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Subject: |
The Dangers Of Buying An Early-Stage Franchise |
| Date: |
2010-03-15
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The Dangers Of Buying
An Early-Stage Franchise
By Cliff Ennico
www.creators.com
"My husband and I have been looking to buy a
fast-food franchise for some time. The problem is that we cannot
afford the large upfront fee that most established franchises
want. We recently found a franchise that we really like, and the
upfront fee is only $10,000. The problem is that the franchise is
only five years old. We would be only the third franchise outlet,
and the only one in our state. What are some of the questions we
should be asking this franchise so we can make sure we’re not throwing
our money
away?"
The main reason for buying a franchise, as opposed
to starting a business from scratch, is that the odds of failure are
much lower in a franchise. The franchise model has been proven
successful in dozens if not hundreds of locations around the country,
the franchise name has instant brand recognition throughout the
country, the franchise has experienced management who will train and
coach you in the operation of the business, and the franchise will
support you during the tough times.
Simply put, a franchise with only three outlets in
one small area cannot give you that. If the franchise owners are
honest, they will admit that upfront. Both you and the franchise
are taking a risk - a big one - that this will work.
First, look at the cost of getting this franchise up
and running. Since this is a fast-food franchise, your total
upfront costs will be a lot more than $10,000. If you look at the
Franchise Disclosure Document (FDD) for this franchise, look at Item 7,
"Estimated Initial Investment", which breaks down the franchise’s
estimates of what you will have to spend to get your restaurant up and
running. Do not be surprised if the total cash outlay is in the
$100,000 to $150,000 range.
For a franchise this small, and this localized, I
wouldn’t rely on the estimates in the FDD, as costs vary widely from
one part of the country to another. A franchise that operates
successfully in Wyoming or Montana - where real estate and labor costs
are relatively low - may not be as successful in high-cost regions such
as California and the East Coast. Do a "reality check" and get
quotes from local contractors, insurance and real estate brokers, and
advertising outlets to find out what your actual costs will be.
I’m a little concerned that this franchise isn't
growing rapidly - only three restaurants in five years? Now, that
could be because the franchise is "working the bugs out" of its
franchise system and is growing cautiously to avoid mistakes. But
it could also be because no one is excited about the business. An
early-stage franchise with rapid and consistent growth is a lot more
reassuring. Look at Item 17 in the FDD, "Outlets and Franchisee
Information," to find out when each franchise was opened. If all
three were opened five years ago when the franchise first started (and
the US economy was going gangbusters) and there have been no new
outlets since, that's a big red flag that something is wrong.
Next, look at the franchise's menu offerings and
ask: will they fly in my part of the country? People in
southern California eat a lot of stuff that people in New England
don't. Now, perhaps that's just because there aren't enough
restaurants in the Northeast offering that type of food. Once
people in your area sample your menu they may fall in love with it and
you will have a hit on your hands - there were no sushi bars anywhere
in the US until the early 1980s, but now they're in every strip
mall.
Or maybe it's because people in certain parts of the
country don't go out of their way for that type of food. A
soups-only restaurant may do great in New England during the winter
months, but will it thrive in August? Will it thrive in Texas any
time of year (unless of course there's chili on the menu)? Will
people in the Midwest consume all-natural fruit smoothies more than
once a week?
Next, look at the franchise's management team:
do they have significant experience in the fast-food industry, in this
particular type of fast food, and in franchising in general? The
biggest reason for buying a franchise, as opposed to striking out on
your own, is that you will receive extensive training and support in
the franchise business. If a fast-food franchise is being run by
people with backgrounds in furniture retail, or by people who developed
the recipes but don't understand the business side of franchising,
don't buy the franchise.
Also, is there "depth" in the management team?
I recently reviewed a franchise agreement for a franchise whose entire
management team consisted of one person - the founder. All the
franchise training is conducted by him personally, he drives or flies
to your area personally to help you pick out your franchise location,
and he's the person you call (on his cellphone number) if you have
questions. Now, that's okay - I'm all in favor of franchise
executives rolling up their sleeves and getting their hands dirty in
the details -- but just keep in mind that if this guy gets hit by a
truck (or has a heart attack from lack of sleep), you will be on your
own.
Next, look at the franchise name and logo - are they
compelling? Can people driving down the street look at your sign
and know instantly what type of restaurant it is? Since this
franchise does not have the instant "name recognition" of a
McDonald's® or Burger King®, the name will not drive customers
to your business unless it describes the customer experience. If
the franchise offers Italian-themed food, a name like "Nunzio's Italian
Trattoria" will work a lot better than "Buona Sera", which could be
just about anything - a clothing boutique, perhaps.
Look out for "disconnects" between the franchise
name and the products and services it offers. If the franchise
name suggests "wholesome, healthy food" but the menu consists of
greasy, high-fat fried dishes, it will turn off your customers.
If the franchise offers low-cost food, the franchise name should not
contain the word "Gourmet", because that suggests premium prices in
most people's minds.
Next, check the Internet and the "trademarks"
division of your state Secretary of State's office to determine that
there are no companies in your state using the same or a similar name
as the franchise. While your franchise probably has registered
its trademark with the U.S. Patent and Trademark Office (USPTO), it
probably hasn't checked to see if the same or a similar name is being
used by someone else in your state. If someone is using the same
or a similar name, they probably will send you a nasty letter asking
you to "cease and desist" using the franchise trademark once you open
your outlet. Make sure that if that happens, the franchise will
assume responsibility for defending the lawsuit and will "indemnify"
you for any losses you may incur if the other company wins and you have
to change your name.
Next, read carefully Items 8, "Restrictions on
Sources of Products and Services," and 16, "Restrictions on What the
Franchisee May Sell," in your franchise's Franchise Disclosure Document
(FDD). The franchise should allow you to purchase your equipment,
inventory and supplies from the widest possible number of
sources. If the only allowed sources are the franchise itself or
its "affiliates" - related companies that are often owned by the
franchise's founders or their relatives - be very cautious. The
franchise system may be merely a distribution chain for the founders'
products - the minute they can find an alternative distribution chain
(such as supermarkets or gourmet grocery stores), the franchise system
will wither on the vine.
Next, if the franchise has several much larger
competitors, there's a better than average chance that the franchise
will merge into one of these behemoths during your initial franchise
term. Ask the franchise point-blank what the founders' "exit
strategy" is, and if they tell you they plan to sell out to another
company or franchise, ask them point-blank who the likely candidates
are, as you will not be allowed to "opt out" of the franchise once the
merger takes place. Although you will be allowed to continue
using the franchise model until your franchise term comes up for
renewal, you will then be asked (not too gently) to convert to the new
franchise model if you wish to renew.
Next, ask the franchise directly what will happen if
the franchise concept doesn't work out. Will you be allowed to
leave the franchise and continue operating your restaurant under a
different name (and perhaps a different menu)? Or will you have
to shut down and eat your losses? Established franchises will
never agree to let you continue in business once your franchise
terminates, but since an early-stage franchise cannot offer you the
comfort and assurance that a more established franchise can, they
should be more willing than an established franchise to share the risk
of failure with you and set you free if things don't work out.
After all, if you are still the only franchise operating in your state,
the franchise isn't giving up much by allowing you to compete with them
if things don't work out.
Last but not least, since you are the first
franchisee in your state, consider buying a "master franchise" or "area
development rights" for the entire state. If the franchise
concept works out, this will give you the right to develop additional
outlets ("area development rights") and/or the right to sell franchises
to others ("master franchise"). Many of the wealthiest people in
the BurgerKing® franchise chain have never flipped a burger in
their lives. They were the ones who bought "master territories"
during its early years, and now spend their lives collecting franchise
fees and royalties from individual franchisees each week, deducting
their percentage "cut", and remitting the balance to franchise
headquarters. Not a bad way to make a living, no?
The franchise will charge additional fees for this,
and may impose a "development schedule" requiring you to open X number
of outlets each year in order to keep your "master" territory, but
given how small this franchise is, now is the time to jump if you
really, really believe in the concept.
Cliff Ennico (crennico@gmail.com) is a
syndicated
columnist, author and former host of the PBS television series "Money
Hunt." This column is no substitute for legal, tax or financial advice,
which can be furnished only by a qualified professional licensed in
your state. To find out more about Cliff Ennico and other Creators
Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT
2010 CLIFFORD R. ENNICO. DISTRIBUTED
BY CREATORS.COM. Permission
Granted for use on Dr.Laura.com.
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