Franchisee lawyer Richard Solomon has a passion for spreading the word about conducting pre-investment due diligence.  His latest post on the BlueMauMau site outlines many of the pitfalls experienced by franchisees in various industries.  It also discusses the fact that a mere review of the franchise disclosure document and franchise agreement is not enough.  On that subject he says,

Every failed franchisee hired some cheap lawyer to “read the contract”.  When you add up what you are risking, you will appreciate that a few hundred dollars for an incompetent review of documents by someone who doesn’t know where else to look for what needs to be considered is really stupid. You can’t afford that approach. But it’s your money and your decision.  

I agree with Richard that due diligence is critically important.  I also agree that prospective franchisees must do more than just read the contract (i.e. Franchise Agreement and Disclosure Document).  Real due diligence will require a multi-disciplined approach.  The prospective franchisee should get a lawyer, accountant, banker, and even a marketing professional into the decision-making process.  If a specific location is key (such as retail or restaurants) you will want a commericial real estate agent also involved.

But above all, the franchisee must become engaged in the process.  Don’t rely on the professionals to do the hard work for you.  You must roll up your sleeves and investigate.  In the next post we will discuss more of the details about how conduct franchise due diligence.    

One of my franchisee clients offered a very simple question that every prospective franchisee should ask of other franchisees when conducting due diligence:

What doesn’t the franchisor do well?

He says this evoked the best responses from franchisees when he conducted his due diligence.  If you are considering a franchise be sure to talk to as many franchisees as possible.  Speaking to only a handful is not enough. 

For more information be sure to read this article on franchise due diligence resources.

In my last post on franchising I discussed some available franchise due diligence resources for prospective franchisees.  And while I know due diligence is critical before buying a franchise, I cannot help but remember an email I received from a non-client franchisee in response to a different franchise due diligence post I wrote after the Franchise 500 issue of Entrepreneur hit the news stands:

The most difficult information to obtain and verify is franchisee profitability.  The profitability of the franchisor and the franchisees is not always related.  Sometimes those selling franchises make money while the franchisees do not.  And it is not always due to lack of due diligence on the part of the franchisee.  It may be because of inaccurate information supplied by the seller or franchise support that was promised but never delivered.

The reality is that franchisors are required to make only limited disclosures about profitability and many will make no earnings claims of any type.  The number one reason listed to not buy a franchise according to Nolo is questionable profitability.  So what is a prospective franchisee to do?

Franchise lawyer Richard Solomon of Houston, Texas says you should consider conducting the ulitimate due diligence by going to work for someone in that franchise business for a year.  In buying your franchise you may be asked to make a substantial investment of $150,000 to $1 million.  Solomon believes that even if you made minimum wage for a year you will be much better off than risking your liquidity on an investment you know a lot less about because you were in a hurry. 

Risk is inherent in any business venture.  You are taking a chance and a leap of faith.  But actually working in a franchise business before you buy would allow you to find out whether you want to stake your life savings on the opportunity.  Taking a chance with maximum information is not random chance but a calculated risk – and that could make all the difference.

*I originally wrote this post forthe Iowa business law section of IowaBiz.com.

Are you interested in a business franchise opportunity?  It seems as though more and more Iowans are choosing franchises as an option rather than starting businesses on their own.  It is extremely to important to conduct due diligence and check out franchisors thoroughly. 

Inc.com has an excellent Guide on Buying a Franchise.  Topics covered include:

and much more.

You should also check out my podcast with Joe Cooney of Frannet which covers some basics of buying a franchise.  Joe also has a list of questions to ask franchisors.  But remember, when conducting franchise due diligence there is no substitute for digging in and working hard.  Above all, always interview as many franchisees as possible to get a better sense of how the franchisees themselves are performing.   

* I originally wrote this post for IowaBiz.com.

If you are looking at a franchise opportunity you should read this article from Barry Kurtz on Digging into Franchises:  The Due Diligence Minefield.  His proposed Legal Due Diligence Checklist within the article is a must read. 

The due diligence process is important when buying a franchise (or any business).  Kurtz’s article deals more with buying the entire franchise company but the article is helpful even if you are buying a single franchise.  I also have multiple articles addressing due diligence issues when buying a franchise including:

Joe Cooney and I have a podcast on Buying a Franchise Basics which also has some helpful hints on franchise due diligence.  Joe has some great insight so I recommend a listen. 

I recently posted on the Secret Sauce for Franchise Investing. The post features an article outlining what private equity investors like about franchises. Today, I want to touch on the first “ingredient” which is whether the franchise’s product is straight-forward and consistently replicated.

This is much harder than you may think for franchise operations to attain but it is often the difference between a successful or unsuccessful franchise. Think about McDonald’s for a second. I would argue that McDonald’s success isn’t because their burgers and fries aren’t the best tasting. In fact, I’d argue that many other places have better burgers and fries. However, the key to McDonald’s success has been that their business is straight-forward AND consistently replicated. Each and every time you walk into a McDonald’s you pretty much know what you are going to get in terms of the experience. The food tastes virtually the same, the service is virtually the same, the locations look and feel virtually the same and the price is virtually the same. There usually isn’t much difference among the various locations.

On the other hand, I am familiar with a different restaurant franchise (mostly regional) that has struggled. One of the major reasons this franchise has struggled is because it has been unable to consistently replicate its customer experience system-wide. In fact, some locations even have different recipes for the food and you are never certain how the food will taste from location to location. This causes issues not only for customers but also among the franchisees. Some franchisees are unwilling to give up their recipes for a more systematic approach because they only consider their location rather than the franchise system itself. In the end this franchise will likely never reach its true potential unless the franchisees buy into a common approach and deliver a consistent experience. There is just too much uncertainty from location to location.

The allure of franchising is that the franchisor has a proven system which will help you be successful. But know that all franchise systems are not created equal. Learn about the system and conduct your due diligence on whether the franchise system you are considering consistently replicates its offerings. It could be the difference between success and failure.

One of the things I hear over and over from distressed franchisees is that they purchased a franchise because it was a “proven business model.” Now, I don’t blame most franchisees for this thought process as they head into their franchise business purchase.¬† The franchise industry has done a remarkable job of marketing itself where people are preconceived to believe franchises are proven business models. Second, some franchises have been in business for a long time which naturally leads someone to believe it is a proven business model. After all, a franchise would not be in business for a long time if it were not proven, right?

Continue Reading Buying a Franchise: Is it Really a Proven Business Model?

In the Des Moines Register today there is an article about a food truck franchiser that allegedly got cross-wise with investors and franchisees. The article shows just how critical it is to perform due diligence when it relates to franchises (or any other business opportunity). I have a number of posts available I have written over the years on franchise due diligence.

But what’s interesting to me is that investors were actually asked for smaller sums of money (example $14,000) than what you might ordinarily expect for a national franchise operation. In my experience if someone is asking for you to “invest” in their business in smaller amounts such as $10,000 to $20,000, be very careful. This may be a sign of someone who is merely looking to meet a short-term cash deficit/problem rather than someone who is actually looking for a long-term investor. Business “investors” are typically asked for larger sums of money such as $100,000 and above. The individuals asked to “invest” the smaller sums of money almost always have a more difficult time getting their money back. To compound the problem agreements of this smaller nature are often not reviewed by lawyers (or sometimes lack a written agreement entirely) and almost always lack key terms to provide recourse and collateral for the investor.

Buyer beware!

 

I read an excellent post recently about The Secrets to Success in Franchising. I love what blog author Mike Sheehan had to say to start the article,

If the title of this article caught your attention because you’re looking for a magic bullet, stop reading right now. There is no such thing – for any of your goals. Whether you’re trying to lose weight, quit smoking or achieve success in franchising, a quick fix or an easy solution will lead you to only one inevitable destination: failure.

But he does come forward with some concrete action steps in the blog post to increase your chances of success in franchising. One thing Mike says is that people will do more due diligence in buying a car than buying a franchise. As impossible as it sounds, particularly given the fact many people are investing their life savings, this is often true. Don’t be one of those people. Conduct due diligence on many fronts including a self-assessment of whether you have the mindset to be a franchisee, your strengths and weaknesses as a prospective business owner, and your financial picture. Only after performing those assessments would I look at researching specific franchises.

By the time most people come to me they have already decided to purchase a specific franchise. Sure I have seen people change their mind but most often they are moving forward regardless of what I tell them. Don’t be one of those people either. Don’t make the review of the franchise disclosure document and franchise agreement an afterthought. A good business person will consider the agreement as an crucial part of the deal. If it doesn’t make sense to sign the agreement, the good business person will walk away. Be one of those who are willing to walk away. You just might find that you will get a better deal and hopefully one that can help put you on the path to success. And if you can’t get a deal done that makes sense, don’t be afraid to acknowledge it just wasn’t meant to be. There are plenty of franchise concepts out there to consider.

Like any business, success in franchising is not easy. The statistics show that franchise businesses fail at roughly the same rate as independent businesses. But following the steps Mike sets out in his post definitely should help to increase your chances of success.

Potential franchisees should read this article from Robert Purvin on Franchising Myth One: Franchises are Safe Investments. In the article, Purvin discusses how franchises and independent businesses fail at roughly the same rate (something discussed at length in several of my blog posts).

It’s critical that prospective franchisees understand that buying a franchise will not automatically increase your chances of success. I hear time and time again from people about how franchises have a "system" and "they will help me with marketing and getting customers". It’s not always the case. 

Purvin gives some good advice to help avoid mistakes when deciding whether to buy a franchise operation:

When you and your franchise attorney are reviewing the Franchise Disclosure Document, don’t limit your investigation to the closure rates. Look at the profitability of each location, especially those that serve in markets similar to yours. Do your due diligence and speak with current and past franchisees. Ask them direct questions about their profitability. It is especially critical to talk to past franchise owners and to ask them why they left the franchise. If you get any sense that the franchisees had trouble making a profit, then think very carefully before moving ahead.

Most importantly, insist that your prospective franchisor provide you with sufficient data to evaluate the profitability of the business. Limit your search to franchisors that make financial performance representations (formerly called ‘earnings claims’). There are many franchise opportunities available that are able to authentically boast high rates of success and profitability. These tend to be the top tier franchisors that require the highest investments and strictly limit their franchisee pool. As you go down the rungs of the franchising ladder to less well-known brands, new franchisors, and those with very low rates of entry, the risks typically grow.

Understanding that buying a franchise, just like starting any business, carries significant risk is the first step. You could lose your money. I see it happen to franchisees frequently. Be sure to approach buying a franchise just like it was your very own. Because in the end it will be up to you, not the system, to make it successful.