How Solid is the Franchisor?

OK, so you have looked at the franchise and you think it is a good business model, one that will you would buy from and one that has some legs so now the question of how solid the franchisor is comes into play. The one great thing about buying a franchise is that you receive a Uniform Franchise Disclosure Document or UFDD. The bad thing about buying a franchise is that you receive a UFDD.

You are probably saying to yourself, how can it be good and bad at the same time? Well, here's the deal. The UFDD will tell you quite a bit about the franchisor but only if you know what you are looking at and the correct questions to ask. Also, by and large they are some pretty long documents and it is very tempting to glance and skim when in reality one should be digging, questioning and prying.

As I have said before, a franchise is a proven business system or concept. In some later posts I will talk about looking at franchises depending on the age and or the number of units they have sold and that are under management. With a franchise, age and size do matter. Oh but I digress for now.

All UFDD's for the most part look the same. That only makes sense since UFDD stands for "Uniform" Franchise Disclosure Document. So what's in this thing and what does it tell me you ask? First and foremost it tells who the owners and or officers of the company are and something about them and their past business experience. You can of course do your own work and search out as much about them as you can. Ask questions about they are, what they do and what they have done. Do the officers draw a salary if they do not work there? These are all things that go into looking at the company you are buying from. One point, there is nothing wrong for a newly launched service based franchise that is designed for home start up to have little or no staff. Many service franchises can be run from home office and many cases that is what prospective franchisees are looking for, a nice living without the headaches of employees. If a franchisor is just starting out selling franchises and their company owned franchise does not have a large staff, do not expect them to have a big support staff for a very few franchisees. That does not make a lot of sense. In a new service franchise you must evaluate the offering based on the business model more so than the brand because the brand is not really established yet. On the other hand, in a more established service or a retail franchise, you are going to want to see some staff for support whether is be operations or marketing Depending on the business and also on the brand a certain about of operational and marketing support included in all franchises. This is true even for newer start up franchises especially in the retail space as prospective franchisees normally need help with things such as site location and advertising in your local market. Its going to take some staff firepower to help you pull that off.

The next thing to look at in any UFDD are the financial statements of the franchise company. Again there significant differences between the financial statements of a new start up franchise as opposed to an established brand. The franchise laws were changed in July of 2007 with the new changes becoming law and mandatory in July of 2008. One of the things that have changed with adoption of the new law is the way that "Start-Up" Franchises are treated. In the past it was mandatory for Franchisors to include audited financial statements. The law now has changed for new franchisors requiring either just reviewed financials or stating that it is a start up franchise and "No" Financial statements at all. In reality what you should be looking for is audited or reviewed financials from the company owned business from which the franchise has been birthed. It should be noted that financial statements are not provided for prospective franchisees to see how much they might be able to make, but rather show the financial health of the company offering the franchise. If you don't know how to read and interpret a financial statement enlist the services of a CPA, he does. Ask hard questions, if you don't get good answers walk away.

As long as you are not purchasing the first franchise from a new franchisor then one most important things you can do is contact existing or past franchisees. The term "validation" in franchising means that franchisors rely of existing franchisees to tell prospective franchisees how great they are. By and large most franchisees will be honest when you call them though even if hey are unhappy they may not totally bare their souls to you. After all, they bought and do not want to look liked they made a mistake as in reality no one does. New start up franchisors bend over backward for their first five to ten units. If you are purchasing a startup franchise and the very few franchisees they have are unhappy, run for the hills. Now if you are purchasing an established brand, see if you can track down franchisees that have been terminated or left the system. As I have discussed in other posts, current and past franchisees are all listed in the back of the UFDD. Disclosure means that the franchisor discloses everything to the prospective buyer and answers all questions truthfully. Ask hard questions, engage your professionals, accounts and attorneys and if you don't get answers you can live with, don't buy.

Evaluating a Franchise Part One

It is often quoted that after 5 years, 80 percent of small businesses fail, but conversely 90% of franchises are still in business. While that sounds good, that figure is not being quoted nearly as much as it used to be. In the early '90s, Timothy Bates, a professor at Wayne State University, studied Census Bureau data on 20,000 new enterprises and found that 38 percent of franchises failed within four years of opening their doors, vs. 32 percent of independent start-ups that went belly-up. While there are current studies as of the writing of this article, it is generally accepted that franchise failure rates are a lot higher than most people think.

Under federal franchise disclosure requirements, Franchisors are required to disclose franchises that are no longer in business as a result of "terminations", "sales / transfers" or "transfers". This information is located in the Uniform Franchise Disclosure Document, UFDD, which replaced the Uniform Franchise Offering Circular, or UFOC in July of 2007 when the new franchise law of 2007 was passed. What is not known is how many of these "terminations", "sales / transfers" or "transfers" are actually failures. This way of reporting can really "hide" the true failure rate.

That said, how can we truly evaluate a franchise before buying one?

In reality there are three components to purchasing a franchise. One the the actual business concept itself, the second is the franchisor and the third one is you. The most basic definition of a franchise is that it is a "proven business concept". I know that sounds simple, but it is not and there are a lot of variables. Most successful franchises and franchisors for that matter say that the best franchisees are people that "follow the system". Well, what if you are a person that does not have the aptitudes or personality the "follow the system"? That is just one reason why it is important to consider all three variables when one considers purchasing a franchise. 1. Is the franchise model a proven business concept? 2. Is the franchisor solid? 3. Are you a good fit for the franchise and prepared to "follow the system"?

Let's go through each of these in order and in separate posts and see.

Is the franchise model a proven business concept?

One would like to think that all franchises are proven business concepts but in reality that is not true, or suffice to say that some are a lot more proven than others. Here are some good questions to ask and consider.

Was the franchise founded on a company store or was it a franchise just birthed from an idea?

Any franchise that was founded on company owned location with a track record has in my estimation a much better chance of success than one that is not. A franchisor owned location permits the franchise company to test and come up with new ideas, to see what obstacles are in the ever changing business environment that we all find ourselves in. How can you sell me a system if you have never done it yourselves? I should say here that most franchises are founded on owned locations and also that the vast majority of retail concepts have company stores as their beginning.

How long was the operator in business before they decided to franchise?

Hey, you are buying a proven business concept, right? How long has the person selling you "the system" been doing what it is that they are telling you can do or should I say selling you what they say you can do? It's important to look back as far as you can at the history of the franchise.
Many service franchises can be start and run from the home where as retail franchises cannot. You want to see some significant business history. Ask questions like, how many deals do you do a year in the company office? How many clients do you have or what is an average day like for you? Ask as many questions as you can think of about how the business works and then think about how you and your skill set fits into what they are doing.

How is the franchise affected by ups and downs in the economy?

Seriously think about how the business does in different economic cycles. At this time the housing market is in the crapper, but that will not last forever. Also, just because housing is down does not mean that people are not remodeling homes, doing home improvements or putting additions on their homes. These things are done in good and bad markets. No matter what the state of the economy people have to live, buy food, get their cars repaired, take care of their kids etc. The number of units and age of them can give you a lot of insight into how the business model weathers economic downturns.


Would you pay or use the services of the franchise, and how big is the market?

This is a big question to consider. Would you buy there? If so why? Remember, not everyone thinks like you think. Not everyone buys because you would and not everyone does "not" buy because you would not. Try to be objective and think about what the franchise really offers, why it is unique and what they do to leverage that uniqueness into a high probability of success business model.

These are just some of the questions that should be considered when evaluating a franchise prior to purchase. Please stay tuned for parts 2 and 3 in the coming days, I hope.

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