You have carefully evaluated and determined that a franchise opportunity would minimise the risk of venturing into a new business. You have a picture of what the future will be like for you as a business owner. All you have to do now is find a franchise business to match your preferences and desires through a process of investigating individual franchise opportunities and determining if they fit perfectly into your plans.
Franchise Investigation Process
The first thing you need to be aware in your investigation is that it is a process of mutual elimination for both you and the franchisor. You might find the ‘ideal’ franchise you are looking for on the first try, but that is highly unlikely unless you have some expert help. You should also understand that it is unlikely that any one person contacting the franchisor will turn out to be a great match for them. Therefore both you and the franchisor are trying to determine if the fit is right from the beginning of the investigation. If either party comes to the realisation that this is not the right match, they simply inform the other party about it and move on.
Remember to ask all the questions you can think of about a franchise business. This will allow you to remain focused and weigh all of your options to find the proper franchise opportunity.
1. Search For The Promising Franchise
Internet provides a very convenient way to search for various franchise opportunities. However, many times you may not get positive response and interaction from the franchisor. The next best approach is to make small investment to visit franchise expo with major franchisors participation such as the International Franchise Expo in Washington DC, etc. Such expo will feature hundreds of franchise opportunities as well as franchise suppliers that could be your valuable resources in identifying the right franchise brands that fit your objectives.
2. Preliminary Information
The franchisor may begin by providing you with overview information on the company (typically a brochure and CD package). They will then ask you to provide them with additional information of yourself (by filling out a questionnaire) to determine if you have the general characteristics that they are looking for, and the financial qualifications necessary for their franchise.
3. Franchisor Headquarters Discovery Day Visit
When you have sufficient information to move forward, you may want to have personal meetings with key personnel of the franchise company. The franchisor may also want to meet you and get to know you as part of a mutual investigation. You will need to travel to the headquarters of the franchisor. Many franchisors facilitate this need by holding what is referred to as “Discovery Days.” These are structured events where you can go to a specified location where all of the key personnel from the franchisor’s side will be available. Be sure to get to know these people as you would most likely be working closely with them as you build your business. Usually, we would expect the President of the company to be there for us, but that is not who will be answering your call when you have a problem. Find out who will be providing the operational support and training directly to you. This helps you to form an opinion about their competence. Make sure that any remaining questions or issues you may have are addressed at this meeting.
4. The Franchise Disclosure Documents
Depending on franchisors and regulation in the country of origin, Franchise Disclosure Documents give you a wealth of information about the franchisor. The form and composition of the documents may vary among the franchisors and their country of origin but normally will include information on a variety of major subject areas including:
- The history of the franchise, its directors and officer
- A complete description of the business to be franchised
- All costs and fees that you will be subject to under the agreement
- The obligations of either party to the other during the term of the agreement and thereafter
- Any relevant litigation history of the company or its officers
- Any business failures, ownership transfers, franchise agreement terminations or other potentially adverse information relating to the success rate of the existing units in the system
- Financial statements for the franchise company for the previous three years
- A list of existing franchisees
Some franchisors may include an earnings claim in their Franchise Disclosure Documents. Though they are not required to do so, this can be a real time saver for you if it is included. Even if it is included in the Franchise Disclosure Documents, it is still imperative that you discuss this subject with franchisees during your fact-finding calls and visits.
You must carefully review the documents and note any questions or issues that the material raises for further discussion with the franchisor. You may also choose to involve outside advisors to review materials that you do not understand.
5. Review the Franchise System Documentation
A strong franchise company will have documented their systems, operations and marketing programmes in a concise and easy to use format for the reference of franchisees. Make sure that such documentation exists. The franchisor will probably not give you a copy of their actual manuals, but they can certainly provide you with the table of contents or index of every support manual they have. This will enable you to confirm that the documentation exists and will show the scope of the coverage of all their major business factors.
6. Franchisee Calls and Visits
The most valuable source of information on any franchise system is the existing franchisees. You need to plan on calling or visiting a number of the existing franchisees during your investigation. Whatever you find the prevailing attitude of the existing franchisees on any issue to be, it could be your attitude on the issue as well if you decide to become a franchisee. Visit a sufficient number of the existing franchisees to ensure you have a sense of the existing attitudes of the network.
Though you want to find the overwhelming majority of franchisees to be happy and supportive of the franchisor, it is important to try to find an unhappy franchisee during your investigation. When you do, not only listen to the complaints but also try to determine what makes this franchisee different from the rest. If you find you can identify with the positive ones and feel the negative franchisee is not at all like you, then you should be fine. However, if you find that you are more like the person who is unhappy, this is probably not the right franchise for you.
The following list covers the principle areas you want to investigate during these calls:
- Training Programmes
You need to determine how well the initial training programmes and support prepared the franchisees for opening and running their business.
- Opening Support
How easy did the franchisor make the process of getting the first unit open and operating? Was there assistance in site selection, lease negotiation, construction and design, securing financing, permits or any other factors unique in getting this business up and operating?
- Ongoing Support
You want to know how effective the ongoing support services of the franchisor are in terms of helping franchisees deal with the problems that come up in the running of their business.
- Franchise Marketing Programme
Most franchisors collect marketing dollars from every franchisee into a pool that is spent to promote the brand. You need to know whether the franchisees are happy and supportive of the way this process is handled. Note: this is typically the area where you will find the most complaints in any franchise you examine.
- Purchasing Power
Does the franchisor use the collective buying power of the total system to get discounts on supplies and inventory beyond what an independent operator could achieve? This factor is one of the biggest advantages of joining a well-run franchise system and should offset much of the upfront fees associated with being a franchisee.
- Franchisor/Franchisee Relations
Determine how the franchisees feel about the franchisor in general. Is the franchisor supportive, caring, focused on their success, responsive, effective, organised, and trustworthy? Make sure you have a good feeling about the values of the organisation and that they are consistent with your values.
- Franchise Investment
The Franchise Disclosure Document will give you a wide dollar range for the investment required in the business. Use the franchisee discussions to narrow that down to a reasonable and conservative estimate of how much capital you will need to be successful in this franchise in your market or region.
It is critical that you have a strong sense of just where the average unit is in terms of earnings. You should know the answers to the following questions: How much money does the typical unit make given a specified length of time in business? How soon does a typical unit start making money after opening? What is the range of answers for these questions? If you are simply not able to determine these answers to your satisfaction in your research, do not settle! Tell the franchisor of the problem and that you cannot proceed unless you have these answers.
It is always a good idea to bring up the subject of earnings as the last point in your franchisee visits. Most people are reluctant to discuss their income with strangers and you will find the franchisees are more willing to cover this subject after you have spent some time visiting with them. At that point they know you are not a competitor trying to get information but rather a serious prospective franchisee who will need the information to proceed. They were all in your position at some point in the past, so if they develop a comfort level with you it may enhance the financial information you can gather.
7. Financial Modeling
During the franchise investigation process it is critically important to know when and how your franchise business will become profitable.
In order to make an educated decision and buy a profitable franchise it is important to organise all the financial data into a cash flow projections spreadsheet. This spreadsheet is also known as a financial modeling. In contrast to a balance sheet or a profit and loss statement, it provides a clear indication of what to expect during the first few months in business.
Usually, we recommend owners to put together projections for the next 36 to 60 months.
That can help you better understand the potential of the business once you get past the challenging start-up period. We always recommend to put together, at least, three revenue scenarios (Worst, Medium and Best). As they say, “Expect the Best, and be prepared for the Worst.” You can’t say that enough in business.
During the franchise investigation process, as you put together cash flow spreadsheets, it is also highly recommended to seek advice from an accountant who is experienced in business acquisitions.
At the same time, remember that it is up to you to verify the accuracy of all the data that you have accumulated or that the franchisor provided you with.
Therefore, your own due diligence becomes critical to the franchise investigation process. Your best sources of financial information are the existing franchisees that currently operate the system you are planning to buy.
As you plug the data into the spreadsheet, pay attention to some of following items:
- Calculate a reasonable hourly rate or salary for the time you will spend on the business
- What other costs are variable in the business?
- Make sure to include a contingency fund, every start-up uses some or all of it (US$10,000 or 10% of the projected investment, whichever is greater)
- Pay close attention to franchise fees and royalties, they increase as your business grows
- Be very conservative (take the higher number) in calculating your overheard (fixed expenses) this is the amount you have to pay regardless of how good or bad you business is doing
- Seasonality of the business, reflect that in projections
- Expect negative cash flow in the first few months in business
- Project your cash flow requirement and return of capital
- Negotiate with the franchisor for start-up assistance (royalties or marketing credit)
In the end, pay close attention to the following final numbers – Monthly Cash Inflows and Monthly Cash Outflows.
Make sure to get as much info from the franchisor and current franchisees to accurately estimate those numbers.
8. Make a Decision
If you have been diligent, the entire process outlined in this article should have taken about four to eight weeks to complete. You have now finished your investigation and have all the information you need to determine if this franchise is right for you. It either is or it isn’t, and you will know which it is. In either case, it is time to make a decision and move on. Use the model you developed for yourself to evaluate what you wanted in a business. Don’t settle. If this company has everything you wanted, do it. If it doesn’t, eliminate it and go to the next one.
For more information
T.K.Lee, Principal Consultant, Asia Franchise Networks
9, Shenton Way, #04-05 Singapore Conference Hall Singapore 068813.