Don't Be Another Failed Franchise

When buying a franchise your success hinges on knowing the answers to these four critical questions

If you’re planning to buy a business, you’ve probably debated between buying an existing business or a new franchise.

Some of the advantages of buying an existing good independent business could include a proven track record of sales and profits, a well-know name and location, a strong mix of products and services, a group of knowledgeable employees and a good customer base. 

There are benefits with buying a franchise too. Buyers are able to purchase an established business plan with step by step guidelines. Plus, most franchisors offer training and operational support due to their incentive of the royalty fee that they will earn from the franchisee. Usually, the franchisee will also have access to other owners for help, ideas and moral support.

When considering a franchise, buyers routinely assume that they never fail, which couldn’t be farther from the truth—every business venture is risky. To increase your chance of being successful  When conducting your due diligence process, find out the answers to the following four questions:

What is the total cost of ownership?  Franchise buyers need to understand the immediate out of pocket expenses they will incur upon purchase, as well as any other ongoing fees.  All franchises are not created equally.  Some will structure a purchase with less start-up fees or allow you to make incremental payments; others may provide incentives for multiple territories, growth and sales volume. Along with the up-front franchise fee, you will likely have to pay the franchisor a royalty based on a percentage of your sales. You may also be required to lease equipment, purchase supplies or services directly from the franchisor.  Depending on location requirements, the additional expense to make leasehold improvements and outfit your new business with furniture and fixtures specifically required by the franchisor may fall in your lap. Finally, in some cases special advertising fees are levied against sales to pay for franchisor marketing costs. 

Understanding all the upfront and ongoing costs of ownership enables new owners to compare their forecasted return on investment with their expectations.

What is the turnover rate?  Unpleasant as it may seem, buyers need to ask the franchisor they are considering what percentage of their franchisees fail each year and how many close within the first two years. 

Do not be surprised to find some failures, even the best franchisors’ experience some bumps in the road. Learn about the frequency of franchisee failures in your industry, plus ask questions about reasons why they failed and look for common traits. For example, you may discover a number of failures are caused by poor management skills, reluctance of franchisees to follow the franchisors script, inadequate promotions and poor location choices. Most importantly compare them to your situation.

Understanding the turnover rate of franchise ownership will help paint a picture of attractiveness vs. buying an existing business in the same industry or shopping for a different franchisor.  This will go a long way to making an informed decision.

Will my territory be protected?  It’s critical to explore the level of regional protection you will have. For example, does the franchisor guarantee they will not sell other franchises in your area, and for a certain time period?

Similarly, you will want to uncover what kind of empire-building opportunities you will have. Some of the more successful franchise owners have multiple outlets in the same area and are able to utilize economies of scale. You will need to find out if you have first right of refusal for new franchises, for which market area and under what parameters.

By uncovering the opportunities or limitations to growth you will ensure there are no disappointing surprises down the road.

What happens when you want to leave?  As with purchasing any business, a buyer not only needs to have a plan going into the business, they should have an exit strategy as well. As a franchise buyer, you need to identify what kinds of restrictions you’ll will be under when you want to get out.

Will you be able to sell it to anyone or only back to the franchisor? You should also research the comparable sales prices of franchises that have recently sold.  And, you must know if there is any transfer fees associated with your re-sale. Many franchisors will charge a one-time transfer fee to buyers of existing franchises, and the fees can be extensive.

Although it’s difficult to make blanket statements about which franchise models are better than others, buyers need to understand where their franchisor’s interests lay before they purchase.  The best thing you can do is thoroughly read and digest the disclosure materials and franchise agreement; probe and question the areas that are unclear; and visit and speak directly with the franchisor to be able to make an informed purchase decision. Remember, franchisors complete a thorough investigation of you before they approve you as a franchisee, it’s in your best interest to do the same with them.

Bill Sivell is a salesperson with VR Windsor Inc., which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. He blogs about selling businesses at Maxbizvalue.blogspot.ca.