STEP 4 - INVESTIGATE THE FRANCHISOR
It is important for you to investigate the franchisor thoroughly. You
wouldn't want to become a partner with someone you didn't know or trust.
Consider your relationship with the franchisor a partnership and check the
franchisor out completely. There are three stages to this investigation.
Beware of any franchisor that wants you to make a decision so quickly that
you will not have time to go through the following investigative process.
1. Investigate the credibility and reliability of the franchisor.
This is particularly critical with franchisors that have been in
operation for a short time. Information from sources such as the Better
Business Bureau and Dunn and Bradstreet can tell you a great deal
about the franchisor. Try to find a person or company who will run a
credit check on the organization. If the franchisor is a smaller
and less-well-known company, you may also want to conduct a background
and credit check on the management and corporate officers.
The disclosure statement must include information about lawsuits.
If there are lawsuits pending against the franchisor, investigate
these by contacting the attorney for the plaintiffs. Ask the attorney to
explain anything he or she can about the lawsuit. Question the
franchisor about what the attorney tells you. You should feel
comfortable that the lawsuit is about an issue that would not affect you.
2. Talk with franchisees about their experience. The disclosure
statement is required to have a list of franchisees. Pick a group of
franchisees at random to contact. Your conversation with franchisees
can provide important information. Some questions to ask are:
- Did the franchisor follow through on its promises?
- Does the franchisor provide good management assistance?
- Does the franchisor provide good marketing and advertising
programs?
- What are the strengths of the franchisor? What are the
weaknesses/
- Do you consider your franchise to be a success? What has
contributed the most to this success?
- Did the franchisor make any mistakes during the start-up?
How could the mistakes have been avoided?
- Have there been management and operational mistakes? How
could these have been avoided?
- How strict is the franchisor about business being conducted
exactly as described in operating manuals?
- If you could do anything over again, what would it be?
- Would you recommend that a person buy this franchise?
Carefully review the answers that you get. Are there consistent
problems or concerns raised by the franchisees? A consistency indicates
a pattern which increases the probability that the problem will be
repeated with your franchise. Likewise, positive answers should
encourage you to seriously consider entering into and agreement with the
franchisor.
3. Seek the advice of professionals about the franchisor and franchise
agreement. Three professionals that you should definitely confer with
are an attorney, an accountant and a banker.
An attorney is needed to review the franchise agreement. This
is your contract with the franchisor and provides the only written
commitment and promises that exist. Anything that has been verbally
promised should be in this agreement. The attorney and you should
review the following items in the agreement:
What is the length of the contract? It should be the same length
discussed with the franchisor.
Does the contract provide an exclusive territory? If not, what
protection is offered against other franchisees taking business away
from you? Proliferation of franchisees can seriously erode your revenue.
This is the reason that you need some protection.
Are there restrictions on selling the franchise? The more
limitations that exist, the more difficult it will be for you to recover
your money. Many franchisors will offer to buy back the franchise, but
there are often conditions. You need to have a clear understanding of
what you must do in order to initiate the buy-back provision.
What are the criteria you can use to cancel the contract? Likewise,
what are the criteria the franchisor can use to cancel the contract?
These criteria should be reasonable and provide a clear process for
canceling the contract.
Does the franchisor agree to buy back the franchise if the
contract is canceled? This is absolutely necessary or you risk losing
all of your initial investment in the company. Furthermore, determine
whether the franchisor will compensate you for the goodwill built during your
operation of the franchise. Goodwill is a valuable asset and takes a
significant investment of time and effort to accumulate.
Are there any franchise requirements that you believe are unwise,
illegal or unethical? Sections of a contract that make you uncomfortable
at the start of a business relationship may result in problems at a later
date. You will probably feel uncomfortable implementing a provision that you
don't believe is right.
Has the attorney identified any problems with the contract?
There are a number of legal technicalities connected with most business
contracts. An experienced attorney will be able to advise you about
these provisions.
An accountant should review two primary items for you. First,
the accountant should examine the corporation's financial information
that is provided in the disclosure statement. Second, the accountant
should review the financial potential of the business. You
should ask the accountant the following questions:
Is the initial investment for the franchise fee, equipment and
building reasonable? The accountant may be familiar with fair market
value for these things or should be able to obtain this information.
Are the royalties and cooperative advertising rates reasonable?
There are ratio tables that illustrate typical expenditures for certain
categories of business. The tables can be used to indicate whether the
rates being charged by the franchisor are within a normal range.
What will your financial situation be during the first five
years of operation? A form that is often used in a business plan is a
financial proforma. The financial proforma is a five year financial
plan. The plan includes projections for income, expenses, cash flow and
profits. Review this plan with your accountant and determine the potential
return on investment for the franchise.
Is the investment a reasonable risk? All new businesses are
risky. However, you must balance out three key areas to determine the
degree of personal risk. These include your personal assets, resources
for financing the franchise and the potential return on investment. You
should be able to afford any loss to your personal assets. The
financing should provide a monthly repayment schedule that is reasonable
and affordable. Potential return on investment should directly correlate
with the risk that is involved.
A banker should be contacted to review the franchise, the financial
proforma and your persona financial statement. The banker can provide
insight into the financing issues that will be involved. The
banker needs to answer the following questions:
Would the bank consider giving you a loan to finance your business?
(This question can be directed to your accountant as well to determine
how affordable the purchase is for you.) The banker's answers are given
from a lender's viewpoint. When a bank turns you down for a loan, the loan
officers note the problems. Ask the loan officers to fully explain the
reasons for not making the loan. This information will allow you to
evaluate for yourself whether these are serious problems that could
impede the franchise's success.
Do the loan officers feel that the franchisor is credible? The bank
will take more risk when your personal assets are sufficient to
underwrite the loan. This doesn't give you any assessment about the
franchisor or the franchise agreement. Make sure that the loan officers
provide a compete explanation of the loan review board's evaluation
about your potential for success. What strengths and weaknesses do they
judge the franchisor to possess?
What are the lending conditions? These conditions, including the
interest rate, provide additional information that can be used to assess
the viability of the franchise. More liberal conditions indicate a more
positive evaluation of the franchise by the loan officers. Also, attractive
conditions will increase your profit potential.
You should weigh the review and recommendations of all three professionals
before you make your final decision about a franchise. These experts can
provide important advice, and you should value their opinions.
Step 1 - Examine Your Opportunities
Step 2 - Examine the Franchise and the Franchisor
Step 3 - Analyze and Evaluate the Disclosure Statement
Step 4 - Investigate the Franchisor
Step 5 - Make a Decision
