by Joyce Mazaro
Every prospective franchisee, whether a business school graduate, corporate refugee or new entrant into business, must have a sound rationale for becoming a franchisee of any brand.
Franchisors seek prospects who reflect strong professional values. Honesty, confidence, patience and commitment to the brand are critical.
Being able to attract, train and properly lead a team is high on the list. Reliable access to sustainable financial resources is a given.
But even with those skills and values in check, the challenge of operating a franchised business may not be sufficiently stimulating for everyone.
For prospects whose primary reason for considering a franchise is running away from a career that has become tired, frustrating or dead-end, operating a franchised business may look like an attractive alternative. But the journey required to become a successful single or multi-unit franchisee cannot be faked; it will require “hands on” hard work and the flexibility and humility to be chief cook, bottle washer, bookkeeper and face to the public, among a host of other roles.
What you need to succeed
Many franchisees have succeeded at doing just that. Many franchisees have not.
For some, instead of operating a franchised business, investing in franchised businesses or focusing on expanding the franchised brand in growing markets is a more compelling vision. Chief among reasons for the increasing engagement in franchising of private equity and investment groups is their growing appreciation of the financial potential of developing units under an established brand and system created by a franchisor that has invested its own capital and time to achieve brand recognition and a consistent demand for its services.
Many prospects are surprised that there is difference between a franchisee and an entrepreneur. If a prospect truly wants to be or thinks he is an entrepreneur, truly does not want to follow the rules and standards set by the franchisor, and is convinced that he has a better “mouse trap” for operating the franchised business — then that prospect should take a pass on being a franchisee.
That prospect will be miserable with the requirements of consistency and adherence to system standards prescribed by the franchisor that all franchisees must meet and the impact on both the system and the relationship between the franchisor and the franchisee will be undeniably negative.
The brand is number one
Enforcing brand and system standards is the first priority for any franchisor, and following and adopting the franchisor’s business model and strategy is job No. 1 for any franchisee.
Once a franchisee understands and embraces his or her role, then creating an infrastructure and managing the franchised business in the mold of the franchisor’s business model will come naturally.
But not all franchisors are equal. Some have a history of a strong culture and proven business model, and others are exploring an idea for the first time. Determining the value in and risk of being associated with either category of franchisor requires savvy investigation, including:
Knowing existing and prior franchisees’ experience with the franchise system;
Validating the costs of starting up and maintaining the franchised business;
Understanding the operational standards with which the franchisee will be required to comply;
Confirming the training, marketing, advertising, accounting and other operational resources available to franchisees; and,
Confirming when and at what cost franchisees will be required to provide training, marketing and advertising services in the local market.
A prospect will want to prepare a business plan, budget and financial forecast to assess the probability of his or success, all of which are part of the investigation needed to determine whether to purchase a single franchise or multi-unit development rights and whether to be “boots on the ground” in the store with the customer or back at the office executing the business plan.
Here are some factors that can help in determining if a person might be suited to franchising and how to investigate a franchise opportunity:
1. Accessing the right resources
A prospect should diligently investigate any franchise opportunities of greatest interest. Any prospect has the prerogative, prior to the start of the franchise relationship, to accept or pass on a particular franchise relationship.
The diligence required involves much more than a review of the franchisor’s disclosure document or participation in a “discovery day” at headquarters. Prospects will need the assistance of an experienced franchise adviser — a knowledgeable franchise lawyer and a knowledgeable financial adviser or business consultant — to conduct the proper due diligence on any franchise opportunity before making an investment.
2. Financial performance representations (also known as FPRs)
Many, but not all, franchisors provide FPRs in their disclosure documents reflecting a broad range of data from annual gross sales to a full profit-and-loss statement and everywhere in between. In many cases, you will still want to visit with existing and former franchisees to confirm or obtain additional operating data to consider for your business plan.
If a franchisor does provide an FPR, review it with your franchise attorney and financial adviser, request the substantiating data supporting the FPR from the franchisor, and request a supplemental FPR if you want specific information highlighting operating information about select locations or featuring years of operation, variations in services, or geographic differences among units.
3. Approved suppliers, purchasing requirements and rebates
In the disclosure document, you will find information on how the franchisor selects and approves suppliers, products and services that must be used in the operation of the franchised business; whether you will be required to purchase from specific sources, including from the franchisor or a related company; whether the franchisor will derive revenue, either directly or indirectly, from those purchases, such as increased margins, rebates or discounts; and whether those funds are reinvested in the franchise system.
Ultimately, a prospective franchisee should assess whether the benefits of purchasing from the franchisor’s designated sources will have a positive or negative financial impact on its business.
4. The franchisee network
Item 20 of the disclosure document includes a list of the franchisor’s existing franchisees with contact information and a list of terminated franchisees as of the franchisor’s most recent fiscal year.
Item 20 also contains information about projected openings during the next year, closures during the prior year and a good sense of whether unit openings are keeping up with the development rights granted.
5. Management team, litigation and financial statements
The franchisor’s disclosure document is a starting point for networking with franchisees, suppliers and others who have a history with the franchisor. In addition to internet searches, the disclosure document will give you information about the experience of the franchisor’s management team and litigation filed against or by the franchisor.
This information may reveal important red flags about a franchisor’s culture, such as one that repeatedly sues its franchisees for unpaid royalties or a franchisor that gets sued by franchisees for misleading FPRs or failing to provide promised services.
In addition, by reviewing the franchisor’s audited financial statements, you should get a realistic sense of whether the franchisor is and will continue to be financially able to support the franchise system.
Joyce Mazero is a partner and co-chair of Gardere’s Global Supply Network Industry Practice, internationally recognized and trusted legal advisers who work in matters of franchising. She can be reached at email@example.com.