By Bill Cherry
Every year thousands of prospective business owners want to buy a franchise business. Some franchises are very good, and others are scams. Below is some helpful information everyone considering investing in a franchise should know.
What is franchising?
A franchise is a legal and commercial relationship between the owner of a trademark, service mark, trade name or advertising symbol, and an individual or group seeking the right to use that identification in a business. Generally, a franchisee sells goods or services that are supplied by the franchiser or that meet the franchiser’s quality standards.
The success rate for franchise owned businesses is very high. According to studies conducted by the U.S. Department of Commerce from 1971 to 1987, less than 5 percent of franchised businesses failed or were discontinued in each of those years.
Although forms of franchising have been in use since the Civil War, enormous growth has occurred more recently. By the end of 1990, more than 500,000 franchised establishments in 60 industries achieved gross sales of over $700 billion dollars and employed 7 million full and part time workers.
Industries that rely on franchised businesses to distribute their products and services touch every aspect of life, from automobile sales and real estate to fast foods and tax preparation.
One reason franchise businesses have a limited failure rate is the many benefits provided the franchisee. Benefits of Franchising: Business franchises often provide a full range of services including:
There are a number of aspects to the franchising method that appeal to prospective business owners. For example, easy access to an established product and a proven method of operating a business reduces the many risks of opening a business.
The franchisee purchases not only a trademark, but also the experience and expertise of the franchiser’s organization. If you are not prepared for the total commitment of time, energy and financial resources that any business requires, you should stop and reconsider your decision to enter the franchise business.
Research Your Options:
As in all major business decisions, nothing substitutes for thorough investigation, planning and analysis of your options. Many so called franchises are scams. The questions below are a guide to your research. Read the franchisor’s entire publication before you begin to gather information.
Ask yourself these questions:
Is the product or service being offered new or established?
Does the business require special skills or aptitudes that you may lack?
Do you feel strong motivation for producing the product or providing the service?
Does the product meet a local demand? Is there a proven market?
Who is the competition?
If the product requires servicing, who bears the responsibilities covered by warranties and
guarantees? The franchisee? The franchiser? If neither, are service options available?
What kind of reputation does the product or service enjoy?
Are suppliers available? What reputation do they enjoy?
Visit at least one of the firm’s franchises. Ask for a list of all of the firm’s current franchises and make sure that you select the one to visit. Avoid calling those names recommended by the franchiser. At the very least, the franchiser must provide you with the names of 10 franchises in your prospective market area.
When you meet with the franchisees, observe their operation, discuss expenses and ask how well the franchiser supports the franchise units. Does the franchiser actively promote and market the products or services of the franchise? You should determine the reputation, stability and financial strength of the franchiser.
When you meet with the franchisees, observe their operation, discuss expenses and ask how well the franchiser supports the franchise units. Does the franchiser actively promote and market the products or services of the franchise? You should determine the reputation, stability and financial strength of the franchiser:
How long has the franchiser been in the industry?
How long has the firm granted franchises?
How many franchises are there? How many in your area?
Examine the attitude of the franchiser toward you. Is the firm concerned about your
qualifications? Are you being rushed to sign the agreement? Does the firm seem
interested in a long term relationship, or does that interest end with the initial fee?
What is the current financial condition of the franchiser? Check the franchiser’s financial
statements in his disclosure document. If the franchisees are paying their upfront fees but
not their royalties, this may indicate that franchise units are being sold to investors but
that they fail to open or perform too poorly to pay royalties. Who are the principal
officers, owners and management staff? What is each person’s
background? How much experience in franchising do they have?
Compare sales promises with existing documentation. Be certain that the sales
presentation is realistic and that major promises are clearly written into the contract. Be
alert for exaggerated claims and pressure tactics.
For newly established franchises, make sure the franchiser has registered the company’s
trademark. If not, the company’s name and logo may have to be altered, forcing you to
change your market identity after you have established yourself.
Verify earnings claims and compare them with other business opportunities. Investigate
all earnings claims carefully. Earnings claims must (1) be in writing; (2) describe the
basis and assumptions for the claim; (3) state the number and percentage of other units
whose actual experience equals or exceeds the claim; (4) be accompanied by an offer to
show substantiating material for the claim; and (5) include certain cautionary language.
Treat this opportunity like any other investment. Does the franchise offer the return you
require? If not, you may want to look at a different business.
What is the legal history of the franchiser? Have any of the executives been involved in
criminal or civil actions? Is any litigation pending, particularly involving any restrictions
on trade that may affect the franchise?
Is the franchise a member of the International Franchise Association (IFA)? If not, why
not? The IFA has a strict code of ethics that must be met before a company can become a
What is the full initial cost?
What does it cover?
Land purchase or lease?
Building construction or renovation?
Use of operations manuals?
What ongoing costs are paid to the franchiser?
Cooperative advertising fees?
Interest or financing?
Are you required to purchase supplies from the franchiser or a designated supplier? At
the prices competitive with other suppliers? What, if any, restrictions apply to
competition with other franchises? What are the terms covering renewal rights?
Reselling the franchise?
The Federal Trade Commission (FTC) requires sellers of franchises and other business opportunity ventures to provide prospective investors with the information they need to make an informed investment decision.
It also requires that all earnings claims be documented, that the information investors receive be complete and accurate and that investors have adequate time to consider and evaluate the disclosures before making any final purchase commitment. All required information is given to prospective investors in the form of a franchise disclosure document, which must be furnished at least 10 business days before any purchase may occur. This document includes 20 important items of information, such as:
Names, addresses and telephone numbers of other franchisees.
A fully audited financial statement of the seller.
The cost required to start and maintain the business.
The responsibilities you and the seller will share once you buy a franchise.
Litigation involving the company or its officers, if any.
Get Professional Advise:
You should consult a franchise attorney, an accountant and/or a business advisor to counsel you and go over the disclosure document and proposed contract. Their advice will help you make a realistic and sound decision. Remember, the money and time you spend may save you from a major loss on a bad investment.
Be very careful choosing a franchise in which to invest. You will have to live with it for many years.