The Dangers of Buying an Early-Stage Franchise: Part 2 of 2

By Cliff Ennico

August 21, 2018 6 min read

Now that you've assessed the viability of an early-stage-franchise business model, it's time to drill down on the franchise disclosure document, or FDD, and look for potential trouble spots.

First, look at the franchise name and logo. Are they compelling? Can people driving down the street, look at your sign and know instantly what type of restaurant it is? Since this franchise does not have the instant name recognition of McDonald's or Burger King, the name will not drive customers to your business unless it describes the customer experience. If the franchise offers Italian-themed food, a name like Nunzio's Italian Trattoria will work a lot better than Buona Sera ("good evening" in Italian), which could be just about anything — a clothing boutique, perhaps.

Look out for disconnects between the franchise name and the products and services it offers. If the name suggests wholesome, healthy food but the menu consists of greasy, high-fat, fried dishes, it will turn off your customers. If the franchise offers low-cost food, the name should not contain the word "gourmet," because that suggests premium prices in most people's minds.

Next, check the internet and the trademarks division of your state Secretary of State office to determine that there are no companies in your state using the same or a similar name. While your franchise probably has a registered trademark with the U.S. Patent and Trademark Office, it probably hasn't checked to see if the same or a similar name is being used by someone else in your state. If someone is using the same or a similar name, a nasty letter will probably be sent that asks you to "cease and desist" using the franchise trademark once you open your outlet. Make sure that if that were to happen, the franchise would assume responsibility for defending the lawsuit and indemnify you for any losses you may incur if the other company wins and you have to change your name.

Next, read carefully Items 8, Restrictions on Sources of Products and Services, and 16, Restrictions on What the Franchisee May Sell, in your FDD. The franchise should allow you to purchase your equipment, inventory and supplies from the widest possible number of sources. If the only allowed sources are the franchise itself or its affiliates — related companies that are often owned by the franchise founders or their relatives — be very cautious. The franchise system may be merely a distribution chain for the founders' products — the minute they can find an alternative distribution chain (such as supermarkets or gourmet grocery stores), the franchise system will wither on the vine.

Next, if the franchise has several much-larger competitors, there's a better-than-average chance that the franchise will merge into one of these behemoths during your initial franchise term. Ask the franchise point-blank what the founders' exit strategy is, and if they tell you they plan to sell out to another company or franchise, ask them point-blank who the likely candidates are, as you will not be allowed to opt out of the franchise once the merger takes place. Although you will be allowed to continue using the franchise model until your franchise term comes up for renewal, you will then be asked (not too gently) to convert to the new franchise model if you wish to renew.

Next, ask the franchise directly what will happen if the franchise concept doesn't work out. Will you be allowed to leave the franchise and continue operating your restaurant under a different name (and perhaps a different menu)? Or will you have to shut down and eat your losses? Established franchises will never agree to let you continue in business once your franchise terminates, but since an early-stage franchise cannot offer you the comfort and assurance that a more established franchise can, it should be more willing than an established franchise to share the risk of failure with you and set you free if things don't work out. After all, if you are still the only franchise operating in your state, the franchise isn't giving up much by allowing you to compete with them if things don't work out.

Last but not least, if you are the first franchisee in your state, consider buying a master franchise or area-development rights for the entire state. If the franchise concept works out, this will give you the right to develop additional outlets (area-development rights) and/or the right to sell franchises to others (master franchise). Many of the wealthiest people in the Burger King franchise chain have never flipped a burger in their lives. They were the ones who bought master territories during its early years and now spend their lives collecting franchise fees and royalties from individual franchisees each week, deducting their percentage cut and remitting the balance to franchise headquarters. Not a bad way to make a living, no?

The franchise will charge additional fees for this and may impose a development schedule requiring you to open X number of outlets each year in order to keep your master territory. But given how small this franchise is, now is the time to jump if you really, really believe in the concept.

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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The Dangers of Buying an Early-Stage Franchise: Part 1 of 2

The Dangers of Buying an Early-Stage Franchise: Part 1 of 2

By Cliff Ennico
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