Ten Questions to Ask Before Becoming a Franchisee
Is franchising the best pathway to business ownership success?
Following up on my previous blog about Ten Questions to Ask Before Buying a Small Business, I wish to turn to the question of business ownership via franchising. Flip through any copy of Entrepreneur magazine and you’re sure to find loads of content and advertising focused on franchise business opportunities. There are thousands of franchise businesses in existence just waiting for the right business owner to come along and invest personal resources to help develop their brand and revenue base. Business franchising has been around for over 150 years (originating with the Singer Sewing Machine Company) and remains as popular as ever. But how does it really stack up as a method for one to become an entrepreneur or small business owner? As with any new venture, there are risks offsetting the upsides that must be carefully considered.
I have been the owner of three Elements Massage franchise locations in Massachusetts, while my friend and business school classmate Jimmy Tran has owned three Code Ninjas franchises in Texas. Here we share from personal research and experience our top ten questions to ask before deciding to become a franchisee:
Are you pursuing franchising to become an “entrepreneur?” In business school, we had a professor who defined entrepreneurship as “the pursuit of opportunity without regard to resources currently under your control.” Still, there is some debate whether becoming a franchisee is truly the same as becoming an entrepreneur. Self-employment, yes. Small businesses ownership, yes. However, is it innovative, disruptive, or creative? Arguably to some extent, but with many limitations and restrictions compared to embarking on a new venture on one’s own. Of course, it also depends on the brand as some franchisors are more restrictive than others. That is not to cast franchising in an entirely negative light. There are upsides to executing a tested model with support and risk mitigation built in – you are not re-creating the wheel and you can get from zero to revenue much quicker. However, being a franchisee is not the same as starting a business concept from scratch, and it’s best to go into it with a clear head about what the tradeoffs will be.
Does the franchise concept align with your personal values and motivations? You are signing up for a major commitment that will have a significant impact on your personal and professional life. As with any business concept, are you pursuing an idea that you are passionate about and feel solves a problem and/or addresses a deficiency in the market? Are you bringing a new concept to the market where it previously did not exist? The more personally invested you are in the concept, the more driven you will be to execute the model successfully. With a franchise, the good news is you can see existing examples of what the business looks and feels like before you decide to jump in. Nothing beats visiting multiple stores ideally as a customer, simply to get a sense for the product/service before you decide to commit.
Have you spoken with multiple current and past franchise owners? Franchisors are masters at selling franchise licenses. This is their lifeblood. If you were to ask a franchise sales rep what key factor leads to a franchise owner not being successful, you might receive an answer like “the franchise owner doesn’t have their head in the game.” This implies that YOU would be a much smarter person than those other failed franchise owners. This type of flattery can also be quite disingenuous. To do proper due diligence, it is essential to talk to multiple current, and ideally past, franchise owners of the same concept. The franchisor will happily provide you with a list of people to contact. Unsurprisingly, this list will favor high performing franchise owners who naturally will have positive things to say. Dig deeper and on your own initiative expand these conversations. Talk to someone who has failed or closed a location – seek out disgruntled franchise owners. Don’t take the easy path in your research and be careful about only listening to those stories that you want to hear. Sometimes the best stories are those that you need to hear.
Are you aware of all of the salient provisions of the Franchise Disclosure Document (FDD)? Every serious prospective franchise owner in the US must, by law, be provided with a copy of the organization’s FDD. This is a document that can run several hundred pages long and is typically filled with legal jargon that will make the average person’s head spin. Nevertheless, it is important to read through this document and ideally have a franchise attorney review and highlight certain key points for you. For example, you will want to know how much territory rights you are given. Are you protected from competing against other franchisees within the same system by a radius of one mile or ten miles? In the case of McDonald’s, it is famously zero miles. It is also worth understanding the jurisdiction of the franchisor. Many are based in Colorado, for instance, where the law is more favorable to the franchisor than in other states. The FDD will make it clear that any dispute can only be litigated in their home state. Other important clauses include termination, renewal, transfer, and dispute resolution – all significant factors in franchise ownership! These items represent just the tip of the iceberg of what is covered by the FDD. As this is a monumental decision, don’t take shortcuts and make sure to understand what is contained within this vital document.
Have you analyzed the financial ROI of franchising versus “going-it-alone?” This analysis is table stakes for assessing whether to become a franchise owner. What value does the franchise offer that you could not replicate on your own? Is it a “protected” formula or recipe, a unique service method, branding, know-how, real estate selection, operational advice, or something else? Contrast this with the fees that you will pay for the privilege of owning a franchise. There are initial buy-in fees, ongoing royalties (commonly 6% of total sales, but this can vary as many franchises also have brand funds and other royalty add-ons), required monthly fees for marketing and technology licenses, fees to travel and attend franchise meetings, regional cooperative fees, mandatory business insurance policy premiums, and potentially others. These fees are commitments, whether or not you feel that the ROI is justified (you may be required to spend money on marketing that you see as wasteful, but you will have no choice in the matter). There is also the fact that the franchise can control what products you offer (and don’t offer) as well as how you market your business. Understand the tradeoffs and make sure, to the best of your analysis, that the upsides more than compensate for the expenses and limitations of joining a franchise system.
What type of support does your franchisor offer? It is important to ask the right questions upfront about what type of support the franchisor will and will not provide. It is certainly reasonable to expect guidance on finding and building the right space (assuming a physical location), product and service offerings, brand guidelines, and general hand holding through the startup phase and ongoing operations. However, most franchises are not able to provide direct assistance with personnel matters and most likely will not involve themselves in any customer disputes. Rarely will they offer legal advice or material assistance in obtaining financing. If you are in doubt about exactly what your franchisor will offer, be sure to ask before signing your franchise agreement.
What are your grand ambitions for operating a franchise? Is your goal to own a single franchise unit as that will provide the self-employment and/or income that you are seeking? Or are you more ambitious? Would you like to own 2, 3, 5, or even more units? There is certainly an element of scalability in that if you can operate one, it will become easier to own more and more. Multiple units will likely require additional overhead if it’s necessary to bring on a General Manager or other dedicated staff such as someone to lead marketing or operations. However, the operational knowledge and potential economies of scale on the revenue and expense side are worth factoring in. There are naturally some organizations that have grown baskets of dozens or even hundreds of units. Take it one step at a time, but if things go well, there is always the option to continue expanding or acquiring units to consolidate a significant position within one or several regional markets.
How challenging will it be to staff your franchise for optimal results? Core to any business, including franchises, is the ability to hire sufficient labor at a reasonable and fair rate. Does your business rely on scarce talent? If you need to hire talent with specific technical knowledge or education, such as licensed coding instructors or therapeutic service providers, then it is essential to understand how large the talent pool is in your local market. Is the market highly competitive? Will you be able to pay a market rate to keep an adequate supply of talent staffed in your business? Will you need to offer a 401k, health, or other benefits on top of a competitive salary? The franchise should be able to provide guidance, but ultimately it will be up to you as the franchisee to hire and retain talent. You should ask yourself whether you enjoy hiring, grooming, and retaining talent as that is almost always critical in a brick-and-mortar, customer-facing franchise.
What type of owner do you want to be? There are generally two types of ownership models: there is the hands-on owner-operator and there is the hands-off owner-manager. Some franchisors specify the type of model they want and will require owners to be hands-on. There are many franchisors, for instance, that only allow owners to own a single territory or unit. Chick-fil-A, for instance, has an owner-operator model where each store has a single owner-operator who typically works in the business. This is important and ties to entrepreneurship and the underlying motivation questions above (#1 and #2). In particular, you need to ensure that the business model is aligned with the type of owner you want to be. If the business model requires hands-on ownership to be successful, are you willing to work in the business on a day-to-day basis?
What are the exit scenarios if things don’t go well? When you sign a franchise agreement, you are signing up to a long-term commitment that cannot be easily rectified if things don’t go as hoped. A typical franchise agreement can be for ten years and generally cannot be broken (at least not without stiff penalties) unless the business is sold to another owner (in which case, transfer fees will apply). That can be quite tricky, of course, if the business is cash flow negative. Moreover, these agreements for brick-and-mortar businesses often require the franchisee to sign a long-term lease with a landlord. Many landlords require personal guarantees as well and these should not be taken lightly. Personal guarantees will hold the tenant (business owner) personally liable for the entire duration of the lease (e.g. 10 years). If nothing else, there will be substantial legal fees at the end of journey if it becomes evident well before the franchise and lease agreements expire that the business has no hope for a positive outcome. Be sure that you understand these risks and have mitigated any personal financial risk as best you can.
The choice to become a small business owner through franchising does hold promise and opportunity – in fact, small businesses are the lifeblood of the American economy. If you look around in your community, you will undoubtedly see many small businesses and franchises. Becoming an actual franchise owner, however, comes with a very clear set of tradeoffs. What you may gain from a proven business model, a known brand, and ongoing support, must be balanced by fees, loss of full P&L control, and sometimes strategic decisions that you may disagree with. Remember that the vast majority of franchises are motivated by how much revenue you as generate as a franchisee and not by your profits or cash flow. This is a fundamental mismatch between the franchisor (who is focused on top-line growth) and the franchisee (who wants bottom line profits). This point is critical and should not be taken lightly. As with starting any business, the decision to start or acquire a franchise is a major life decision and the upsides and risks must be weighed with a realistic mindset about whether this is the right move for you and your personal and professional goals.