, and inquire about franchiseregistration information. If you are not in one of these states,contact your state consumer protection officials about franchiseinvestments-you might be able to learn whether there are anycurrent problems with a particular franchisor. The Better Business Bureau isalso a reliable source of documented complaints lodged againstfranchise businesses.

The two prime areas of research on your list are the franchisoritself and existing franchisees in the system. Franchisors arerequired by law to provide an invaluable document to prospectivefranchisees, and you should look for a copy from a franchisor ifyou are serious about its offering. This document, called theUniform Franchise Offering Circular (UFOC), must be delivered to aprospective franchisee at least 10 business days before a contractis signed or money is paid, or at the first personal meeting todiscuss the sale of the franchise, whichever comes first. Thatmeans the company is not required to deliver a document to everyonewho applies, just to those who have a face-to-face meeting oractually commit to buying a franchise. The franchisor may choose togive you a copy at any time, so by all means request one.

The UFOC serves essential information to you on a platter;it's research in its simplest form. You can read all about thecompany, summaries of the fees to be paid to the franchisor andyour total investment (see Item 7), required purchases, territoryand trademark rights, earnings claims, and system statistics.Attached as exhibits are lists of current franchisees and recentlydeparted franchisees, the form of franchise agreement you will beasked to sign, and up to three years of the franchisor'saudited financial statements. Be sure to read this vital documentbefore you put your money on the line. Take the financials to aqualified accountant and the franchise agreement to an attorney forevaluation, and you'll have the right experts on your side.

Your final stop on your research quest is to talk to franchiseesand interview as many existing franchisees as you can.

How Much Will You Make?

The most vexing part of research is finding business performanceinformation. Any rational investor wants to know how much money heor she will make and how the franchise will perform financially.It's vexing because franchisors are restricted by law fromproviding any performance information (known as "earningsclaims") unless it is disclosed formally in Item 19 of theUFOC. About two-thirds of all franchisors have no such disclosuresand so, at least according to the rules of the game, give noearnings claims information. So where do you turn for answers tothis vital question?

Your primary research source is franchisees. They aren'trestricted in any way by the franchise laws and are free to shareinformation with anyone. When you gather information fromfranchisees, note it carefully and use it as one factor whenworking with your accountant to prepare a conservative set offinancial projections. Many factors affect how those numbers relateto your business performance.

Also ask your accountant to help you examine thefranchisor's audited financial statements in the UFOC.Sometimes the presentation will break out royalty revenue fromfranchisees and may (if 100 percent is collected), with some simplemath, give you an idea of the average franchisee'srevenues.

If your franchisor is among the one-third of franchisors thatprovides earnings information, examine Item 19 and pay attention tothe data qualifications and limitations discussed in the footnotes.There is always a wide range of performance levels in a franchisesystem-some locations are unbeatable, but some owners are fantasticmanagers and operators, and there are weaker locations and poorerperformers among us all, franchisees included. Keep this in mind asyou review the performance information in Item 19.

The action at the lower investment levels of franchising iswhite-hot, no question about it. Since the mid-1990s, the power ofthe PC has allowed many businesses to become homebased,dramatically lowering overhead and opening up a remarkable array ofbusiness franchise concepts that don't require the investmentexpense of a built-out retail location.

Even if it is a relatively low investment, you still need totake the time and spend the effort necessary to thoroughly researchthe opportunity. Read the UFOC, talk to current franchisees, call afew former franchisees, and ask tough questions. You'll form aclear picture of the company and its franchise program veryquickly, and you'll be able to make the franchise investmentwith confidence.

For more information on low-cost franchises, visit Entrepreneur'sFranchiseZone.

Franchises Are Your Friends

Your best sources of information are existing owners in afranchise system-talking to them is a must. A good approach and asensitive discussion makes all the difference. Remember:

  • Owners are sympathetic. They immediately identify with you;they were in your shoes before they bought into the franchise. Theywant to help.
  • Respect the franchisee's time. Don't show up atlunchtime and try to get a restaurant supplier's attention, anddon't expect to get a franchised magazine publisher'sattention when an issue is approaching deadline. Make anappointment for a convenient time before or after a busy periodwhen you can meet in person and have a focused discussion.
  • Ask about training value. In any franchise, training is a largepart of what you pay for. With a low-cost franchise, you want tomake sure the training is rock-solid. Ask current owners what theythought of the training and whether it equipped them well foroperating the business.
  • Confirm franchisor support. Just because you haven't sunkhalf a million dollars into a franchise does not mean thefranchisor should be weak on support. Ask owners if they think thefranchisor has sufficient resources to provide the supportfranchisees need to be successful. Is there someone who'sknowledgeable at the other end of the line when you need help?
  • Explore business success. An important question to ask whenyou're interviewing a franchisee is whether the business hasbeen successful in the owner's eyes. It's all right to aska business owner what his or her company's gross sales were inthe past year. Then pop the ultimate question: "If you had thechance to do it over, would you invest in thisfranchise?"

Take Your Money and Run

Keep an eye out for these warning signs that the franchisesystem is not healthy or the program isn't working well forinvestors.

  • High turnover rate: Item 20 of the UFOC shows you the number offranchisees who have left the system in the past fiscal year, aswell as their names and addresses. Is the turnover figure more than20 percent? Ask why those people left: Did they sell theirbusinesses for a tidy profit, or did they fail in the business andclose their doors? Talk to several people who left. A highturn-over rate caused by business failure or franchisee unhappinessis a reason for concern.
  • An aggressive franchisor dispute resolution style: If thefranchisor has a history of suing its franchisees to collect feesor enforce the terms of the franchise agreement, it will berevealed in Item 3 of the UFOC. When you see a large number ofdisclosed cases, ask the franchisor and franchisees what itmeans.
  • Disappointing franchisee reports: When you talk to franchisees,what do they say about their experiences with the program? If theyare discouraged, not making money or mad at the franchisor for somereason, you need to understand the problem. Do not be quick toconclude that the same problems can't happen to you-theycan.
  • Little or no track record: Some of the most promising low-costfranchise investments on the market are new and don't have muchof a track record. That's not fatal, but it should alert you toan elevated risk.

Andrew A. Caffey is a franchise attorney in the Washington,DC, area; an internationally recognized specialist in franchise andbusiness opportunity law; and former general counsel of theInternational Franchise Association.

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