Business Ownership: Starting a Small Business FIGURE 5.9 BUYING A FRANCHISE
Since buying a franchise is a major investment, be sure to check out a company’s financial strength before you get involved. Watch out for scams too. Scams called bust-outs usually involve people coming to town, renting nice offices, taking out ads, and persuading people to invest. Then they disappear with the investors’ money. For example, in San Francisco a company called T.B.S. Inc. sold distributorships for in-home AIDS tests. It promised an enormous market and potential profits of $3,000 for an investment of less than $200. The “test” turned out to be nothing more than a mail-order questionnaire about lifestyle. A good source of information about evaluating a franchise deal is the handbook Investigate before Invest-ing, available from International Franchise Association Publications.
Checklist for Evaluating a Franchise
The Franchise
Did your lawyer approve the franchise contract you’re considering after he or she studied it paragraph by paragraph? Does the franchise give you an exclusive territory for the length of the franchise? Under what circumstances can you terminate the fran-chise contract and at what cost to you? If you sell your franchise, will you be compensated for your goodwill (the value of your business’s reputation and other intangibles)? If the franchisor sells the company, will your investment be protected?
The Franchisor
How many years has the firm offering you a franchise been in operation? Does it have a reputation for honesty and fair dealing among the local firms holding its franchise? Has the franchisor shown you any certified figures indicat-ing exact net profits of one or more going firms that you personally checked yourself with the franchisee? Ask for the company’s disclosure statement.
Will the firm assist you with A management training program? An employee training program? A public relations program? Capital? Credit? Merchandising ideas? Will the firm help you find a good location for your new business? Has the franchisor investigated you carefully enough to assure itself that you can successfully operate one of its franchises at a profit both to itself and to you?
You, the Franchisee How much equity capital will you need to purchase the franchise and operate it until your income equals your expenses? Does the franchisor offer financing for a portion of the franchising fees? On what terms? Are you prepared to give up some independence of action to secure the advantages offered by the fran-chise? Do you have your family’s support? Does the industry appeal to you? Are you ready to spend much or all of the remainder of your business life with this franchisor, offering its product or service to the public?
Your Market
Have you made any study to determine whether the product or service that you propose to sell under the franchise has a market in your territory at the prices you’ll have to charge? Will the population in the territory given to you increase, remain static, or decrease over the next five years? Will demand for the product or service you’re consider-ing be greater, about the same, or less five years from now than it is today? What competition already exists in your territory for the product or service you contemplate selling?
Sources: U S. Department of Commerce, Franchise Opportunities Handbook; Stove Adams, “Buying a Brand: Patriot Ledger (Quincy. MA), March 1. 2008.
franchisee A person who buys a franchise.
Disadvantages of Franchises There are, however, some potential pitfalls to franchising. Check out any franchise arrange-ment with present franchisees and discuss the idea with an attorney and an accountant. Disadvantages of franchises include the following:
1. Large start-up costs. Most franchises demand a fee for the rights to the franchise. Start-up costs for a Cruise Planners franchise range from $2,000, but if it’s Dunkin’ Donuts you’re after, you’d better have a lot more dough—approximately $1.7 million.26
2. Shared profit. The franchisor often demands either a large share of the profits in addition to the start-up fees or a percentage commission based on sales, not profit. This share is called a royalty. For example, if a franchisor demands a 10 percent royalty on a franchise’s net sales, 10 cents of every dollar the franchisee collects (before taxes and other expenses) must be paid to the franchisor.27