Buying a franchise can be a great move for a would-be entrepreneur who doesn’t want to create a new business from scratch. In theory, franchisees acquire a model that already works on every level, from branding to pricing to marketing. A ready clientele eagerly spends on Dunkin’ Donuts, McDonald’s and 7-11. The market has tested the best recipes for glazed crullers, Egg McMuffins and the right combo of energy drinks to stock next to the register. But making a go as a successful franchisee can be a lot more complicated than simply finding an appealing brand and plunking down some cash. For a taste of what can go wrong, see Forbes’ piece about the problems at sandwich franchise Quiznos, which paid $206 million to settle a suit brought by franchisees who claimed the chain had oversold its markets and excessively marked up supplies.
If you’re thinking of becoming a franchisee, how should you prepare yourself? We asked three professionals with extensive knowledge of the franchising world. Ed Teixeira is both a former franchisor and former franchisee, and the author of two books on franchising, including The Franchise Buyer’s Manual. Josh Brown is a Carmel, Indiana lawyer who specializes in franchising, and Sean Kelly is a former executive at the successful Amish pretzel franchise Auntie Anne’s. Kelly runs the muck-raking website, Unhappy Franchisee. They recommend you do these 12 things before you buy a franchise.
- Give yourself a personality test.
There’s a reason military veterans tend to be successful franchisees, says Brown. They’re used to following the rules and operating within a highly regulated system. If you’re the creative type who likes to cook without recipes, paint walls wild colors and experiment with mood lighting, you’re probably not cut out to be a franchisee, says Kelly. “You have to know that you’re going to be an implementer, not a creator,” he says.
- Study the field.
Avail yourself of publicly available information on the ABCs of franchising. An excellent place to start: The Federal Trade Commission’s Guide to Buying a Franchise. Did you know that many franchisees are required to spend a designated amount on advertising and yet have no control over how those ad dollars are spent? Two other helpful sites: The International Franchising Association’s Franchising 101 guide and The American Association of Franchisees and Dealers’ Road Map to Selecting a Franchise.
- Assess your strengths.
How do you feel about cold calling? Business-to-business sales? Teixeira used to run a franchise called Vehicle Tracking Solutions, which sold GPS systems to trucking companies. The product involved technology, which attracted tech-savvy franchisees. But some of them hated sales, the most essential part of the business. They flopped. Teixeira recommends asking friends and family to help you evaluate how well your personality matches the business you’re considering. Experience also matters. Thinking of running an Applebee’s? What do you know about food service and management? “There’s a big misconception out there that franchises are just a business in a box,” says Brown.
- Count your money
Look beyond the minimum requirement for buying a franchise, usually listed as the franchise fee and the cost of equipment. Getting a franchise up and running can involve hefty marketing costs and the need to survive on break-even books, or a period of net losses, before your business catches on. Even if you’re franchising a well-known brand like 7-11, customers have to discover your new location. The Franchise Disclosure Document (FDD), which franchisors must make available to would-be franchisees, is required to list additional working capital under item No. 7. But in the FDD, Teixeira says most franchisors calculate three months’ worth of expenses, when it’s wiser to think of your likely expenses for up to six months. The FTC’s guide says it may take a year to become profitable. You should have access to capital that will cover both business expenses for six months and personal living expenses for a year.
- Beware of franchise consultants.
Most franchise consultants are paid salespeople, according to Sean Kelly. Consultants want to get you signed onto a franchise deal as quickly as possible, because their cut is often half of the franchise fee of $20,000 or $30,000. Ask them to make their financial arrangements clear, up front.
- Don’t believe the “Franchise Lie.”
An urban legend about franchise failure rates persists: Franchises only fail 5% of the time. Not true. They fail at roughly the same rate as other businesses, which is to say two-thirds of businesses with employees last two years, and half survive at least five, according to 2012 findings by the Small Business Administration. Yet many franchisors make claims like this: “after five years in operation, more than 90% of franchises continue to operate while less than 25% of privately owned companies stay in business.” Wrong.
- Dig for dirt.
Take advantage of sites like Sean Kelly’s Unhappy Franchisee and search for negatives about the franchise you’re considering. For example, Kelly has run a series of exposés on NY Bagel Café, documenting the stores’ high closure rate. (A consultant to the chain, Richard Taggert, disputes Kelly’s reports and says the company has had only had a handful of closings in the last decade.) Blue Mau Mau also reports on the franchise industry.
- Talk to franchisees.
FDDs include the names and phone numbers of current franchisees. Talk to at least 10. Ask about pros, cons, and hidden costs. What did they learn that they didn’t glean from their research before they became franchisees? How long did it take them to become profitable? How much did they budget for their enterprise, and how much did they wind up spending? What was the toughest part of building the business? How supportive is headquarters? How challenging is it to hire good staff? Ask if, given what they know now, they would do it again or recommend the franchise to a close family member? Keep in mind that “ego is a big thing,” says Teixeira. Some franchisees might not want to admit that they’ve struggled. All the more reason to talk to as many as you can.
- Read the entire Financial Disclosure Document (FDD).
The FTC’s online guide describes how to make your way through this document, which can run 50 pages or more. Don’t be intimidated. The FDD offers a gold mine of information, like bankruptcy filings by the franchisor, litigation involving the company and/or its executives, the type of training the franchisor offers franchisees, and costs that may not seem obvious, like opening day expenses when headquarters may want you to give away free stuff and do special promotions. (For more on evaluating the FDD, click here.)
- Consider hiring professional help.
If you have accounting know-how and feel comfortable reading a balance sheet, you’ve insured a past business and you’ve negotiated legal contracts, you may not need an accountant, insurance agent and lawyer. But with some self-interest, lawyer Josh Brown says you should have a lawyer and other professionals review your financial health and how it will be affected by the franchise arrangement before you sign a franchise contract. His pitch for his services: “If you’re buying a business that costs between $150,000 and $1 million, you need an attorney to look at the documents and tell you what they mean.” He says he charges “a few thousand dollars” to help most of his franchisee clients get started. An accountant can help you assess whether the numbers add up.
- Explore working in a store.
This is the best way to see how a franchised business works from the inside, and whether your personality fits the company culture. Domino’s strongly favors franchise applicants who have worked their way up from delivering pizzas and since 2008, Dutch Bros., a successful drive-through coffee franchise based in Grants Pass, OR, has stuck to a policy of granting franchises only to people who have worked for the chain for at least three years. Kelly recommends spending six months as a worker before you become a franchisee.
- Do a cost/benefit analysis.
Make an old-fashioned pro v. con list. Draw a line down the center of a piece of paper and on one side, write down the benefits you’re getting, like established brand, proven market, training, recipes if it’s a food franchise, staffing guidelines, store design. On the other side list the costs and liabilities, including franchise fee, money you’re required to pay for marketing, mark-ups on merchandise and ingredients the chain requires you to buy, the share of sales you must pay in royalties. Consider whether you could hire a consultant to help you open up your own donut or sandwich shop, and instead of paying royalties, mark-ups and marketing fees, keep that money for yourself.
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