How to Evaluate a Franchise Opportunity

If you’ve

been following our series on buying and running a successful franchise, you’ll know that we’ve put a lot of emphasis on doing your

research before buying a franchise.

But what

does that research involve, exactly? That’s what we’re going to cover in this

tutorial.

The first

two tutorials were about understanding how franchising works, and generating a

shortlist of promising opportunities. In this one, we’ll take you step by step

through the process of researching and evaluating each opportunity on that list.

We’ll show you how to assess the business plan, what questions you need to ask,

what extra research to do, and we’ll list some common mistakes to avoid.

Before

making a final decision, you’ll also need to read and understand the Franchise

Disclosure Document (FDD) and the franchise agreement. These documents are so

important that we’re going to cover them in a separate tutorial. For now, we’re

looking at all the other research you can do beyond reading those documents.

Step 1: How to Evaluate

the Business Plan

The first

step is to understand the business plan you’re buying into. You should be able

to gather a lot of this essential information from the franchisor’s website or

from other materials they provide.

At a very

basic level, how does the business make money? If it’s a simple retail

operation like a convenience store or fast-food restaurant, that should be

pretty obvious, but franchises can cover a wide variety of business types. If

you’re getting into a less familiar type of business, make sure you understand

the basic model for generating profits.

Beyond

that, you need to look at what makes that business unique. Imagine yourself

running the franchise, and ask yourself how you would sell it to customers. If

it’s a burger joint, for example, what makes it different from well-known

brands like McDonald’s and Burger King? Is it cheaper? Better quality food?

Better service? Why would a customer choose your business over another?

Check out

the demand for the products or services you’ll be selling, and how well that

demand is currently being served in your area. Sticking with the fast-food

example, you could count up all the existing fast-food restaurants in the area

you plan to open a franchise in, plot them on a map, and see what the coverage

is like. Are there any areas that are poorly served? If there are already

dozens of competitors, ask yourself if there’s space for your business to

thrive. Visit existing restaurants and see how busy they are. Maybe even do

some polls and customer surveys, asking people whether they’d visit your

restaurant.

The success

of a business, after all, is largely driven by the traditional laws of supply

and demand. If there’s a large demand for your product or service, and little

supply, you should thrive. If the balance is tilted towards the other end of

the scale, you’re likely to struggle.

Look at how

much money you’ll have to invest yourself, whether the franchisor will help

with additional financing, how much you’ll have to spend on buying or leasing

real estate and equipment, and what kind of support you’ll get in terms of

advertising and marketing. You want to estimate how quickly you can break even,

and gauge the long-term prospects for the business.

Step 2: Key Questions You

Need to Ask

Beyond

reading, of course, you need to ask lots of questions. Pay particular attention

to the source of any numbers or profit estimates you’re given, and don’t be

afraid to ask the franchisor for extra details. Here are some key questions to

ask:

1. How Long Have You Been

in Business?

A long

track record is no guarantee of success, but it should at least give you some

comfort. If the franchisor has been operating for decades, it’s more likely

that the business model has been refined and improved over time. If it’s quite

new, it’s not necessarily a red flag, but you’ll need to pay more attention to

the background of the key executives, and be a bit more skeptical about any

estimates or promises.

2. Can You Provide Earnings

Estimates, and What’s the Basis for Them?

Often,

franchisors will give estimates of how much you can expect to earn. But the

Federal Trade Commission warns that the numbers can sometimes be misleading. So ask them to substantiate any

earnings estimates—if they claim an average income is $100,000 a year, for

example, is that figure inflated by a few very large franchise units, or is it

truly what you can expect to earn yourself? How does the income vary by

location? If revenue figures are provided, ask for profits instead—you want

to know the bottom line.

3. What Training is Provided?

One

attraction of franchising is the support offered by the franchisor to newbie

franchisees. But the amount of training can vary widely, so you need to

understand exactly what’s being provided. How long does it last, and what form

does it take? Is there any additional cost, or is it included in the franchise

fee?

4. What Controls or

Restrictions Are There?

As we

discussed in the first franchise tutorial in this series, franchises often place

significant restrictions on what you can do, to enforce uniformity across the

brand. Make sure you understand what these restrictions are. Will you be forced

to buy particular products, or comply with design standards, and what will the

costs be? Will you be restricted from offering particular services, or from operating

in certain territories?

5. How Does the Marketing

Work?

Another

attraction of franchises is the ability to take advantage of a bigger brand

with name recognition and marketing clout. But check the details of how

marketing will work. Sometimes you’ll have to pay into a marketing fund, but

the publicity may not directly benefit your business. So ask what’s provided,

how much it costs, and whether it’s mandatory to keep paying in if you’re not

seeing results.

6. How Do You Resolve

Disputes?

You may not

want to start a business relationship by asking a question like this, but it’s

important to understand it. Disputes between franchisor and franchisees can

happen for any number of reasons, and you need to know what the process is for

resolving them. Also find out if there are any pending lawsuits against the

franchisor.

As well as

asking these questions directly, you can also research the franchise online,

for example by checking with the Better Business

Bureau to find out if there have been any complaints against it, or by

checking out the articles and forum discussions on a site like UnhappyFranchisee.com or BlueMaumau.org to find out about any negative

franchisee experiences.

Step 3: More Research You

Need to Do

Once you’ve

done your research and asked plenty of questions of the franchisor, it’s time

to interview other franchisees. The franchisor may supply you with some

references, but like any references or testimonials, they’re likely to have

been selected because they’ll say something positive. So by all means contact

the suggested franchisees, but also find some of your own.

A good

place to start is with franchisee associations. Sometimes these are sponsored

by the franchisor, but often they’re independent organizations, set up by

franchisees to give them a way of communicating with each other and advocating

for franchisees’ interests. Examples of franchisee associations are Domino’s Franchisee Association and National Jack in the Box Franchisee Association.

Contacting

these organizations is a good way to get information on the state of the

relationship between franchisor and franchisees, and to find out more about

what you can expect. You may also be able to make contact with individual

franchisees, so that you can interview them about their experiences.

Also check

the Franchise Disclosure Document, which we’ll look at in more detail in the

next tutorial. There’s a section in it where current and former franchisees are

listed, so you can track people down that way.

And if

you’re thinking of buying an existing outlet that was reacquired by the

franchisor, the FTC says

that the franchisor must tell you who owned and operated it for the past five

years.

Questions

the FTC recommends asking former franchisees include:

• How long they
  
  operated the franchise?


• Where the
  
  franchise was located?


• Whether
  
  they were able to open the outlet in a reasonable time?


• Their total
  
  investment, including any hidden or unexpected costs?


• How long it
  
  took them to cover operating costs and earn a reasonable income?


• Whether
  
  they were satisfied with the cost, delivery, and quality of the goods or
  
  services they sold?


• Whether the
  
  franchisor’s training was adequate?


• Their
  
  satisfaction with the franchisor’s advertising program?


• Whether the
  
  franchisor fulfilled its contractual obligations?


• Whether the
  
  franchisee would recommend the investment?

Keep in

mind that some franchisees may be wary about giving out too many details of their

business, particularly if you’re cold-calling them. Think about how you’d feel in

their shoes, and think of ways to make it easier for them to help you. If

you’re asking about finances, for example, it may be better to ask generally

how much you can expect to make as a new franchisee, rather than specifically

how much they’ve made.

Step 4: Common Mistakes to

Avoid

Buying a

franchise can be a wonderful decision, but there are some pitfalls. Here are

some common mistakes to avoid:

Being in a Hurry

The

research we’ve outlined in this tutorial will take a significant amount of

time. It’s not always easy to find all the information you need, and locating

franchisees and getting them to talk to you can take patience and

determination. And we haven’t even covered the Franchise Disclosure Document

and franchise agreement yet.

But if you

rush all of this due diligence and cut corners with the research, you may find

yourself getting into problems. If you find that someone else is pressuring you

to hurry before the great opportunity passes you by, definitely push back and

insist that you need the time to do your own research.

Relying on Other People’s

Opinions

With pretty

much any investment, it’s dangerous to rely entirely on other people’s

opinions. By all means get recommendations from people you trust, but

ultimately it’s your money, your life, and your responsibility to get this

decision right. Ask for the rationale behind any recommendation you’re given,

ask for data and facts to substantiate it, and do your own research to verify

it. If you’re being advised by an expert, be very clear about what that

person’s motivation is, and whether it aligns with your own interests.

Buying a Good Franchise,

But One That’s Not Right For You

The

research you’re doing in this tutorial is not just aimed at helping you avoid

bad franchise businesses. It’s also aimed at helping you find the franchise

that’s right for you personally. You may come across a franchise that’s a

wonderful opportunity for someone,

but not for you. It’s important to return to the self-evaluation that you did

in the previous tutorial, and compare your own goals and needs against what the

franchise is offering. A franchise that offers big financial rewards but

requires a huge time commitment, for example, would be a dream for some people,

and a nightmare for others.

Looking for the Latest

“Hot” Opportunity

Sounds

exciting, doesn’t it? But remember that one of the main benefits of running a

franchise is getting access to a proven business model that’s generated profits

in good times and bad. A hot new opportunity means one that’s untested, and it

adds to the risk you’re taking on. If you really want to do something new and

exciting, why not launch

your own startup?

Conclusion and Next Steps

Buying a

franchise is a major life decision. Often you’re investing a substantial amount

of money upfront, and also tying yourself into running a business for a period

of up to ten years, with all the extra commitments of time, money and energy

that such a decision involves.

It’s a

decision that works well for many people, giving them greater financial freedom

and independence. But it can also be a way to lose a lot of money if you rush

into buying a franchise that turns out not to be right for you.

If you

follow the steps outlined in this tutorial, you’ll give yourself a much better

chance of success. You’ll understand the business plan completely, you’ll have

asked all the right questions, and you’ll know what to expect from talking to

existing franchisees. You’ll be ready to avoid some of the common franchisee mistakes,

and buy a franchise that’s right for you.

But your

work isn’t done yet. You still need to read and understand all the official franchise

documents, particularly the Franchise Disclosure Document (FDD) and the

franchise agreement. We’ll cover those in the next tutorial in our series on

buying and running a successful franchise.

The post How to Evaluate a Franchise Opportunity appeared first on DICKLEUNG DESIGN 2014.