April 2013 Archives

If you have been searching for a perfect franchise opportunity and think that you have found it, make sure to avoid the costly mistakes that franchise buyers often make.

Below, in no particular order, are 4 costly mistakes that can easily be avoided and save you time and money.

1. Incomplete Background Check:

Most franchise buyers do not take enough time to look into the history of a franchise before buying. Skimming the franchise documents and talking to the corporate owners is insufficient.

This is the equivalent of buying a house after speaking to the seller and the seller's agent, but failing to complete a home inspection. It is vital that you visit with other franchisee owner-operators in and around the geographic location in which your franchise will be located. If there are none, speak to other owner-operators regardless of geographic location.

Perhaps the single most important part of a background check is talking to current and prior owners of the franchise. Don't let blind faith and the excitement of the opportunity short circuit your due diligence.

2. Poor Understanding of Business Model:

I am amazed at the number of franchise buyers that fail to understand the business model that serves as a foundation for their business. And, no, having a clear understanding of the service or product you provide is NOT the same as understanding the business model.

To have a complete understanding of your business model, you must have an exacting knowledge of cost structure, expenses, revenues, profits, inventory, staffing, and overhead.

You must have a basic understanding of how to read and interpret balance sheets and profit/loss statements. Understanding these key financial metrics is essential to understanding your business model and will dramatically improve your likelihood of success.

3. Lack of Professional Assistance:

Reading about a franchise opportunity on the internet, speaking with the franchisor, and attending a Discovery Day is NOT the professional assistance I am speaking of.

Buying a franchise business the right way requires that you seek accounting, insurance, banking, and legal assistance. Though this may add to the cost of the purchase, it is well worth it if the counsel you seek is well-versed in franchise and small business matters. And, please, stop going to your cousin's uncle's brother-in-law that is a family law attorney for franchise and small business advice.

You wouldn't go to a pediatrician for knee surgery, so why would you go to an attorney that does not practice in the area in which you need expertise. Don't be pennywise and dollar foolish.

In the end, you will end up spending more on each or going bankrupt.

4. Undercapitalized:

This is a huge problem for franchise buyers. From an expense perspective, think of buying a franchise like going on vacation, it is going to cost 2-3 times more than you think.

Trust me, it will!! If you do not have sufficient cash on hand, the ability to raise capital through friends or family, or a line of credit or other loan source sufficient to get your business through downturns, you will fail.

Make sure you speak with a trusted advisor experienced in small business money matters so you get off to the right start.

The honeymoon period ends quickly, make sure you are ready for the financial realities of the small business world.

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The term Conversion Franchise refers to the situation in which someone with a successful small business is offered the opportunity to convert his independent business into a franchised business by affiliating with a franchise organization. And so, thereafter, if the proposal is accepted, the business would no longer be known by its former name, but rather by the name of the franchise chain.

Many of these conversions have been successful.

The realty brokerage business is one of the more notable instances in which belonging to a large organization with national coverage has facilitated synergies that would never be available to a small or even a regional group of realtors. However, many, maybe even most, conversions are a disaster for the unfortunate person who converted an independent business to a franchise and didn't know how to do the "due diligence" before making the decision to convert.

So many have come to me with this problem, usually no longer having sufficient funds even to hire a lawyer, that I have decided to put the due diligence protocol on this web site in the hope that some fine small businesses may be saved from a franchise conversion disaster.

Mitigation of Risk

What is needed to mitigate the conversion decision risk is never offered. What is offered is a franchise agreement with an initial franchise fee, subsumes an initial investment in changing the business identification to that of the franchise organization, a required regular payment to an advertising fund, a required periodic royalty payment which starts with the first dollar of income every month.

The franchise contract purports to obligate the converting franchisee to a term of affiliation of at least five years, with a non-competition agreement to prevent departure from the franchise chain - you lose your business if you leave. While these are much less enforceable in the context of a conversion franchise, they are not entirely free of enforcement risk, and even if you win you have spent a great deal of money to fund the litigation.

Then, too, there is the cost of re-identifying your business to its old name and advertising blitz expenses to get that name back out there where people are educated and conditioned to accept and patronize it.

Every conversion franchise agreement I have ever seen has these provisions. If this is the deal being offered, and it always is, there are certain obvious exercises that must be done to analyze its investment worthiness. Obvious, yes, but almost never done. I guess it is obvious if you know about it and how to do it. Well, now that you are reading this article, you will know.

The Conversion Formula - What's in it for You?

The formula is quite simple.

You will, by converting to a franchised business, add to your expense profile the monthly royalties (anywhere from 4% to 8% of sales), plus the advertising fund payments (usually around 2% to 4% of sales) plus other expenses.

Frequently use of e-commerce facilities and other "support" elements are not included in the fee and royalty structure, but are separately and additionally charged for. These monthly expenses must be added up and subtracted from your profit and loss statement.

What is the impact upon your profit as a percentage of gross sales? That reduced profitability will be your future profit-as-a-percent-of-sales profile if you decide to convert.

What do you get for that? You are told that you will get greater name recognition, the impact of being in a national organization that can generate more sales, "support" (whatever that is), and the privilege to participate in that franchisor's "unique" system of doing business.

Be Objective & Verify

There is an objective way to determine how much of what you are being told is true and how much of it is blatantly untrue.

The test is that you aggregate the monthly incremental cost of being a franchisee, and mathematically determine how much in incremental sales at the now-reduced profit percentage you will need to reach break even on your having assumed this additional financial burden. Your accountant can do this for you. And that is merely a break even sales number. To make the conversion decision a profitable investment you have to exceed that sales number by a substantial margin.

Once you have derived that sales number, go to Item 19 of the Franchise Disclosure Document (FDD) that the franchisor is required to have provided to you before you signed any contract, and see if sales ranges achieved by their franchisees is provided. If not, you are about to make a big mistake if you decide to convert your business to their franchise.

Immediately and absolutely refuse to convert to any franchise that does not provide their franchisee sales ranges broken down into the categories of:

(1) the number of franchisees in the top 25%, the second 25%, the third 25% and the bottom 25%;

(2) the number of franchisees in each geographic region that are in each sales percent category (frequently there is great variance in sales performance by region, and knowing which region you would be in can be critical - not all regions perform with equal success profiles for any franchisor); and

(3) the length of time the franchisees have been affiliated with the franchisor in each percentage of sales grouping (if it takes ten years to get near the top tier, you don't want to convert your business).

Now that you know how your sales would have to increase just to cover your expenses of conversion, without any incremental profit to you from having converted, ask the question, "How many of this franchisor's franchisees have achieved this sales level?

Don't Deviate from the Formula

The reason so many conversion franchisees have ended up in my office wanting to know how to get out of the franchise contract and how to get their money back is that their franchisor had few or no franchisees generating sufficient sales to justify the conversion investment.

It is a loss situation for the converted franchisees. In many instances, the answer to this exercise is that the franchisor has never had even one franchisee with sales at the level you would need to justify converting your business.

This analytical exercise tells you whether the sales pitch about how wonderful the franchisor's stuff really is is true or false. While there may well be franchisees in that system that are satisfied with their relationship with this franchisor, that is not the question. The question for you is whether the affiliation with this franchisor will provide sales results for you to make you happy at the reduced profit percentage caused by the costs of affiliation.

If the results of this exercise are not positive, but for some reason you still wish to consider converting your business and joining this organization, you can mitigate the risk by insisting upon the following terms being put into your franchise agreement:

1. Current sales are exempt from all payments based upon percentage of sales. Percentage of sales payment obligations apply only to sales above current levels.

2. If sales growth does not exceed 20% by the second year, you may terminate the franchise agreement with no non-competition or other constraint upon your right to do whatever you want to do with your business.

3. If you are still in the system when the time comes to renew your franchise agreement, you have the right to renew upon the same terms as your current agreement, with no adverse changes. Many franchisors want you to renew on their new agreement that frequently has higher fees and less protection for you.

4. If you sell your business, your buyer gets your contract, not some new contract with different rights, including renewal rights.

If the franchisor if unwilling to agree to these terms, reject the conversion offer. So endeth the lesson.

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Author Richard Solomon is a Franchise Lawyer with 50 years of experience in business development, antitrust and franchise law, management counseling and dispute resolution including trials and crisis management. Give him a call at 281-584-0519.

In almost 50 years of practice I have managed to alienate a lot of people. Face it. Some people are not qualified to be my client. Insane, you say. For you it would be insane, but for me it works perfectly.

Over the years I created my own model of practice. I did not spend any time in a large law firm. I hung out my shingle after leaving in house corporate practice with very large companies, went looking for work and got very lucky. The harder you work the smarter you get and the better you seem.

My model worked. I didn't promise people things that I probably could not achieve. Even when hungry, I turned down work that should have been turned down. It has always been more than money for me. I wanted (still want) a reputation for professional excellence and I worked very hard to get it.

For many years it was difficult trial work. I love it. But now I try fewer cases. After almost 50 years people want my insights based on what I have learned in that time. They want me to show them how to solve problems without having to try lawsuits as the only approach. I am enjoying the problem solver role, the expert role, the collaborator role and the analyst role.

Life is still a lot of fun. I will probably never quit.

Most law firms feel blessed by long client lists and heavy foot billing methods. The law factory approach has been the model for most large law firms for many decades. They will put enough lawyers on any matter to do everything that could possibly be done. Sometimes the spend the project into the ground approach may exhaust the opposition.

Large clients like to think they can just buy the pot, outspend everyone and win every time, regardless of the merits. That was always the General Motors approach -we don't have to care and we are always right because no one can afford to be as right as we can afford to be.

But, that gravy train is slowing rapidly. Clients are looking at those bills and shaking their heads. Clients are looking more carefully for talent than for sheer weight. Talent isn't cheap, but the file jobbing approach to billing for legal work is on the way out.

The big firms that lived on excessive billing are now splitting up and in some cases just going out of business.

Fortunately for me, most of the clients who seek me out would prefer a best solution approach, a netting out of potentialities and prioritizing them for risk, expense, impact upon other collateral interests. My clients are usually spending their own money, not that of hordes of anonymous shareholders. They don't always know that's what they want when they first come to see me.

When they first walk through the door they want to be reassured that they are right and that they will prevail - whatever prevail means. I could have a lot more business if I played that game.

I have reservations about giving clients a line of misleading salesmanship just to get retained. Many times the client is not as "right" as he thinks he is, and many times that is somewhat obvious in the beginning of the relationship. Often ancillary matters negatively impact prospects for a good result. These need to be identified and taken into account.

Rather than tell a potential client that I agree with him, I tell him that I am going to be a "devil's advocate" and ask a lot of challenging questions to see to what extent his view of things and his expectations can withstand cross examination. That's about as nice as I am capable of being. Accordingly, many potential clients go off and seek a more compliant resource.

While I would very much appreciate being retained, it is better that someone who cannot or will not tolerate challenge go elsewhere.

I handle mainly crisis, bet the company situations and groups of people with common life threatening business problems. Few people understand that a client in crisis is rarely without some responsibility for the fight. In these situations no one is entirely without blame. If the boss cannot accept qualifications to any endorsement of his position, I am really not the right person to be his lawyer. I am not a potted palm and I have been around too many blocks to accept stories on their first telling.

The guy who has to be "right" will pay a lot more elsewhere, and very often he will in the end have spent that money for nothing.

I strongly believe the Rupert Murdock debacle is a product of simple client arrogance. Maybe he has so much money that nothing matters and no result can affect him adversely. He is certainly conducting his response to the hacking accusations as though he had divine immunity. His son is an even worse example of how not to do this.

But even if the Murdocks can afford to mishandle everything, most people cannot. His lawyers follow anything he says without question. If there were effective questioning either things would go better for them or they would be cashiered. I suspect they believe they would be cashiered and just go along for the sake of the fees.

The Murdock spectacle has to be the worst example of crisis management this year. It should be a case study on the subject. I know there will be at least one book on the story and maybe a movie, like the Enron debacle. At least the public financial harm in the Murdock matters is not as substantial.

Your lawyer has to be able to tell you the hard news and not get fired. If your lawyer is more worried about getting paid than about doing the best possible job for you, you are defeating your own cause with a very negative attitude.

You can always get a second opinion to be sure you are not missing anything. I can guarantee you that you would much rather hear bad news in private than in court before the public, a jury or in a written court opinion about what is wrong with you. Of course it is better to provide a spoon of sugar to help the medicine go down, but this is a world where people have to grow up and to do it more quickly.

The digital age has accelerated the speed of calamity. Reality is an imperative in what I do. Your pastor can punch your card if that is what you need.

In the not too distant past a company that thought they just had to be represented by a large Wall Street law firm instead of by the people who prevailed in the nearly identical case a few years before, paid $ 16,000,000 to a Wall Street firm to lose. It was worse than that. They charged $ 16,000,000 and then told the client they couldn't win. Even worse, they had filed suit before they knew what to expect. To me running up a $ 16,000,000 tab and then telling the client you can't do anything for him is a description of incompetence. Competent pre filing due diligence on your client's case really should prevent such a travesty. Maybe if the client had hired the folks who knew how to try such cases he would have been better off. My team won the nearly identical case three years earlier against the same Defendants for around $ 1,000,000. My clients told this client about our success and recommended that they come see us. They didn't. An army of upper crust honor graduates is surprisingly ineffective in a crisis.

My client to this day tells everyone that he almost didn't hire me because I had very different and contrary views about the situation from the views his lawyers had been telling him. They had missed their very best strategic position and had focused upon a technical rather than a real theory of recovery. The opposition had hired four of the biggest firms in Texas to represent them. The opposition was used to "buying the pot", so finding their Achilles Heel was not easy.

But we found it and the big guys cried uncle instead of us. Now my client follows his statement about almost not hiring me with a lot of praise. His is one of the posts on http://www.franchiseremedies.com/what_others_say_about_richard_solomon.htm.

There are occasions when someone really is on the right side of a conflict, and the wonder is that they are in the fight at all. When it seems that my client is that correct and that the opposition is that incorrect, unless I know the client for many years, I am still skeptical. If I can't find the hole in the boat, the boat probably doesn't have a hole in it, or at least not a big one.

I have been told many times that "I'm not going to let a damned lawyer tell me how to run my business." On the other hand, if I see you headed for a fall, based on what I have seen others do to their detriment, I can't just sit there and smile and salute. My guts won't let me do that. I failed to get a good client just a week ago on just that kind of scenario. The potential client told me the plan going forward and I have had a few clients in the past go down in flames doing things like that. When I told her that if she retained me I was going to ask her to rethink that plan, I was dead meat. She had already announced her plan to everyone and was not going to reconsider. I could see on her face that I was about to be shown the door, but no one in her organization was going to tell her anything that she might consider questioning her "authority" as the owner of the company. I am reasonably certain her company will fail within eighteen months if she goes forward with that plan, and I could not salute it. On the way out I asked her one more time to "test market" the plan before betting the farm on it. The look on her face was extremely combative.

As one friend often tells me, "You are a good lawyer but a bad businessman." So be it.

Now had I not insisted on being up front about the need to cross examine every investment plan before going forward with it, I probably would have been retained. I have an awful lot of experience representing clients in her business. The plan would still have failed. I'm a lawyer, not a magician. She would only have been upset with me later anyway. She might even have blamed me then for not having spoken up earlier. People are like that. How does one finesse that? I am certain there are folks who can do that. It takes a pretense that you really think their idea is great and faking it until your relationship with the client is on firmer ground. However, when the drop dead date is staring you in the face, you don’t have time for that. Her plan was going to be put into effect almost immediately and there were three other conflict issues that were about to come to a head within a month or so. Things are closing in on her and she is about to implode her company. Sadly, some other law firm will smile and hold her hand right into oblivion. The rough justice will be that they will go out holding a rather large and uncollectible receivable. When the bad news does roost she will owe them a lot of money that she will refuse to pay.

A long time ago someone I respect told me "Bad news can't wait." I have seen a lot of times when bad news really couldn't wait and no one had the guts to say what it was. I have always spoken up. Most of the time, although I pissed off everyone in the room, I was later thanked for it.

Part of the issue may be that clients often wait until it is the last minute and they have already gone out on some limb before they call me in. That's when things are really tough. I published an article about what not to do when bad things happen. My first recommendation is to say and do absolutely nothing until you really do know what all the facts are. But people seem never to do that. They are always into denial of wrongdoing before they are aware of whether there really have been some shenanigans on the part of their company. It's tough to stuff shit back into the horse. There is no harm in saying that you have nothing to say now and that you may have something to say when you are certain of what the facts are.

Being the owner of a company does not mean you know everything that is going on. Sometimes it turns out that you really did know about bad stuff. Sometimes it turns out that someone you might want to protect has gotten the company into a jam and you don't yet know about it. That stuff will come out. Don't make a fool of yourself by ignorantly denying wrongdoing when you aren't certain what really happened.

The standard P R firm advice is to make immediate self justification statements in response to any accusations. That is really nonsense. If you want credibility you need to make responsible statements. Claiming to be right before you could possibly know the facts and have sorted them out is not responsible or credible. Why do that to yourself?

When you have taken a public enforcement position on a defective contract that seems facially to agree with you but in reality does not give you the rights and prerogatives you think it does, be prepared to spend a lot more money than you really had to spend in getting to a livable result. When the source of the bad news is someone who used to be with your company and knows the truth from the inside, deniability may not be just a matter of hiring a PR firm or a nasty lawyer. Talk is usually not cheap in these situations. Everyone, no matter how much of a good guy he may be (or think he is), has enemies.

It is dangerous to rely upon advice from people who were on watch when the bad conduct in question took place. They are usually on the defensive about it and for that reason less reliable. Get a fresh outside look before you take a position. Tell the fresh outside resource that you really do want to know the news, good or bad, and that you promise to deal with it realistically, whatever it may turn out to be. You will never regret having done that.

I know these admonitions seem simplistic. Truth usually is direct and simple. The amazing thing is that these obvious more successful approaches are so seldom used. If they seem so obvious to you when you read this, you might ask why the more harmful approaches are so often adopted. I think the answer may be that when you are the target of an immediate threat, your reflexes engage more intensely than your ability to be logical. In many instances it is ego driven.

Educating clients is dangerous stuff in moments of emergency. I think I am getting better at it. However I still get shown the door more often than I would like. This is the best mode of emergency representation, however, and I do not intend to change it. Clients in really serious difficulty need to grow up quickly and swallow fear. Fear never drives successful tactics and strategy. If you don't start by sorting out the truths that are in play you will spend a lot more money for a much less favorable result.

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