July 23, 2010
10 Things to Ask Before Buying a Franchise
Like any investment, buying a franchise requires a significant amount of due diligence. Not even the best business opportunity comes with a guarantee, so an entrepreneur’s best defense is information. Andrew J. Sherman, a corporate and transactional lawyer, business school, law school professor and author of Franchising & Licensing: Two Powerful Ways to Grow Your Business in Any Economy ($29.70; AMACOM), recommended asking the following questions before cutting a check:
- What is the background, team and track record of the franchisor? Visit the franchisor’s website, use Internet search engines as well as social media to see what’s been said about them.
- What are the key trends within the franchisor’s industry? “You have to look at what macro or micro trends are out there that might affect the business over the next 5, 10 or 15 years,â€ says Sherman. “Back when the Atkins diet was popular, bread shops didn’t do so well. Sometimes people focus so much on the franchise, they forget about what’s going on in the world.â€
- What is the competition in the local market and who are the target demographics? Some businesses do better when there’s a concentration, like coffee or women’s shoes, says Sherman. “But if it’s a QSR you have to ask yourself if the market can support multiple franchises.â€ If the franchise targets a niche market, such as daycare or certain ethnic foods, be sure that the area’s population has that audience.
- What are the total project costs to get the franchised business open to the public? Though self-explanatory, Sherman points out that some forget to factor in personal expenses. “If I have a kid heading to college and there’s not going to be cash flow from the franchise for awhile, I need to be aware of that. Take a holistic view at your personal financial situation.â€
- What is the franchisor’s relationship with its current franchisees and has there been any history of litigation? Things like relationships won’t show up in a Franchise Disclosure Document and it doesn’t hurt to visit a franchisee and ask a few questions.
- What is the business model and profitability of the franchised business? Speak with existing franchisees about what works for them. “It’s very important to do you own budget, projections and pro forma,â€ Sherman recommends “That’s ultimately what’s going to be the most relevant. If you don’t know how, sit down with your CPA. Don’t just take the numbers given by the franchisor at face value.â€
- What is the size of and degree of protection of the assigned territory? The franchisor is required to tell you if the territory is protected and its size and how many other franchisees can they appoint in your market.
- Are there any requirements to purchase any good or services directly from the franchisor, its affiliates and designated vendors? In the case of eateries, food components will just about always be purchased from the franchisor but the franchisee may be able to buy things like cleaning goods and toilet paper elsewhere at a discount. “So you have to figure out all the things you’re going to need on a day to day basis and figure out which ones you’re required to buy from the franchisor and its recommended sources.â€
- What’s the company culture like? Sherman suggests asking other franchisees in the system whether the parent company’s management is thought leaders that interact with the IFA and do they seem to care about the success of their franchisees and the integrity of franchising in general.
- What is the strength and market recognition of the franchisor’s brand and strength of its intellectual property? You want to determine if you can build off their brand or struggle to introduce it to your market.
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