13 Essential Steps
For Evaluating a Franchise Opportunity
By Jason Rager
Smashwords Edition Copyright © 2011 by Jason Rager
Smashwords Edition License Notes
This ebook is licensed for your personal enjoyment only. This ebook may not be re-sold or given away to other people. If you would like to share this book with another person, please purchase an additional copy for each person you share it with. If you’re reading this book and did not purchase it, or it was not purchased for your use only, then you should return to Smashwords.com and purchase your own copy. Thank you for respecting the author’s work.
Contact Jason Rager at: info@franchise-analyzer.com
Note about table of contents: Please print the italicized pages listed below if you prefer to do the workbook by hand. Note: You will have to print multiple copies of the italicized pages, one copy for each franchise you are evaluating.
Table of Contents
Step 4: Internet Research & SBA Failure Rate
Step 6: Franchisee Interview—Current Franchisees
Franchisee Interview—Current Franchisees Workbook
Step 7: Franchisee Interview—Current franchisees selling…
Franchisee Interview—Current franchisees selling … Workbook
Step 8: Franchisee Interview—Franchisees with Past Lawsuits …
Franchisee Interview—Franchisees with Past Lawsuits from FDD …
Step 9: Franchisee Interview #2—Current Franchisee Financial Analysis
Franchise Financial Model Workbook
Step 10: Financial Model Analysis & Scoring
Financial Model Analysis & Scoring Workbook
Step 11: Incorporate and do not PG anything
Step 13: Signing the Franchise Agreement
I want to thank you and congratulate you on your purchase of this book. You will be confident knowing that you have made a wise investment in your future by purchasing this book. I have made many mistakes and lost a great deal of money by making various mistakes that I attempt to prevent you from doing within this book. While I have become a very successful franchisee in my own right, I feel that I have an obligation to pass on my knowledge so that others may replicate my success. All too often I see a franchisee that works over 80 hours a week and still cannot make ends meet because they did not do their due diligence when choosing a franchise opportunity. My method will help you weed out the bad franchises and enable you to have the greatest chances at being successful (and highly profitable). Thank you for purchasing my book and please have a friend buy my book online to help support me creating additional books of what I have learned through my years as a franchisee.
Truly Yours,
Jason Rager
These resources are biased only in the sense of which companies I truly feel provide the most information for free. While some of them are for-pay services, it never hurts to do a lot of homework; after all you will be investing a lot of time and money into running your franchise.
Franchise Information—http://www.bluemaumau.com - Today’s franchise news, blogs, discussions, events, tools and community to prosper and amuse the franchisee and wannabee. Contains links to franchise info, largest online directory listing of over 2400 franchisors and Web’s #1 franchisee community.
Franchise Information— http://www.thenakedtruthonline.com —Franchise news and blogs. What real people are saying about your franchise, right now.
Franchise Information— http://www.franchisewire.com/ - FranchiseWire.com carries news and press releases issued direct by companies/organizations involved or affiliated with franchising, such as franchise companies, franchise attorneys/lawyers, franchise consultants, franchising expo organizers, franchise publications, franchise lenders, and other franchising service providers.
Franchise Information— http://www.franchise-chat.com/ - Franchise-Chat brings franchise news stories and resource articles from around the world to one convenient location. They also provide a forum where prospective/existing franchisees and franchisors, and other interested parties, could interact, ask questions and discuss franchise-related issues.
Franchise Information— http://www.entrepreneur.com/franchises/franchise500/index.html.
The de-facto standard for ranking franchises as well as general franchise information.
Free UFOCs— http://www.openfran.org/. This site is awesome. You can get any UFOC for free. You don’t even have to talk to the franchisor’s salespeople.
Franchise Consultant— http://www.franchoice.com/. FranChoice provides a free franchise consultation service to individuals considering franchise ownership.
Franchise Blog— http://franchisepundit.com/. Ryan Knoll’s blog analyzes and explores various facets of the franchising industry. They typically approach an issue from the franchisee’s perspective (the individual buyer of a franchise). Essentially they critique franchises that they find interesting or newsworthy.
Franchising Data— http://www.frandata.com. For 20 years, FRANdata has been focusing exclusively on franchising activity in every industry in every company. They have very in-depth data from marketing trends to financial information for most franchise systems.
Incorporation— http://www.incfile.com —Low-cost site to incorporate your company.
Franchise Attorney— http://www.lanardlaw.com/
Franchise Attorney— http://www.marksklein.com/
Franchise Attorney— http://www.gpmlaw.com/practices/franchise-and-distribution.aspx
Franchise Name
The first step of our franchise evaluation method is to write down the top five franchises in which you are interested and what factors motivated you to choose it as a viable opportunity. Feel free to list as few or as many factors as you deem necessary. Also, utilize our Resources section on Page 3 for different opportunities available within your area and investment criteria. Also, dig deep and investigate into what people are saying about the franchise both in the
news, in web blogs, and on social bulletin boards. These preliminary steps will begin to weed out your initial thoughts regarding a specific franchise concept.
SWOT
Step two involves performing a SWOT analysis on a few of the franchises that you have selected. List both internal and external factors. An internal factor to choosing a particular franchise may be that you know another successful owner within the same franchising system. However an external weakness may be that the fast food restaurant you like does not serve any organic foods which are a dominant growing trend. Again, visit many of our resources pages and find out what people are saying about a specific franchise opportunity!
Mentally ask yourself:
How can I Use and Capitalize on each Strength?
•How can I Improve each Weakness?
•How can I Exploit and Benefit from each Opportunity?
•How can I Mitigate each Threat?
UFOC Analysis
Now we are beginning to dig into the real “meat” of a franchise concept, the UFOC! The franchisor will often ask you to sign many documents before they even send you a UFOC. Well because you’re smart and bought our book, you don’t have to even talk to the franchisor to get a copy of the UFOC. Better yet, all UFOCs are available online for free at: www.openfran.org.
I cannot stress how important this document is as this agreement lays out how your relationship with the franchisor will be dictated. For example, I have seen all too often a franchisee complain that a franchisor “cannibalized” their sales by selling another franchise with a territory too close to their location. The UFOC will also help you answer questions such as:
What happens if I am unable to pay my royalties? What happens if I want to sell my location?
What happens if the franchisor wants to buy my location?
The biggest mistake that many people make is signing a franchise agreement without even reading it, much less having their attorney review the document. This is understandable as the UFOC is usually a few hundred pages of legal jargon. However, it is important to keep in mind that UFOCs became a requirement by the FTC after many franchisors misrepresented information to potential franchisees, which erupted in a pile of bankruptcies and lawsuits. Let’s go over each section of the UFOC.
Cover Page
Isn’t the Cover Page self-explanatory? In most documents it is, but the UFOC is quite different from most documents. The Cover Page identifies the name under which the franchisee would operate upon purchasing the franchise as well as what type of business it is. It also includes the amount of the initial franchise fee(s). Further, any additional risk factors are included on the cover such as: which state governs the franchise agreement and where legal proceedings against the franchisor must take place.
Item 1. The Franchisor and Its Predecessors and Affiliates
Item one gives you the background of the Franchisor, including any company they have purchased the franchise from, and any affiliates who have a controlling interest in the franchise. Note that it also includes the industry experience of key personnel. Do your research on all key representatives, as you will be investing your life savings with these people. You should know any other businesses in which they have been involved and how well they have managed them. You do not want to give your hard-earned money to individuals that have a track record of mismanaging their own money or their own businesses.
Item 2. Business Experience
This item includes the identity and business experience of everyone affiliated with the franchisor. All names of individuals having significant responsibilities in the operation of the business or in support services provided to the franchisees must be disclosed. Item two gives you the background of each officer and director of the franchise during the past five years. Like the information in Item one, you want to carefully review the expertise that the management has in place. These are the people you will be working with day-in and day-out. These individuals will contribute greatly to the success or failure of your franchise. You should get to know them on a personal and professional level.
Item 3. Litigation
Any history of litigation, including court cases terminated by settlement, must be disclosed in Item Three. Stay away from any franchisor who is currently embroiled in large legal battles as this will affect you as a franchisee regardless of your involvement. Also, if a franchisor or any officer, affiliate, etc. has a criminal history or any litigation pending it will show up in this section. These are all tiny red flags that should be taken into account while selecting a franchise.
Ultimately, you don't want to uncover a lot of litigation between the franchisor and its franchisees. Regardless of which party has instigated litigation and why, the percentage of franchisees in litigation should be small. Analyze the total number of litigations listed for the past two years. Ideally, less than 1 percent of total franchisees are what you want to see. If the amount is more than 4 to 5 percent, you will want to seriously consider another franchise. Why go into business with people that will sue you two or three years down the road?
If you're finding that the franchisees are primarily the ones instigating litigation, you should conduct a thorough examination of the financial performance of the business(this should be done anyway!). 9 times out of 10, franchisee claims against a franchisor are disputes over being sold a franchise system that is not profitable. Franchisees that are doing well generally will not initiate litigation. Franchise owners may be successful but want to invest their money elsewhere, in which case they often sell their business, not sue the franchisor to get out. However, if you see that litigation that is started predominantly by the franchisor, it indicates that they use their lawyers to fix problems rather than initiate a dialogue its franchisees.
Even if you uncover a small amount of litigation, you should still dig into the nature of the disclosure. Imagine if it was you being sued by the franchisor! It’s a good idea to get both sides of the story then you can discern the truth. A franchisor should not have any reservations for discussing any items of litigation unless it is ongoing and the franchisor is acting under an attorney's advice. If a franchisor is reluctant to provide a history of the lawsuit or to at least talk to the company's lawyer to determine the nature of the dispute, then you should not invest your money with that franchise.
Just as you might speak with representatives of the franchise company about litigation, you’ll also want to discuss these issues with the franchisees involved to hear their points of view. These first-person accounts often reveal more about a situation than what might be found on paper. Further, they will give you an idea of how the franchisor pursues its franchisees when a dispute arises.
Item 4. Bankruptcy
By law all franchisors must provide prospective franchisees with a Franchise Disclosure Document (FDD). One of the most essential components of this disclosure report is any history of litigation and bankruptcy related to the company, its executives, or affiliates. The bankruptcy disclosure requires a franchisor to tell you about any bankruptcy in the last 10 years by, “the franchisor, its affiliate, its predecessor, officers, or general partners”. Note that Directors and some other executives are not required to divulge this information. While many entrepreneurs have several failures before they are successful, you are paying money for a franchise system. You are buying the rights to own and operate a proven business model, a franchise. So be extremely cautious if you see a bankruptcy filing by a franchisor or its key management.
Keep in mind that a bankruptcy in the disclosure is not a sure prediction of a bankruptcy in the future. However, you should review the circumstances of the bankruptcy carefully, including the amount of time that has lapsed since the individual or company filed for bankruptcy. You don’t want to give your money to a company that still has some skeletons lurking in the closet!
If the franchisor has been recently bankrupt it will most certainly affect its near future as well as its relationship with franchisees; and ultimately, your profitability.
Item 5. Initial Franchise Fee
Item Five outlines the Franchisee's initial franchise fee and other initial payments. This section states that the franchise fee and any other initial payments must be made by the franchisee to the franchisor, upon the execution of the franchise agreement. The section will also disclose the use of the funds, and whether any fees are refundable. Note that these initial fees are paid for the right to operate as a franchise and utilize the franchise’s brand. These fees do not include all of the other fees that may be required to build out or carry on operations.
The point of emphasis within Item Five is to understand exactly what you are receiving for the franchise fee. Also, a large initial franchise fee does not always equate to a better investment! While McDonald’s charges $45,000 for a franchise fee, you could sign with many other franchise systems for a much higher cost.
Item 6. Other Fees
The fees in Item Six include any other fees you will be required to pay to the franchisor after signing the franchise agreement. Including but not limited to: royalty fees, advertising fees, site build-out and selection fees, service fees, training fees, or any other ongoing or one-time fees that you as a franchisee will be expected to pay directly to the franchisor. Be leery of high fees for referrals, internet leads, or other ongoing business activities.
Item 7. Initial Investment
Item Seven will give you a general idea of what is will cost you to build out the franchise and get it operational. This section is laid out as a table and includes an estimated cost for equipment, marketing, training, inventory and any other cost associated with opening your franchise. For each item in the list, you are given the amount and when the payment is due. Review this information carefully and be sure to budget it into your short-term financial projections. Later you will speak with other franchisees and see if the estimated costs were realistic, in many cases they’re not.
You must consider more than the sum of Item Five, Item Six, and Item Seven before reaching a conclusion on what it will actually cost to open your franchise. Build in a “cost overrun account” for unexpected expenses, which should amount to about 20% of your total investment.
Remember that most businesses are not profitable for at least a year, so include the amount of money it would take you and your family to survive for a year without income. Also, keep in mind that many municipalities and other factors may require significant modifications to build out your location.
Item 8. Restrictions on Sources of Products & Services
Item Eight describes what franchisees are obligated to buy or lease and from whom. Basically, it tells you who you can buy from and where these suppliers are located. Note that there are some risks associated with this section. Sometimes a franchise agreement may require you to buy a certain amount of product per month regardless of whether you need it or not. While this may not seem like a big deal now, it would be horrible to find yourself in breach of your franchise agreement because you are not buying and throwing away enough product.
Another risk to note whether a specific vendor is unreliable or raises their costs significantly, it may hurt your business greatly. Often, these purchase restrictions are in effect because the franchisor has negotiated a lower price for product in return for guaranteed orders. However, the cost may not be competitive and the franchisor could be taking kickbacks from these negotiated agreements(yes, this is unfortunately legal). This makes the franchise more expensive for you to run on an ongoing basis, even if the startup cost is low. If the business maintains a high profit margin according to other franchisees, then the restrictions are not a big issue. Again, the key is to talk with existing franchisees to see if they feel these restrictions are reasonable and whether the franchise as a whole is a profitable investment.
Item 9. The Franchisee’s Obligations
Item Nine often lists your obligations in a table and cross-references items within this section to the section of the franchise agreement and UFOC, where they are discussed. Your obligations may include such things as: post-termination obligations, location resale obligations, non-competition restrictions, your renewal opportunity, selecting and acquiring your site, maintaining your lease, training, fees, standards and policies and sales quotas. Watch out for franchisors that can purchase your unit for the cost of the assets or for litigation or dispute resolution in another state.
This section should list all of your obligations to the franchisor and exactly where in the legal documentation you can find the specifics of your obligations. This is an important section for you to scrutinize, as the items within contain all of your contractual obligations and if you fail to fulfill these obligations, your franchise can be terminated. When you interview current franchisees, be sure to determine whether any of these obligations are unreasonable. If so, you will need to negotiate them with the franchisor or select a completely different franchise concept.
Item 10. Financing
Item Ten outlines any financing arrangements that may be offered to franchisees. Often, to avoid conflict the franchisor will not offer any financing for equipment or working capital. If financing is offered, review the conditions to make certain that they are competitive and that you can repay your obligation. The recourse for failing to pay the franchisor who has lent you money could be losing your entire investment!
Be sure to have your accountant review Item Ten and give you their candid thoughts. Keep in mind that most franchisors provide financing, most financing is provided by a third party. Be extremely wary of a franchisor that is a direct lender as it may lead to complications in the future. Imagine if many units begin failing and the franchisor is left on the hook, it could sink the whole franchise system!
Item 11—The Franchisor’s Obligations
Item Eleven is usually the longest section of the UFOC and outlines the franchisor's obligations to its franchisees. These obligations may include assistance in locating a suitable site and hiring then training employees. Item Eleven lays out the obligations of the franchisor in the same way as Item Nine did for the franchisee. I have read great advice that the best way to approach this section is to envision what you need to be successful as a franchisee. If the items that you need to be successful are listed by the franchisor, then you may have found the right business partner. You must understand that everything you will be given and support you will receive MUST show up in this section. It may be wise in your franchisee interview to discuss the level of ongoing support given by the franchisor and how it could be improved. Also, note that verbal promises from salespeople must be in this section; otherwise the franchisor will not give them to you. What the franchisor verbally promises should be written explicitly in this section. If the items that the franchisor is verbally promising do not show up in this section, ask them to add them to your franchise agreement. If they refuse to add them to your agreement or to draft a separate agreement indicating the promises in writing, then you should not count on receiving them. Be on the lookout for words such as “as necessary” or “at our discretion” as they may make their obligations null. Also, if the franchisor says they will guide you through the steps until grand opening, make sure these promises show up in this section!
Item 12. Territory
There is no feeling worse than finally seeing your operation grow its profit substantially only to see the franchisor sell another territory right next to you. Item Twelve lays out your precise territory and does not allow the franchisor to sell any franchise agreement within that territory. Your right to an exclusive area will cut down on the competition from your own fellow franchisees. This is extremely important in highly successful models where the franchisor attempts to “saturate” the market to gain market share. If your franchise is less-well known and you are building out a new area, the franchisor will most likely sell another unit in your area because you have shown that their business model is successful in your local market.
Unfortunately, not all franchisors think alike. Some will take full advantage of their area and develop a market to its fullest. Others will assume that the lack of competition in an immediate area means they have a right to the business and therefore don’t work quite as hard to develop that area, thus allowing their franchisees to build a strong profitable core. There are many other situations in which an exclusive territories cause issues for a franchisor, and many will not grant them. Some will grant an exclusive area only for a specified amount of time or only as long as a certain level of achievement is reached by the franchisee. However, this is a must-negotiate for multi-unit franchisees.
Item 13. Trademarks
Item Thirteen is where you learn who owns the trademarks for the franchise and whether this trademark is registered with the US Patent Office. The brand is quite possible the greatest asset of a franchise. Therefore, you want to ensure that a certificate of registration for the trademark has been issued to the franchisor. Note that a trademark registered in the Supplemental Register does not have the same legal rights as a trademark registered by the US Patent Office. There will also be a disclosure in this section if this is the case. The franchise’s brand is one of its most valuable assets. Make sure you are getting what you pay for!
Item 14. Patents, Copyrights, and Proprietary Information
Item Fourteen is of little significance to most franchise systems. This section should only be of great importance to you if specific patents provide the franchise with a significant to be above the competition. to you only if patents are important to the franchise. If the franchise you are evaluating falls in this category, review a copy of the patent from the U.S. Patent Office. Many patents expire after twenty years, so you don’t want to lose your competitive advantage right after joining the franchise system.
I should not overlook that most franchises have a proprietary confidential operations manual which details the day-to-day activities at a franchised location. Ask to review it before signing the franchise agreement, even If you have to sign an NDA. This will give you a better idea of what managing the day-to-day entails.
Item 15. Obligation to Participate in the Actual Operation of the Franchise
Item Fifteen designates all requirements for the franchisee to be involved in the day-to-day operation of the franchise. If the franchisor does not require the franchisee to manage the business him or herself, then there must be a statement outlining whether the designated manager must complete the franchisor’s training program or have an ownership stake in the business. Further, limitations may be placed upon the franchisee’s ability to designate a manager and may be subject to franchisor approval. If you are planning to operate multiple businesses or open another location if this one is successful, be sure to get it in writing.
Item 16. Restrictions Upon What the Franchisee May Sell
Item Sixteen which designates restrictions upon what you may sell is quite common within a franchise agreement. You should ask existing franchisees whether their target market is undergoing any demographic or social trend changes which make it difficult for the franchisees to accommodate. This section is also important if you are limited to selling goods or services that won’t make you enough return.