EVALUATING A FRANCHISE OPPORTUNITY
Franchises appeal to would-be entrepreneurs who want to be in their own business – but not completely on their own. Franchise businesses can be highly successful but there are many pitfalls and each opportunity must be carefully evaluated.
Here are 32 points you should consider.
The franchisor may be well-known and have a good reputation but take nothing for granted and look below the surface.
1. Check the franchisor’s financial standing and business reputation with a credit agency.
2. What is the business record of the directors?
3. Accept nothing other than that which is put in writing by a member of the organisation with the authority to do so.
4. Make personal contact with established franchisees. Talk with them about all aspects of their operation. This could be the most important part of your research, so beware of any franchisor who refuses to supply you with a list of the existing franchisees.
5. Be sceptical of franchisors whose main activity is the sale of franchises and whose profit is primarily derived from these sales or from the sale of franchise equipment.
6. If a franchise is advertised with only a post office box number as identification, forget it! The same applies to offers of opportunities to get rich with minimum effort.
7. Is the franchise already operating or is it a new operation? If the latter is the case, how can projected sales be verified?
8. Study the competition – if there are no obvious competitors, what are the chances of them arriving on the scene after you have made an investment? In other words, what are the barriers to entry?
9. Who is responsible for advertising and the recruitment of clientele? Some franchisors take care of these tasks.
10. Find out if the product is protected by patent or liability insurance and if the same protection would be afforded to you as a franchisee.
11. If the product is to be manufactured by someone other than yourself, ask the manufacturer how its price will be established.
Return on Investment
12. A prospective purchaser should clearly establish what their total investment will be, what their investment buys and what return, apart from wages, is expected. While there are no guarantees of any return on an investment in a franchise, prospective franchisees should compare the expected return from a conventional investment i.e. term deposit, debenture, with the return from the franchise.
13. If additional equipment is required to be purchased from the franchisor, are these prices comparable to the open market?
14. The same applies to supplies purchased from the franchisor. Does the franchising agreement prevent you obtaining supplies from another source?
15. If royalties are charged as a percentage of gross sales, make sure these are not out of line with the sales volume and projected net profits for the franchise.
16. Ask to see validated profit figures of franchisees operating on a level of activity you can reasonably expect.
17. How is the wages component costs made up? An important incentive for a company to become a franchisor in the first place is that it is a means of ensuring enthusiastic, energetic managers of branch outlets. However, the profit projections may assume exceptionally long hours at effectively low rates of pay for the franchisee proprietors. There is nothing wrong with this, as long as the prospective franchisee recognises it and takes it into account when calculating the return on investment. Owners’ wages, at a realistic level, should be deducted from the income.
18. Ensure the franchisor details all the outgoings including items such as power and delivery vehicles.
The Franchising Agreement
19. Don’t just have the agreement inspected by your accountant or bank manager. Take the t rouble to have a good lawyer – preferably one who specialises in franchising – go through it with you thoroughly.
20. Pay particular attention to provision in the agreement affecting termination, transfer and renewal of the franchise. Franchisors generally reserve the option to buy back an outlet on termination of the contract and once the franchisee has made the outlet a success, there is a natural incentive to do this – at the lowest price.
Some franchise agreements provide that franchisors have the absolute right to terminate the agreement if, in their opinion, certain conditions have not been met. The feeling of insecurity this may engender in the franchisee will be accentuated if the contract does not provide a means whereby a fair market price of the franchise can be established. Some franchisors include provisions in the agreement ensuring the repurchase price does not exceed the original franchise fee or historical cost of the investment.
A possible solution would be for the contract to specify that repurchase by the franchisor should be made at a minimum multiple of the established pre-tax earnings of the business. This would give the franchisee a better chance of realising capital gain by improving the earnings of the business and building its goodwill.
If you are buying a franchise with the intention of passing it on to your family as a profitable business, take particular heed of the contract’s transfer provisions. Not only does the franchisee usually not have the right to sell a business to the highest bidder, but the agreement of the franchisor is often required before it can be left to a family member in a will. Some franchisors demand up-front payment before providing documents. Be wary of this practice and appreciate that if you don’t proceed you may have difficulty in recovering your money.
The Franchise Territory
21. What specific territory is being offered and is it clearly defined?
22. What is its potential?
23. Do you have a choice of territories?
24. What competition would you meet in marketing the commodity in designated territory today and in (say) five years’ time?
25. If the franchisor says a market survey indicates given potential, get a copy and investigate the reputation of the organisation who prepared it. Particularly note the assumptions behind the survey conclusions and, if possible, talk to the researchers responsible.
26. Are you protected from the possibility of the franchisors selling additional franchises within the territory at a later date?
27. Are there any limitations upon you if you desire to open additional outlets in the territory, or even another territory, at some future time?
28. Has a specific business site within the territory been selected? If not, how will this be decided?
Are you suited to being a franchisee?
Some franchise promoters would have investors believe that through a minimum or part-time effort, or even “absentee ownership”, they can become extremely successful in the franchising world. Franchisees can only expect to succeed by hard work and full-time effort. Franchise plans based on part-time work generally produce only modest results for the franchisee.
Investors should ask themselves:
29. Am I genuinely enthusiastic over the franchise plan?
30. Am I physically and emotionally equipped for the work and confident about my management ability or potential?
31. Am I temperamentally suited to spending my business life working with this particular franchisor and selling this particular product or service to the public?
2. Do I seek complete business independence? (If yes, you are more likely to find it in an enterprise other than franchising.)
Franchisees do invest considerable amounts of money in franchise businesses, and consideration as to the progressive recovery of this capital investment over the expected commercial life of the business (usually the term of the franchise) is vital.
There are many businesses which can be franchised, there are many which cannot. Businesses which cannot be franchised include those which rely on the charisma of the owners; businesses which are dependant on “arts” rather than “sciences” and businesses with low barriers to entry, e.g. those which any competitor can enter easily and inexpensively.
Franchising allows an organisation with the correct character and culture to expand rapidly with limited capital and provides motivated owner-operators. It spreads the organisation’s image and advertising dollars and allows bulk buying.
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