FRANCHISE FUNDAMENTALS

Date: SEP 14th, 2010

Topic: Industry Experts

Your path to franchising must begin with research to determine which franchise is really right for you. Your search will start wider, of the franchise marketplace generally, and then narrow down to a particular industry. Begin your search by attending franchise trade shows in or near your local area market. It is a wise investment to visit a trade show in a large close-by urban area if you are located in a smaller city or town, because more franchisors exhibit at larger trade shows. Purchase a franchise directory at such a trade show or in a book or magazine store, as many franchisors in diversified industries advertise in franchise directories. You will quickly discover that one or more franchises exist in most industries.

There is a franchise opportunity for just about everyone. It is important to narrow the options by focusing on those franchise opportunities that best suit you. Start by examining the franchise industries that you will enjoy, and choose the franchise opportunity that best fits your lifestyle. For instance, if you will be the owner-operator of the franchise business and you are a single mother of school-age children, you may want to consider a home-business franchise, a franchise that permits you to work part-time, or a breakfast restaurant franchise that typically closes daily at 3 pm. Decide how many hours you wish to work and how many employees you are capable of handling. Determine how much capital you have available to invest (whether bank-financed, friends-or-family-financed, or personally-financed) and narrow down the choices further by the level of investment required.

It is important to plan for a contingency fund as there are always unexpected costs that arise in the initial years of running a business. You also have to have enough liquidity to support yourself in the initial years of business as some businesses provide a slower return on investment than others. Assess whether your local area market is saturated by franchise and non-franchise competition in those industries. Determine how many other franchises have been granted in or near your local area market by the franchisor you are investigating. If there is already too much competition, you may want to consider a different franchise opportunity. However, some market development and brand awareness of the particular franchise is good, because you will be entering a system that has established goodwill and credibility.

Once you have zeroed in on the particular franchise industry and a few specific franchisors within it, a more concentrated investigation can begin. Visit the franchisor’s official website. Many franchisors have a dedicated franchise section on their site that provides terrific basic information. Speak to current franchisees within each franchise system you are investigating and ask them a lot of questions. Visit their retail locations and see the condition of their “store”. See if the other franchises in the system tend to be owner-operated or not. Advise that you are considering becoming a franchisee. Ask the current franchisees if they are happy with their decision to franchise, if they received adequate initial training to launch their franchise business, and if they are continuing to get support from the franchisor. Ask if they plan to renew their agreement at the end of their term and what that term is. Ask if they are making a profit and how long it took them to turn a profit. Ask what their total initial investment was and if they have earned back their investment. If not, when do the current franchisees expect to earn back their investment? If you are unaware of any brand advertising that has taken place, ask the current franchisees if the franchisor has set up a marketing fund and what marketing and advertising the franchisor has undertaken or plans to this year.

Ask the current franchisees if they are aware of any franchisees that have left the system and why. If you like the general picture of the franchisor and the franchise system that is starting to emerge, the next step is to complete the franchise application form.

The franchise application form is the important first step in the mutual due diligence that takes place between the franchisor and the prospective franchisee. Many franchisors require applicants to put up a deposit at this stage, typically ranging between $5,000-$10,000. The deposit shows a franchisor that you are serious about becoming a franchisee if the investigation leads to the conclusion that you are an appropriate candidate. In most franchise systems, your deposit will be fully refundable, at least up to a fairly late stage in the qualification process. You must be aware of all of the conditions surrounding the deposit and its refundability.  If you are not comfortable with the particulars relating to the deposit, you should move on from this franchise opportunity.

Importantly, your application will be treated confidentially by the franchisor. However, your application authorizes the franchisor to conduct an investigation of your identity, your creditworthiness, your past record with employers, landlords, etc. It is important to complete the application form fully and accurately because a franchisor can quickly tell by your answers if you seem right for the franchisor’s system. Incomplete forms will likely be disregarded by franchisors. In any event, you want to find the franchise that is not just right for you, but you for it, as you are more likely to be successful when the fit is good.

Assuming the franchisor likes what it sees from your application, you will be invited to undergo a series of interviews, designed to elicit deeper information about you at each stage. In some cases, these interviews can take several weeks or even months. You may be required to travel outside your home city to the franchisor’s head office for these interviews, and you will be expected to fund this travel.

As a prospective franchisee, use this time to further your own investigation of the franchisor and the particular industry as well. Ask to meet the executive management team of the franchisor involved in operations, marketing, business development, etc., and ask questions about the franchisor’s market share, its 5-year growth plan, the competition, etc. See if there’s a fit between you and the members of the executive team that you will be working with on a regular basis. Remember, if you are dealing with dedicated sales personnel now, you will not be working with those employees once you become a franchisee. Ask for the list of past franchisees and contact them afterwards to learn why they left the system. Bear in mind that while a disgruntled past franchisee may have an interesting story to tell, his or her perspective may be somewhat self-serving. Also bear in mind that either you or the franchisor can end the qualification process at any time if the information elicited about either of you seems inappropriate.

In many Canadian provinces, but not all, it is legally required for the franchisor to give the prospective franchisee a disclosure document. The disclosure document is a kind of consumer protection document which sets out, in detailed layman’s terms, all of the obligations of a franchisee, as well as other pertinent information, like the background of the franchisor and its principals. It is important that you read this document fully and carefully.

Assuming both you and the franchisor pass this mutual qualification process (meaning you are accepted as a franchisee in principle), you will be given a draft franchise agreement to review. To a certain extent, the franchise agreement balances the interests between the franchisor and the franchisee. Each needs the other to make money and succeed. Typically, the principals of the new franchisee company (its key shareholders and directors) will have to sign personal guarantees with the franchise agreement. It is important to invest in having the draft agreement reviewed by a franchise attorney. Many provisions of the franchise agreement will not be considered negotiable by the franchisor. This is so because an important factor for the success of any franchise is consistency. Consistency of experience for a franchise’s consumers begins (but does not end) with consistency of the franchise agreement. A franchise attorney can best determine if the franchise agreement is drafted to industry standards and if the non-negotiable provisions are reasonable and customary. A franchise attorney can zero in on the areas of the franchise agreement that truly require and permit negotiation in the interests of the franchisee.

You will be given, or can ask for, a financial pro forma, which is a theoretical financial statement for the first year of business for a theoretical franchisee. The pro forma is not a guarantee that you will earn the gross and net revenues reflected in that statement because actual earnings will vary from market to market, franchisee to franchisee. But it will provide an idea of what a possible franchisee in the circumstances described in the pro forma could theoretically earn. It is important to invest in the review of the financial terms of your franchise agreement and of the pro forma by an accountant.

Before you sign on the dotted line, you must be comfortable that you have fully investigated, understood and accepted the risks of the particular franchise business.

Cheri Bell is an experienced franchising, licensing, business-growth and commercial lawyer/advisor. She consults for franchisors, franchisees and businesses across Canada and internationally on all aspects of their business, from their growth model to legal issues, contracts, operations, branding, marketing and sales. Contact Cheri at (514) 488-8007 and cheribell@sympatico.ca.