We asked franchise industry insiders who have been franchisees, franchisors and area developers what they would want to know before purchasing a franchise. Here is the big big list of questions you must ask when buying a franchise.
Why should I buy a franchise instead of opening my own independent business?
Your odds of success are significantly increased – hands down! Did you know that 95 percent of franchised businesses overall are still in business 5 years after they are started versus independently owned businesses that only experience a 5 percent survival rate after five years. (source: E-Mythe Revised) This is also a great way to be in business for yourself, but not by yourself. This form of doing business often further reduces your financial risk because it has been time-tested and proven. The franchise system of doing business provides you operational and marketing support expertise, experience and continuous advertising support.
I’m interested in your franchise, what track record of success does it have?
Anyone can create a franchise system, but not everyone can establish a track record of success. Like any new business, even franchises need to prove their methods. Therefore, unless the concept you are considering is at least 3 years old, you will have to undertake extraordinary measures to validate it adequately. It’s a good idea to also investigate similar franchise concepts as well as talk to existing franchisees.
What expertise and experience does the franchiser have in its specialty area?
Like any investment, you should meet and know who the principals (not just managers) of the franchiser are and what kind of background they have to launch and operate a successful business operation. Many franchisers will host you for what is commonly referred to as a “Discovery Day” with them. This is critically important to attend so you may see their entire operation and meet all the key players who will show you their operations and processes.
How does your franchise compare to other franchises in the same industry category group?
Today franchising is growing at an unprecedented rate because the model historically offers greater safety and success for investors and operators (franchisees). This success gives rise to competitors who also want to achieve similar rewards. You should look at as many competing franchises as possible after you have narrowed your industry category choice.
What do your existing franchisees say about the company? Are they happy and successful?
This is one of the most important questions that need to be addressed by you thoroughly. Contact as many franchise owners in the system as you can and be prepared to ask lots of thoughtful questions. Also check out www.fransurvey.com and see if the franchiser submits to an annual system wide audit of its franchise owners. Fran Survey is a franchise survey company in the U.S. that conducts comprehensive screenings of franchisees. Fran Survey utilizes a written methodology created by people with direct experience as franchise owners, franchise area developers, and a University PhD who specializes is in this field.
What is the company’s litigation track record?
No record of litigation would be best. Unfortunately, it’s almost unheard of to find a franchiser who has not experienced litigation at one time or another. You should read about the litigation proceedings in the FDD (Franchise Disclosure Document). Look for repeated patterns of accusations being claimed. If you see the same or similar accusations in more than three cases be cautious.
Does the franchiser encourage input and innovation from its franchisees?
There are many really great franchisers out there who do an excellent job helping their franchise owners become successful. Unfortunately there are also a few who become egotists and treat people with disrespect and get away with it. Generally speaking if the franchiser makes himself accessible to his franchise owners, and has an open mind and willingness to hear you, it’s a good sign. If he does not – you may want to keep shopping.
Is training and follow-up assistance available?
In nearly every franchised system there is a system in place to provide training and follow-up support. Therefore, ask the franchiser if he has dedicated employees who are available everyday for franchise owner assistance. Also, as a rule of thumb it is not unusual for up to 10% of the franchisees within any system to request assistance or raise operational concerns about a various issues in any given month.
What is the largest single risk involved in your opinion?
You are. It is true; you are usually your own worst enemy. You must be honest in evaluating yourself for franchising. If you have a tendency for raw entrepreneurial start-up experience, you may not be the best choice to enter into a franchisee relationship. You may be a better franchiser. Franchising provides you a track to run on, if you feel you must constantly make improvements or redesigns in the system along the way, you are likely in for a wreck you don’t really want.
How many company owned stores do you operate?
It is important to your success that the franchiser has previously established a track record of success themselves with a couple of corporately owned stores. Further it is advisable to see a franchiser continue operating a couple of stores for continued product development and systems improvements.
What is your business?
Many businesses are not what they appear to be. Listen to how the franchiser describes his vision and discover his big picture theme.
How many people are at the HQ full time?
This is important because you want to find out if they have the capacity to grow with the sales of new units and provide adequate support to the build out of the system overall. Too many home office employees may be as dangerous as too few, this is often subject to the type of business being franchised.
Do you outsource any services?
Outsourcing certain services makes good economic sense for many businesses, however it is important to understand what services are outsourced and what ones are not. Will these services impact the level of support you need positively or negatively?
What is your exit strategy?
As a rule in any business, it’s just as important to understand your options for getting out of the business as it is getting in. Ask the franchiser about their plans and the timing of such plans; this may influence your decision and timing as well.
Are you a subsidiary of another company?
If the franchiser is subsidiary, then it is important to include in your due diligence the investigation of the parent company including its financial condition and other information regarding its intentions for the franchised system.
What other franchised businesses does the parent company own, if any?
It is common that “Brand Companies” own multiple franchised businesses. This approach to the overall development of a larger business has proven successful in franchising.
What are the strengths of your business?
Listen carefully here. The answer should be strong and clear. If a franchiser can’t confidently provide a solid list of answers about what differentiates his business from his competitors, look elsewhere.
What are the weaknesses of your business?
It is just as important to know that your prospective franchiser is keenly aware of his weaknesses. If they can’t think of any, it’s a red flag, drill deeper.
What is the franchise fee?
It is whatever it is, and they’re non-negotiable. Refer to the FDD section entitled “Initial Franchise Fee”.
Is the franchise fee refundable at any time?
This is generally non-refundable, but often subject to certain requirements being met. This is an area where your franchise attorney can help you protect your payment by reviewing and insuring that there are no unexpected surprises here.
When do I have to pay the franchise fee?
Typically the franchise fee is paid at the time you execute your franchise agreement, following the delivery of the FDD and subsequent appropriate “cooling period.”
Can I borrow the franchise fee?
Generally speaking most franchisers are not concerned if you borrow your franchise fee. They are concerned however, that you understand the business risk, development time, the reserves that you should plan on and that you do have adequate financial ability (net worth) to adequately fund your business and your living expenses during the start-up period. The typical start-up period is between three (3) months to one (1) year from the date you execute a franchise agreement.
Do you offer any financing for the franchise fee?
Generally no – but ask, some may, especially if it is for a second unit. First Financial can get an unsecured loan up to 150K.
Can I defer any part of the franchise fee?
Many franchisers do not make allowances for this. However, particularly when purchasing a multi-unit contract, you may get some deferral time here; it will not hurt you to ask.
What does the franchise fee cover exactly?
The franchise fee often helps the franchiser cover the costs associated with marketing his concept. As an example, if you were working with a franchise broker company, it is not unusual that that franchise broker be paid 50% of the franchise fee for his services. This would be considered an acquisition cost by the franchiser. Also, the FDD may reveal this information. See FDD Item “Other Fees”.
What earnings claims can you share with me?
This is a sensitive issue for all franchisers and it is also defined by law as to what claims may be made. Each franchise is different and each franchise determines the state laws that it is subject to in deciding what they can claim. See FDD Item “Earnings Claims”.
What is your vision and goal for the next 5 to 10 years?
You want to and should expect to hear a definitive answer from the franchiser. This should realistically be viewed as a test for finding out if the philosophies of the franchiser meet with yours.
Why do you want me?
This is an important test of the franchiser to determine if they understand who you are. They should be aware of your history and expected behavior as a franchise owner in their system before they sign a contract with you and accept your money. If they have not taken the time to learn about you, this is a red flag.
Will I be proud to own this franchise?
This is a question to ask your self. If you feel that you’ll be proud to invite your family and friends into see this business, then it is likely an image or business you are looking for.
What is the term of the franchise?
There is a wide range of terms (typically 10 to 20 years) depending on what industry you are becoming involved with. There is no hard and fast rule, just be sure you’re comfortable with the term and it aligns with your goals.
Is the franchise renewable?
Most franchise agreements provide for renewal periods of 5 or 10 years. You also should expect to pay a renewal fee of five or ten thousand dollars in many cases; this would not be out of the ordinary.
If I elect to renew my franchise agreement later, what should I do now?
Before you sign your first franchise agreement, be sure you have made an agreement with the franchiser that the same agreement will be the one renewed. It is not uncommon to get unfavorably surprised here. Many franchise owners find that when it is time to renew, they are not really renewing their existing franchise agreement, but entering into a wholly new franchise agreement, often with materially different financial and operational terms.
Is the franchise transferable at any time?
More franchisers are allowing a franchisee to have some flexibility when it comes to transferability before the franchisees have established the new business in their local market and there is territory available in the desired are where the transfer is desired to be placed.
What does it take to succeed?
Hard work, commitment, cooperation and a strong desire to succeed. In franchising you need to also understand that it is a very interdependent relationship that is usually positive.
If a brick and mortar location is required, what are the characteristics of an ideal location?
Every concept has its own unique site requirements. You must rely on the help of your franchiser and/or an area developer of the franchiser or local commercial real estate broker as they are nearly always your best resource for assistance. DO NOT make the mistake of falling in love with a site; this is strictly a business decision that must be made carefully and with factual data only.
How long does it generally take to identify a suitable location?
It is dependent upon several factors including but not limited to the local real estate market conditions, changing demographics, community planning, specific use, etc. However, that said, you should be able to identify a suitable location usually within six months to one (1) year.
Do you have any locations on military bases?
This opportunity is often overlooked by prospective franchise owners, if your franchiser has a concept suitable for a military base situations, it’s often a great captured audience and can be very lucrative for you as well as being able to hire from a pool of reliable employees.
Do you have protected territories for each franchise?
Some do, some don’t; too often new franchisees feel they must have a protected territory, however, depending upon the concept; it may or may not have real value for your business. You should rely on the opinion of your franchiser since they understand this issue best and they share a commonality of financial interest in being mutually successful.
Will you help me negotiate my lease or purchase?
Franchisers may provide some help here, but you would be better served with the help of your attorney, experienced business advisor or real estate broker.
What is your market share currently?
Quantity is not what you’re looking for here; actually you want to learn how well the franchiser really understands his market potential. This question should open up an entire discussion that will help you better understand how well the franchiser understands his potential market overall.
How do you plan to gain brand recognition in the future?
You should expect to hear the franchiser explain a four or five pronged answer here. Gaining brand recognition includes multiple marketing strategies from local in-store point of sale items, direct mail, local advertising and national advertising programs. Building a brand is the top priority and responsibility of any franchise system.
What levels of support do you offer?
Support should be offered at many levels that you can depend on. Initial and on-going training, 800-help-lines, field support, annual meetings and conventions, purchasing, marketing, and promotions all need to be in the mix. You should expect the franchiser to fully help you understand the scope of his support system including his initial training, who’s providing it and where, and ask if there is continuing support or coaching and to what extent do you have access. Also, be sure you ask other franchisees about their historical experience in this specific area. Support and training is what creates consistency in the system. Consistency is as important as building the brand in any franchised system.
Do you provide on-site pre-opening and grand opening support?
Again, this can’t be emphasized enough, you should find out if there is a designated on-site pre-opening team to help you and your new employees. Additionally, the field support team should be working with you during the grand opening period and for up to several weeks thereafter, depending on the concept.
How do you (franchiser) do research and development for your concept?
This is an important asset for you and you should expect that the franchiser has complete and satisfactory answers. Most franchisers own and operate at least one or two company stores. These stores are generally used to do market research and product development, especially in the case of food franchises.
Do you require that I have insurance that names you as an additional insured?
This varies from concept to concept, however it is more common in this litigious society that franchisers require this in the franchise agreement. This works as a benefit for everyone involved.
Can I buy adequate insurance from any company I choose?
Not necessarily. Some franchisers will enforce a policy that only allows you to purchase from a franchiser selected insurance company. However, in these cases, you may want to check with your attorney since individual state laws prevail over terms of this nature in a franchise contract. Get a legal opinion here.
Does your agreement lien my business assets?
Nearly always. This is generally a poorly understood point in franchise agreements. However, this arrangement is not uncommon as franchisers often have contractual claims to secure their royalty rights. Further, most franchise agreement reach personal assets as well. However, there are specific legal tools and structures that can substantially reduce your exposure to personal assets and still be satisfactory to franchisers.
What special assessments can you demand from franchisees?
This is an issue you want to examine closely with your franchise attorney before you sign a franchise agreement. While there is a significant variance of terms on this issue by different franchisers, it can be a serious matter if you don’t understand the rights of the franchiser. For example, a franchiser often has the right to require you to invest in design changes periodically, sometimes to a great extent. This has often caught franchise owners off guard and short of cash. The good news is that franchisers who value their franchisees will work with them to allow implementation of changes over an agreed to period of time so that the franchise owner isn’t negatively impacted to a point of serious financial burden.
How often can you make demands for special assessments?
These, if made, are made any where from annually to 5 or 10 year increments. This all depends on the kind of franchise you have. Again, read your FDD carefully. Also, if it makes reference to the terms of your operating manual and that those terms are also enforceable, examine the operations manual as you would the FDD. Be sure when you sign your contract with the franchiser, you and your attorney make specific reference to the operating manual and incorporate the date of the manual. If any subsequent changes are made by the franchiser, and are substantial, insist that you and your legal advisor give consent of the change before it becomes effective for you under your contract. This is very important.
Can I terminate my franchise agreement under any conditions?
Almost never. Even under justifiable reasons, the franchise agreement is often difficult to terminate. However, if you are losing money in your business and simply close it, most franchisers are not going to chase you down for values lost. You should be aware that by contract, a franchiser nearly always has the right to claim damages (usually by a stated formula) equal to or greater than the value of lost royalties for the remaining period of the franchise contract. If you decide to replace your franchise with another franchise, particularly in the same location, or similar concept, you can just about count on being sued quickly.
What are the guidelines to owning multiple units?
Franchisers typically don’t permit a first time franchisee to operate more than one unit during the first year of operation. Once you have proven that you can and will comply with the system and you are profitable, then most franchisers will permit you to build or own additional units. This should be a part of your long term plan since multi unit owners are often the most successful franchise operators.
Can I get a multi-unit agreement?
Often, these are usually reserved for professionally experienced franchise owners with a verifiable track record of success. It’s worth discussing this issue before you sign a contract so that you clearly understand the rules, historical practices and philosophy of the franchiser on this issue.
Should I quite my job right away?
Definitely Not. Most concepts take anywhere from three (3) months to a year to open for a variety of reasons. The franchiser can share with you an expected time-line based on his specific experience. Generally, you should keep your job right up until the time you must leave for training at the corporate headquarters of the franchiser.
Can I own other non-competing franchises at the same time?
This has become a more common need as more people own franchises. Franchisers don’t like this idea generally, but many are willing to agree to it under certain conditions or guidelines that must be met in order to acquire their franchise.
What parts of the franchise agreement are negotiable?
One of the characteristics of successful franchising is that consistency must be achieved and therefore established systems adhered to strictly. Therefore, franchise agreements are mostly inflexible with the exception of some minor issues. As an example, say you live in Michigan and the franchiser is in Texas. If there is a dispute between you that needs formal mediation, the franchiser usually wants it to take place in his home state; however, this is an issue whereby they would likely agree that if you wanted to name Tennessee as a place instead, to be on neutral ground, they would often allow you to negotiate that point. This may seem like a minor point, but if the relationship should deteriorate, it forces both parties to consider the costs of traveling and having their lawyers travel to settle a dispute, this can be expensive and undesirable by all parties, but also fair to both sides.
If I must enter into mediation or arbitration with a franchiser, must I settle?
No. You are only expected to be prepared to settle, however, at the end of the day you may lawfully have your day in court and these processes can’t force settlement. You do not have to accept unacceptable terms. Be wary and look for franchisers that consistently drag franchisees into mediation or arbitration. This is a trap! Some unethical franchisers use this to cause you grief, cost you so much that you can’t later afford to get to court and try to embarrass you to the point of shame and deflate your confidence and your attorney’s confidence.
Can I work in an existing franchised unit before I sign a contract?
This is often an excellent idea. In fact many good franchisers encourage prospective owners to do this for a week or two in order to “test the waters” to be sure it’s a concept you’ll truly enjoy being a franchisee in.
What differentiates you from the competition?
Listen carefully, take notes and ask lots of related questions here. This comment by the franchiser that is usually very revealing about the vision of the concept and its leadership. A good franchiser will have very definitive discussion if they have a solid grasp on their market and competitors.
Do you sell, or do you plan to sell your services or goods through any other distribution channels including under other names or companies?
Most franchisers are interested in protecting the franchisee and looking after them to be as profitable as possible. The more profitable the franchise owner is the better the royalty income is for the franchiser. This is not widely problematic for most concepts. What you should ask as a follow up is whether or not the franchiser has distribution channels other than franchisees for the same products under a different brand name. If so be sure to dig in and find out how this could potentially affect you in your market and how it could affect the overall business of the franchiser long-term.
How long have you been in business franchising?
This is easily discovered in the FDD . See FDD Item “Business Experience.”
What material or constructive changes, improvements and modifications have you made since starting this franchise?
Details here are important to understand. Ask why and how type questions relating to the franchisers answers. A concept that has gone through major changes often indicates a riskier business model. On the other hand, you want to see some changes implemented periodically. A stale concept is a failing concept. Change is important and is a dynamic process that growing franchises and franchisees should expect in reasonable doses (every 5 years is reasonable for most concepts).
Are your company stores owned voluntary or have they been acquired from distressed owners?
If the franchiser answers that they were distressed stores, you have a franchiser that really cares about his brand.
How long did you operate your first store(s) until you initially franchised?
Franchisers who operated a company store for less than two years were a more risky proposition for a prospective franchisee.
How many units have you closed in each of the last 3 years?
Look closely here in the FDD under Exhibits. Be sure to have this item understood clearly. Some FDD’s are not well written on this point. As an example, it is not unusual to close one unit and then re-open it across the street. If you didn’t have a clear understanding of this practice, it would be easy for you to misinterpret important information.
How many units have you either transferred or sold in each of the last 3 years?
Again, be specific when you are identifying this issue because it may pose some confusion for you. Find out the specifics of these transactions, particularly if a select market has a high incidence of this occurrence. Look at Exhibits in the FDD.
How many units have you opened in the last 12 months?
This is an important indicator of market trends and managerial skills. Trends here are the most important item to watch. If the trend has suddenly stopped or slowed, ask why. What has happened?
What is your current capacity to open new units?
It’s important to understand the capacity and ability of the franchiser and their willingness to commit adequate resources to stay ahead of the curve. Some franchisers develop a dependency on the cash flow of new franchise fees but don’t have the capacity to keep up with the rate of sales and requirements to get those sold units open within a reasonable period of time. This is aggravating for the franchise owner and dangerous for the franchiser.
How many planned unit openings have you cancelled in the past 12 months?
High levels of postponement or cancellations should be a big red flag for you. There is something running amiss and you need to dig in and find out why.
How many contracts have you refunded due to cancellations?
Be cautious of a franchiser that doesn’t admit to having done this at least once and who has been in business for at least five (5) years.
How many units are you planning on opening in the next two years?
Does the answer coincide with the home office support levels. This response should prompt you to get an indicator of how realistic the franchiser is being and how much different is it when compared to the previous two years.
What is the royalty and how often do I pay that?
It is the monetary compensation you pay the franchiser in exchange for rights and services received from the franchiser periodically. The majority of franchisers require an ongoing periodic franchise royalty fee consisting of some or all of the following: an initial franchise or licensing fee; training and supplies cost (tuition and/or room, board and transportation) and on-site start-up support and promotional charges (some or all of which may be included in the initial franchise or license fee or may in whole or in part be separately stated); periodic royalties or service fees and sometimes are inclusive of advertising contributions (often stated and payable monthly or weekly and based on a specified percentage of sales).
Have you ever granted royalty relief to a franchise owner and for how long?
This is another indicator of potential franchisee problems and may raise a red flag you should investigate closer. Royalty relief is often a result of a variety of issues including but not limited to operational problems including, training, support, burdensome unit upgrade demands or advertising disputes.
What levels of support do you provide me after I open?
Depending upon the concept, this is generally a service that runs concurrent with your license agreement. Support comes in many forms locally, regionally and nationally. Get a clear understanding of each concept and its operating plan. Franchised systems often include requirements that you attend annual conventions and quarterly regional meetings. Don’t discount the importance of these meetings. You will find these to be highly valuable opportunities to exchange information with other franchisees and better understand the vision of the franchiser. These meeting will contribute to your success within the system.
Where is training held?
Answer: Most franchised systems will conduct training at their home office location. Additionally, and particularly in the food industry, you should expect to train and work in an operating store, at every position from being the cashier to the general manager. It is imperative, especially in the food franchise industry, to know every station in the store and fully understand those positions.
What expenses should I anticipate for training?
Most often your transportation, hotels and meals plus other incidental expenses are paid by you. However, most franchisers will arrange special discounted rates with a local hotel to help you out.
Is training optional, recommended or mandatory?
It is nearly always mandatory, if it isn’t, then be very cautious.
What requirements for training must I meet?
What else do I need to pay attention to during training?
There may be legal considerations you should be aware of during the process. For example, ff you are required to work in a store of any kind and are asked to sign additional waivers of liability, indemnifications or consents, remember to always sign them consistent with your representations on your original contract for the franchise agreement. The trap here (if you are being set up) is that an unethical franchiser will have a manager have you sign these documents the day you arrive at his store. If you should happen to sign these documents in a personal capacity versus a corporate capacity, for example, you are now on the hook for everything personally and you can lose the legal protection you desired by your corporate entity. This is an easy and common mistake that a few franchisers actually want you to make. Don’t.
How long does training last?
This is solely dependent upon the kind of franchise you are investing in. The training can be anywhere between 3 days and 3 weeks long.
Can my partner or manager complete training with me or by themselves?
Most franchise opportunities that require training also offer the opportunity to have your partner or manager attend with you. Often times you should expect to pay a small additional amount to have them attend. However, if you ask and tactfully negotiate a little bit they sometimes waive this extra amount.
What meetings am I required by contract to attend?
Required meetings of this nature need to be spelled out and made a part of your franchise agreement. Don’t accept ambiguous terms on this point, be specific. Also insist that if additional required meetings are scheduled beyond the scope of your agreement you have the right to accept of deny your attendance. This is not closely understood by novice franchisees who have been hurt because the franchiser has abused his “right” to call meetings at unreasonable times, intervals or locations. Some franchisers have even been known to use this opportunity to drive franchisees away from their system.
What will other franchisees tell me about operations support?
You should hope to hear a clear response that is positive and supportive. Also, be sure that there is a live person available during normal business hours to help you quickly. Many of the better franchise systems have in-house business coaches who do nothing all day except provide advice, guidance and support to their franchise owners, these are the exceptions, not the rule.
Are there fees for advertising?
Pray there are. Any franchise system that does not have a specified local and national advertising plan and contribution requirement, either as a percentage of sales or flat rate amount monthly, would cause me to look else where. Advertising is one of the most important aspects to branding and delivering consistent and timely messages to consumers of their goods or services.
Who is accountable to the franchisee for NAMF fee expenditures?
A responsible and ethical franchiser. A good franchise system will provide franchise owners continuous access to information detailing the use of funds collected from franchisees for the NAMF (National Advertising and Marketing Fund).
Is a part of the advertising fee used for administration or marketing salaries?
Answer: This will vary from concept to concept. Using funds for reasonable administration and marketing salaries directly for the benefit of advertising support system is generally customary and acceptable. However, this information should also be disclosed in the FDD and be reviewed before you purchase your franchise. See FDD Item “Exhibits”.
Does the franchisee have any say in the use of advertising expenditures in the local market?
Yes. Local marketing and advertising budgets are typically managed and administered by the local group of franchisees. It is typically for local franchisee groups meet at least once each month to discuss a variety of topics including local advertising budgets and decide, as a group, where they want to spend those dollars for the benefit of the entire group. Franchisees that fail to meet regularly and plan their local market adequately don’t generally enjoy the level of success of those that do.
Does a franchisee get credit for his advertising fee requirements if he can document appropriate related expenditures on other local advertising?
Many franchisers will accept proof of advertising expenditures in lieu of paying the franchiser direct. However, not all franchisers are this flexible for various reasons. Be specific and ask the franchiser about this at their Discovery Day.
Does the franchiser provide advertising materials such as camera-ready art, circulars and other collateral materials?
Most often, yes. Maintaining consistency in all respects is a big key to the success of all franchise systems. Marketing departments are consistently developing new programs that coordinate with other media placement. Consistent messages and designs are inherently important to the long-term success of the system.
Is there a franchisee association within your franchise?
Having an established franchisee association is very common and should not be denied by the franchiser under any circumstances. Further, in my experience, a good franchiser may also welcome a representative of the franchisee community to retain an Advisory Board (or Committee) seat in the franchiser organization.
Is there franchisee representation on your Board of Directors?
If the answer is no, ask if there is an established Advisory Board?
Who are your Board Members?
This information is found in the FDD under Business Experience, however, you should find out if they are passive or active in the business. The more active they are (i.e. founders) and involved in the business, the better, generally.
Where you are not registered to do business?
You want to know if they are doing business in registration states. These are states that are generally stricter about who can operate there and have met specific criteria that can not be met by some franchisers. This is not necessarily an indication that the franchiser is a high risk. If the franchiser is in some registration states but for example not NY, IL or MN look carefully at the financials, they may not be meeting solvency requirements of those particular states and require a closer review by your independent counsel or CPA.
Should I Expect to sign a Software License Agreement?
Yes. Today one of the most valuable assets of a franchiser is his intellectual property and its use by franchise owners.
Are you a publicly traded company?
A franchiser does not need to be a public company to be regarded as an excellent franchiser. This status is not in any way indicative of being a stable or unstable company.
Have you ever been a public company?
It is not unusual to find companies that have become publicly traded and later elected to repurchase all their own stock in order to withdraw from the public markets and return to being privately owned. Being a public company is often a significant cost and is not any longer necessary. Companies go public to raise expansion capital or to reposition their equity holdings among other common reasons.
What is your trading symbol and with what exchange?
If the company is public, be sure to examine their public filings with a qualified and licensed securities broker or your CPA to learn more about them.
How has the stock performed?
This is often a good indicator of historical events that may help you understand issues and opportunities that the franchiser should explain to you. If the P/E is unusually high, have your professionals examine why.
Do you own and operate subsidiary companies?
Today especially, it is not unusual that a franchiser is owned by a holding company in some form and that that holding company owns other franchised business concepts.
Do you have any provisions regarding Gag Rules?
Some franchise agreements prohibit franchise owners from discussing any aspect of their franchise experience with anyone outside the system. This defeats the FTC rule and other state disclosure laws which require lists of terminated franchisees to be provided to prospective franchisees.
Why do many Franchisers Require Mandatory Arbitration Provisions?
Generally speaking arbitration is a faster and presumably cheaper, it has major disadvantages to the franchise owner. Arbitration is private, with the resulting decisions not creating any precedents. In addition, the ability of a franchise owner to obtain documents from the franchiser and to take depositions is severely limited.
Does the franchise contract offer reciprocal cure periods?
Many franchise agreements give the franchiser 30, 60 or 90 days to cure any alleged defaults; some do not allow the franchisee any remedy if the franchiser defaults. On the other hand, some franchise agreements do not provide cure periods for any alleged defaults by the franchise owner. What is good for the goose is certainly good for the gander! If you select and negotiate an alternative state, which often is a reasonable compromise, be sure to select the state, when possible, that has an abundant population of franchise attorney’s that represent franchise owners. This will also save you costs and expenses of an attorney who may be required to travel to the described venue who represent you.
What is a “Nonreciprocal Non-competition Covenant” and what do you need to understand about it?
Many franchise agreements have oppressive post-term non-competition covenants, both in terms of duration and geographical scope. At the same time, many franchise agreements allow the franchiser to place competing units pretty much where they want. If the franchiser wants protection from the franchise owner after the agreement expires or terminates, why shouldn’t the franchise owner be entitled to the same protection during the franchise agreement?
Why do I need to be aware of the franchiser demand for sole sourcing requirements?
Many product-oriented franchise systems require franchise owners to purchase products solely from the franchiser or from suppliers designated by the franchiser. No allowance is given to purchase from alternative sources even if the quality standards are upheld. This leaves the determination of the gross margin achieved by the franchise owner solely in the hands of the franchiser. This tactic is popular because the franchiser typically enjoys significant manufacturer rebate(s), this is not always in the best interest of the franchise owner.
What is a Mandatory Sublease?
Mandatory Subleases with Rent Overrides are common when a leased premise is required. Many franchise systems require the franchise owner to sublease the franchised premises from the franchiser who has in turn leased the premises from the landlord. This places the franchiser in the real estate business and able to net a profit essentially without risk. These overrides and the amount of them are rarely disclosed in franchise offering circulars.
Should the franchiser be Accountable for Advertising Funds?
Yes. Over the years, franchise agreements have increasingly been drawn in a manner to give the franchiser maximum discretion over the use and application of advertising funds. Agreements are often drafted in such a way as to allow franchisers to not spend advertising dollars in the market where franchise owners have contributed ad funds. Particularly in rapidly growing franchise systems, these funds are used to market the franchise opportunity in virgin territories at the expense of the franchise owners in the system.
Should Legal Fee Provisions be Reciprocal?
Absolutely. Many franchise agreements require the franchise owner to pay all of the franchisers legal expenses in the event of litigation between the parties. However, if the franchise owner wins the litigation, the franchise agreement does not provide for legal fees. The only way a franchise owner can obtain legal fees is if a state statute allows such recovery or in the unlikely event the franchise owner prevails on a RICO claim.
What is a RICO claim?
The short answer is unpredictable and complex. The RICO Act was passed in 1970 by Congress to eliminate the ill-effects of organized crime on the nation’s economy. To put it bluntly, RICO was intended to destroy the Mafia. RICO claims progressed into commercial business litigation claims that, if proven, offer the prevailing party to receive a judgment in the amount of three times their actual damages that would be awarded for their costs. This is a technically and legally complicated issue that ONLY your lawyer can manage. But, if you feel that anyone has threatened you physically in exchange for an interest in your franchised business, you may have a claim. Racketeering is not common, but has been done in franchising in rare cases and can cost the franchiser or others their entire business.
What about Kickbacks?
Some franchise agreements openly acknowledge that the franchiser has the right to make deals with vendors who sell goods and services to franchise owners that are mandated in the franchise agreement. Very often, these vendors provide kickbacks, promotional fees, and commissions to the franchiser in return for being allowed to sell their products and services to a captive market. Instead of passing these kickbacks, promotional fees and commissions on to franchise owners to reduce their costs of goods sold and increase their margins, these payments are pocketed by the franchisers.
Why are references to or inclusions of Unilateral Amendments to the Franchise Agreement Red Flags?
Many franchise agreements provide that the franchiser can change its operations manual or other company policies from time to time without notice to or with the consent of the franchise owner. Thus the franchiser has the right to unilaterally change the franchise agreement. Moreover, the franchise owner is rarely given an opportunity to inspect the franchisers operating manual in advance of the sale of the franchise. Always demand to have your attorney be able to do this before you buy!
Do The Numbers Pass The Smell Test?
Don’t be a sucker for big promises franchisers can’t keep. Any verbal claims about performance should square with the numbers in the FDD –that is, if they are in there at all. According to the International Franchise Association, just 18% of franchisers provide details on a new franchisee’s expected performance–and only half of those will receive any expense estimates. Full pro-forma income statements are almost unheard of.
What Do You Have To Pay Upfront?
Franchisers make money upfront (in the form of a one-time franchise fee, equipment sales and training); along the way (ongoing royalty fees); and, sometimes, upon termination of a contract (liquidation damages). Be sure to figure out what the split is. If a vast majority of a franchiser’s revenues comes from upfront fees, run–the franchiser has already gotten his money and may not be exactly supportive when things start going bad for you. A franchiser’s financials (including income statement, balance sheet and statement of cash flows) are available in its UFOC.
What Is The Franchiser’s Ongoing Take?
Make sure the royalty payments are reasonable. Franchisees kick back roughly 6.7% of their gross sales in ongoing royalty fees, according to the IFA. The cut varies by industry: from 4.6% for hotel franchises, up to 12.5% for personnel-service shops. Check out the average for your industry at www.franchise.org
Can You Choose Your Own Suppliers?
Franchisers often strike deals with suppliers compelling franchisees to work only with them. Domino’s Pizza offers rebates to franchisees who buy their ingredients through the head office; Hobby Town, a craft retailer in Nebraska, requires franchisees to buy all initial supplies from it, though replacement inventory can come from anywhere. Such agreements can cut two ways. On the one hand, bulk purchasing by the franchiser can lower prices; on the other, proprietary deals can also limit competition, perhaps driving up franchisees’What Is The Size Of Your Territory?
Size matters in franchising. If your region is too small, other nearby locations may cannibalize your business; too large, and you won’t be able to afford the marketing costs. Also, choose a region where the brand is already recognized–or at least where the franchiser has demonstrated a serious commitment. (When Carvel, a household name in ice cream on the U.S.’ East Coast, tried to march on California, it failed miserably, shuttering 34 out 35 West Coast branches in less than a year.) Finally, try to get first dibs on the sale of any existing locations in or near your region–and get them in writing
How Easy Is It To Get Out Of Your Contract?
Franchise agreements can last for 10 years, and many franchisers make it difficult for franchisees to cut and run. Breach the contract and you’ll pay “liquidation damages.” Every FDD contains (or should contain) a section devoted to rules governing termination, renewal and transfer of contracts. Read it–closely.
Ticking Time Bombs
Once you think you’ve found the right outfit, keep digging. There are plenty of time bombs lurking in franchise contracts, but with plenty of foresight, due diligence and the aid of a decent lawyer, aspiring franchisees can defuse them before they blow.
If a vast majority of a franchiser’s revenues comes from upfront fees, run. In this case, the franchiser has already gotten his money and may not be exactly supportive when things start going bad for you. A franchiser’s financials–including income statement, balance sheet and statement of cash flows–are available in its FDD.
Make sure the royalty payments are reasonable. Franchisees pay an average of 6.7% their gross sales in monthly royalty fees, according to the IFA. The cut varies by industry–from 4.6% for hotel franchises, up to 12.5% for personnel-service shops. Check out the average for your industry at www.franchise.org.
Consider the size of your territory. If your region is too small, nearby locations may cannibalize your business; too large, and you won’t be able to afford the marketing costs. Choose a region where the brand is already recognized–or at least where the franchiser has demonstrated a serious commitment.
Finally, look for tripwires in the termination clauses. Franchise agreements can last for 10 years, and many franchisers make it difficult for franchisees to cut and run. Breach your contract and you’ll pay “liquidation damages.” Every FDD contains (or should contain) a section devoted to rules governing termination, renewal and transfer of contracts. Read it–and every other section of the FDD–very closely.
Ask which type of franchise is for you.
There are two kinds of franchises: “business form” (or “package”) franchises and “product” franchises. Package stores run according to the franchiser’s own business model. Think Subway, McDonald’s or Dunkin Donuts. Product franchises are basically a means to distribute the parent company’s goods, so franchisees have more of a say in how to run their own business. Examples include gas stations (Mobil), auto parts dealers (Goodyear) and some financial services companies (Raymond James).
Be honest about what you can take on.
Even if someone hands you a proven business model, you still have to put up a significant funds to make it happen. On top of your typical start-up and construction costs, expect to pay a $20,000 to $30,000 initial franchise fee. Before you invest, figure out how much you can you afford to lose.
Thoroughly dissect the federal disclosure document.
Under the Federal Trade Commission’s Franchise Rule, all franchisers are required to disclose information about their business and the mechanics of the franchising relationship. These documents run into the hundreds of pages. Read carefully; better yet, hire a franchise attorney. Two items to watch for: the number of lawsuits brought by unhappy franchisees and franchise cancellations or nonrenewals.
Interview other franchisees.
Try to call or meet with at least half a dozen current and former franchisees and ask them about their experience. The names, addresses and telephone numbers of franchisees from the previous year must be included in the franchiser’s disclosure documents, including those who left the system within the previous year. Questions to ask: Are the estimated start-up costs accurate? Is the franchiser providing the services they say they do? Would they add another store if they could?
Look for the escape clause.
If things go sour, you’ll want options–so understand clearly the process for resolving disputes. Most franchisers, for example, demand that franchisees take up litigation in the franchiser’s home state, and that can get expensive. Also, clearly define the terms and conditions forKnow your rights.
There are rumors of change, but for now, the federal government doesn’t do much policing in the franchise industry. (The Federal Trade Commission is not required to review franchisers’ disclosure documents.) Fifteen states have their own franchise disclosure laws. More legal information is available from FranchisingLaw.com, where you will also find a roster of franchise attorneys.