3.0 Minimize Your Risk in Business Ownership

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3.1      Franchises have been around for over 150 years.

Guess what…

Franchises have actually been around for over 150 years and longer if you research history!!

Fredrick Henry Harvey founded one of the first recorded restaurant franchises in the United States in the 1850’s.  It failed during the Civil War but reemerged in 1876 to be known as the Harvey House restaurant, which was established in terminals for the Atchison, Topeka and Santa Fe Railroad.  Later the railroad asked for Harvey House restaurants to be set up in all their depots for passenger use.

There are franchises for nearly 75 different business industries, from food to construction.

Remember, franchising is a method for delivering products or services.  There are three players, the franchisor, franchisee and the franchise.

The franchisor is a person or entity that lends their trademark or trade name and a business system.

The franchisee is the person who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.

The franchise is actually, or technically, the contract binding the two parties.  But, is often used to mean the actual business that the franchisee operates.

Franchising makes up a large part of the United States GNP (Gross National Product).

There are thousands of franchises in the United States and hundreds of thousands of franchised locations.  Franchising, as a method of doing business, has been growing quite rapidly in the past 40 years.

3.2       What’s so unique about a franchise?

Well, to start, in the first 3-year period of time that a franchise is open, the success rate is around 80%.  In other words, only 20% of the franchises fail in the first 3 years.

If you recall, for those entrepreneurs that start a new business, only 20% succeed in the first 3 years leaving nearly 80% of the businesses to fail in three years.

Therefore, a 20% success rate of a new business compared to the 80% success rate of a franchise provides a clear picture why entrepreneurs consider franchising a great opportunity.

Lower risks and higher success rates make franchises worth exploring.

Let’s look at some other reasons:

A franchise has a proven system.  You get the ability to start a business that already has a successful track record!

You get training and support from the franchisor.

A majority of the franchising opportunities require no experience or background.

You’re in business FOR yourself, not BY yourself.

Win-Win Relationships

- Franchisee and franchisor

- Franchisee and franchisee colleagues

- Brand recognition

- Marketing multiplication

UFOC now called the FDD

UFOC?  FDD?  What are these things?

UFOC = Uniform Franchise Offering Circular

FDD = Franchise Disclosure Document

Franchisors are federally regulated by the Federal Trade Commission (FTC) and are required to prepare an extensive document for any prospective franchise purchaser before they buy a franchise.  The FTC, in order to make things more understandable, has recently required franchisors to rename the UFOC to FDD.

Franchise Disclosure Document is a better way of describing this document, but you may hear both terms used in the industry.

The FDD makes a franchise a very viable option to consider because it enables the franchisee to compare each franchise side by side.  Everyone is playing from the same rules along with the experience, training, support and business system from the franchisor.

3.3       Royalties provide more than support

Most franchises will charge a royalty to the franchisee.  So expect to pay regularly scheduled franchise royalty payments usually on a monthly basis.

These payments can be based on a flat monthly rate or a percentage of net or gross profits per month or per year, depending on the nature of the franchise operations.

Flat monthly rates can range from $50-$1000 a month

Percentages can range from 1% – 50%.

In the case of some franchises, they also charge an additional monthly “Ad Fund.”  This royalty helps generate national ad campaigns that you might see on billboards, radio, television, and magazines, creating national brand recognition for the entire franchise system.

Remember that royalty payments are the price that franchisees pay for buying into a “ready-made” business structure rather than incurring the expense and time of structuring and creating a business model independently. Your royalty payments are in exchange for the existing structure and brand that you purchased for the privilege of selling.

Many independent business owners say they don’t want to give away their profits as royalties to a franchisor.  But they’ve got to consider the price they would pay to obtain the same marketing efforts that their competitive franchisor is using.  Because of the economies of scale in creating brochures and ad campaigns the franchisor receives a lower rate for all the franchisees.  Perspective is everything.

Royalties, franchise fees and total investment are all things to consider.

The total investment of a franchise takes into account the franchise fee ($20k – $75k on average) which is the access to the business and marketing plans, the build out of a retail center or vehicles, equipment, and operating capital for a period of time. Franchisors will list these common expenses in the FDD (Franchise Disclosure Document).  Having conversations with the franchisor and other franchisees will help uncover your total investment costs.

Keep in mind that franchise royalties are designed for much more than franchisor profits.  Royalties help provide on-going education, outreach, publicity, advertising, trademark and brand development, and other initiatives to advance the success of the entire franchise organization.  So it benefits both the franchisor and the franchisee.

3.4       Explore, validate and plan a discovery day.

You should consider three steps when looking at buying a franchise, explore, validate and do a discovery day.  Let’s use the analogy of buying a home as an example.  Once you’ve found a few homes that you find interesting and are in your price range, there are a few things you might do prior to making an offer to buy.

First you might want to walk around the house both outside and inside to see if it meets your requirements.  Next you might hire a home inspector to make sure the structure is sound, you might also call the utilities to verify the average monthly expenses, even go as far as interviewing the neighbors to see if they are friendly and helpful.  Last, you might visit with the homeowner and get them interested in you for easier negotiations in the future.  When all the criteria match to your satisfaction, your choice of the right home for you is easy.

Similarly, once you’re focused on a few franchises, begin researching using the web to find out more information, without contacting the franchisor.  Check out the franchisor’s web site.  You might search for industry information or who the competitors are.  Call some competitors and ask what makes them different than the franchise your interested in.  So to speak, it’s the same as walking outside and inside a home you’re looking to buy.

Next, get an introduction to the franchisor.

You may need to complete an application, talk on the phone, or have a broker or coach perform the introduction.  This is where you’ll get a better understanding of the franchise business model.  This is a time to listen and ask questions.

Franchisors will do their best to make sure you have an understanding of their model.  If they hear your interest, enthusiasm, or excitement in their franchise, it will be contagious and the franchisor will begin to see you as a viable prospect.  Lack of interest or rudeness on your part may cause the franchisor to lose interest in you as a prospective franchisee.  Be ready for an invitation for further phone calls, conference calls with other prospects, or webinars.

Each franchisor may have different processes when working with prospects.  So, to get the most value and knowledge, work with several franchisors to learn new ideas and questions to ask. This holds true for conference calls and webinars, the more individuals participating, the more you’ll learn from hearing questions you hadn’t considered previously.

By this time, the franchisor has probably sent the FDD (Franchise Disclosure Document) to you.  In the FDD, you’ll want to read through the Table of Contents and scan through the documents.  One section that might interest you is the Item 19, which contains earnings claims by some franchisors.  Not all franchisors include an Item 19, so don’t be alarmed if it is blank.  However, for those that do have an Item 19, keep in mind that this is not a guaranty of income.  It is an idea of what is possible under certain circumstances and needs to be investigated by a prospective franchisee during due diligence.

Consider this, in the franchise world; franchises are AWARDED, not bought.

Meaning, if a franchisor sees in you the qualities of a good franchisee, they’ll consider awarding you a franchise.  However, if the franchisor is uncomfortable with your interest, enthusiasm, or attitude, they may reject you as a candidate.

Regardless of how much money you have or your desire to own a franchise, you’ll be rejected.  Why would they do that?  The franchisor is looking for individuals that they can envision as good franchisees, so that the brand is held in high rapport with less opportunity for failure.  If a franchisee fails, it hurts the franchisee, the franchisor, and the franchise.

Also, franchisors look for people who want to be in the business of business, not those who want to be technicians in the business.  Franchisors want you to follow a proven formula that has worked for numerous franchisees before you.

When will the franchisor give you their decision to become a franchisee?

Typically it will be after a discovery day.  A discovery day is a face-to-face meeting where you travel to the franchise headquarters and meet with the franchise executive staff.  When you’re invited to attend a discovery day, you’re on the final path toward a choice.

All the while you’ve been evaluating the franchise, the franchisor has been evaluating you.  So, can you see yourself fitting into the franchise culture, and by the same token, will the franchisor see you fitting into their business model?  The offer may come while you’re on site or after you return home.

Be prepared, as the decision time will come for you and for them.  As the captains say on the charter fishing boats, are you here to fish or cut bait?

3.5       Lenders are willing to help fund a franchise.

Why are we talking about finding money after finding a franchise?

You could get pre-approved for a loan before looking at a franchise, but will you know how much total investment will be needed?  You should know how much money you’ll be putting in as a down payment, which will typically be 20% of your total franchise investment.

For some individuals, they’ll feel more comfortable getting pre-approved for a loan first.  If this is the case, by all means do so.  And if this is you, will you be creating a false limitation to what you can achieve? What if pro forma financial work indicated that with a little larger investment going into a franchise, your return is far greater than the extra investment.  Would that make a difference to you?  And could your decision be open for discussion?

Okay, let’s talk about lenders.  If you recall in section 2.5 “Working on the money”, we listed nine lending opportunities to consider.  There’s a tenth.

Franchise lenders, or those that understand franchise concepts and are willing to lend based on the individual’s credit score and the high success rate of franchising.  What?  Yep, if your credit score is around 700 or above, there’s a good chance you can lock in a loan to purchase a franchise.

Here are a few to look at:

Benetrends

FranFund

Guidant

Tenet Financial

ACTION ITEMS: Complete the Action Items in your Action Guide.

Do you know what your credit score is?   You should find out, as it could be just what you need to secure a loan, or correct your credit for the future.

AnnualCreditReport.com states that a credit score is a complex mathematical model that evaluates many types of information in a credit file.  A lender uses a credit score to help determine whether a person qualifies for a particular credit card, loan, or service. Most credit scores estimate the risk a company incurs by lending a person money or providing them with a service — specifically, the likelihood that the person will make payments on time in the next two to three years. Generally, the higher the score, the less risk the person represents.

The best thing you can do is make your credit payments on time and at least make the minimum payment or more.

You can purchase and receive your credit score by contacting one of the nationwide consumer credit reporting companies.

Equifax – www.equifax.com

Experian – www.experian.com

TransUnion – www.transunion.com

An evaluation of your credit report will help determine if any corrections should be made.

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