Invest In My Idea

■ Real Life Example

 

Hector was interested in a restaurant franchise. Given that he had begun work as a busboy and had moved up the ranks to become a general manager of a restaurant chain, he decided that owning his own franchise would be the next step. Hector settled upon one very wellknown chain and began to do his research.

He was surprised to discover that many of the franchisees he talked to were very displeased with the franchisor. They felt that the franchisor was hard to work with, didn’t follow through, and seldom listened to their ideas. Hector was even more surprised when he became attracted to a much smaller, less famous restaurant franchise.

Both his instincts and homework told him that the smaller franchisor offered a better opportunity. He was right. Within ten years, the small chain had grown exponentially, and Hector was there, almost from the beginning. His advice and expertise were actually welcomed and sought out by the franchisor. Hector eventually owned 12 stores in the chain.

 

Finding the Right Franchise

 

With so many franchise systems from which to choose, the options can be dizzying. It is best to start with a global perspective. In the universe of franchising, which industries seem to match your interests? Narrow the choices down to a few industries in which you are most interested, and then analyze your geographic area to see if there is a market for that type of business.

Once you have decided which industry interests you most and seems to have growth potential in your area, contact all the franchise companies in that field and ask them for information. Any reputable company will be happy to send you information at no cost.

A great place to learn about all of your options is at a franchise trade show. This is a terrific way to gather a lot of preliminary information and survey the field in a short period of time, and you can find them in most goodsized cities. When attending a franchise trade show, keep a few thoughts in mind. First, remember the companies exhibiting at the show by no means make up all of the franchise opportunities available. Indeed, these events showcase only a small selection of the available franchise programs.

Second, when you do go, take full advantage of the information available. Pass by the sellers who are out of your price range or do not meet your personal goals. Be sure to dress conservatively when you go to the show, carry a briefcase, leave the kids at home, and take business cards if you have them. Show the representatives you meet that you are a serious prospect. Have a short list of questions ready to ask them:

 

•   What is the total investment required?
• What is a franchisee’s typical day like?
• Is financing available from the franchisor?
• What kind of support can you expect from the franchisor?
• What is its advertising plan?

Of course, you cannot rely solely on promotional materials to make your decision; you also need to do your own research. The most important thing you can do is talk to current and former franchisees. They can tell you what it is like to work with the franchisor, how much money you can really expect to make, and what to be on the lookout for.

It also can be very helpful to visit your library or go online to look up all the articles you can find about the franchisors you are considering. Is the company depicted favorably? Is it growing? Check with the consumer or franchise regulators in your state to see if there are any complaints lodged against the companies you are considering. Be sure to check with the Federal Trade Commission, the better business bureau, and your local chamber of commerce.

Analyzing the Costs

Obviously, one of the most important things you must consider when choosing a franchise is the cost involved. There are three fees associated w ith buying a franchise. The first is the franchise fee. This is the amount you will pay the franchisor for the right to use its system and trademark. In a wellknown food franchise, these fees typically run between $15,000 and $50,000. The second fee is the royalty payment. This is an ongoing monthly fee paid to the franchisor. Usually, it runs between 3 and 6 percent of gross monthly sales.

The final fee is the largest—the cost of buying the actual physical business. There are many costs associated with this. These include:

•   Real estate fees. You may need to pay for a real estate agent to help you find a location. You will also have to put down a security deposit and utility deposits.
• Architecture fees. You may need either an architect or a civil engineer to create plans to modify (or design) your location. A good franchisor may have a set of standard architecture plans that you can use.
•   Contractor fees. This is a bigticket item. It can include everything from landscaping to major construction overhauls.
•   Equipment and fixtures. You may need to buy everything from tables, chairs, telephone systems, kitchen equipment, and display counters to computer systems, software, and cash registers.
•   Décor. This will include things like signs, pictures, lights, and interior design.
•   Inventory. Your opening inventory includes many things, such as ingredients, raw materials, product, paper goods, office supplies, and janitorial supplies.
•   Insurance. You will need to buy workers’ compensation insurance (required by law), as well as liability, property, auto, and other insurance.
•   Labor costs. You will likely need to hire staff and managers, and may need to pay for training with the franchisor.
•   Professional fees. You may need to hire a lawyer and an accountant before you open your doors.
•   Working capital. This is the amount of money you will need to keep the business going until it begins to turn a consistent profit. You probably need to have at least six months’ worth of working capital before planning your grand opening party.

Needless to say, you shouldn’t underestimate these costs. Nothing is worse than spending a lot of money to start your new business but not budgeting enough to keep it going until it becomes a success.

So, how much do you need? Let’s examine some of the costs of various franchises in order to get an idea:

•   McDonald’s. McDonald’s estimates that new restaurant costs range from $455,000 to $768,500. Many things affect those costs: the size of the restaurant, the area of the country in which it will be located, inventory, equipment, signs, décor, and landscaping. In addition, at the time of opening, a franchise fee of $45,000 is paid to McDonald’s
• Corporation. You must have in liquid cash a minimum of $175,000 for a conventional purchase or $100,000 for a lease. The rest can be financed, although McDonald’s itself does not finance franchises.
•  Subway. Subway estimates that new restaurant costs range from $97,000 to $222,800. While the franchise fee is only $10,000, the real costs are in building the restaurant, which includes leasehold improvements, signs, equipment, etc. Subway requires that you also have funds to operate the business for three months, above and beyond any other capital requirements.
•   ServiceMaster. ServiceMaster provides services to homeowners such as cleaning, janitorial, maintenance, and disaster restoration. The capital requirements for this franchise range from $10,200 to $52,000. The franchise fee (between $14,500 and $26,500) as well as the equipment purchase can be financed up to 80 percent.
• Meineke Discount Mufflers. Meineke’s franchise fee is $25,000, and it requires that you have a minimum of $50,000 in cash. Financing is possible to qualified candidates.
•   Mail Boxes Etc. MBE’s capital requirements range from $125,862 to $195,882. The franchise fee is $29,950. MBE offers up to 40 percent financing for fixtures and equipment.

With thousands of franchise choices available, and costs that vary greatly, it is incumbent upon you to do your research and find a franchise system that fits both your personality and your pocketbook. It is out there.

 

Analyzing the Franchisor

 

As you go about this research, understand that successful franchisors have certain traits in common. Following are the traits that are most important. If you can find a franchisor that has these traits, you are headed in the right direction.

 

The Franchisor Supports the Franchisees

 

The best franchises are ones where the franchisor sees its relationship with the franchisees as a partnership. As Steve Reinemund, the former head of Pizza Hut, puts it, “Franchisees are only as successful as the parent company and the parent company is only as successful as the franchisees.”

Not only do such exceptional franchisors offer plenty of communication, opportunities for growth within the company, and help during hard times, they also offer lots of advice and training. A good example of this is Dunkin’ Donuts. To support new franchisees, it created Dunkin’ Donuts University. There, franchisees and their personnel are invited to attend a sixweek success program that teaches them everything from basic instructions on how to run the business to how to produce the products, deal with employees, and use equipment. It even offers advice on inventory control and accounting. Now that’s support.

The Franchisor Advertises a Lot

 

Not all franchises are dependent on advertising, but so many are that this is an important distinction. You want a system that does not skimp on advertising and promotions because that is where your customers will come from. Dunkin’ Donuts spends roughly $40 million a year on extensive advertising campaigns for TV and radio, and in newspapers across the country. Similarly, Pizza Hut spends about 7 percent of its gross sales on sales and marketing. That is the kind of advertising support you should be seeking.

 

The Franchisor Offers Uniformity, Tempered with Flexibility

 

One of the great strengths of franchising is that customers know what to expect when they walk into a wellknown franchise. For example, that sort of uniformity is one of the main reasons people choose to eat at McDonald’s.

But by the same token, you want to avoid a franchisor that is so strict that it does not allow for creativity and some independence. The good franchisors know that some of the best ideas come from franchisees that try something new. One reason for buying a franchise is that you want the freedom to be your own boss. Avoid the paternal franchisor.

After narrowing your choices, it is time to sit down with the franchisor and get all of your questions answered.

The important thing is that you get a very clear picture of the cost of purchasing the franchise—both startup and ongoing costs. Once you have gathered all of this information, you will be able to make an informed decision. Carefully examine everything with your attorney, accountant, or business advisor. You want to be sure that every item of importance is addressed in the franchise contract.

■ Real Life Example

 

What kind of training do various franchisors offer? Here’s a sampling.

Alphagraphics. Alphagraphics provides four weeks new franchisee training, one week instore training, and advanced franchisee training; a tollfree technical support hotline; marketing and advertising programs including automated direct mail programs and newspaper and radio ads; ongoing training includes conferences and store visits by field reps.

Martinizing Dry Cleaning. Martinizing Dry Cleaning provides comprehensive managerial and technical training in the classroom as well as at franchisee’s store; equipment shakedown and ongoing service hotline; a grand opening marketing package, and ongoing local store and marketwide promotional programs; field and operations assistance; ongoing support staff that is only a tollfree call away.

Fastsigns. Fastsigns provides initial site selection and finance assistance; fourweek new owner training program; twoweek onsite support during store opening; a grand opening marketing campaign; ongoing support includes marketing, operational, technical, and business management training as well as a fully integrated Internet system.

Petland. Petland provides a fiveweek training academy, which includes three weeks of onsite training prior to and following the grand opening; video and audio tapes backed up by operations manuals as resources for ongoing, instore training; field operations managers to review monthly financial performance and provide consultations.

Tinderbox. Tinderbox provides complete turnkey, startup assistance, which includes location, site selection negotiations, demographics, store layout, classroom training, onsite support operations manual, proprietary computerized operating system, and continuing operational support.

 

Location, Location, Location

 

Not all franchises need to pick a dynamite location. For example, janitorial services, direct mail companies, or lawn care services really don’t need to worry about their location because dropin business is not their business model. But a restaurant needs a good location. Typically, if you are looking at a retail establishment, location usually is a priority.

The first thing to do is speak with the potential franchisor. One of the best aspects of buying into a good franchise operation is that you should get plenty of advice and help from the franchisor. Start there and see what it says. The franchisor will know what you should look for, what works best, and what locations are available in your area. In fact, in some cases, site location may not even be up to you; the franchisor may make this decision. You need to find out who chooses your location. If it is you, you want to make sure that the franchisor will be helping you in the site selection process.

Additionally, you need to find out about territorial exclusivity. Does the franchisor offer this and, if so, what is the size of the territory? Territorial exclusivity has been the subject of many lawsuits between franchisees and franchisors, so make sure that you really understand this issue and have any agreements put in writing.

As always, one of the best ways to know what to expect from a franchisor on this or any subject is to talk to the current franchisees. They will tell you if the franchisor plays fair, if territorial limits are respected, and if site location analysis is accurate.

 

Area Development

 

A topic related to location is area development. Area development allows you to open more than one franchise in a certain locale. If, for example, you want to open eight auto body repair shops, you can go to the franchisor and buy the rights to your area en masse. This allows you to monopolize the market and excludes challengers under the same franchise umbrella from competing with you. The key things to consider regarding area development are

•   picking a franchise system that is not yet developed in the area, and getting the franchisor to grant you market exclusivity.

 

How Much Money Can You Reasonably Expect to Make?

 

All of this research begs the question: How much can you really make buying a franchise? The early days of franchise sales in the United States were marked with many instances of abuse in which misleading earnings claims were used to sell franchises. In 1979, in an effort to try to stop these practices, Congress authorized the Federal Trade Commission (FTC) to regulate the franchise industry. While the current FTC rules do not forbid a franchise company from supplying information about earnings, they do have tough rules on how this information can be given to a prospective franchisee.

Basically, if a franchise does want to provide this information, it must put it in its disclosure document, called the Uniform Franchise Offering Circular (UFOC, see sidebar and next section). Most franchisors opt not to disclose this information. Why? There are three reasons. First, it is not so easy to put together an accurate, reflective, earnings estimate. Second, the results may

simply not be attractive enough to entice new franchisees to join. Third, once it’s in writing, the estimates may be seen as a benchmark, and if a franchisee fails to hit that mark, they just might sue the franchisor for making false promises. Because they don’t want to get sued, many franchisors simply refuse to divulge this critical information.

When a franchise does not provide an earnings claim in its UFOC, it is still possible to get this information. The best way to find out how much money you can make is by asking existing franchisees. Make sure to select enough franchisees to get a clear picture of the ranges for earnings within the franchise system.

A good rule of thumb is that you can earn 10 to 15 percent on your money over time in a passive investment. Because most franchises require that you invest your time and efforts, as well as your money, you should expect a significantly higher return in order to justify the investment. You should look for earnings of at least 30 percent of your total investment on an annual basis to consider any franchise as having a reasonable return, and you should expect to reach this level, at the latest, by the third year of operation of the business.

 

Analyzing the UFOC

 

The franchisor is obligated under law to provide you with the UFOC at your first facetoface meeting. The UFOC, though often written in legal gobbledygook, is nevertheless a wealth of information. There are 23 standard items in the document. The key areas you should concentrate on are as follows:

•   Item 2 describes the business background of the officers, directors, and managers of the franchisor. Scan these summaries to get an idea of their experience. You definitely want to make sure that they know what they are doing.
•   Item 3 summarizes the litigation background of the franchisor and the people listed in Item 2. If they have been sued a lot, a red flag should go up. If there have been actions taken by state or federal enforcement agencies against the company or its officers, or if private lawsuits have been filed against the franchisor in the past ten years, they are summarized in this section. Look especially for cases where franchisees have sued the company.
•   Item 4 lists any bankruptcies in the backgrounds of either the company or the people listed in Item 2.
•   Items 5 and 6 summarize the initial franchise fees and any ongoing royalty fees and other charges franchisees must pay. Go over these numbers with your accountant.
•   Item 7 presents the franchisor’s estimate of the typical total investment by the franchisee. You will need this information when you prepare your business plan or if you will be seeking financing for the franchise. Again, go over this with your accountant.
•   Item 8 discloses the restrictions placed on your ability as a franchisee to purchase supplies and products. You need to investigate whether other franchisees think these products are fairly priced. Because supply arrangements are a vital aspect of running a business, make sure their system works well.
•   Item 10 discusses financing. Many franchisors either provide their own financing or make arrangements with banks or other lenders to assist franchisees. Even if there is no mention of special financing arrangements in this item, ask the franchisor about them.
•  Item 11 is the longest section in the document and it is critical. It discusses the franchisor’s obligations to the franchisee under the franchise agreement. It also describes required computer equipment purchases and initial training programs.
•   Item 12 explains your territorial rights. If the franchisor reserves the right in this item to distribute competing products or services through other channels of distribution, find out how the company intends to use that right.
•   Item 13 details your ability to use the franchisor’s trademark—the company’s name and logo.
•   Item 19 explains potential profits. This important section shows what kinds of sales or profits other franchise owners have made. Interestingly, the franchisor is not legally obliged to supply this information in this section, and many don’t. If a franchisor does provide this information, it must also provide data to prove the claims if you so request it. If the franchisor supplies no profit information here, find out why. It may be because the franchisees don’t make a lot of money, or it could simply be that earnings vary widely from one region to another, or from one franchisee to another. The important thing in this realm is to go beyond what the UFOC says and ask franchisees about their sales and profits. Most are happy to share their experiences.
•   Item 20 contains statistical information, such as how many new stores have opened over the past few years and how many franchisees have recently left the system. This section also contains a list of the names, addresses, and telephone numbers of current franchisees and those who have left the system in the past year. That alone makes the UFOC worth its weight in gold.

As in the case of a franchise, a preexisting business can be a great option, if you do it right. The fact is, you need not be an innovator to be a successful entrepreneur. Many entrepreneurs are great turnaround artists. They have far You will be buying not only the business but also the staff. Review personnel files and meet with employees individually. Find out whether any have contracts that could prevent you from letting them go for any reason. You also need to speak with some of the business’s customers. Discover what they think of the business, how they like it, and how long they have patron-ized it. That alone will tell you a lot.

Finally, make sure the owner is someone you can work with. He or she should disclose all financial, legal, personnel, and customer information. If in-formation is refused, then there’s a problem.