Buying a Franchise…
Asking Yourself the Difficult Questions
by MaryAnn Waring


Considering a franchise? Ask yourself these key initial questions when doing your research:

* What are my income objectives?
* How quickly can I generate that income?
* How much will it cost to get started?
* How much can I expect in overhead costs?
* How much can I expect to pay in stocking inventory?
* How long can I survive without a profit?
* Can I get financing?
* What risk am I assuming with a franchise?
* Will I be restricted by a geographical territory?
* How much personal sacrifice will be required of me and my family?


Income Potential

While individual franchisors may make income claims, there are no known studies examining the return on investment in the franchise industry. It’s safe to assume the franchisor’s projections will be optimistic. Speaking with individual franchisees about their individual experiences is critical in establishing realistic projections you can depend upon.

It should be noted that several years ago, franchisors regularly quoted on the success rate in franchising compared to independent businesses. Quotes of these old statistics are rarely now seen due to the determination they simply weren’t valid.

However, while no exact figures are known it’s generally believed that the annual gross income for a typical franchise is in the range $75,000 - $125,000 (before taxes).


Initial Investment

The average initial franchise investment is $250,000, excluding real estate. This includes your initial franchise fee, which generally allows the franchisee to use the franchisor’s name and business system for a specified time period. The FTC’s A Consumer Guide to Buying a Franchise states, “…your initial franchise fee, which may be non-refundable, may cost several thousand to several hundred thousand dollars.”


Operating Costs

With a franchise, you can expect significant expense to build your store, or build out an existing structure. Other considerations are signage (which may require special zoning approval), furniture, décor and office equipment.

Additional franchise costs to consider are operating licenses and royalties fees. Royalties fees will cost 4-8% of your total sales every month (regardless of whether or not you’re profitable). These expenses can amount to tens of thousands, to hundreds of thousands of dollars depending on the franchisor.


Inventory

Inventory for a typical franchise can, again, cost in the range of tens of thousands to hundreds of thousands of dollars. Warehousing that inventory can range from a couple dollars per square foot to hundreds of dollars per square foot, depending on your local real estate market.


Surviving Without Profits

As a franchisee, if we look at the example with an average investment of $250,000 and an assumed annual gross income of $75,000 - $125,000 (before taxes), “break even” would happen around 3 years. In the meantime you’d need enough cash to sustain yourself, your family and your business.


Getting Financing

Among the very first considerations to make when considering a franchise is your financial position. How much personal capital do you have for your business?

Assuming you chose a franchise, you would need a business plan that you could bring, along with a draft copy of your franchise agreements, to your lender(s). Your business plan would include your venture’s goals and objectives, your financial projections, the background of management, and a market analysis describing your products, services, competition and projected business life cycle.


Risk Assessment

A franchise agreement is much like a prenuptial agreement, in that it describes in detail the nature of the franchisee’s relationship with the franchisor – including under what circumstances that relationship may be terminated.

Keep in mind - the franchise agreement is primarily designed to protect the franchisor – not you, the franchisee. More often than not there’s an uneven balance of power involved – with the weight of power being on the side of the franchisor (not you, the franchisee). While most franchise agreements allow the franchisor to easily terminate their relationship with the franchisee if certain obligations aren’t met, most franchise agreements make it very difficult, if not nearly impossible, for a franchisee to terminate the relationship.

Other risks involved in buying a franchise include the potential of defaulting on the sizable loan you’ll likely need to get your business off the ground, and additional financial requirements for third-party property leases or sub-leases.


Professional Assistance

When buying a franchise, mistakes can be especially costly - so professional guidance is critical. Unless you’re a CPA, you’ll need an accountant. And unless you’re a lawyer, you’ll need professional legal advice – preferably from a lawyer specializing in franchise law.


Employees

Unless you plan to work 120 hours a week juggling the responsibilities of your franchise, you’ll need employees. The type of employees you’ll need will depend on the franchise. You may need employees with management experience, with specialized skills or simply with high school diplomas.


Territory

Most franchise agreements involve designation of a territory in which you can operate. Some will have provisions for exclusivity within that territory. When considering a business relationship with a franchisor, it’s critical to determine the number and locations of other franchisees in your proposed geographic territory.


Sacrifice

Unless you’re prepared to hire management staff right from the start, your franchise is likely to require many hours of your personal time for an extended time period. It’s also likely you’ll find yourself covering employees during unexpected absences and terminations.

It’s important to have realistic expectations of the personal sacrifice that not only you, but your family, will have to make while you’re working toward profitability of your business.


Summary

For those considering franchise ownership, much sleep can be lost worrying about the potential pitfalls. However, there are alternatives to entering into encumbering franchise agreements, tying up large sums of cash, carrying massive debt obligations and committing countless hours of precious time and lost sleep in the interest of creating a substantial income-producing business. And asking yourself the difficult questions will ensure you identify a business model that makes the most sense for you and for your family.