Evaluating Franchise Investments - Tips From The Experts
By: By Kevin B. Murphy, B.S., M.B.A., J.D. on Sep 14, 2012 02:21:06 PM

Evaluating Franchise Investments - Tips From The Experts

 

Contents

Millions of people dream about owning their own business. Having the independence that being your own boss brings, the security that no one can fire you, enjoying a good income - and for the most successful - the accumulation of wealth and prosperity. Unfortunately, the cards are stacked against a new small business making it big - or making it at all. An endless stream of problems makes competition from large, sophisticated chains just too intense. Most new start-ups end as failures.

Franchising represents a more viable approach to business ownership. For a price, the parent company teaches its proven business methods to the franchised-operator who shoulders all operating and financial responsibilities of the outlet. The statistics are impressive: over 40% of all U.S. retail sales are through franchised establishments. While giants like McDonalds, H&R Block, 7-Eleven and Radio Shack are familiar, household names, franchises are available in a wide range of industries. The list of 3,000-plus franchise companies span over 100 different categories. But just as franchising represents a chance to get rich, it's also a chance to get stung. An alarming number of franchised operators make less than the minimum wage, working seven days, sixty to eighty hours a week, pursuing an expensive and elusive American Dream that turns into a nightmare.

What follows is a bottom-line check list of tips compiled from leading franchise experts that will help you eliminate 95% of the companies you are considering. Then, you can concentrate your efforts on the 5% "cream" of the crop" companies that deserve consideration. This check list assumes the franchise company: (1) has itself successfully operated the concept being franchised for at least five years at multiple locations; (2) is not plagued by litigation or complaints from disgruntled franchise owners; and (3) has a balanced, fair franchise contract.

Industry Trend

Is the franchise in a cutting-edge industry that is doing well currently and is projected to do well in the future despite any economic slowdown? Education and home-improvement services are stable categories. Food is over-saturated generally, and except in exceptional circumstances, is not worth the high investment, headaches and marginal income.

Total Initial Investment Required

In general, don't expect a franchise that requires a five-figure initial investment to produce a six-figure income. As with most things in life, you get what you pay for. Is the total initial investment range (including working capital) $125,00 or less; and the maximum investment less than $200,000? You can find solid companies in this investment range if you're willing to look around. Don't forget to consider long-term financial commitments, particularly the real property lease (see discussion below under "Leasing And Location").

Real Business

Is this a legitimate retail business, as opposed to a "work out of your home" operation? The vast majority of work out of your home concepts produce marginal income at best.

Management Expertise

Does the management team have executives with demonstrated past achievement and experience in operating other franchise companies? If not, this is a big RED FLAG. Many companies enter franchising and fail to realize they are in a brand new business - one requiring entirely different management skills and abilities. If the management team lacks strong franchise credentials, you might as well take a trip to Las Vegas with the money you're intending to invest. Your chances of making vs. loosing money are roughly equal.

Normal Working Hours And Days; Sufficient Income Level

Will the nature of the business allow you to work a normal five-day, fourty-hour work week? Life is too short for the seven-day, sixty to eighty hours a week, workaholic lifestyle,that can destroy health, family and pocketbook. Financially, the true hourly rate for franchise owners who work these workaholic hours is often less than minimum wage.

Minimum Number Of Employees

Can you operate the business with five or fewer employees? Managing dozens (or hundreds in the case of some fast-food operations) of minimum-wage teenagers who are constantly quitting or simply not showing up for work is a sure formula for stress.

Leasing And Location

For most retail franchises, the triple net lease of the location is the biggest financial commitment, larger than the total franchise investment. Yet, the typical real estate lease and its ramifications are not required disclosure in any Franchise Offering Circular (FOC). For example, an estimate that you'll need 2,000 sq. feet of space with expected rental of $5 to $10 a foot per month is normally disclosed in the FOC's initial investment table as Leased Real Estate $10,000 to $20,000. A footnote to the investment table may say "assumes 2,000 sq. ft. at $5 to $10 a foot." But, that's only the beginning of the story. The lease is normally a 5 to 10 year triple-net lease. So, the financial commitment made when the lease is signed is at least $600,000 (at $5/foot for 5 years) to $2,400,000 (at $10/foot for 10 years). And this doesn't include substantial, additional obligations to pay all of the landlord's yearly property taxes, insurance, common area operating expenses, etc. Key questions to ask here: (a) is the franchise you're considering one that can be operated in a low rent commercial business zone? Avoid franchises requiring the costly expenses and triple-net leases of a visible retail storefront and the extravagant rent associated with areas of high foot traffic, like shopping malls or strip centers. You'll sleep much better at night. (b) What's your total financial commitment under the lease? (c) Do you have sufficient liquid assets (or a willing, sufficiently liquid third party guarantor) to meet the landlord's lease qualification standards? If you don't, you might as well forget about investing in the franchise. Or even worse, getting involved in a questionable franchise, realizing you've made a big mistake - only to discover you're on the hook for a $500,000+ lease obligation.

Image And Lifestyle

How does flipping burgers, scooping ice cream or cleaning restrooms fit the image of what you want to do for a living? Investing in a franchise will be the most important psychological and financial decision you ever make. Does the typical working day of the franchise you are considering fit your personal image and desired lifestyle?

Franchise Brokers

Does the franchise company have its own in-house marketing department, or does it utilize outside franchise brokers? The use of franchise brokers is a definite red flag. First, it indicates the franchise company is not very serious about who it lets into the franchise network (or even worse, they're desperate to sell franchises). Second, franchise brokers receive a substantial commission up to 50% or more of the franchise fee you're paying the franchise company. They definitely do NOT have your best interests in mind and will do whatever they can to close a deal. This accounts for the common observation that franchise brokers tend to give glowing recommendations for all franchises they represent. A detailed analysis often reveals these highly touted franchises produce mediocre or even below minimum wage financial performance. Yet franchise brokers won't mention this, and individuals continue to rely on their recommendations, believing the broker represents them. Nothing could be further from the truth.

About the Author: Kevin B. Murphy, known in the industry as "Mr. Franchise", is a San Francisco Bay Area attorney, author, instuctor and expert.

 

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