By Cliff Ennico
Are you thinking about buying a franchise?
If so, here are more tough questions you should ask the franchise’s management team after reviewing their Franchise Disclosure Document (FDD).
Is the franchise adapting to changes in the market, technology, etc.? We live in a time of rapid social and technological change. Is your franchise making efforts to adapt to a digital, multicultural, anything-at-anytime world?
Last year, McDonalds restaurants changed their menu to offer breakfast at all times of day. Many franchisees complained about the costs involved in making this change, but most would now agree it was an excellent business decision.
How “hands on” do you need to be to run the business? Many franchises hold out the tantalizing possibility that you don’t really have to work in the business but can hire “managers” to serve customers day to day while you focus on the fun stuff.
While you certainly should look to hire managers at some point, you still need to know how everything works. I have had franchisee clients called back from their cruiseship vacations because a manager was sick or involved in a traffic accident. Somebody’s gotta make the doughnuts every day.
How many customers must you have, or how many products must you sell, to meet your monthly operating expenses? Do some simple math when reading the FDD. If you are selling sandwiches, potato chips and soft drinks with an average ticket of $12, with a $5 gross margin per ticket (sales minus cost of goods sold), and the rent for your restaurant is $2,000 per month, you will need to sell 400 sandwiches per month just to cover your rent. That’s 100 sandwiches a week.
If your monthly operating expenses are $10,000, and you want your restaurant to generate $20,000 in profit a month after paying the franchise a 10% monthly royalty on gross sales, you will need roughly $33,500 in monthly gross sales. With an average ticket of $12, that’s 2,972 sandwiches per month, 697 sandwiches per week, or about 100 sandwiches per day.
Will the franchise let you exit gracefully if things don’t work out? When you sign a franchise agreement, you commit to a “term” of (usually) 5, 10 or 15 years. If, despite your best efforts, things just don’t work out and you want to exit the franchise, technically you can’t – the agreement requires you to find a buyer for your franchise territory, or wait until your franchise comes up for renewal.
Here’s a dirty little secret – as long as the franchise is convinced you did the best you could, most franchises will let you out of your agreement, regardless of what the agreement actually says, as long as you agree:
- Not to sue the franchise or badmouth it to prospective new franchisees when they call to ask you “what happened?”;
- Not to ask for any of your money back;
- To be bound by the noncompete clause in the franchise agreement (usually 18 months or 2 years); and
- (Sometimes) by paying “liquidated damages” — a lump sum equal to a percentage of the royalty payments you would have paid the franchise over the balance of your term.
Look at Item 20, Table No. 3 of the franchise’s FDD, and especially the column headed “ceased operations – other reasons.” These are the people who negotiated their way out of the franchise before their terms were up. You want to ask the franchise about the specific circumstances behind each of these early terminations.
Are the franchisees happy? When you speak to franchisees, don’t just listen to what they say. Listen to the music. Do they sound happy or energized, or do they sound as if they are just going through the motions?
Always, always ask each franchisee a simple question: “If you had to do it over again, would you buy this franchise?”
Will the franchise “bail out” at some point? Remember that franchises are entrepreneurial ventures. Just like any other entrepreneurial venture, the founders want to cash out at some point by realizing an “exit strategy.” Since very few franchises launch initial public offerings (IPOs) of their stock, most will exit by merging with, or being acquired by, another franchise or a large corporation.
Ask the franchise’s management team how likely it would be that the franchise would be acquired within the term of your agreement, and if so, by whom.
How does the franchise reward success? If you are a “top performer” within your franchise system, you don’t want to come up for renewal and have the franchise buy your territory for a discount and operate it as a “company store”. Or reduce your territory so that they can put two or three new franchisees in to “share the wealth.” Get the franchise to agree – preferably in writing – that if you are extraordinarily successful you will have the absolute right to renew your agreement without changing your basic rights.
Cliff Ennico (firstname.lastname@example.org) is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2017 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. @cliffennico.