Buying A Franchise: How to choose the right franchise for you
This article appears in the January/February 2014 issue of Business Franchise Australia & New Zealand
WHAT ARE THE ESSENTIALS TO CHOOSING AND SECURING A SUCCESSFUL FRANCHISE THAT MEETS MY BUDGET?
Business Franchise asked Rod Young, one of the world’s leading franchise consultants and Chairman of the DC Strategy Group for his advice on buying a franchise. His advice has guided many franchise networks in establishing successful franchise ventures across the globe.
Buying and operating a franchise is an exciting and adventurous process. For most people, buying a franchise will be the most significant investment they make in their lifetime, akin with buying their first home. Imagine buying a house without looking in every room, getting a surveyors report or researching the value of similar houses in the area. At least the same level of due diligence should be undertaken when buying a business, even if it is part of a successful franchise network.
The primal motivator for every franchisee is the opportunity to build an asset that has future saleable value and an asset for the future of the family. Franchising has created opportunities for hundreds of thousands of franchisees around the world. It has proven to be one of the most successful business models over the last 100 years and with the continual interest in people advancing their lives combined with the shrinking of the global labour force, franchising has many years of success ahead.
Franchising however is not a guarantee of success. Like all businesses, franchises can, and do fail from time to time. When this happens, franchisees blame the area or territory, the location, their competitors, the franchisor or some other factor beyond their control. Rarely will franchisees admit that “I failed to understand my business before I invested and if I had done my research I would never have bought it”. In the future, don’t be surprised to see businesses, including established franchises fail.
Blaming external factors or the economy for failure is glossing over the deeper issues of why the business failed. Good businesses should be able to withstand and weather the ups and downs that many businesses experience over the years including the financial challenges that the world goes through from time to time.
The average tenure of a franchisee in many networks is between seven to eight years. It is hard to find a period in history when we have gone seven years without some form of economic turmoil. Why then are people prepared to invest their life savings into a business which they should have known would not survive if revenue dropped by, say, 10 per cent?
Avoiding failure in any business, franchises included, begins a long time before you sign an agreement and commit to a contract for a significant period of time. It begins when the idea of owning your own business first enters your mind. Given the financial and contractual nature of the franchising relationship, it is crucial that prospective franchisees thoroughly evaluate the business opportunity and the franchisor before committing to buy into a franchised business. Just because the anecdotal evidence strongly suggests that franchising is not as risky as an independent business where you are on your own should not be considered a guarantee of success.
Set Your Limits
Assuming you have an open mind on the particular type of franchised business you would like to operate, the two key considerations in buying a franchise are:
• What size of investment can you afford?
• What are your criteria and industry/area of interest?
With a wide range of franchised systems on offer, from mobile man-in-a-van, or service franchises, education franchises to large scale multi employee retail, food service or B2B service businesses, the prospective franchisee is faced with a seemingly endless range of opportunities.
Assuming you’ve already culled out those systems which don’t interest you, those for which you are not suited or those that demand operating constraints you are unwilling to meet, the first step in filtering this range of potential opportunities is to be ealistic about the amount of money you are prepared to commit to the business.
Here, the smart prospective franchisee will determine what they can afford and then commit to no more than that - just like the rules at an auction, set your limit and stick to it.
Other criteria to consider include:
• Where will the investment funding come from?
• What is the level of debt and the cost of debt service and principal repayment?
• How much income do you expect in return for your investment?
• In what geographic area should the franchise be located?
• How many days will your franchise trade?
• How many staff are you prepared to employ and manage every week?
• How many days/hours are you prepared to commit per week?
• How many years are you expecting to be involved?
• Do you have the support of your spouse or partner and what role, if any, will they have in the operation of the franchise?
Ask the Right Questions
You must reduce your list of potential franchises down to a manageable level - say, three or four. Take a good look at the list.
Do you really see yourself operating any of those businesses for a period of years?
Ask yourself these questions:
• Does the business present well to you as a consumer?
• Do you understand the business?
• Have they proven their ability to secure quality locations or operate in multiple regions?
• Are current franchisees profitable?
• Are they seen in the media and portrayed well?
• Are current franchisees happy?
• What is the marketing and advertising program like?
• Do they have strong relationships with the banks?
• What is the quality of the management and leadership team?
• Do they have company owned operations?
• Do they listen to and learn from their current franchisees?
• Do they have a clear vision and growth plan?
• Do they have a good, solid growth history?
• How good is the induction and training program, especially if you are a novice in the product, service and/or business?
• How well developed are their management information systems?
• Do they have an operations and procedures manual?
• What level of ongoing support is provided?
Make Your Application
Most franchisors will ask you to submit a formal application form. Be wary of those who don’t - it’s a sign they don’t care about who becomes a franchisee or they may not fully understand the business of franchising. Take your time with any application. If you have to hand write it, do so carefully. Be honest and forthcoming with information, it’s not in your best interests to mislead anyone about your ability to operate or fund the franchise.
A constant recurring issue for prospective franchisees is underestimating the amount of finance and working capital that is available. You should live within your means and invest within your means as an undercapitalised business is difficult to make successful.
You may be asked to pay an application fee of some kind. Make sure you receive a receipt for the fee and a written assurance that the amount is fully refundable until you sign a Franchise Agreement. In Australia, the Franchise Code of Conduct can help protect you here in that the Code which is part of the Competition and Consumer Act which dictates that a franchisor cannot charge a non-refundable fee until the franchise agreement is signed and a cooling off period of seven days has elapsed but it is best to get the franchisor to acknowledge that is the understanding as well as the law.
Talk to Franchisees
There is perhaps no more telling test of a franchise system than to speak with a range of current franchisees. The validation of the franchise system by the current franchisees is a key test of the success of a franchised network. Don’t just limit yourself to those suggested by the franchisor - they will undoubtedly pick the happiest franchisees.
Speak to a range of franchisees and ask them:
• Are they satisfied with their investment and the business?
• Would they recommend this franchise to their friends and family?
• Would they sign up again knowing what they know now?
• What support does the franchisor provide?
• Is the franchisor reasonable?
• Is the franchisor willing to listen?
• What problems are other franchisees experiencing?
• What would they change?
• Are the marketing campaigns delivering customers?
New or Established
Let’s assume for a moment that you’re the type of person who can tolerate a reasonable level of risk and as such, you’re prepared to venture into a new Greenfield franchise where the franchisor has not operated from a location in the area or within the territory. What should you look for, what are the questions to ask and how do you arrive at a commercially sound decision?
Some of the benefits of taking on a new Greenfield franchise include:
• No goodwill is payable to a previous franchisee
• It is a brand new operation and the local reputation of the business can be established as desired
• If it is a site based franchise, the landlord may be prepared to make a contribution toward fit out and/or negotiate the lease terms to link rental to sales levels.
Obviously, the balancing factor is that you will not have the certainty of a proven trading history for that particular location.
As an alternative to a Greenfield franchise, an established business enables you to take some comfort in the proven trading history so, in effect, it is generally perceived as a lower risk option. However, you may have to deal with the history of the previous franchisee. If the premises or vehicles are looking a little tired, a refurbishment or upgrade can restore the appearance. Don’t forget the current franchisee’s reputation in the market - which could be good or bad. Similarly, existing employees could be a positive or a negative influence. A key issue to consider is the potential for further growth of the business; is there more growth to be had or has it reached its peak?
There is no substitute in business for having detailed and accurate historical financial information for the performance of a business. The quality of the numbers is crucial and frankly, some examples defy belief - they lack detail and in some cases, any semblance of accuracy.
Do your Own Due Diligence
By this stage you should have contacted and met with your target franchisors and secured a first meeting or, hopefully, some financial details about the offer. You may be asked to sign a confidentiality agreement.
Regardless of the information the franchisor provides, you must develop your own view of the financial aspects of the business. There is no substitute for a thorough understanding of the establishment costs, revenue potential and operating expenses.
Choose an accountant who is experienced in small business and franchising. Discuss how he or she can assist you in reviewing the financial information and advising you on the potential of the business.
Your assessment should be conservative - err on the side of understating revenue and over-stating expenses to gain a conservative view of the business. Ask yourself:
• Are my assumptions reasonable?
• Do any other franchises in the network achieve the levels of patronage I think I can achieve?
• Are businesses close by achieving the level of patronage I think I can achieve?
• Do my rental and wages expenses include ancillary costs like rates, utilities, employee benefits, holiday pay and health insurance?
• Is my cost of goods assumption realistic and consistently achieved by other franchisees?
• Are the accounts of the existing operations accurate?
• If it is a mobile or service franchise, are the running costs of a vehicle adequate for the territory?
Present your assumptions and findings to your accountant and ask for his or her candid opinion.
Some franchise systems are accredited with major banks. This means the banks have done their due diligence of the franchise system and may be prepared to finance part of your establishment costs against the business. Be careful. You don’t want to exceed the limit you set for yourself originally. Test the financials again to see if the business can sustain the loan repayments required to fund the initial capital costs.
Use a Specialist Lawyer
You will most likely be provided with a pro-forma copy of the franchise documentation. If you receive only a summary of the Franchise Agreement or just the Disclosure Document ask for a full copy. No reasonable franchisor should refuse this request. A franchisor that won’t provide a full copy of the franchise agreement should ring warning bells. If the franchisor refuses to provide one - walk away.
The franchisor should provide you with a copy of a Disclosure Document as well as the Franchise Agreement. The purpose of a Disclosure Document if to provide information on the sector the franchise operates in, outline the history of the business of the franchisor, who the directors and shareholder are, the business history of the franchisor’s directors and key officers including any previous history of business failure they may have been associated with, the number of units granted, opened and the units that have closed or been terminated and importantly details of the capital costs including working capital needed to establish the franchise and the profit and loss model based on the performance of current franchisees. The contents also should include items such as the intellectual property being licensed.
You should engage a specialist franchise lawyer with experience in both business and franchising to review the proposed agreement, disclosure document and any other documentation the franchisor provides. There is no value in engaging a non-specialist to review the Franchise Agreement because such agreements are, by their nature, substantially different to ordinary business contracts. A specialist legal advisor is a must. It’s a worthwhile investment and importantly saves you the investment of paying a lawyer to learn franchising at your expense.
Keep Asking Questions
A quality franchisor will be willing to answer all your questions and provide you with enough information on which you can make a fully informed decision. Don’t fail to ask simply because you think the question is stupid - ask it anyway. You must be comfortable with every aspect of the business, so ask, ask, ask and keep on asking until you are satisfied.
Only after you have completed all these steps should you contemplate signing a Franchise Agreement. So, in summary:
• Set your limits - know how much you can comfortably afford
• Make sure the franchise meets your criteria
• Ask the right questions - use key questions to shortlist three or four potential franchises
• Make your application - complete it as thoroughly and accurately as you can
• Talk to current franchisees - they are an excellent source of information about the franchisor and the business
• Do you own due diligence - err on the conservative side and use an experienced accountant
• Establish finance - evaluate the various banks with whom the franchisor is accredited
• Use a lawyer with extensive franchise experience - only a specialist should review your legal documentation and advise you
• Question - ask all the questions you want until you are satisfied you understand everything.
Only after completing these steps should you contemplate signing any legal documents that bind you in any way and commits you to investing your hard earned money. It’s your responsibility to understand the business and make a fully informed decision.
Understand the franchisor is not responsible for your success or failure. That obligation rests with you as the proprietor of your own franchise. It will be your job as a franchisee to ensure your franchise is profitable. If you cannot accept that responsibility you are not yet ready to make the transition to being your own boss!
Rod Young is considered to be one of the world’s leading franchise consultants. Rod has over 30 years’ experience in franchising, licensing and business development in Australia, Europe, China, South East Asia, India and the United States and is the founder and Chairman of DC Strategy, the specialist franchise consulting, legal and recruitment firm.
DC Strategy is the region’s leading and longest established franchise advisory firm comprising consulting, legal, recruitment and brand and marketing divisions. Their highly experienced specialist teams have developed many of the region’s most successful franchise networks and brands creating well over a billion dollars of enterprise value for their franchise clients in the last decade alone.