Franchising 101: Terms, Traits, and Tools, Part II
In last month’s article, I discussed the basic terms and definitions associated with franchising, the influence franchising has to the U.S. economy, and how to perform a cost/ benefit analysis of a franchise purchase. This month’s article of our three-part series will talk about analyzing yourself and how to evaluate the franchise after narrowing your search.
When you are looking at a franchise, remember that you are going to spend about the next 10 to 20 years of your life in this franchise. Because so much of your time will be devoted to this business, you should look inside yourself and talk with your family and friends to determine if this is for you.
Ask yourself whether you want to work on the business as an owner/ operator or are you looking for a franchise where you can hire someone to manage it in your place. Many franchises require that you be an owner/operator, which can mean attending training, annual conventions, and dedicating your working hours to the business. In the alternative, there are some franchises where you do not have to run the day-to-day operations and can hire someone to be your manager. If you are looking for the second type of franchise remember that in almost every franchise you will have to guarantee the performance of the franchise which means you should be very careful about who you hire to run your franchised business.
Another important question to ask yourself and those close to you is how well you work with others. Most of the franchises that people are exposed to, such as restaurants, have a lot of employees and a lot of face-to-face interaction. However, there are also franchises that allow you to work from home and make phone calls or email customers. Regardless of your social skills or preferences, there is a franchise that will work for you.
You should also ask why do you really want to own a franchise. During the various seminars that I give to franchisees, I pose this same question to everyone. Most entrepreneurs give the same general answers, such as I want to be my own boss or I want to buy a business that I can make my own money from. These are all great answers, but they only touch upon a few of the reasons. Those that people will not talk about out loud are that they recently were fired and don’t want to experience it again, or they are retired but are bored, or they have reached a certain age where they are too young to retire and just old enough that it is harder for them to find a job. Whatever your reason, you should know and understand it before you move forward with a franchise purchase to ensure you are making the right decision.
One question that franchisees fail to ask many times is whether the franchise will work in their market. An over exaggerated example of this is that a snow removal business would not make a lot of money in Miami, but a bathing suit retailer might. Many franchises are for sale in areas that the product or service may not work well in, but franchisors will typically leave it up to you to determine that. As the potential business owner, you should research whether this business has competitors or similar concepts in your target market and whether those businesses are doing well. Another great way is to spend a little extra money to hire a marketing company to perform research into your area. This may cost a little more, but it could be worth it in the end.
One big question to ask is whether your family and friends will support your decision to buy a franchise. This is a very important question to ask because statistically a family owned and operated franchise is more successful because each member of the family has a vested interest in the success or failure of the business. Additionally, without support of your loved ones, you will have no outlet for your frustrations, concerns or celebrations.
So now you have looked at different franchised businesses and thought about who you are and what your goals and support structure look like, but what should happen next? Next, you should read or re-read the Franchise Disclosure Document. If you do not understand the Franchise Disclosure Document and franchise agreement, then how can you expect to successfully follow the franchisor’s model?
When evaluating the franchise, most buyers look straight to the total investment, which can be very deceiving. Item 7 of the Franchise Disclosure Document lists the total investment required to purchase the franchise; however, this Item gives a range for the franchise investment. In some franchises, this range can include costs for running the business from your home to leasing commercial space, which can vary greatly. Also, there are many franchises that require you to have a specific vehicle, which can greatly change the total investment if you do not have the vehicle already or if your financing terms are not exceptional.
Every franchisee is concerned with the fees. The main questions that I get regarding fees are is the franchise fee to high, what am I getting for the royalties I am paying, and what is the franchisor doing with my marketing fee? Of course, everyone asks if they can negotiate the fees, but that will be addressed in our third part in the Franchising 101 series next month.
The franchise fee is your ticket to get in the club that is the franchise system. Depending on the franchise, you can expect to pay between $10,000 and $35,000, with the average franchise fee being around $25,000. This franchise fee is what the franchisor uses to rent space to train you, pay trainers, cover printing expenses and costs of meals during your training. Most franchisors expect this fee to be used almost entirely on the above expenses and as a payment to cover the costs associated with finding you.
The next expense franchisees ask about are the royalties. Royalties are always an area of contention between franchisors and franchisees. Every franchisee at some point argues that they are paying high royalties and not getting enough support for it. It is best to think of a royalty as your payment to continue using the franchise name, buying power, reputation, and support system. Admittedly, there are franchisors that charge high royalties and give very little in return, but most good franchisors have evaluated their royalties and charge an amount that is reasonable based on the services they give in return. When someone buys one of the popular fast food franchises, they know that people will come and buy food based solely on the name; however, what most franchisees will not acknowledge is that the famous fast food chains have spent a lot of money negotiating with suppliers of the various food products to reduce prices to the franchisees to save them money. Good franchisors will look for ways to make the lives of their franchisees better and more profitable in order to earn that royalty.
Another fee that franchisees look at is many times two separate marketing. These are the local marketing fees and the national marketing fees. Almost all franchisors require a national or regional marketing fee, which is a separate bank account that the franchisee pays typically between one to four percent of gross sales into for marketing on a nationwide or regional scale. Many times franchisees will not see their bottom line increase and therefore argue that they are not getting any benefit from the national or regional marketing. If the franchisee is the sole franchise owner in a state then this may be true, but in most instances franchisees will experience some exposure in their general area from the national or regional marketing fund. A national or regional marketing fund should be supplemented with your local marketing efforts. Franchisors will often require that franchisees spend a minimum amount in their local territory. These amounts can vary from franchise system to franchise system, but normally run between one to three percent, or in some franchises can be a flat monthly, quarterly, or annual rate. Local marketing can be used in many different ways including sponsoring local sports teams, TV commercials, radio, newspapers, and even door hangers. Franchisees should always talk with the franchisor, other franchisees, or marketing companies to determine what type of local marketing works best.
There are many other areas of the FDD and the fees that could be explained, and in next month’s conclusion to the Franchising 101 series, I will discuss who to talk with about these fees, some tips for negotiating, and what you can do to finance some of the initial investment.
Jason Power has been helping entrepreneurs review and negotiate franchise purchases since 2009. Jason is a regular speaker at the International Franchise Expo, West Coast Franchise Expo, Franchise Expo South and various other franchise expos where he gives tips on how to analyze and negotiate a franchise purchase. Jason is a senior attorney with Shelton & Power franchise law firm.