Download - Top 10 Mistakes Franchise Buyers Make

Top Ten Mistakes

Franchise Buyers Make

©Copyright 2014 Fran5

Robert Edwards began his career in corporate Sales working for companies such as Pitney Bowes developing and managing sales teams. After starting a small part time mail order company in the 90’s Robert left the corporate world to pursue entrepreneurship full time. His varied business ventures included a Toronto based video store chain, a property development company, a web design firm and a Franchise Brokerage. Robert is currently a franchise broker and the Founder of the FRAN5 group.

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For the first 20 years of his career Joe Fedorchuk worked as a Chartered Accountant and Senior Project Management Professional for several large corporations. In 2005 citing burnout Joe left the corporate world and opened two Subway restaurants which he successfully developed and eventually sold. Seeking to leverage his years of franchising and business experience Joe became a Franchise Broker in 2013, and is now a Senior Partner with the FRAN5 Group.

http://www.linkedin.com/in/robbedwards

http://www.linkedin.com/pub/joe-fedorchuk/91/957/506

1. Buying a Franchise Name, not an Operational Model 2. One Brand Fixation 3. Buying a Job 4. A $500,000 Ego 5. Inappropriate Financing 6. Assuming a Franchise is "less work" 7. Buying into industry Hype and Awards 8. Not understanding profit model and obligations 9. Glossing over the FDD 10. Lack of Capital

TABLE OF CONTENTS:


the following pages outline common mistakes frequently made by aspiring franchise owners.

This guide should be used for informational purposes only. Each franchise buying situation carries unique variables for which these suggestions may or may not be applicable, and to varying degrees.

We hope you find this guide helpful.

CHAPTER 1: The Dream……


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The vast majority of franchise buyers choose a franchise simply because they were attracted to it as a consumer. It hits them where their heart is . Good sandwiches, great haircut, a neat new franchise idea.

A typical scenario goes something like this: A husband and wife are driving along the interstate and stop at a coffee shop that happens to be both quaint and busy. The statement “This brand would do great in our town” is followed by a call to the franchisor. Several brochures and hype and hoopla filled telephone calls later they drop $300k and now have a store in their city. Hopefully it works out. Unfortunately very often it doesn’t.

There is also the “I love pets I would be great at owning pet franchise” justification that often results in the owner dreading running their business or even closing the doors as they had no idea there was more to the business than shampooing Fido's and felines. They had to perform SALES?

By exploring the franchise’s core operational model you can truly align your skills, strengths and weaknesses with your new business. The actual product or service becomes secondary to the functions you are expected to perform and should be proficient at doing in order to build a big business.

For example not many people wake up and say “I want to own a cleaning franchise” as it conjures up visions of mopping and scrubbing . And frankly cleaning is not perceived as a glamorous profession.

But the truth is that the operational model of most cleaning franchises is executive oriented, meaning it is all about sales, marketing, hiring and managing, landing contracts and closing deals. The fact that cleaning happens to be the service offered is inconsequential. It could be painting, driveway sealing, furniture repair or anything else with a similar operational model.

And as boring as cleaning and painting may be – they are historically very solid money makers. One of the largest cleaning franchises has over 25% of their owners grossing 1.4 million a year with an investment not much over 100k. The largest painting franchise has average annual franchisee revenues of almost $750k.

While initial attraction to a franchise may be emotionally driven be certain you also have a solid understanding of the operational requirements and day to day functions before you sign on the dotted line. Performing activities you dislike or not adept at can result in eventual failure.

Mistake #1 – Buying Franchise Name not an Operational Model

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Top 10 Mistakes Franchise Buyers Make…






When prospective franchisees engage with the franchisor they are presented with information that is biased from the franchisors point of view. This is not to insinuate a franchisor will outright mislead (although there are some less than ethical operators), however many will focus on positives while glossing over negatives. Much the same as a parent perceives their own child as the brightest and best, a franchisor will also often harbor a favorably biased opinion.

Surprisingly many prospective franchise buyers stop their research right where it should begin. They accept the franchisors multiple industry awards, historical earnings, and many years in business as proof positive that they will also do well. And many people want to drink the Kool-Aid. Not a week goes by where we are asked to provide a second opinion regarding a specific franchise and the prospective buyer becomes indignant when we offer up some potential negatives. People want the perfect dream of business ownership. When we jeopardize that mindset many prefer close their mind rather than leave the comfort of their delusion.

This single mindedness becomes most prevalent when investors have mentally created a perfect (yet erroneous) image of themselves operating the franchise: Sun shining through gleaming windows as smiling customers rave over yogurt smoothies and the cash register rings its unending approval. It’s admittedly a nice dream but not a foundation to bet 300k on.

The truth is that there is not a single franchise of the 3000+ that exist today that do not have negative attributes of some sort. High attrition, high failure rates, seasonality, poor management, nearing the end of the industry growth curve, junior brand , at the beginning of the growth curve, high royalties, limited support, strong sales requirement, they all have some weaknesses alongside their strengths. But under the right ownership these weaknesses can be minimized or even become strengths IF the investor has not been oblivious to their existence.

The key is to look at several brands. Unemotionally explore both strengths and weaknesses. Find the brand whose weaknesses will not be debilitating to you and strengths are most appealing. Review them all with a critical mindset and once satisfied you have a clear picture then make an educated decision. Fixating only on the positive aspects of one brand is a terrible way to make an investment.

Yes, it is advisable and commendable to harbor a positive outlook for your future business, however too many investors allow this perfect vision to propel them forward while putting on blinders to potential negatives.


Mistake #2 – One Brand Fixation

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As Brokers we are familiar with the earnings levels of most available franchises. Some are very high, others very low. This information however, as crucial as it is to making a buying decision, is not easy to come by. In fact it is one of the last details a franchisor will provide you with.

Why? Well in an effort to protect franchise buyers from exaggerated earnings claims the FTC has disallowed any franchisor or broker from making potential earnings claims. This makes for a difficult presentation as that is generally the first question a prospect asks. “How much can I make?”

While protecting consumers on one level this gag order has harmed them on another. As it stands the prospective franchise buyer must first engage the franchisor, become qualified, fill out an application, have several discussions and only then they will be mailed the FDD. (Franchise Disclosure Documents)

Within the FDD the franchisor may legally disclose their earnings in what is known as the “item 19” of the document.

Most franchise shoppers have neither the time nor the inclination to research dozens of franchises, and if they do their selections are often within the same vertical market and investment level. As such they often reflect similar earnings. Most however never look beyond one brand.

Many aspiring franchise entrepreneurs will purchase a low grossing franchise for 100k+, spend many hard days working on growing the business only to max out at 60-70k a year or even less. They have bought a job. And some people are satisfied with that and grow laterally through multi unit ownership. The question is - would they be happy to learn that other franchise owners in their city who invested the same amount are working equal hours and are grossing over 2 million a year? Unlikely.

There are two options in this case. You can either engage multiple franchisors in several verticals, take the time to go through the process and obtain their FDD (make sure you ask upfront if they have an item 19 earnings disclosure as not all do) or you can engage a franchise broker and request they guide you towards higher historical earning franchises within your selected segment.

Historical earnings of course are no guarantee of future success and establishing compatibility with individual skills, background and life goals should be the primary goal. That being said many people prefer to avoid lower grossing franchises if other suitable options exist that offer potentially higher ROI.

Mistake #3 – Buying a Job

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Everyone wants to be the smartest and the brightest at everything they do. It is a natural human condition. We often feel we know more than everyone else. But when investigating franchises our own ego can be costly .

Along with our ego comes the natural human need for safety. We all want to protect ourselves from negative outside influence. We are especially wary of any “advice”. In a post Madoff world this mistrust of other peoples suggestions ranges from the waitress promoting the special of the day to the Realtor suggesting a “hot” location. We are an mistrustful bunch.

In certain cases this attitude is justified. However if ego and fear impair your ability to analyze and evaluate data effectively , or even ignore key points, it needs to be addressed. Investors driven by emotion don’t make good buying decisions. Educated, cautious, well researched investors who avoid hype often make great ones.

Several years ago an investor came to us inquiring about a popular sandwich franchise resale in a nearby city location. We took a quick look and within 5 minutes provided multiple reasons why this might be a bad investment. We suggested several alternative s which the investor completely closed their mind to. In the end after encountering a brick wall we suggested instead of the $250,000 asking price he offer half that as it was likely that the desperate seller would jump at any offer.

Driven by his emotional bias the investor ignored our advice, believing we were misinformed at best (this was a very well known franchise brand after all) or misleading at worst. In the buyers world we were out to mislead him and he knew best. A mere 5 days later after succumbing to manipulative “sense of urgency” tactics on part of the seller the investor offered full asking price. Sigh.

18 months later we heard through the grapevine the investor had driven all their savings to the tune of $500,000 keeping this store afloat and ultimately had to close the doors. It is absolutely heartbreaking to see people go through this. Had they only kept an open mind and tethered their ego they may have purchased a franchise that would have provided a great retirement. And the sad thing is this was not an isolated incident. The scenario happens with predictable regularity.

Maintaining an open mind and an information receptive ego throughout the due diligence process will provide an environment conducive to uncovering details that have been missed otherwise. An ego driven fixation on any brand prior to extensive research can be costly - even if it appears to you to be “The deal of the century”

Mistake #4 – A $500,000 Ego

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Nobody goes into franchising expecting to fail. Armed with best intentions most aspiring entrepreneurs put little thought into contingency or failure planning. In the event of failure however inappropriate financing can create a “double whammy”

Once the franchise has been decided upon most people are justifiably eager to start their business. This often lends itself to engaging the most expedient methods to access readily available cash. The first choice is generally to leverage equity in a home with a secured line of credit, or HELOC.

In the event the business thrives this is not such a terrible thing. However can you imagine your business closing after all that hard work, and then losing your home as well?

Franchise investors should step back and realistically examine their risk tolerance. As a society we have conditioned ourselves to leverage the maximum amount possible without blinking an eye.

Statistics tell us that investing higher amounts in the hopes of greater gains is not a sound strategy. In fact there are many franchises under 100k investment that can be extremely profitable. Additionally when we take historical franchise failure rates into consideration high investment amounts don’t necessarily reflect higher probabilities of success or higher earnings.

Once we have determined a realistic investment budget the next step is consider appropriate financing. The strategy should be suited to your specific situation.

Beyond traditional financing choices other options are available, some which carry significant tax benefits. For example in the USA a well planned 401k rollover can have you withdrawing monies tax free (up to a 40% tax savings) from a low yielding portfolio and investing in your own business. You can potentially even draw a salary which can provide a major reduction in stress particularly in the initial stages of opening the business.

FRAN5 has contacts with several franchise-centric lending institutions contact us for details.

Mistake #5 – Inappropriate Financing

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Part of the appeal of franchise ownership is leveraging an established system and operational model.

Many challenging business elements and processes such as logos and branding, product sourcing, customer acquisition, marketing and sales have been streamlined and refined, making a franchisees job much easier.

Many franchise buyers unfortunately misinterpret these benefits as it being “easy” to own a franchise. This is far from the truth.

Each franchise carries its own specific requirements that an individual franchise owner must fulfill. Despite having many of the operational tasks clearly listed in the operations manual the franchisee will still have many days, weeks and years of work ahead of them. This is why in previous pages we recommend aligning oneself with the core operational model rather than the franchise brand. Going to work, regardless of how much money you make is no fun if you don’t enjoy doing it or are not particularly good at it.

A franchise, like any other business will require an investment of time, money and effort. How much you get out is often proportionate to how much is put in. If you choose wisely, have realistic expectations and an understanding of the franchisors expectations you can do quite well.

If you are seeking the “perfect” business where you simply sit back and the money flows you might be better served investing in a $29.00 online “Super Turbo Cash Money Machine” . At least you won’t lose too much money!

Franchising as any other business is hard work but it can be enjoyable work. If you have matched your skills , done your research and have realistic expectations you can do extremely well.

Mistake #6 – Assuming a Franchise is “Less Work”

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The franchise industry, like many others, has created a system of awards and exciting accolades relating to outstanding achievements amongst their ranks.

New award groups such as ”Fastest Growing Potato Based Franchise” (Yes we made that one up) are constantly being created. As typically meaningless as these awards are many franchise seekers accept them as validation that a franchise is universally successful.

Consider the “fastest growth” franchise award. Simply because a franchise has sold a huge number of franchises does not imply anything other than what it states. In fact a “hard selling” franchise may also be one with lousy franchisee support. Some of the slow moving franchise brands do so by choice and select to embrace outstanding franchisee support rather than amassing huge swaths of territory.

Similarly just because a brand sells a bazillion sandwiches a year, or has great prices, or the best tasting fries has little relation to how happy or how successful you will be as an owner . In fact most existing food service franchisees complain about being obliged to provide those discount sandwiches because the margins are so low!

Yes, awards do indicate some levels of credibility, success and industry acceptance. Those successes however may not directly benefit you as a prospective franchisee. Don’t become emotionally propelled forward by awards and certainly don’t use them as a foundational cornerstone to rationalize your decisions.

We regularly work with clients looking at popular brands and when we present statistics and facts trending towards the negative . Their counter more often than not is: “But they are a top fastest growing franchise ” or some other such award.

If one of the reasons for choosing your franchise is an industry award you may want to dig deeper for more compelling facts. Be sure to make decisions based on sound business analysis and personal suitability rather than the franchise flavor of the month.

Mistake #7 – Buying into Industry Hype and Awards Claims

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Investors that have taken the time to research several franchise brands should be commended. Most seldom look at more than one. However when making a selection from 4 brands in the same vertical market, prospective franchisees will often base their selection one factor, the lowest initial price tag.

Franchises in the same vertical market will have different operational strategies, efficiencies, inventory purchase minimums, and product markups. For example if you buy XYZ concrete refinishing franchise for $39,000 but you are obliged to buy their coatings for $5 a square foot, and you turn down ABC franchise for $69,000 despite their coatings being provided for $1.50 a square foot, you have likely made a poor decision.

With XYZ franchise you may have saved yourself $30,000 however you will be less competitive right out of the gate. ABC franchise charges more at the front end and has chosen to monetize the initial franchise fee rather than tie a ball and chain to their franchisees. ABC franchise is likely a far better deal and the franchisee would have recouped that 30k difference in a few months of operations. XYZ however will be forever operating at a market disadvantage having to quote higher just to maintain reasonable margins.

This example is an oversimplification of the subject however does illustrate the importance of understanding the business expense and revenue model, and your specific obligations to purchase supplies from the franchisor. If you are bound to purchase supplies at inflated costs it won’t make much difference how much business you get. In the past (and present) fast food franchises have been sued by franchisees over perceived unfair practices regarding mandatory supplies and inflated markups.

Make sure you understand the operational model, the profit centers and how each franchise stacks up against each other. Investigate royalties, ad spend requirements, product purchase minimums and costs. Item 8 in the FDD outlines products, supplies and inventory and must also indicate if the franchisor generates a profit from them.

Would you rather invest $69,000 and generate $180k a year or spend $30k and go under? That choice is obvious.

Mistake #8 – Not Understanding Profit Model & Obligations

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The FDD (Franchise Disclosure Document) also known as the UFOC (Uniform Franchise Offering Circular) is a critical component of the due diligence process. By law franchisors must provide the FDD to all candidates prior to the purchase of a franchise. After receiving the documents the prospective buyer must wait a minimum of 14 days (that number may vary depending on your location) before they can sign any contract or purchase agreements.

Many franchise buyers will simply gloss over the agreement assuming the good folks over at ABC franchising would not steer them wrong. And that may be the case. However there are no shortage of disagreements and lawsuits stemming investors that felt wronged.

The advantage of the FDD is that they all are created using the same format. Item 19 is always the financial disclosure, item 5 always covers the franchise fees. There are 23 sections in total. The FDD also outlines the franchisors financial well being, any lawsuits against them, your anticipated costs and operating expenses, as well as the contact numbers of existing owners and people who have left the system.

Item 8 is an often overlooked section which outlines your responsibility to purchase or lease goods through the franchisor or authorized suppliers. Make sure you have an understanding of exactly what you are expected to buy, how much and whether there are penalties or minimum requirements. Make sure to take the time and research the material costs to see if these prices are inflated. If you will be contractually obligated to purchase goods at non competitive rates this will make the franchisor money and you unhappy. The franchisor will legally have to disclose if they are making a profit from any of the transactions.

Item 20 will list existing franchisees and if applicable some that left the system. Speaking with a wide range of owners will provide broader insight into the dynamics of ownership. Specific questions can help uncover clues to personality type suitability, best and worst location selections, overall franchisee satisfaction, reasons for failures and much more. The process of contacting existing franchise owners is known as “validation” and should be a critical component of your franchise research strategy.

Having standardized disclosure available is another benefit of franchising. Franchise shoppers should take advantage by completely understanding the FDD and the requirements placed on you as a new franchisee. Hiring an attorney experienced in franchise law may cost money upfront but can save you a lot of money and heartache down the line.

Mistake #9 – “Glossing Over” The FDD

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This common mistake is not relegated only to the world of franchising. It is the #1 reason for business failures throughout the modern world.

An additional benefit of franchising is that investors are provided relatively accurate estimates of the duration required to turn a profit. Specific variables such as location, owner expertise, local economy and many other factors will affect those numbers however the more locations a franchise has the more accurate their estimates are likely to be.

The psychological repercussions of working in a cash strapped environment are obvious. Running a business should be an enjoyable challenge, not a do or die situation. Desperation has a tendency to manifest visibly in every aspect of the business. The public (your customers) will often pick up on this state of desperation and eventually fewer and fewer patrons appear. Interestingly online review sites such as “Yelp” often list reviews indicative of foreknowledge of franchisee desperation and imminent failure.

If you are able to invest in lower cost franchise while preserving a reasonable amount of capital you are in a far better situation than if you had spent the farm on a higher priced franchise and left the bank account dry. Premium franchise brands will require investors to have a minimum net worth prior to consideration so you are best served not to inflate your true net worth by exaggerating your 401k or home equity value.

Yes, the franchisor will provide estimates to break even point. That said the web is littered with comments from disgruntled franchisees who failed due to much longer than promised break even times. When in doubt leave as much as possible for contingency, or even wait a couple of years to bank more funds.

Your broker or franchise brand manager will be able to provide required ranges of net worth and recommended liquidity requirements for each specific franchise.

Mistake #10– Lack of Capital

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Thank you for reading this guide. We hope you found it helpful.

Our Broker services are available at no charge to buyers. If you are considering franchise ownership we welcome your inquiry.

More information can be found at www.FRAN5.COM

Or contact: 1-800-432-1583 [email protected] m

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Conclusion: Buying a Franchise

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