Stories of people who struck it rich by investing in a franchised business in the early stages of a company’s growth are commonplace. McDonald’s comes to mind, of course. Kentucky Fried Chicken and Subway are other examples of franchise winners.
Unfortunately, there are also losers in the franchise industry. If you are planning on buying a franchise business, and to avoid becoming a statistic on the losing side, there are a number of steps you need to take before signing on the dotted line of a franchise contract.
Here are a number of questions and areas of investigation you should pursue before you buy a franchise:
Do you have the right personality?
Franchise owners must have the right temperament to be successful. You need to be able to follow rules set forth by the parent company in order to be compliant with your franchise contract. People who thrive on creativity and self-expression could have difficulty in adapting to the business culture of a franchise. One rule to keep in mind when deciding about becoming a franchise owner is you will be an implementer and not a creator.
Study the Industry and Competition
Learn everything you can about the franchise industry by reading articles, books and publications likeThe Federal Trade Commission’s Guide to Buying a Franchise. Being informed about all aspects of franchising is one of the best things you can do before you buy a franchise.
Determine Your Available Cash Amount
It’s easy to list all of the known costs of purchasing a franchise, furnishing it with equipment, buying insurance and providing capital to hire and pay employees.
What’s not easy is summarizing all of the hidden costs like marketing expenses, surviving until you reach break-even, cash reserves to cover unexpected emergencies like equipment failure and the cost of weather damage.
Most franchisors calculate three months’ worth of expenses in there planning, but experts recommend using a six-month figure in order to cover business expenses. In addition, one year of cash reserves to cover personal living expenses is also suggested.
Learn the Truth about Success and Failure
You might have heard that franchises fail only 5 percent of the time. In fact, the truth is that franchises have about the same success and failure rate as other standard small businesses.
If a prospective franchisor claims that 90 percent of their operators are still in business after 5 years, ask for documentation to back that up. Chances are you won’t get any.
Individual franchises have differing success rates, of course. Some of the larger firms have incredibly high success rates. Do your homework and investigate the rate for the individual firm you are interested in.
Talk to Current Franchisees.
Often the best source of information about a franchise is direct from the franchisee themselves. Plan on visiting at least ten operators and ask for their pros and cons about this particular company and what hidden costs they encountered after opening.
Try to encourage them to give you an honest appraisal as to how they are treated by the franchisor, how long before they showed a profit, how many hours they work each week and would they recommend the franchise to a friend or close family member.
Read the Entire Financial Disclosure Document
In order to thoroughly understand the franchisor’s Financial Disclosure Document, go on line and read the Federal Trade Commission’s guide on how to read and understand the detailed, often confusing and lengthy FDD document.
The franchisor’s FDD will reveal any bankruptcy filings and law suits involving the company or its executives. It will also spell out the training provided by the franchisor and unexpected fees required by the franchisor.
Consider hiring professional help.
Unless you have experience in reading balance sheets, negotiating contracts and dell with business insurance agents, it would be wise to consult with professionals who are experts in all aspects of the franchise industry.
Let these professionals guide you through the process of evaluating your finances, your insurance needs and the actual signing of the franchise agreement. Once you sign the franchise contract, you are tied into the terms set forth in the document. Have a professional review the contract details with you and point out any potential hidden costs or clauses that could present a serious problem down the road
Work at the Franchise
The best way to see how a franchise works is to get involved in the operation. Flip burgers, build a subway sandwich, hang window draperies, brew and serve coffee or whatever else the franchise you are considering buying does. This opportunity not only gives you some insight as to what your future employees will be doing, but it also helps you determine if you fit into the corporate culture of the parent company.
This need to have work experience at a company location can’t be emphasized enough. Large franchisers insist on this hands-on experience from potential franchise buyers. McDonald’s and Kentucky Fried Chicken both have company “colleges” that franchise prospects must attend. Others require up to three years of work experience at one of their locations before they will even consider selling you a franchise.
Once you have all the numbers and information collected that you need in evaluation a franchise, sit down and make out an old-fashioned “T” chart.
Start by drawing line down the center of blank piece of paper and a horizontal line across the top. On the left side of the center line, list all of the positive benefits the franchise has to offer. On the right, list the costs, liabilities and negative aspects of owning that franchise.
Place an arbitrary number value for each item based on the value or cost of each item. Add up both sides and compare the two scores. If the benefit score far outweighs the liability score, it should give you added confidence that the franchise is the right for you. If, however, the opposite is true, you might want to consult with a professional and get a detailed analysis of your analysis worksheet