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.
 

 

 The Classic Battle

A group of franchisees file a lawsuit contending the franchisor forces them to buy products and/or services at inflated prices while setting retail prices so low the franchisees cannot profit. The lawsuit also alleges that the franchisor omits or misrepresents key facts about its business operations when selling the franchise.

The franchisor, of course, denies the allegations and intends to vigorously defend the lawsuit.

The Issue

Many franchise agreements contain restrictions on the products and suppliers the franchisee may use. While this may seem reasonable in the beginning, (after all, you’re buying a proven system, right?) many franchisees discover later they can get cheaper products and find better suppliers than they can using the franchisor’s system.  The franchisees begin to question why they are paying for higher priced products along with paying royalties which eat into profits even more. When this happens franchisees tend to get upset and file lawsuits like the one described above.

If the franchisee agreement you are considering contains restrictions on products and suppliers be sure to consider those provisions very carefully. Be prepared to ask the tough questions of the franchisor when it comes to products and suppliers. Also, don’t take for granted just because you are going with a franchise that you are getting the benefit of the franchisor’s "bargaining power."

Above all, make sure to talk with as many current franchisees as possible regarding the products and services of the franchise and conduct your due diligence.

In meeting after meeting with prospective franchisees I am asked what I would look for in a franchise opportunity. It’s not an easy question. But trust me when I say that all franchise opportunities are NOT created the same.

What separates the good franchising opportunities from the bad franchising opportunities in my experience? Here are my top four reasons:

  1. The Brand Must be Recognizable. Talk to 10 of your friends. If they’ve never heard of the franchise you may want to reconsider the opportunity. The upfront costs of franchising are often greater than starting your own business because of the associated franchise and other upfront fees. If the brand isn’t recognizable, can you really justify paying the franchise fees or are you better off starting your own independent business?
  2. The Franchise Has a Fantastic System. Are the operational processes the franchisor has in place so special that you couldn’t duplicate it yourself or perhaps it would take you years to develop?  I say a franchise better have those fantastic operational processes in place or it probably isn’t worth buying.
  3. Unique Concept or Product. Does the franchisor have an unique concept or product that you are unable to duplicate yourself or perhaps it would be to expensive to develop on your own? 
  4. Protected Intellectual Property. Does the franchisor possess protected intellectual property that would make it difficult or impossible to start the business on your own? If so, then franchising may be your only alternative to break into a particular market.

Time and time again I see people invest their life savings into franchising.  Some of these people achieve great results while others do not. There is no validity to the claim that franchise operations fail less than independent business opportunities. Be sure to examine franchise opportunities carefully and conduct your due diligence. The due diligence should include extensive interviews with the franchisor’s management team and as many franchisees as possible. Get advice from a franchise lawyer, accountant and a banker regarding the opportunity. Educate yourself and be willing to walk away from the negotiations to get the best deal possible from the franchisor.

In conclusion, there are many other issues to consider when evaluating franchise opportunities but if the franchise opportunity doesn’t have one of the four things above, it’s been my experience you can probably just move on to the next opportunity.

 

If you’re interested in buying a franchise and in the process of reviewing the franchise disclosure document (FDD), I recommend a post from business attorney and franchise consultant Mike Sheehan on Item 19 financial disclosures. Mike starts his post by giving some good general information about FDDs including the fact, despite the voluminous nature of the document, it is not everything you need to know about the franchise and its operations. Rather, the FDD is really just the starting point and the most useful information contained in the FDD is the list of franchisees and former franchisees that should you should interview about the franchise.

Item 19 of the FDD is the section that covers financial performance representations. There are several things to keep in mind when reviewing Item 19 of the FDD. First, understand that franchisors are not required to provide financial performance representations. In fact, most franchisors do not provide this information in their FDD. Why? As Sheehan points out, this could be for a variety of reasons including the fact the franchisor does not have reliable information or perhaps the financial representations do not paint a pretty picture. If the franchisor chooses not to provide financial performance representations, it’s an important part of your due diligence to understand why.

If past financial performance representations are made by the franchisor, it’s imperative to understand the limitations of these disclosures. Sheehan cites as an example that it may not do you much good to have financial performance representations from just Florida franchisees if you are seeking to purchase a franchise in North Dakota. The results could be dramatically different in those regions. Additionally, there is no obligation that the financial representations are based upon generally accepted accounting principles (GAAP). This makes comparisons potentially difficult. Moreover, any future forecasts or projections are really just guesses. 

Overall though, I’d like to see Item 19 financial performance representations in the FDD. But understanding what the numbers show is a must for anyone conducting due diligence of a franchise.

I read an interesting article from Entrepreneur Magazine entitled Back to Civilian Life, Veterans Try Franchises. The article discusses how a former fighter pilot purchased a franchise after retiring from the U.S. Air Force.

A couple of months ago I spoke at the Iowa Veterans Career Retreat. Many of those in attendance were looking at starting their own businesses. None in the audience that day were considering a franchise. However, a franchisecould be a good alternative.

How do you go about choosing the right franchise among the many offerings out there? Good question. My friend Joel Libava a/k/a The Franchise King wrote a book on the subject called Become a Franchise Owner! I recommend the book for any veterans that may be interested in purchasing a franchise.

Some wisdom I’d share is not to get sucked into the notion that franchising is less risky than starting your own business. Franchisees fail at about the same rate as other businesses. Conduct due diligence and carefully formulate a business plan even if you are purchasing a franchise because "they already have the system in place". And it’s also very helpful to be honest with yourself in assessing whether a franchise is right for you.

Finally, evaluate whether you are buying yourself a job. You should purchase a franchise as an investment and expect a return on that investment. Otherwise, veterans (or anyone for that matter) is better off just looking for employment. It’s less risky and a lot less stressful.

Prospective franchisees should read a new book from The Franchise King, Joel Libava, called Become a Franchise Owner: The Startup-Guide to Lowering Risk, Making Money, and Owning What You Do.

I don’t make that recommendation lightly. But Joel and I share a common passion. We are both passionate about making sure that franchisees investigate and research franchises carefully. All too often people invest their life savings in a franchise only to find out that the franchise wasn’t for them. While proper due diligence and investigation doesn’t guarantee success, it definitely gives you a better chance!

Joel’s book is straight-forward and full of practical tips in researching franchise opportunities. He says that most people start off their franchise research by making two mistakes:

  1. Going it alone without anyone experienced in franchising to assist them;
  2. Starting the search by searching for a franchise. You’ve got to determine if franchise ownership is right for you first.

Now I must disclose that Joel included a short piece I wrote for the book on my thoughts in reviewing the franchise disclosure document and franchise agreement. After reading the entire book, I am even more flattered that he asked me to write the piece because I believe his book is the best I’ve read on the steps franchisees need to take in order to properly research franchising and how best to lower risk in the process.  It’s a small investment ($8.99 for the Kindle version and $14.63 for the hard cover) but could save you big bucks down the road. If you’re thinking about researching a franchise, my hope for you is that you read this book before starting. And if you’ve started, stop now and read this book before it’s too late.

The Business Record has an article on a couple of Iowa fitness franchises that are apparently growing at an impressive clip. In the past I wrote a post questioning whether fitness franchises are a solid investment. Based upon my experience in representing a number of franchisees in the fitness industry, I would say the competition is fierce and a prospective franchisee needs to carefully consider whether their franchise location can be profitable. 

Specifically, you should look very carefully at the trends of the franchise concerning the number of outlets.  Carefully study the number of transfers and not just the number of closures.  A high number of transfers may be an indication that franchisees in the system are struggling, but unprofitable franchises have not been shut down.  Of course if there is a significant number of closures in the system that is definitely a bad sign. The reality is that profitability in any market with a fitness franchise gym is often a tough task to achieve.

The franchises mentioned in the article are different than traditional gyms and are relatively new to franchising.  In these concepts you are really purchasing a program rather than a gym.  In evaluating these fitness franchises, or ones similar to them, it would be important to determine whether the exercise program offered is unique and whether the franchisor’s intellectual property is protected. After all, the exercise program is the critical part of the system – not the gym itself.  

As always in evaluating franchises, do your homework. It is important to have in-depth discussions with management to get a feel of their experience in franchising (not just running a single gym or exercise program) and talk with as many franchisees as possible to learn about their experience with the franchisor.

In the case of new franchises people are often attracted by the prospect of getting in on the ground floor of an opportunity but not everyone thinks it’s a great idea to buy a new franchise. Also, there are common mistakes to avoid when selecting a franchise. Before you invest your savings commit to doing the best due diligence you possibly can.

 

 

  

Franchise attorney Charles Internicola busts the myth that franchise agreements are non-negotiable in his post, Myth:  Is it Illegal for a Franchisor to Negotiate and Modify the Terms of its Franchise Agreement. This is one of the best posts on the subject that I have seen.

In addition to the fact that you should take your right to negotiate the franchise agreement seriously, I would encourage you to stay on the alert for other common red flags from franchisors (I have written about these previously but it bears repeating):

  1. You don’t need a lawyer to review the agreement.
  2. I would prefer you don’t talk with other franchisees. You should only talk with me.
  3. Trust us, we can’t (and won’t) change the agreement but we won’t really hold you to that provision anyway.

Like many people you may considering an investment of your retirement savings in a franchise. You absolutely owe it to yourself to do the best job possible investigating that franchise and performing the most due diligence possible. That includes hiring experienced franchise counsel to review the franchise agreement and disclosure document. You need to talk with as many franchisees as possible but be sure to visit with those in your area. The success of a franchisee in New York, for example, may differ significantly than the success of a franchisee of Iowa especially when franchises are more of a regional flavor.

Some franchisors won’t negotiate the terms of the agreement but that can be okay. Hopefully the franchisor can explain their reasoning for not negotiating a provision rather than hiding behind a blanket statement that they cannot negotiate because it is illegal.  You definitely want to deal with a franchisor that is willing to listen and consider your needs. 

And never, I mean NEVER, believe the franchisor that tells you they won’t hold you to the terms of their written agreement. You can be assured that the franchisor’s lawyer in any lawsuit will never acknowledge that statement was ever made and most franchise agreements are written so that any such statement could not be used as evidence in court. 

 

 I am excited that the Wall Street Journal featured Rush on Business as one of the blogs that provide insight for would-be franchisees.  One of my passions for a long time on the blog is providing information to franchisees on pre-investment due diligence.  Recently I ran across a potential franchisee that was told by a franchisor that he should not seek legal counsel. The franchisor told the prospective franchisee that a lawyer would only try to talk them out of the deal.

The purpose of a franchise agreement and disclosure document review is not for the lawyer to talk the client out of their franchise business opportunity. An appropriate review will help point out the legal and business risks and possible areas of negotiation. (Yes, many franchise agreements are negotiable). After the review, the client must still make their own decision about whether to proceed forward. I have been told by more than one client that a review opened their eyes to help them better understand the franchise opportunity. Some moved forward while others backed away from the deal.

There are some classic warning signs of franchisors that I have written about in the past. You could probably guess #1. There are a significant number of excellent franchisors out there. Don’t waste your time on those that don’t believe you should seek counsel when you are potentially investing your life savings.  You owe it to yourself to do the best job possible investigating the franchise and performing the most due diligence possible.  

Some of the other sites in the WSJ article are a great place to start for that due diligence including:

Blue MauMau (www.bluemaumau.com)

Franchise-Chat (www.franchise-chat.com)

The Franchise Pundit (franchisepundit.com)

Unhappy Franchisee (www.unhappyfranchisee.com)

www.wikidfranchise.org

I would also add one of my personal favorites, The Franchise King Blog. The blog’s  author, Joel Libava, is pro-franchise but is a big proponent of franchise due diligence.

 

With the recent economic downturn, layoffs have begun to occur. A potential option for many former corporate employees is franchise ownership. While franchising does offer many advantages it is critical to approach a franchise opportunity just as you should any other business opportunity – with caution.

 

It is a misnomer that franchises are more likely to succeed than other businesses. In fact, the International Franchising Association has discouraged all franchisors from making such claims. The truth is that franchises fail at a rate that is similar to non-franchised business.  So careful due diligence is important when considering a franchise opportunity. One of the best things you can do is talk to as many existing (and former) franchisees as possible. Also, consider several key disclosure issues including:

  1. Franchisor’s litigation history;
  2. Amount of the initial investment;
  3. Vendor rebates and products you must buy from the franchisor;
  4. Earnings claims made by the franchisor;
  5. Franchisor’s financial statements;
  6. Trends concerning the number of outlets.  It is important to closely review the information regarding outlets. Carefully study the number of transfers and not just the number of closures.  A high number of transfers may be an indication that franchisees in the system are struggling, but bad stores have not been shut down. 

And finally, be willing to walk away. This is the paradox of successful negotiation. Those that are willing to walk away usually find they get more in negotiation.

For more on franchise due diligence be sure to visit the Federal Trade Commission’s Consumer Guide for Buying a Franchise