Do Your Homework Before Buying That Franchise
A recent issue of The Wall Street Journal ran a special advertising feature written by Julie Bennett and titled The Future for Emerging Brands. It was targeted at companies that might want to franchise their concepts as well as franchisees who might benefit by buying a smaller, newer, or lesser-known franchise than one of the “household names” that everyone knows. It reminded us that there are benefits to buying less well-known franchise concepts and that there are also risks. This post is more about the risks and how an entrepreneur can mitigate those risks.
Several years ago, a client came to us to write a business plan for a hair salon franchise the client wished to buy and open in New York City. The client intended to submit the business plan to a commercial bank that would provide some of the funds that would be used to purchase the franchise and then open the salon. One of the first things that we do either before the client hires us or immediately upon being hired is to request that the client provide a digital copy of the Franchise Disclosure Document (FDD) that all franchisors in the United States must provide to any potential franchisee. The FDD tells the franchisee everything that he or she would ever want to know about the franchisor including its history, financial position, the number of franchises open and operating, all estimated costs associated with buying and operating the franchise, and many other important aspects of the business.
In the case of the hair salon, the FDD revealed that the franchisor had opened one company-owned store and that a total of 6 franchises had been sold of which 2 were open. Interestingly, 4 of the 6 franchisees had the same last name as the franchisor’s CEO, and of course, on further review, it was explained that the franchises had been sold to the CEO’s family members. That, coupled with a very small balance sheet, led us to recommend that the client pass on this opportunity and find something else.
Please don’t misunderstand, buying a franchise from a young or smaller franchisor is often an excellent business decision and a great opportunity. In fact, according to research firm FranchiseGrade.com, 71% of all franchises have 100 units or less.
The benefits of buying a franchise from a smaller franchisor include:
- There will be more market areas available.
- Franchise fees will often be lower due to the fact that the brand is not as well known.
- You might be able to negotiate a lower franchise fee and royalty payments.
- You will often receive more attention and better training from the franchisor.
When looking at franchise opportunities, what are some of the ways that you can reduce the risk of making a bad investment? In addition to carefully reviewing the FDD, you should also:
- Visit at least one existing franchise location.
- Personally talk to at least 3 franchisees. They will be listed in the FDD.
- Understand the franchisor’s commitment to you in terms of training, ongoing support, etc.
- If you are asked to pay a monthly advertising fee based on a percentage of your revenue, be sure you understand the benefits you will receive in return for your monthly fee.
- Be absolutely certain that you have a passion for the business you are about to purchase.
What if you are confident that you will be an excellent operator but you lack the confidence or even the skill to analyze the FDD and the ultimate strength of the franchisor? Get help. There are a number of reliable sources that you can find online such as FranchiseGrade.com. You can even call us and we will do a review of the franchise opportunity that you are considering and then provide our opinion as to the strengths and weaknesses of the opportunity. Our franchise review costs are modest and considerably less than making a mistake.
Last thing, many new franchisees require a business plan for one or more of the following reasons:
- An investor or banker requests one.
- The franchisor will often request a business plan.
- You wish to have a “road map” that will guide you through the launch and early operation of the franchise.
That is what we do. As you leave this page, you might want to stop by our very comprehensive Business Plans for Franchisees page.