4 Risk Factors to Consider Before You Buy a Franchise
The idea of starting a franchise can spark from anywhere – maybe you enjoyed a nice smoothie at your local café and decided to start your own franchise of creamy milkshakes.
What’s the risk in starting after a successful retail chain that has done financially well locally and, nationally right?
Even the most successful company in the world won’t automatically guarantee success to its franchisee.
A successful franchise runs on well-trained executives, quality control, marketing campaigns, logistics, operating channels, product deliveries, and most of all, consistency.
Consider all the following things when opening your first franchise.
POINTS TO KNOW BEFORE BUYING YOUR FIRST FRANCHISE
Becoming an entrepreneur by owning a franchise can be a wonderful dream.
Unfortunately, when we dream, we eliminate the risks that we take up and often focus on making a fortune.
Selecting a franchise to invest in is the most important part of starting a franchise.
Decoding the Various Terms of a Franchise
Before we get into the dark and grim bits of buying a franchise. Let’s iron out a few basic things about franchises first.
- The franchisor (Seller) – A company or a person that provides a license. A franchisor owns all the rights to owning the company and trademarks to the business in question.
- The franchisee (Buyer) – The person who has the license to run a business model of the franchisor in their preferred location.
- Franchise (Business Model Concept) – A business expansion concept that belongs to an entity or an individual with an idea for expansion.
Example – Tom owns a clothing brand and designs fashion apparel for a living. His friend Mark is interested in the business and requests Tom to give him the license to run the same exact store with all the permits and licenses.
Tom is the Franchisor who owns his business.
Mark is the Franchisee who is interested in opening a business model with Tom’s clothing trademark.
Tom’s clothing brand is the Franchise.
Now let’s understand what are the necessary characteristics that a franchisee should know when buying a franchise.
What good is owning a franchise when the brand makes no money from it?
And even if a franchise looks financially secure from the outsider’s perspective, it requires a thorough set of eyes to gauge the return on investment.
Take the iFranchise Group Acid Test to ensure the return on your equity is positive. According to the iFranchise Group, a return on your investment of 15-20% by the 3rd year is considered as a safe bet.
Any lower than 15% or if the duration exceeds beyond the 3rd year and your ROI diminishes and enters a risk pattern.
Services and products are heavily based on their geographical locations. What sells in one part of the country won’t necessarily do well in your regional location.
That’s why adaptability plays a key role in selecting your franchise.
With different geographical locations comes varying laws of the state.
Ensure no state laws are being broken and double-check all documentation with a lawyer.
The franchisor must ensure all laws are shared with the franchisee before they sign the documents.
Ensure the logistics or shipping team deliver the goods on a timely basis.
Non-availability of products for distribution can cause disruptions in your franchise’s operations.
Every franchisor is entitled to educate their franchisee with the knowledge of running operations and to explain the system.
Businesses with a complicate learning curve are to be strictly avoided by new entrepreneurs. Getting caught in a difficult-to-understand franchise can only make matters worse.
Before signing the dotted lines, ensure you’ve got the full support of your franchisor.
Training modules are to be provided by your franchisor and every aspect of setting up a franchise should be made convenient.
Credibility isn’t just about being popular. Plenty of brands are popular but don’t have the consumer’s good faith.
As a franchisee, when you take up the reins to own a franchise, you directly represent all the beliefs projected by your franchisor.
That includes controversies, success stories, Unique selling propositions, and other aspects of the franchise.
Unless you’re completely committed to believing in your franchise, it’s not a good idea to invest in a franchise that you don’t believe in wholeheartedly.
A franchise is a lifetime decision for many working individuals. Investing a lifetime’s worth of money into a business that they have doubts about can have serious repercussions moving forward.
Does your franchise innovate with exciting opportunities for the future?
Are there deals and offers laid down for their consumers?
A franchise must hit all the right strides in order to gain the attention of its consumers.
This includes coming up with jaw-dropping deals and awe-inspiring products and services.
A franchise must create the right buzz and market their products and services in a positive manner.
For example, a chain of health fitness clubs offering 80% off to all senior citizens and 50% off to all couples on Valentine’s Day across all outlets is an exceptional way to attract customers and drive the word around town.
Imagine investing in a fitness franchise that had the same monotonous pricing structure for all its members without offering any discounts, you’d lose your customers to other attractive health clubs.
As explained above, opening a franchise isn’t just a golden opportunity. It’s a cumulation of several different aspects that contribute to the success of the franchise.
While some things are in your control, other prospects are already established by your franchisor which makes it critical to read the fine lines on your documentation before even beginning to consider investing your sum.
4 RISK FACTORS THAT CAUSE A DENT IN YOUR FRANCHISE
Whether you’re a retired military general or a part-time professional looking to invest in a business – a franchise offers so much potential to create wealth for everyone.
Unlike starting a brand from scratch, a franchise retains the value of its franchisor and hence, the clientele is already aware of the products and services before your store goes live.
While franchises are an excellent option to invest, a franchise certainly has its weaknesses in the form of the franchisee not being aware of the pitfalls.
Before you begin going through the list of franchises, it’s important to understand your interests and the type of field that is best suited for your personality.
OnePaceFranchising’s personality test offers just that — a personality test to provide you with information that matches you with a franchise that appeals to you.
A set of 15 questions are asked and at the end, you’ll be rewarded with the appropriate fit based on your behavior.
Now that you’ve found the right field to set up your franchise, it’s time to understand all the issues faced by franchise owners before and after setting up their preferred franchise.
The following franchise hazards demonstrate exactly why it’s necessary to keep an eye open when investing in a franchise.
1. Financial Risk & Hidden Costs
The first question posed to your franchisor is – What kind of financial risk are we talking about if it all gets blown to dust?
A justified question as any smart investor prefers to understand how their money will work for them when putting into a franchise.
Unfortunately, a smart franchisor will never reveal this information to you and will sugarcoat their brand as the best there is.
They are willing to pull out long sheets of successful partnerships and how their business is the next big thing following the invention of the wheel.
Here’s where the financial risk in franchises come into play –
- Growing capital required every year to include market trends
- Not enough budget for marketing campaigns to turn a profit
- Weak geographical locations with not enough demand for product/service
- Long duration for your return on investment(ROI)
- Outside economic factors like the Economic recession
- Controversies afflicting the franchisor such as a boycott of products and services by public
- Bankruptcy filed by the franchisor
With all these hidden factors contributing heavily on the downfall of a franchise, a legal disclosure document was prepared to safeguard the interests of all franchise owners by the United States government.
This document is called the Franchise Disclosure Document or FDD for short.
Every U.S. citizen is entitled to an FDD and it’s the franchisor’s sworn duty to provide every minor hidden cost in this document.
A franchise owner is entitled to 2 weeks of time after receiving the FDD before he or she must transfer any money or capital to the franchisor.
These two weeks are the most important period of your life.
The 14 days of immunity provide you with a legal right to consider whether a franchise is good to invest in or not.
The FDD should be verified by legal government personnel or a lawyer to ensure the treaty you’re about to sign is verified and valid.
Once you’re confident with the financial numbers, proceed to sign a Confidentiality Agreement or CA with your franchisor.
A Confidentiality Agreement is a binding clause between you and your franchisor. A contract that proves you’ve entered a business relationship with your franchisor.
According to your exclusions and inclusions, a CA can be customized and drafted to your preference.
If there’s something you don’t want to be included in your terms of the agreement, this is the place to put it in writing.
Many first-time entrepreneurs enter into an agreement with a franchisor without fully researching the type of competition that the business has.
Even the top brands in the world have top competitors to keep them on the edge.
It’s critical to understand that if a competitor’s brand is already doing well in your local area, you’ll have to double up on the advertising costs and this still won’t guarantee that you’ll succeed.
Let’s take an example to make the point.
Assuming you’d open a franchise with the world-famous Wendy’s fast-food restaurant.
You decide on an area in your region without spending too much time knowing about the competitors of Wendy’s.
Let’s have a look at what some of the top competitors of Wendy’s are –
- Burger King
- Jack in the Box
Quite a list there, isn’t it?
And these are just the popular food chains, other local restaurants that have attracted their loyal clientele for decades also exist and it’s almost a colossal task to grab the attention of the public among all this fierce competition.
If you’ve got limited finances, setting up camp in a location that’s already popular with other famous restaurants can almost bury your new franchise before it opens in operating costs alone.
Add to this, you must allocate your financing budget to counter the marketing campaigns setup by these vicious competitors and you have a hole in your franchise that leaks money.
Hence, it’s advisable to research your competition before you sign your contract and understand the audience’s expectations. ‘Strategy’ is the name of the game in the franchise world.
3. Franchisor’s Success Isn’t Everything
Don’t be swayed by the glitter of billboards and by press articles of your franchisor.
It doesn’t mean you’ll stand to make a profit by investing in a slice of the award-winning pie.
Many of the franchisors employ several PR gimmicks to influence their franchisees.
Even if your franchisor has a successful business model, it doesn’t automatically guarantee you success.
Let’s take a popular example below.
Krispy Kreme – The famous American doughnut company decided to go public in the year 2000. Initially, the public was excited when they began their franchise program, and everyone wanted to be in the doughnut business.
Due to the rapid growth globally, Krispy Kreme’s quality control didn’t meet the expectations. By 2009, many of their stores shut their door due to poor revenue. While the parent company itself is very successful, this is a classic example of a popular franchise not hitting the homerun.
And there you have it. Don’t invest because the company has a popular fanbase. If the parent company takes a hit in bad PR, your franchise will undoubtedly sink with it.
Hence, it’s necessary to read the FDD carefully and make smart decisions when selecting your franchisor.
4. Franchise Sharks
When setting up a franchise, there are franchise developers that will offer to help you set up your franchise at a low price.
Many of these companies offer grand schemes, asking you to relax while they take care of everything from acquiring the FDD to advertising for your company and even recommending the best franchise to invest in.
Don’t believe these half-baked promises. They are simply lying through their teeth to get a huge investment thrown at them.
Once you invest your money, you can expect these companies to withdraw from their agreement and you’ll soon be knocking on their doors to get the work done.
These are known as ‘Franchise Sharks’, they smell blood in the form of opportunity and swim around your ship until you throw them a huge chunk of finances.
These companies come in the form of PR consultants, lawyers, coaching services, free consultancy, advertising agencies, digital marketers, real estate brokers, and others.
Their bundle of services is usually overpriced but they convince you that this is a ‘Once in a lifetime deal’ and that you’ll miss out on not using their services.
Ignore their sales gimmicks and concentrate on researching about your franchise on your own terms.
After all, you’ll be responsible for all the actions that you take when purchasing a franchise, so you might want to spend time knowing the workarounds of your franchise.
Many of these franchise sharks usually have a recommendation on who a good franchisor would be for you. They recommend franchisors that pay them a huge commission when a deal goes through.
If you must absolutely utilize the services of one of these companies, utilize an online review system to see if their claims check out.
Always pay for these services using an escrow or in partial payments. Paying in full is madness and a completely irresponsible choice.
FREQUENTLY ASKED QUESTIONS REGARDING PURCHASING A FRANCHISE
When investing in a franchise, questions to the franchisor provide insights on whether you’re making the right or wrong choice.
Questions evaluate whether you’re making an informed decision or whether you’re making a hasty one.
Questions are your best friends when investing.
Hence, here are popular questions that entrepreneurs ask their franchisors before entering into an agreement.
And why you should consider asking these questions yourself.
Q1. How long will my investment take to break even?
Imagine investing in a business that takes forever to net a profit.
This question forces your franchisor to give you an estimated time on how long it takes for their franchise to break even.
Preferably the time taken shouldn’t exceed more than 3-5 years.
Remember you’ll be feeding the franchise with more investments just to keep the business going.
If you sink finances into the franchise to cover operating losses, you’ll never recover your investment.
Q2. Can I have a financial report of the performance from other franchisees?
Of course, it’s necessary to know how a franchise would do when you first open it and who better to answer these questions than existing franchise owners.
Looking at their financial balance sheet should give you a clear answer on how the franchise is doing.
Consider the demand and supply as well as the location.
These factors contribute to the overall success of the franchise.
Q3. What kind of money will I stand to make in this franchise?
Yes, we know the first year isn’t going to make you roll in profits but what about the consecutive years after that?
You have living expenses to cover in the time you open a franchise and bills to pay. Looking at all of this, an estimated range of the income you make is critical.
Q4. Do our values align with each other?
Asking your franchisor this question will save you from finding it out the hard way. Every franchise comes with its unique business culture.
Many of these values might not match with your own and this causes plenty of feuds between the franchisee and franchisor.
They may end up terminating your contract without returning your investment if you don’t pay attention to the rules and regulations.
Q5. Can you describe the training module in detail?
The success of a franchise is dependent on the assistance you receive from your franchisor in the initial phase.
Once you’ve purchased a franchise contract, every franchisor is obligated to provide a system to pass over to their franchisee.
This system comes in the form of operational training, employee training, financial management, leadership training, and other essentials.
Apart from this, the franchisee can request on-site assistance depending on the level of comfort they share with the franchisor.
Q6. Would there be an exit strategy?
An exit strategy isn’t just a strategy to get you out when the going gets tough, it’s an option to pass on your business to the custody of a family member or your children.
It gives you an idea on how you’d like to progress with your business plan if you no longer wish to be a part of it without shutting it down. Your franchisor can offer you options such as a buyback or an interested 3rd party buyer.
If the franchisor refuses to deal with an exit strategy, it’s not favorable to invest for a long long-term – such as 10, and 20 years from now.
Q7. Will I have any help in marketing and advertising?
Depending on your contract, either a franchisor will take the full responsibility of dispensing the marketing duties of your franchise or none.
Reading the fine print in the marketing section is advisable.
If you have an advertising fund sorted out according to the contract, it’s in the best interests of the franchisor to advise you on how to proceed and attract your customers.
Marketing campaigns must be decided in view with the local and regional public in mind.
For example – A McDonald’s restaurant in the United States is considered a family-friendly restaurant and hence, no alcohol is served.
However, many franchises of McDonald’s in Europe also sell beer.
This is how regional consistencies differ from each location and appropriate marketing campaigns are necessary.
Q8. Am I allowed to talk to other franchisees and ask them about their experiences?
Under the FDD rules, it’s your legal right to have the contact information of every franchisee that the franchisor has a business connection with. Transparency is the most important thing when looking to strike a deal with the franchisor.
If your franchisor cautions you against contacting their other franchisees, there sure is trouble brewing in the horizon.
Most successful franchisors encourage their new prospects to contact their other franchisees to ensure their clients are well informed.
Buying a franchise without investigation is like walking up a mountain slope blindfolded. It’s extremely dangerous to go by first looks.
Take your time and do your diligent examination on every aspect of the franchise.
You’d be surprised how many inconsistencies show up when you look deep. Invest only if every question to your answer is satisfactory and not before.
A franchise is a life-time investment and for many their only means to earn their bread, it’s necessary to arm yourself with knowledge and your legal obligations during your discussion phase.
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