Franchisees Beware! 4 Factors to Understand Before Buying A Franchise

Beware of 4 Factors of Franchise

In our previous article on Franchise Asia, we mentioned about a new generation of franchisors who are new/ first-time franchisors that are less stable, smaller in business size and experience, yet need to respond to changing economic and industry pressures, to meet the increasing demands of customers.

Many of these brands had little or no structures and systems. They based their strategy by simply expanding into more locations to ride the demand for their products and as such, eroded the confidence of franchisees and impacted on the franchising industry negatively.

In this edition, we aim to provide some guidelines to prospects when analyzing which franchise to invest into, when the trial-and-tested methods of assessment are not as effective, for these new and less established franchises.

For franchises which have brand awareness, multiple outlets/centers and established track records, the conventional ways of assessment include, but not limited to:

• Visiting existing franchisees and arranging for a discussion, with the approval of the franchisor;

• Meet-the-Franchisor seminars in which financials and dialogue take place between parties;

• Doing traffic count and sales estimation on outlet/ center to assess the business potential; and

• Analyzing the financial statements and annual reports (for public listed companies)

However, for first time franchisors, and also franchisor-wannabes without their first outlet, such methods may not be applicable or viable. Prospects are often left to punt and decipher which part is the truth and which is sales talk. As per mature and established franchisors, these new players will present impressive brochures and catalogues, detailed sales and profit estimates, elaborate Q&A and professional looking franchise application form and website information.

Common marketing avenues for their franchise opportunities include participation in tradeshows, advertising on industry magazines, organizing of open house and seminars to attract prospects to enroll and investing into Search Engine Marketing (SEM) to bring traffic to their franchise opportunities page on their corporate website.

To many untrained prospects who are in the franchising market for the fi rst time, these appearances may attract them to invest into unstable franchises, which may prove to be a big mistake, ending in disappointment in expectations, loss of investment dollars and time (resources). Prospects may like to explore the following recommendations to safeguard their interest when assessing these new franchises:

1 Ask the franchisors on their franchise-related background

This information includes their year of corporate establishment, the year of their franchise development and the number of franchises established-to-date. As a rule of thumb, business which start to develop their franchise system and offering shortly after their own corporate establishment face a higher risk of failure due to their infancy stages and the lack of time-proven system and support from their backend. Check on the number of franchises they had secured over the years, since the launch of their first franchise (if any). Concepts which have been participating in tradeshows, advertising on various platforms and yet still unable to get their franchises going, will indirectly reveal flaws in their corporate organization.

2 Franchise Fee & Royalties as indications of their positioning

New franchises will tend to position their franchise fee and royalties at a lower level as compared to similar competitors. While it is prudence for these franchises to do so in order to entice the market, these fees should not be substantially lower than the market average. As a rule of thumb, franchise fee should not be more than 20% lower than industry peers for the same period of franchise tenure. All else being equal, recurring royalties from these franchisors should be similar to the industry norm. Do not be tempted by the irresistible offer of low franchise fee. The term “No Free Lunch” applies in franchising too.
No Free Lunch In The World, Even When Franchising

3 Personnel involved during franchise talks and exploration

Be mindful of the corporate personnel whom you meet during all the franchise engagements with the franchisor. This may be an indication of the size of the organization, and more importantly, the franchise support team which you are going to be heavily liaising with once you become their  partners. For newly established franchises, the franchise manager is probably also the same person who did the presentation, the one who did all the follow-up, training, negotiations and operations. Do not be afraid to ask about the organization structure and the make-up of the franchise department within the franchisor. You rather be safe than sorry, and should you feel any sense of uneasiness, do not hesitate to walk away from the relationship, regardless whether a deposit had already been committed or not.

4 Scrutinize the presentation materials and costing

New franchisors are keen to impress prospects to establish the first deal. During these seminars, tradeshows or open houses to share their concept with prospects, make sure you comb through every assumptions and projections presented. Key questions to ask may include:

• The basis in which the projections are being made, especially for future projections when the franchisor’s own outlets have yet to reach the years of establishment i.e. if franchisors show a 3 year projection and yet they have only been in business for one year, question on the assumptions for Year 2 and 3;

• Sales/revenues projection (this is the single most important number in the entire fi nancial projection), as many of the other items on this projection will inevitably be a % of sales i.e. royalties, marketing expenses, Cost of Goods Sold, etc. As such, the basis behind the sales projections must be credible and achievable. Ask the franchisor on how the sales is being derived, i.e. no of customers per day x average spending per customer x no of days in a month;

• Initial capital (renovation and equipment purchase) to be committed into the business – many franchisors will require their franchisees to procure equipment and machinery from them, rather than directly from the equipment vendors. Be realistic about the purchase price of these equipment and machinery. Unscrupulous franchisors may do a steep mark-up and profit from such transactions, in the name of protecting their source and intellectual property content, without considerations of their franchisees.

• Breakeven of the business – franchisors may market a short breakeven of their business, sometimes in a matter of months. Do note that the franchisor will be able to achieve faster breakeven as they do not need to pay royalties to themselves. In cases whereby royalties are in double digits, i.e. 10% and above, sometimes the difference between business survival and failure in retail business, this margin is all the difference. Considering that retail business net profit margin can be as low as 3% to an average of about 12-15%, franchisees are left with no profits in many instances after paying for this recurring royalties.

In conclusion, while it may be difficult to extract sensitive information from the franchisors, especially in jurisdiction whereby franchisors are not mandated to share financial information to prospects, prospects can only do their best to question and be guided by their gut feel toward the authenticity of the franchisors and their offerings. While the above recommendations can only serve as a rule of thumb in many instances, the ability to walk away from a suspicious offer which sounds too good to be true may turn out to be one good decision.

Gary LohGary Loh is the Director of Purpleclay Consulting Pte Ltd, which is a franchise consultancy fi rm and grant application specialist. Purpleclay Consulting has assisted many promising franchise brands for local and overseas expansion, as well as assisting these brands in winning various business accolades and awards. This company is an approved SCOPE-IP Business Consultant under the Intellectual Property Offi ce of Singapore (IPOS) and an I-Advisor under International Enterprise Singapore (IE Singapore).

Gary can be reached at +65 6561 3011 or email at For more information, visit

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