By Andrew Pena, Founding Partner of Cubism Law
Franchising provides a well trodden path for individuals to set up and grow their own business. The 2011 Natwest/BFA Franchise Survey recently reported that the industry was now worth some £12.4 billion with the vast majority of franchisees (90%) reporting their business as profitable.
Whilst this suggests that the franchising can provide a sound investment opportunity, there is no getting away from the fact that every business venture has risk and that the job of a potential franchisee is to properly consider and assess that risk. But, what steps can you take to make the right assessment?
Tip 1 – Check out the Financial Position of the Franchisor
Surprisingly, and in many cases (I would suggest well over 80%), an individual makes a decision to invest without any real due diligence into the background of the company into which they are investing.
On many occasions we have been approached by franchisees that lost money as a result of entering into contracts with franchisors that were (1) financially unsound (having consistently made losses or failed to file proper accounts) and (2) dormant or non-existent companies.
So, understand who you are dealing with and carry out a full company search on the company you are proposing to do business with.
Tip 2 – Check out the People behind the Franchisor
A franchisor is only as good as the people that run the business. So you need to understand who you are dealing with and their track record in business. You should ask for a full CV and obtain appropriate references.
Do these people have the right experience to run a franchise business properly and who will you be interacting with on a daily basis. What is the personnel structure of the franchise and who within that business is responsible for what. In the end, you need to be satisfied that these are people that (1) you can work with and (2) will help support and grow your business. Remember, once you sign the Franchise Agreement, your money will be in their hands and you need to make sure that it will be used wisely.
Tip 3 - Understand the Business
A franchisor will always have a well prepared patter on its business and the benefits of its franchise. It is always best to prepare fully for that meeting with a list of key questions so that you can dig beneath the patter. These questions should aim to allow you to fully understand (1) their business and systems, (2) your role as a franchisee, (3) how much time do you need to commit to the business, (4) the amount of your investment (including the working capital requirements), (5) your likely returns from the business (and the assumptions and basis for those returns, (6) their current franchise base (including names and contact details) and evidence of their average returns, (7) the percentage of franchisee failures/terminations (and why they failed and/or were terminated) and (8) the average duration of each franchise (including start date for each of the current franchisees).
You should write down all the answers and ask for documentation to support what you are being told.
Tip 4 – Understand the Numbers
Most franchisors will provide projections on the likely returns for the business. These should never be taken at face value. Again, you need to dig deeper. You should always question the numbers and understand the basis for the projections. The BFA’s Code of Ethics requires an affiliated franchisor to show the basis for any projections and to state whether they are actual performance figures or average performance figures. It may well be that the figures are based on best performing franchisees rather than averages.
In some cases, and after proper questioning, you may find that the numbers bear little resemblance to reality and have simply been plucked out of the air. Recently, we were involved in a dispute against a major franchisor that admitted its numbers were “theoretical” and not based on historical performance.
You can only be accurate in your assessment of the likely returns if you have the information and documentation to be accurate on the quality (and basis) for the projections you are being provided with.
Tip 5 – Speak to the Franchise Base
The BFA’s code of ethics requires an affiliated franchisor to provide full details of all their franchisees (including contact details, terminations and disputes). You should approach as many of these franchisees as possible to get a more rounded view of the business and profitability.
Tip 6 – Get the Franchise Agreement checked out
The Franchise Agreement will govern your relationship with the Franchisor so you need to be satisfied that it will properly protect your position as franchisee. As a general rule, most Franchise Agreements are drafted in favour of the Franchisor but you need to make sure that the clauses as drafted allow you to ensure that the Franchisor will meet the appropriate obligations. You need to go into the relationship with open eyes so always get your Franchise agreement checked by an affiliated BFA lawyer.
Tip 7 – Get your business plan checked.
Before committing, you should also speak to a financial specialist who can provide you with an independent view of the business opportunity. Is your business plan achievable and what will be your realistic net income (after all expenses) if you run the business. One of the key reasons that franchised businesses fail is lack of working capital to meet drawings and expenses so you should always check that you have sufficient resources to meet the start up and running costs of the business.
Tip 8 – Think clearly not emotionally
Buying a franchise will always be a step into the unknown. The key is not to get caught up in the emotion and excitement of the purchase. Ensure you take the step consciously having fully and accurately investigated, analysed and tested (1) the quality of the opportunity presented and (2) your ability to run that type of business.