DONE RIGHT, America is entering an opportune time to embrace the franchising path to small business ownership. Clearly, these are difficult times with a sinking economy, disappearing credit markets and rising unemployment. The Wall Street Journal recently reported the results of a survey finding that franchise sales in 2008 are reportedly 48% off from the previous year, and 72% below industry goals.
But the woes of the economy enhance the opportunity for expansion through franchising, and prospective franchisees are a rich source of capital that is not currently available from traditional business lenders! If you have money to invest, and the necessary skills to manage a small business, a prospective franchise investor’s value has never been higher, and the rare opportunity to find and negotiate franchise investments has never been greater.
But what constitutes “DOING IT RIGHT?” There are many books and articles about how to select and investigate a franchise opportunity (often called ‘due diligence’), including the “AAFD Road Map to Selecting a Franchise” (FREE at our website, www.AAFD.org). Such information is important and valid, but it is only the tip of the iceberg if your goal is to drive value and to attain the AAFD’s vision of achieving Total Quality Franchising.
Identifying the right opportunity is a key element, but equally important is 1) negotiating a great deal (something some say is not possible), 2) assuring you actually get what you bargain for, and 3) protecting your future rights (i.e., making sure you have exit options should you decide to end your franchise relationship). These last three considerations are often not addressed in typical articles about ‘finding the right franchise.’
A Checklist of ‘Due Diligence’ Steps for Franchise Investors
Here is my list of critical steps in franchise investing:
- Know Thyself. Evaluate who you are and what kind of business is right for you. Many investors leave corporate America for a retail environment only to discover they don’t like being on their feet all day, or don’t like working with customers. Is franchising suitable for you, as opposed to being an independent business owner? They aren’t the same. A franchisee must follow a defined business system which may be quite detailed, but which ideally has already met the test of time. If you want to set your own rules, franchising is likely not for you. Franchisors are looking for loyal lieutenants, and entrepreneurs need not apply!
- Package and Market Yourself. Many investors fail to ‘package themselves’ so franchisors will bend over backwards to recruit them. Keep in mind that fundamentally franchisors are looking to add great operators who will drive their brand, and your ability to negotiate will depend on how valuable you appear to the company. You are likely to hear that franchisors will not negotiate their deals, but if you bring valuable talents, capital, resources or contacts, you may be surprised at what concessions you might achieve, and especially in the 2009 marketplace. Do you imagine that Marriott Corporation signs a standard contract when it places a franchised business in one of its hotels?
- Evaluate the Business Model. Fundamentally, the business must demonstrate attractive financial rewards, both for your labor and a return on your invested dollars. If the company will not provide you with the information or tools to evaluate the viability of its business model, go on to the next deal. Don’t be romanced by a fun concept or a new fad without ‘running the numbers’ to determine if the business makes economic sense!
- Evaluate the Franchise System. The conventional wisdom is that franchising promises a ‘proven business system,’ which includes products, services, operations, marketing, and system culture. Sadly, too often the promise of a proven system proves to be false. Moreover, all vibrant businesses evolve and must embrace change, such that it may be false to think any system is truly ‘proven.’ Prospective franchisees must carefully consider 1) if there is a ‘system’ in place, 2) whether the components of the system work as represented, and 3) whether the system is sufficiently malleable to evolve with the company’s market. Successful management cultures which are organized and sustaining through research, training and good management can be a great investment recipe.
- Verify Equity Ownership and a Fair Franchise Agreement. Very often the excitement regarding a brand or business concept can lead to an investing impulse without a sober evaluation of the nuts and bolts of the business deal. Most franchise investors are seeking to ‘buy a business,’ but the modern franchise agreement rarely conveys business ownership. This is where competent legal counsel is essential. Understand your franchise agreement. Verify that you actually are contracting for significant equity ownership, and that your legitimate interests are protected. There are good choices in today’s franchising marketplace, including more than a dozen brands that have earned the AAFD Fair Franchising Seal.
- Franchisee Associations and Collaborative Franchise Cultures. Not surprisingly, the AAFD’s cardinal rule is to limit your search to franchise systems that embrace a collaborative culture including a strong franchise owners association. Franchisee Associations serve as the voice of franchisees, and are able to provide streetwise oversight and the negotiation of system changes. Use the AAFD’s Fair Franchising Standards (free at the AAFD Website) as a guide to evaluating a franchise system’s culture. In 2008, the Federal Trade Commission amended franchise disclosure rule now requires franchisors to disclose contact information about franchisee associations.
- Evaluate Your Rights on Termination. Most prospective franchisees are so focused on ‘getting into business’ that they fail to think about their ‘exit strategy.’ This is a grave mistake. Most businesses have an end, whether you sell the business, grow tired of it, retire, wish to go independent, suffer a health or other catastrophe, or simply your franchise rights expire. Carefully evaluate your termination rights, including how your equity and personal rights are affected when your relationship ends.
The Government’s Role in Franchising.
Exploding a myth about franchising, franchise investors are not protected by state or federal regulations concerning franchising. The FTC requires that all franchisors provide a disclosure document concerning certain aspects of your franchise offering. The FTC doesn’t review these disclosures, and you have no personal legal recourse for FTC Rule violations! A handful of states (14) have their own franchise disclosure laws, but there are few laws that establish or protect franchisee rights.
Nevertheless, legally mandated Franchise Disclosure Documents (formerly called a UFOC) are important tools to help investors screen and investigate franchise offerings. In the hands of competent legal and financial counsel, disclosure documents provide revealing information that lead to intelligent investment decisions.
Franchising can be a rewarding vehicle towards a career where you can ‘be your own boss.’ Nevertheless, investing in a franchise is likely the most important venture most investors will ever make, and decisions should be made soberly and with caution. The AAFD has published a valuable list of “Eight Things to Look For in a Franchise”, which is set forth in its entirety to help guide you to a successful experience in franchising. Happy hunting!