Franchising 101: Terms, Traits, and Tools Part III
Throughout this Franchising 101 series, I have discussed the basic terms associated with franchising and topics such as why consider buying a franchise, what to ask yourself before buying a franchise, and how to analyze the FDD and the franchisor. This month’s article will discuss the final steps to becoming a franchisee, namely tips for negotiating with the franchisor, who to talk to, and acquiring financing.
There are a disturbingly surprising number of franchise buyers who do no read the franchise disclosure document or franchise agreement before buying a franchise. These are the franchisees that are ignorant of the contractual obligations that they have committed themselves to and end up filing frivolous lawsuits later during their term or constantly are complaining that the franchisor is not doing something that can be easily explained by reading the franchise agreement. There are other franchisees that read through the franchise documents, but do not talk with a third party who is knowledgeable about franchising. After talking with many of these franchise buyers, I have found two reasons that people do not talk with their advisors. The first reason is that they feel there is nothing they could do about the franchise agreement anyway, and the second reason is that they do not have the money to hire someone to review the documents.
Without stretching the truth, most franchise agreements can be negotiated to a point. Many franchisors will tell buyers emphatically that they do not negotiate, which many times will stop a buyer from talking with an attorney or CPA because they think the terms are set in stone. What many franchise buyers do not realize is that if they take a different approach that many of these franchisors will move at least a little.
A general rule is that franchisors do not want to set a trend for future franchise buyers to negotiate dollars and percentages. This is because if a franchisor discounts a royalty fee, marketing fee, or the initial franchise fee that they have to disclose that negotiation in the FDD for future franchise buyers to see. This creates the trend that future franchise buyers want to get the same deal that the other buyer received, which has led many franchisors to have a “take it or leave it” mentality.
They key to negotiating is to know what is most valuable to you and your situation. If leaving a business for your family is important then focus on those provisions. If you are interested in having a larger territory then think about the give and take that you can work with to acquire the larger territory which does not always mean paying twice the franchise fee for twice the territory. Everyone wants to pay lower fees, but that is not going to happen for most franchise systems.
The second reason franchise buyers do not talk with advisors is that they feel advisors will cost too much. Before talking about cost, the first step is to know who your advisors are. Many of these advisors do not cost anything but time. Advisors consist of family, friends, franchise brokers, the franchisor, and franchisees, which cost no more than some time to call and maybe a lunch. There are those advisors that cost money such as accountants and attorneys, but looking at the overall investment for a franchise and the possible problems that could occur without someone helping, the cost of an attorney or accountant is minimal.
When talking with friends and family, ask them what type of business they think you should be in and then talk with them about the prospective franchise purchase. In most cases, friends and family know you better than you think and can give great suggestions. The other benefit to having friends and family on your side is that they give a support structure, someone to vent to on bad days, and people to celebrate with on good days.
Talking with franchise brokers is a great way to learn about various types of franchises. Many franchise brokers will give you multiple franchise options to evaluate. These options can be very out of the box for your skillset, but could also be very well tuned to your personality type.
Finally, the franchisor and franchisees are a great resource. During a Discovery Day there are opportunities to talk with the franchisor’s staff about different points and talking with franchisees will give any buyer the opportunity to learn about the day to day life of a franchisee which can be a very valuable experience.
The next types of advisors are the advisors that require payment. Accountants and attorneys are very valuable sources of information related to the franchise. Talking with accountants can help any buyer understand the financial performance representations of the franchise (i.e. the “how much do franchisees make” representations) and can help franchise buyers understand what their financial limitations are for the particular business, which we will discuss in more depth below.
Having an attorney review the franchise agreements is a big step that a lot of franchise buyers avoid. When talking with an attorney about the franchise agreement, the key is to find an attorney that works in franchising. Most people see the franchise agreement as a contract, but what they do not know is that there are special rules that apply to franchising that do not apply to other areas of law. This means that yes, your business attorney could review the franchise agreement, but they may, and probably will, miss some of the areas that are interpreted under franchise law. Talking with an attorney does not need to be costly either. Most franchise attorneys, whether they charge a flat rate or hourly, will bill somewhere around $1,500 to $2,500 to review the franchise documents. This cost compared to many times a $100,000 or more franchise investment is a small price to pay to understand what the obligations of both parties are under the franchise agreement.
Lastly, I want to discuss financing the franchise purchase. When looking at financing, every franchise buyer needs to ensure they have enough money to not only cover the franchise purchase but also to cover their living expenses and employee salaries for anywhere from a few months to a year or more. Over the last several years, everyone has learned that acquiring financing has become harder, but what most people have not realized is that financing for franchise purchases has been better than most. The reason franchise purchases are getting finances are for the same reasons I have shown in this three part series why franchising is a great way to own a business. Banks and other lending institutions see the value within different franchises and many times can be given financial documentation from the franchisor to assist with the application process.
There are alternatives to bank loans too. Companies have appeared across the U.S. to help people tap into their retirement accounts to finance their franchise purchase. Before approaching one of these companies, research them. When rolling over an IRA or 401k, there are many rules that must be followed to avoid penalties with the IRS, so be sure to thoroughly research the company before working with them.
Researching franchise attorneys, accountants, or financial lenders can be very easy. With organizations such as the International Franchise Association, research can be done through their website to discover different advisors who focus on franchising. Additionally, with publications like Franchising USA, you can find advisors who are at the forefront of the franchise industry and want to help.
It has been my pleasure to discuss the various aspects of buying a franchise during this three part Franchising 101 series. Owning a business is a dream of many people and franchising is a great way to experience that dream while still maintaining some protection from those hurdles that new businesses can experience. With the right team and with some self-awareness of strengths, weaknesses, goals, and desires, this dream can become a reality for every person.
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.