Taken from:http://www.franchisefoundations.com/generic3.html
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. Many new start-ups end as failures.
Franchising represents a different 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. Some 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:
has itself successfully operated the concept being franchised for at least five years at multiple locations;
is not plagued by litigation or complaints from disgruntled franchise owners; and
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
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. On the other hand, don't assume a six-figure investment will lead to a six-figure income. Be realistic and conservative. 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"). Also, the working capital estimate (called ' additional funds' in Item 7 of the company ' s offering circular) does NOT cover operations up to the breakeven point. It only covers a short initial phase (usually only three-months) of operating costs. As the breakeven point (where revenues cover all operating costs) may not happen for one, two or more years, it ' s imperative to have enough reserve capital to reach this point. In many cases, this may be more than the total initial capital amount. Don ' t ever forget the name of Item 7 in the Franchise Offering Circular: ' Estimated INITIAL Investment. ' If you don ' t have enough capital to reach the critical break even point, your entire investment will go down the drain.
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 a franchise company? 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. A seasoned franchise management infrastructure must be in place. 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, forty-hour work week? Life is too short for the seven-day, sixty to eighty hours a week, workaholic lifestyle, that destroys health, family and pocketbook. Financially, we've calculated the true hourly rate for franchise owners who work these workaholic hours and discovered many are making less than minimum wage.
MINIMUM NUMBER OF EMPLOYEES
Can you operate the business with 5 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 royal pain in the ..... Well, you know what we mean.
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 a much longer 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, then 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? Find this out BEFORE you invest by working for a couple weeks in an outlet owned by one of the existing franchise owners.
TRUE FRANCHISE VALUE
Buying a franchise from a ' blue chip' franchise company that has spent decades and hundreds of millions on advertising to develop their brand can make a lot of sense. These companies have ' true franchise value' that compensates for the long term disadvantages of ongoing royalty and advertising fund payments. Often these payments literally mean the different between earning a profit or operating at a loss. In unknown franchise chains, you the franchise buyer are building their brand from scratch, and are at a severe, long term competitive disadvantage. In these chains, you have to ask yourself a simple question. What value is the company giving you that you couldn ' t learn on your own by working at one of their locations as an employee for a couple months? Truth be told, what most unknown franchise companies are really selling is just a business opportunity ? teaching you how to get into a new business venture. But unlike a business opportunity seller that charges a one-time fee to help get you into business, they call it a ' franchise' and charge ongoing royalty and advertising fund fees like they're a McDonalds or other blue chip franchise company. The reality is they're not a McDonalds-type franchise - not even close to one. In the majority of these lesser-known franchise chains, you'd be much better off starting an independent business on your own. You can learn most or all of their so-called secrets' in the franchise interviewing process and by talking to (and possibly working a short time for) existing franchise owners.
FRANCHISE PROFITABILITY
Dr. Timothy Bates ' study released in 1993 by the Entrepreneurial Growth and Investment Institute in Washington , DC was the first to compare the profitability of franchised and nonfranchised firms. In his analysis of some 7,270 firms over his test period, Dr. Bates found that startup capital for a franchised business averaged $85,293 compared with average startup capital for nonfranchised firms of $30,156. In 1987 nonfranchised firms reported average pre-tax net income of $19,744 as compared to a loss of (-$1,548) for franchised firms. Dr. Bates concluded ' Despite their larger revenues, much better capitalization, and their supposed advantages of affiliation with a franchisor parent firm, the franchisees lag behind cohort young firms in profitability and rates of survival.
FRANCHISE BROKERS
Does the franchise you are considering 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.
CLOSING REMARKS
Remember, you are the only guardian when it comes to your franchise investment. It ' s definitely an environment where the phrase ' Buyer Beware ' applies. The franchise disclosure laws, while requiring franchise companies to give you certain, limited information, don ' t come close to protecting your interests. For example, as discussed above, Item 7 of the Franchise Offering Circular only requires an estimate of additional funds for 90 days as part of the investment information. But economic reality is you need to know the additional funds you ' ll need to reach the break even point, which can be years away, or your entire ' initial ' investment will go down the drain. You ' d think this type of information would be required, but it ' s not. Finally, don ' t ever assume that because a company has registered its Franchise Offering Circular in your state, someone at the state has approved or reviewed the document in your favor. Registration is obtained by simply forwarding documents and paying a filing fee. In most cases, franchise offering circulars are given an extremely limited review to ensure state-specific disclaimers are present. I remember filing a registration application for a franchise company in a state that has a reputation for being one of the ' toughest ' franchise registration states. After the three week review period set forth in the statute had gone by, and not hearing anything, I called the examiner assigned to the application. After looking through his files, he finally found my client ' s offering circular and application. After apologizing for entirely misplacing the file, he promised to immediately review the application and call me back. Ten minutes later, he called and said he was making the registration effective that day. Ten minutes of review and the franchise company was given the state's green light. So, before you sign on the line and make what will undoubtedly be the most serious financial and emotional commitment of your life, get all the facts and figures. An indispensable level of inquiry is whether you ' re getting true franchise value and whether you ' d be better off doing the business on your own. In the overwhelming majority of franchises touted by unknown companies, franchise value isn ' t there and doing the same thing independently makes better economic sense and decreases the risk of failure.
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