Buying a Franchise--When Are You Getting Value For Your Money?

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Every day people eager to own a business invest $500,000 to a million dollars in franchises where the FDD said the top of the range for "estimated initial investment" was under $250,000-and where the "initial franchise fee" is only about $35,000. When buying a franchise, the first question they should be asking is what are they getting for all that money?

The promise of franchising is four things:

(1) a well known tradename or trademark;

(2) initial training in how to operate the business;

(3) a proven system with most of the "bugs" already fixed; and

(4) ongoing support and training.

It is the perceived difficulty and risk of not having those things that prevents most people from undertaking to launch an independent business.

Those are the benefits that franchise sales people preach daily and that the "trade press" touts. In some cases those things are true.

Unfortunately, in a large number of franchises, including in some that are "highly ranked", one or more, if not all of those promised things is either missing or of little value. A franchise without a well known trademark among prospective customers of the business is like buying an airplane without wings. A recognized trademark is the very essence of franchising. It is the thing that brings customers through the door. If you are considering investing in a franchise, you have to ask whether the trademark, in your area and for your prospective customers, has any greater value than "Bob's Gizmo Sales". If the name is not well known (thus having value), then it will only acquire value the same way "Bob's" would-through your investment and hard work. It is nearly unheard of that a franchisor will spend advertising money developing its name in your neighborhood for your benefit.

As a prospective investor, you should also closely examine the value of the initial training. Remember, you are paying up to about $35,000 for it. Look carefully at the disclosure in Item 11 of the Franchise Disclosure Document, but also talk with existing franchisees. Did they really get that much value? Will you really learn everything you need to know about how to operate the business? Or will you, as many franchisees discover too late, be in business "for the franchisor and by yourself"?

The third promise you should evaluate is whether the franchisor offers a "proven system". The business system is of no value to you if you are going to be the franchisor's guinea pig-to work out those bugs. It would be extremely rare that a franchisor with only a few outlets would have a "proven system". The only way to find out is to spend a lot of time in the franchisor's business or the business of any existing franchisees to determine just how "proven" it is. Otherwise, you will discover-too late-that you have to go through all the same pain of working the bugs out that you would have had you opened as "Bob's Gizmo Sales".

Finally, you should evaluate what the franchisor promises regarding ongoing support and training. Examine Item 11 of the FDD very carefully. If the FDD lists the franchisor's "after you are open" obligations in "wiggle words" such as "we may", "as we determine" or "in our discretion", then the franchisor is not making any contractual promises to provide ongoing support. Look for clear and unequivocal promises, without conditions. If you don't find them, be suspicious and continue your search. An experienced franchisee lawyer can help you in identifying and understanding all of these issues as you make your decision about buying a franchise.

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If you going to invest in an emerging brand you should start with the premise that it's an unproven franchise concept.

And ask the newly minted franchisor how they got their proof?

This is a very sensible article and it makes excellent points that franchise prospects should consider. Unfortunately we know that people buy emotionally and not intellectually, thus we've got an immediate problem. We also know that many franchisors must sell franchises to remain in business -- another problem.

One thought occurred to me when I read the reference to a $35,000 franchise fee. I agree that's a lot of money. But it should probably be double to triple the amount. Now that kind of fee would keep some folks from buying franchises, and that might be a good thing for franchising. It would also put some franchisors out of business, and that would be a good thing for franchising.

There are multiple reasons for the franchise fee -- franchisor profit is not one of them, and I do not subscribe to the belief that the franchisor makes a pile of money from the franchise fee. I was a franchisor, our franchise fee was $50,000 and we lost money -- we needed to charge in the range of $75,000, and we would then have broken even, or perhaps made a little money. Because franchisors DO lose money on the franchise fee, and because they want to sell franchises, they keep that fee as low as possible (usually under $35,000) and I think that's a disservice to the franchisor and to the franchisees.

A good franchisor is capable of teaching a franchisee HOW to succeed in the franchisor's business. It may not be possible to train the franchisee in a week or two -- in fact, the training could take a couple of months. And why not? Well, no one wants to be "away from home" that long, and no one wants to risk increasing the franchise fee for fear "we won't sell franchises." But what's the goal? Is it really to sell franchises? Is it really to consider how long a franchisee would have to be away from home? Or is it to equip a franchisee with the knowledge and skills to succeed in a business?

Here's another way to think about the franchise fee. If it does what it's intended to do -- show someone how to succeed in a business (at least that's part of the purpose) -- what's that worth? Is it worth $50,000, $60,000, or more? Take the guy who spent $30,000 and failed. What's the chance he would have succeeded with some additional training and know-how and better skills? If there's a chance that's true (and I can tell you it is -- I've seen franchisees turn around with the right training and coaching) would that guy have rather paid $75,000 and succeeded, or $30,000 and failed?

I realize I'm making a lot of assumptions -- is better training really the answer? Yes, in some cases it is. Better selection of franchisees is also part of the answer. Better franchisors (who understand how to select and train franchisees) is also part of the answer. Whatever the answer is, I think a higher franchise fee, with the additional money invested properly (and delivered to the franchisee appropriately) helps franchisors develop franchisees who are more likely to succeed.

Based on years of experience, I am still shocked by how little some franchisors know about their franchisees. Ask them to tell you who their top 10 franchisees are and they can't do it. Ask them what's different between their top 10 franchisees and their worst 10 franchisees and they can't do it. Okay, so paying more money won't necessarily get franchisors to care more about these important matters, but it may make it possible for more franchisors help more franchisees succeed. "But we won't sell as many franchises!" Yes, true, and too bad . . . but in five years when you have a successful network of franchisees you won't have to work so hard to sell franchises. Bite the bullet now.

It's interesting to me that people will spend $100,000 to get an MBA and still not know how to run a business successfully. But if you put $100,000 into the hands of a good franchisor (with a real operating system and a viable brand), and you spend several months (not weeks) in training (not all of it full-time, necessarily, and some of it can be online) I think you'd have a better chance of operating a franchise business successfully. I agree that $35,000 is a lot of money, but not when you consider that the franchise fee is supposed to deliver MORE than just an education. I don't think it's enough money and that's part of the problem. The question isn't, "Am I getting my money's worth when I pay the franchise fee?" . . . the question should be, "Am I paying enough money to get what I will need to succeed as a franchisee?"

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This page contains a single entry by Howard Bundy published on January 21, 2014 1:24 PM.

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