Franchises offer individuals tremendous earning capabilities and the power of established brands – something you can’t ignore when compared to start-up businesses. However, franchises are not “businesses in a box.” You can’t simply plunk down your dollars, get franchisee approval and start making money like magic. Smart franchisees know that it’s going to take 2-3 years to see substantial profits and that the more popular the franchise is, the more you’ll have to pay to be a part of the in-crowd.
In addition to mentally assessing yourself, there are three very important steps you should take before considering buying in to a franchise:
- Investigate the franchise thoroughly
- Go undercover
- Find the funding
Every step takes you that much closer to being a franchise owner – but unless you’ve been through the process before, you can’t afford to skip over any of them.
Investigate the Franchise
Your first step towards franchise ownership begins with a cursory search to discover the brand that’s right for you. During these early stages, you should be most concerned about the types of businesses that will fit your personality and your goals – the rest will come along later. Consider your energy levels, your desired level of involvement, your ability to respond to rapidly changing needs and any other existing drains on your time.
Once you’ve got a list, you can start narrowing things down. Investigate individual franchises in your desired areas. Weed out the ones that cost too much, those that aren’t available in your geographic area and the opportunities that don’t seem like they’d be profitable in your region.
Next, it’s time to get some data from the franchises you’re interested in. The Wall Street Journal recommends getting a copy of the franchise’s Uniform Franchise Offering Circulars (UFOCs). These documents include data such as annual revenue per location, franchisee requirements, and lists of current and past franchisees.
If you want an accurate predictor of short-term success, pay attention to three-year percentage figures on franchise turnover. Double-digit figures representing this particular metric are a red flag warning you should never ignore.
Once you’ve looked over these documents, you should have a good feel for how profitable and turnkey these businesses are. The next step is getting your hands on more detailed financial data. The franchisor is required by FTC regulations to give you a copy of their disclosure document at least 14 days before you’re required to sign anything. Many will furnish these ahead of time if you ask, so put in your request as soon as you’ve narrowed down your potential franchise list.
These documents are usually extensive and can be confusing. Entrepreneur Magazine recommends investing in advice from a financial expert or business lawyer in order to really understand everything that’s found inside. A few key concerns to look at any instances of past litigation and the number of franchise outlets the company is currently operating. In particular, watch out for language like “breach of contract” or “unfair encroachment,” as these instances indicate bad franchise behavior that you’re better off avoiding.
The best way to get the real scoop on a franchise is to ask those currently involved in the business… and those who are no longer active franchise owners. Often, franchises will put you in touch with the best of the best – the franchisees that are enjoying the most success. But to get a full and balanced picture, you should contact others as well in order to get an unbiased picture of the business’s stability.
Some of these current and former franchisees will be happy to share. Others will be a little more wary. To improve the quality of the information you’re able to gather, assure these franchisees that you’ll keep everything they divulge completely confidential.
Next, ask if you can work at the franchise for a few weeks, a month or longer. Consider offering this service voluntarily – everybody loves free labor. If not, consider actually working at the franchise for a certain amount of time. This can save you a ton of hassle, legal red tape and money if you find that you simply don’t like the franchise in the first place.
Find the Funding
Once you’ve found the perfect franchise for you, you need to find the funding. Fortunately, if you don’t have a sizable savings account, there are a number of other options available to you.
Most potential franchisees will either approach the Small Business Association (SBA) or their local banks for loans. SBA loans are a bit of a hassle to get, but they tend to be more affordable and require significantly less money down than conventional offerings. Banks will often require 30%-40% down in advance and charge a lot of interest for the privilege of borrowing money. They’re also reluctant to work with first-time business owners, leading to plenty of paperwork hassles that can frustrate would-be franchisees.
Alternatively, finding a wealthy (and potentially silent) partner could be a better option for you. This could be a family member or friend, but be sure to treat any money that changes hands as a business arrangement. Draw up legally-binding documents that state each party’s responsibilities specifically and then stick to your agreement.
Other options for financing your franchise include digging into your home equity, borrowing against your 401k or getting a second mortgage on your home. These options may be the “easiest,” but they also involve your nest egg. There is significant risk involved, so be sure to balance the pros and the cons carefully before moving forward.
The key to getting any funding at all is having an in-depth and accurate business plan. A financial advisor can help you draw one of these up or you can do it yourself. However you approach it, be sure that your plan contains important details on your estimated expenses (including the franchise payment, any hidden fees or incidentals, and any additional money you expect to be putting in of your own accord), your potential profits (based on real world numbers, not exaggerated estimates) and how you’re going to get from Point A to Point B.
Always Have a Way Out
Franchises tend to peak within ten years or so. Therefore, it’s always a good idea to have a way out (and to understand the costs of each individual option). The best possible way out is to sell your franchise at a profit. If you did your homework before hand and continually research your market, you should be able to build your business in such a way that it’s attractive to potential buyers in five or ten years.
The other way out – slipping out of your contract early –will cost you. Many franchisees see this as a failure (especially first-timers), but cutting your losses and moving on is almost always better than riding a business into the ground.
If you’ve ever purchased a franchise before and would like to add further tips to this guide, share your recommendations in the comments section below!