How To Evaluate A Franchise

How To Evaluate A Franchise

To improve your probability of success, you must take the time to evaluate yourself, your strengths and weaknesses, and, most importantly, the franchisor and the industry in which it operates. The “fit” is critical. Square pegs in round holes are seldom highly successful–and often fail. If you’re not comfortable filling the job description needed in your franchise, your chance of excelling diminish dramatically. Continue to study and learn, but gain the strength to be decisive. Don’t let a great opportunity pass you by because of fear or indecision.

Choosing Your Franchise

There are four main ingredients found in each business. A quality franchise provides help in all four areas.

  • The product or service that is delivered to its customers. The franchisor has proven the need for the product or service. The existing units are already addressing that need. The franchisor has developed a specific business plan showing how to market to its customer base, how to price, sell and deliver the product or service too! There will be training on hiring and training employees to help run the company; guidance on pay schedules and benefits; and details (often computer software) to help manage your money.
  • The location that the business occupies. The franchisor helps with professional site selection. This is critical for site-specific businesses as is the demographic survey that confirms that your territory contains enough target customers.
  • The amount of capital that was invested or borrowed by the venture. The franchisor provides budgets that work & cost-control systems. You will know when you begin, if you have enough money to get started. Buying power will keep costs down and following the prepared plan will help you reach profitability in short order.
  • The management team that runs the company–You! The home office’s training and on-going assistance keeps you on track, working the system that increases your probability of success.

Always remember your franchisor has helped many others succeed in this industry. You’ve paid them for their expertise and advice—now Follow It!!

Making a Choice

Choosing the right franchise can be a confusing process.

  • First, you must believe in the product or service that the franchise network delivers. Is the niche stable, expanding, long-term, saturated??
  • Next you must verify the industry’s future. What do the trade papers predict? Check your aptitude for the job. If you don’t enjoy math, an accounting franchise isn’t for you, etc. Often outside sources can help here. A personality and aptitude test (similar to those used by major corporations) will help you discover your hidden talents.
  • Determine the earnings capability. Most franchisors can’t provide earnings projections, but you must make an effort to determine your future return. Confirm the potential earnings and the franchisor’s integrity with existing franchisees. Each franchisor will give you a list of its network members.
  • You should call them to get their confirmation of your projections. If a franchisor (or business opportunity seller) will not give you a list of its franchisees, you should heed the red flashing lights and end discussions.

Looking for Gold

Creating pro-forma income statements is not a complicated process… The formula is basically quite simple:

A – B = C

A = First you project Gross Sales for the year.

B = Then you estimate all Expenses for the same period

A minus B equals Cashflow $$.

This is the pool of funds you’ll have to pay yourself, repay debt and invest in expanding your venture.

To develop your Income Statements, first project gross sales.

  • What is the average sale?
  • How many units will you sell per hour, per week, per year?

Use these to establish Annual Gross Sales. Determine cost of Goods Sold.

  • What is your cost for the materials sold?
  • Often this can be determined by an industry average. Gross Profit is the difference between Sales and Cost of Goods Sold.

Next you must subtract each expense category:

  • Employees’ Payroll & Taxes
  • Rent
  • Utilities
  • Advertising
  • Insurance
  • Royalties
  • Supplies
  • Accounting & Legal Fees
  • Repairs & Maintenance
  • Equipment Replacement Fund
  • Miscellaneous Expenses.

Note: this is before your salary and any perks you give yourself, such as a company car, etc. The balance is Net Cashflow. Again, this should be compared to your gross salary on your current job.

THE FRANCHISE DISCLOSURE DOCUMENT

The franchise disclosure document is usually a thick, 50+ page document that seems imposing. It contains a great amount of information about the company allowing you to become familiar with the details of your future relationship. This document answers many questions.

  • Who is the Franchisor?
  • The principals of the company and their business background as well as the history of the venture.
  • What is the Offering? Exactly what is being offered? This section describes the length of the agreement, territory, responsibilities, opportunities, etc.
  • How Much Will it Cost? Initial fees, royalties, advertising fees, start-up costs for equipment, and working capital are covered.
  • What Does the Company Promise? Will they train? Develop training materials, ad programs, generate accounts?
  • What do you promise? Most franchisors will restrict your activities to prevent you from using their system without paying royalties, during and after the agreement ends.
  • Financial History of the Franchisor. Is the company stable? Will they be in business for the long-term?
  • List of Existing Franchisees. These are the franchisees you’ll want to call to verify that this is a venture you’d like to pursue.
  • A Copy of the License Agreement. This is the actual contract that will govern your relationship over the next 5, 10 or 20 years. Read it & understand.

Overall, the documentation seems restrictive and somewhat negative. There are more “you can’ts” than “you cans”. The penalties for violating the agreement are harsh, but don’t be put off by the legal aspects of the contract. It is written to give the franchisor the power to keep a “wild” franchisee from ruining the good reputation of the entire network. That franchisee will be terminated if they operate a renegade operation. Unless you plan to break the rules, this is only good for you. Your net worth will rise as the value of your franchise goes up. If the company gets a black eye, it will adversely affect you, too. Understand the extent of your restricted or exclusive territory and verify that it makes sense to you and your advisors. Also be sure you compare your favorite franchisor with others in the same industry. Are you getting the most you can hope for at the least cost?? What are the comparative advantages?

Advisers.

Talking with others as you decide which franchise is right for you is of great value. Recognize that many friends and family members may discourage you from moving toward your goals. They may sincerely believe they are protecting you from the chance of failure. Sometimes they’re afraid you’ll outshine them!! Your best advisors are those who have taken a small business risk and achieved the success you desire.

Other Franchisees.

Other franchisees are one of the best groups since they’ve got the “insider’s view” you need. Be sure to listen for warning signals. If many are willing to sell, especially for low prices, there may be problems afoot.

Accountants.

Accountants can help you with the financial aspects of the business. The one you choose must be a small business specialist, with franchisees for clients. Remember most accountants are very conservative and they may not understand your strong desire to take control of your financial future.

Attorneys.

Attorneys can provide advice on the contracts you’ll sign. Again they should have experience dealing with franchisors to understand your needs. Many “generalists” will try to negotiate a better deal for their client by rewriting the contract. This will not be possible. At best, it will slow your purchase, at worst, it will alienate the franchisor to the point they will not allow you to join. You must understand that the contract is written very one-sided in the franchisor’s favor. It contains many prohibitions and stiff penalties to remedy your breach. You should realize that the strength in franchising is that each unit produces the same products or services. If you’re the kind who loves to experiment, reinvent the wheel, and “push the envelope,” maybe franchising is not for you. You must recognize that standardization is critical. To your benefit, if your neighboring franchisee decides to modify the list of products or services, you can ask the franchisor to enforce his contract to protect the value you’re building in your unit.

Making the Final Decision

Completing your research brings you to the most critical moment of all–making a decision. Evaluate the problem you’re trying to solve–low pay, no job, no challenge, lack of control, inability to build your net worth–and look at this franchise as a possible solution. Don’t become a dreamer. You must be realistic about the future. Then set a final date (3 to 5 days should be enough) and MAKE A DECISION. If you reject the franchise, begin the process again with another company. Time is fleeting and you must work at solving your problem promptly.

*Used with permission of franchisedoc.com