Before You Buy a Franchise: Part 2

By Cliff Ennico

May 30, 2017 6 min read

Are you thinking about buying a franchise?

If so, here are more tough questions you should ask the franchise management team after reviewing its franchise disclosure document, or 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, McDonald's restaurants menus were changed to offer breakfast all 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 and 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 cruise ship 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 cover 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 and 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 percent 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, or 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, usually five, 10 or 15 years. If, despite your best efforts, things just don't work out and you want to exit, 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: Most franchises will let you out of your agreement regardless of what it says as long as they are convinced you did the best you could and as long as you agree to the following:

—Not to sue the franchise or badmouth it to prospective new franchisees when they call to ask 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).

—(Sometimes) To pay 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 3 of the franchise FDD, 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 this 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, or IPOs, of their stock, most will exit by merging with or being acquired by another franchise or a large corporation.

Ask the franchise 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 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 modification of your basic rights.

Cliff Ennico ([email protected]) is a syndicated columnist, author and former 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 webpage at www.creators.com.

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