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

By Cliff Ennico

August 14, 2018 6 min read

"My husband and I have been looking to buy a fast-food franchise for some time. The problem is that we cannot afford the large upfront fee that most established franchises want. We recently found a franchise that we really like, and the upfront fee is only $10,000. The problem is that the franchise is only five years old. We would be only the third franchise outlet, and the only one in our state. What are some of the questions we should be asking this franchise so we can make sure we're not throwing our money away?"

The main reason for buying a franchise, as opposed to starting a business from scratch, is that the odds of failure are much lower. The franchise model has been proven successful in dozens, if not hundreds, of locations around the country: The franchise name has instant brand recognition throughout the country; the franchise has experienced management who will train and coach you in the operation of the business; and the franchise will support you during the tough times.

Simply put, a franchise with only three outlets in one small area cannot give you that. If the franchise owners are honest, they will admit that upfront. Both you and the franchise are taking a risk — a big one — that this will work.

First, look at the cost of getting this franchise up and running. Since this is a fast-food franchise, your total upfront costs will be a lot more than $10,000. If you look at the franchise disclosure document (FDD) for this franchise, look at item No. 7, the estimated initial investment, which breaks down the estimate of what you would have to spend to get your restaurant up and running. Do not be surprised if the total cash outlay is in the $100,000-to-$150,000 range.

For a franchise this small and this localized, I wouldn't rely on the estimates in the FDD, as costs vary widely from one part of the country to another. A franchise that operates successfully in Wyoming or Montana — where real estate and labor costs are relatively low — may not be as successful in high-cost regions like California and the East Coast. Do a reality check, and get quotes from local contractors, insurance and real estate brokers, and advertising outlets to find out what your actual costs would be.

I'm a little concerned that this franchise isn't growing rapidly — only three restaurants in five years? Now, that could be because it is working the bugs out of the system and growing cautiously to avoid mistakes. But it could also be because no one is excited about the business. An early-stage franchise with rapid and consistent growth is a lot more reassuring. Look at item No. 17 in the FDD, outlets and franchisee information, to find out when each restaurant was opened. If all three were opened five years ago, when the franchise first started (and the U.S. economy was going gangbusters), and there have been no new outlets since, that's a big red flag.

Next, look at the franchise menu offerings and ask: Will they fly in my part of the country? People in Southern California eat a lot of stuff that people in New England don't. Now, perhaps that's just because there aren't enough restaurants offering that type of food in the northeast. Once people in your area sample your menu, they may fall in love with it and you may have a hit on your hands. (There were no sushi bars anywhere in the U.S. until the early 1980s, but now they're in every strip mall.)

Or maybe it's because people in certain parts of the country don't go out of their way for that type of food. A soup-only restaurant may do great in New England during the winter months, but will it thrive in August? Will it thrive in Texas any time of year (unless, of course, there's chili on the menu)? Will people in the Midwest consume all-natural fruit smoothies more than once a week?

Next, look at the franchise management team: Does it have significant experience in the fast-food industry, in this particular type of fast food and in franchising in general? The biggest reason for buying a franchise, as opposed to striking out on your own, is that you will receive extensive training and support in the franchise business. If a fast-food franchise is being run by people with a background in furniture retail, or people who developed the recipes but don't understand the business side, don't buy the franchise.

Also, is there depth in the management team? I recently reviewed a franchise agreement for a franchise whose entire management team consisted of one person: the founder. All the franchise training is conducted by him personally; he drives or flies to your area personally to help you pick out your franchise location; and he's the person you call (on his cellphone) if you have questions. Now, that's OK — I'm all in favor of franchise executives rolling up their sleeves and getting their hands dirty in the details — but were this guy to get hit by a truck (or have a heart attack from lack of sleep), you would be on your own.

More next week ...

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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