Evaluating A Franchise Part 1

19-May-2013
19-May-2013 20:48
in Franchising
by Colin Smith

The purchase of a franchise is a very serious step.  The financial commitment is huge, including the initial fee for the franchise, the capital to fund the franchise to its breakeven point and the ongoing franchise fees, not to mention the further losses you could be exposed to if the franchise was to fail.  Given the huge upfront and ongoing costs of franchise ownership as well as the potential for catastrophic losses in the event of partnering with the wrong franchisor for the wrong opportunity, it's remarkable just how cavalier an attitude prospective franchise owners have when engaged in the purchasing process.  For most franchise owners, this purchase will be the most significant and expensive purchase you will ever make other than the purchase of your home.  

Most people are fairly well equipped to assess most aspects of a major purchase such as a house purchase themselves, but it is almost universally accepted that those things that you are not equipped to assess yourself, such as the things that would be revealed by a house survey, should be placed in the hands of competent professionals.  There are several things in the purchase of a franchise that are not evident to the untrained eye and we believe at Continuous Business Planning that every potential franchisee needs to be armed with certain important information, both about the franchise and wider market and industry in which it exists and the franchisor themselves, before they sign on the dotted line.  We offer a franchise evaluation service which will help prospective franchise owners tell a good franchise from the rest.  We offer this service in response to feedback from frustrated prospective franchise owners who are looking for impartial help and advice but who struggle to find it from either the franchise sales team or from the numerous franchise brokers offering to guide people through the purchase process.  Franchise sales teams are looking for a sale and franchise brokers ultimately work for the franchisor.  It can be a lonely and difficult process, with few if any people involved who can honestly say that they soley have the best interests of the prospective franchisee at heart.  

As with everything in life, there will always be those who believe that they ought to go with their gut and that they do not need any help sizing up the franchise opportunities that interest them.  Especially for these people who insist on trying to evaluate a franchise and the franchisor by themselves, I'm writing a three part article which will cover the top twenty questions you should ask when evaluating a franchise and the top 10 questions you should ask when evaluating a franchisor.  These questions represent the tip of the iceberg for thorough due diligence on your franchise opportunity but, as a bare minimum, do not proceed without getting the answers to these questions.

This first part of the article will cover the first ten questions to ask when evaluating a franchise opportunity.  Part two will cover the next ten and a third article will cover ten questions that you must ask when evaluating the franchisor with whom you will be entering into partnership.

First Ten Questions To Ask When Evaluating A Franchise

1. Is the franchise already operating or is it new?

If the franchise is already operating, it is important to verify the sales projections.  Ask the franchisor for sales reports from previous years so that you can evaluate the validity of the projected sales trends.  If it is new, you will need even more information on the opportunity.  

2. Who is the competition and what barriers to entry exist in the industry for businesses seeking to compete in the future?

Just as it would be with any business, it's important to understand the competitive environment in which your franchise will be operating.  Where does your business sit relative to the alternatives to your business for your customer?  Never accept that this is a unique concept with no competition.  Understanding the indirect competition and potential for new competitors in the industry niche is vital in assessing the long term viability of a franchise.  It's also important to pay close attention to whether you will be awarded exclusive or non-exclusive territory rights.  If territory rights are non-exclusive, you may find that you end up competing with another franchise from the same business within the lifetime of the franchise agreement.

3. Who is responsible for marketing the franchise?

Some franchisors take care of all sales and marketing and leave delivery of the service to the franchisee.  Others implement national or regional marketing campaigns and leave all sales and local marketing to the discretion of the franchisee.  Others still take no responsibility for sales or advertising at all.  This is a crucial question to answer before taking the leap with any particular franchise.  If sales and marketing are not your strengths, you will either want to purchase a franchise where success is not hugely dependent upon your sales and marketing ability or you will need to build a team that does contain these skills.

4. How will products to be manufactured and/or supplied by an external supplier be priced? 

It's important to know how these products will be priced.  In our experience, tthe honest answer to this question will provide real insight into the character of the franchisor.  Many franchise agreements stipulate that franchisees must purchase certain products from the suppliers nominated by the franchisor.  If you are to become a "captive" customer, you will want to make sure that you are benefitting from the franchisor's purchase power, not being exploited by a franchisor-supplier arrangement that benefits the franchisor, often in the form of e retrospective discount paid to the franchisor when the combined business hits contractual volume targets, at the expense of the individual franchisee.

5. Will you be required to be personally involved in the operation of the business?

Whilst most franchisors market their franchises as "turn key" opportunities that require little input from the franchise owner to be succesful, just how "turn key" each franchise actually is can vary dramatically from opportunity to opportunity.  Some franchises come with detailed operations manuals covering every aspect of the business with all essential support provided by a support centre.  Other franchises are little more than the rights to sell a particular product or service in a particular territory and huge latitude in how the business operates is possible and the franchisee is left to their own devices.  Obviously, the more"turn key" the opportunity, the less the physical presence and involvement of the franchise owner will be required for the business to be a success.

6. Do you require any technical skills or expertise to successfully operate the franchise?

It's crucial to consider the suitability of your abilities, skills and personal experience to the nature of the business you are considering buying.  There is a reason why the franchise sales process is often called franchise recruitment and a significant mismatch of critical skills is a major reason for the ultimate failure of some individual franchises.  You should definitely buy a franchise that suits your professional strengths and be extremely wary of the assurances offered by most franchisors in franchise sales literature that "no experience is necessary". 

7. Is the product protected by patent or liability insurance and does this protection apply to you?

Before signing the franchise agreement ensure that all trade marks, intellectual property or relevant insurance is unique and identifiable and that they are not subject to cancellation or pending litigation.  Franchises are often associated with celebrities whose association with the business is usually temporary.  Be sure not to buy into the cult of celebrity but to purchase a franchise because of the merits of the underlying business.

The last three questions in the first part of this article relate to any lease agreement that may be involved as part of starting a franchise.  Lease agreements are not unique to franchises, but the repurcussions of signing a lease agreement can be so far reaching that I am keen to hammer home the importance of properly understanding your lease agreement as it relates to franchise businesses.  Simply put, next to your franchise agreement, the lease agreement will be the most important document you sign in this process of starting your own franchise business. 

8. Does the lease agreement allow assignment to any permitted assignee of the franchise?

As a franchisee, you will obviously seek the maximum possible flexibility in terms of avoiding onerous lease obligations.  Look carefully at the terms of your lease agreement.  Under the terms of many franchise agreements, the business premises will be leased by the franchisor and sub-leased to the franchisee.  This means that in some instances, franchisors can step in and assign the lease to a new franchisee.  Franchisor's are often keen to do this to preserve locational goodwill.  Watch out then for franchisors offering as part of the overall lease arrangements to take over the the franchisee's position under the lease in the event that you as the franchisee wish to or have to break the lease agreement or do not wish to exercise renewal or extension options.  This arrangement offers significant protection to you as a franchisee from action against you by your landlord.  It does not, however, necessarily protect you against action by the franchisor.  Fully understand what the consequences of breaking the lease agreement would be before you sign it.   

9. Does the term of the lease coincide with the term of the franchise?

For those franchises that are conducted from business premises the term of the franchise may also be affected by the term of the lease.  Ideally the term of the franchise agreement and any option terms should coincide with the term of the lease and any option terms contained in that lease.  Unfortunately, in the majority of cases this does not occur.  Sometimes the term of the franchise is longer than the term of the lease (for example a franchise agreement may provide for a term of, say, 10 years while the lease may be a five year lease with no options).  Sometimes the reverse is true.  Either way, this little detail could have potentially disastrous consequences, so be sure to look out for it before you sign either your lease or franchise agreement.

A well drafted Franchise Agreement should deal with what happens if the terms do not coincide.  For example, some franchise agreements provide that the Franchise Agreement will end if the lease ends.

10. Does the term of the lease provide sufficient time for the recovery of the capital outlay?

This is a problem when only short lease terms are available from the landlord.  If the franchise fee is significant, you will want to have enough time to earn a reasonable return on your capital outlay.  SInce the return on investment will only actually materialise after you have recovered the initial costs of the franchise, you need a lease of sufficient length to achieve that.  The whole exercise is wasted if all you achieve is getting your money back.

So there we have the first ten questions we would hope any prospective franchise owner would ask about their franchise.  The final ten can be found in part two of this article.  Remember that there is no need to go through the due diligence process alone.  Our project managers at Continuous Business Planning are ready and waiting to help you with the franchise evaluation process.  Contact us today if you need a helping hand.  As independent advisors, we can give you the information that you need to make an informed decision, information that the franchise sales team and franchise brokers may not want you to know until it's too late.  Franchise ownership is a big decision.  Whether you seek our help or perform the due diligence yourself using the questions in this three part article, make sure you go into this with your eyes wide open.  You'll be glad that you did.  

 

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