Franchising FAQ’s

Purchasing a franchise is a big investment, so be sure to get your questions answered before taking the plunge.

Franchising FAQ’s

Here is some useful advice to address some common concerns when researching a franchise.

Readers have almost as many questions about franchising as there are franchises to buy. Here are answers to recent questions.

Q: I’m interested in buying a fast-food franchise. But I’m not sure that I have enough saved to cover the entire transaction. Is it possible that a franchisor will help finance my purchase of an outlet?

First the good news. More and more big franchisors offer financing to those who would buy their franchises.

And the bad news: It’s tough to qualify for those financing deals as a first-time franchise buyer. The good news about franchisor financing stems from the fast growth of the franchising industry. For most people, coming up with the initial fees, licences and start-up costs is a significant investment. Whether franchisors will lend to a first-time buyer of a franchise depends on many things, including how much you invest and your track record as an entrepreneur. Any bruise on your personal credit history is likely to disqualify you.

Some franchisors have relationships with third-party finance companies and banks that specialise in lending to their franchisees.

For the franchisor, how much to lend franchisees is a tricky question. If a franchisor is too aggressive in its financing, it could saddle some of its franchisees with debt that may be too difficult to repay, which is in no one’s interest.

Franchisors need to draw a line between lending for ‘hard’ and ‘soft’ costs. For instance, it might make sense to finance a franchisee’s acquisition of real estate. But franchisees who seek funds for the initial licence fee or employee training will probably be too strapped to make the enterprise work.

Other good news on the borrowing front: Since franchising has experienced such a boom, the industry has established a track record that raises the comfort level for mainstream banks.

If you’re a first-time franchise buyer, you’d best have sterling credit and a nice nest egg to qualify for these programmes. Otherwise, if your heart is set on buying a franchise, you may have to save a while longer.

Q: What are the common issues that franchisees overlook when reviewing a franchise contract?

Just like in life, it’s not what we anticipate and fret over that gets us. It’s the odd banana peel that throws us into a skid as we run for the bus. In acquiring a franchise, most people thoroughly examine the fees, the long hours and the financial commitment required, looking at those issues from all angles. But rarely do they give sufficient attention to the terms of ending the franchise agreement. That’s always the one thing they don’t think about.

This isn’t like planning your divorce before you get married. There are all sorts of legitimate reasons for franchisees to end their relationships with their franchisers. They may just want to sell the business after a good run. A health issue may arise, or a spouse receives a job offer in another town, or they may decide that they’ve made a horrible mistake and just plain hate what they’re doing.

When the time comes to end things, you might find yourself obliged to pay fees even after you’ve shuttered your business, or endure other unpleasant and unexpected terms.

Here are some things to watch out for. Beware of an agreement which gives the franchisor the right to buy your franchise under a predetermined formula. You might do far better selling it on the open market.

Another scenario: You’ve paid all your current fees to the franchisor for three years, but now want to end a five-year contract. Even if you’re closing your business, you may owe the franchisor for the fees covering the remaining two years on the agreement.

Some of these issues are negotiable going in, depending on the franchise. One rule of thumb: the bigger, better-known and generally more desirable franchises typically have fairly standard, cookie-cutter-type contracts that leave little room for negotiating these terms. Meanwhile, it’s buyers of newer franchises who tend to have more leverage to draft the language addressing their exit.

Need we say this aloud? You must find a reputable attorney in the franchise field, one who is knowledgeable about these issues and will ensure you understand and can live with the terms of ending the franchise agreement. Get referrals from the local bar association and other franchisees.

Another troubling area for neophyte franchisees as they execute their purchase agreement: an over-emphasis on territory. Very often, a franchisee feels greedy about territory, assuming the bigger, the better.

Actually, the opposite is often the case. With more franchises already operating in a given city, a market presence is likely to exist for your business before you invest your marketing money. Many have cost-sharing plans for advertising that give you a bigger bang for your advertising buck.

Don’t forget to look beyond the contract. Take your time and interview as many franchise owners as you can. Ask questions like: ‘Knowing what you know now, after several years with the franchise, would you do it again?’ and ‘What surprised you after you purchased your franchise?’

If it takes you three weeks to do that, so what? Consultants can do this research for you, should you desire, but it’s best for you to get this information firsthand and write a report for yourself about what you find, looking for trends. At the end of this process, you’ll have very useful information.

Q: I’ve made a deposit on a pizza franchise. The franchisor has 40 stores in Gauteng and Mpumalanga. It wants to expand into Cape Town, and I’d be the first one there. Is this a good idea?

You sound a bit ambivalent about the fresh territory, which is understandable. Franchise buyers generally regard territory in one of two ways.

One is that the best territory is a big and lonely expanse. You plant your flag and declare dominion over all you survey, proclaiming all of Cape Town’s pizza lovers are mine, mine, MINE!

Other franchisees prefer the safety-in-numbers approach. You join a battalion of pizza purveyors sharing turf as well as your advertising costs and marketing presence. Together you impart a sense of scale, marching in lockstep to conquer the world with your many convenient locations.

If you buy the franchise in Cape Town, you belong to the first group. If you buy in the Gauteng area, you are in the second example.

Franchises differ in how they address territory, of course. Some offer ‘protected territory.’ Under these agreements, the franchisor promises that you have a certain specified turf to yourself. It could be defined by geography, demographics or other parameters.

Others scatter their franchises or crowd them where they like. It’s been a subject of litigation over the years, often with franchisees suing to keep their parent franchise from opening a new store down the street.

You’re in an interesting spot. Judging by its expansion in the region, your franchisor appears to have done quite well in the Gauteng area. Whether this translates into happy franchise owners you must discern from your own research. You’ve done that, right? Including talking to other franchisees?

You may be in a fortuitous position. If the franchisor is very interested in expanding, it’s going to want to help the first franchise in a new market.

To a great extent, the success of the franchisor in a new market depends on your success. So don’t be shy asking for help. Sometimes that may come in the form of financing, perhaps, or negotiating your lease. These are things you’d like to negotiate with the franchisor.

One issue for a franchisee in your position to address is the advertising and marketing agreement. Typically, the franchisees kick in a percentage of revenue toward advertising. Will you be paying to advertise in Gauteng? Will the Gauteng stores be paying for advertising in Cape Town? Or are there national advertising buys that help all?

Q: What franchises are good for absentee owners?

If you are searching for a franchise that is more of an investment than a lifestyle, they are out there. It depends on the franchise. For some franchises, it’s entirely possible, and, for others, it doesn’t make economic sense or is expressly forbidden.

This is an important issue for franchise chains, and it doesn’t take a genius to see why. A business can only benefit from on-site ownership. No one has a stronger incentive in the success of the business, after all, than the owner with his own capital at risk. Many franchises have become well-known for the long hours required to run their businesses – rising at 3am to make the doughnuts – a far cry from the distant oversight you envision.

For that very reason, many franchises demand an on-site owner, and make it a condition of franchise ownership. McDonald’s Corp franchises, for instance, are famous for turning away passive investors and corporate owners, and only accepting owner-managers. With people lining up for a chance to buy a McDonald’s, it can afford to be picky in the selection of its franchisees.

Most franchisors strongly prefer owner-operators. A franchisor selects franchising as a method to expand the business in part to have someone share the risk, and to have an owner with the vim, vigour and vitality to grow the business. Unlike the owner, the typical manager can too often say: I’m off the clock, that trash on the floor is someone else’s problem.

Look for exceptionally strong systems and effective marketing plans, factors that you wouldn’t control even if you were hovering like a nervous mom over the premises every day. Look to well-established chains that have worked the kinks out of their systems. Someone else is going to be following these blueprints, and the more specific, the better.

Food operations are poor candidates for absentee owners, because the detail work and interaction with customers is so important. On the other hand, an absentee-owner might do well with, say, brake or muffler shops, or hair salons.

An absentee owner requires an excellent manager, of course, someone with a track record of integrity and results. Less important is that the manager has experience in that particular franchise. If you are part of a good franchise system, an experienced manager can follow the plan.

Economies of scale also come into play. A small franchise, especially in its early phase, may not throw off enough cash to support a strong manager with profits left for you. It’s likely to be a different case, though, for the owner of several franchised units, all operating under one manager. So, going into this, you’ll require a reasonably good sense of sales and profits, which only a few franchised operations will project. You’re likely to discern this important information only by talking to other franchise owners in the system.

You still will have to figure out a way to stay close to the business, whether it’s reading through the data generated by automated reports or talking frequently to your manager. Nothing substitutes for the unannounced drop-ins. It’ s the best way to detect dirty floors or rude employees before those issues translate into anaemic sales.

Franchise Zone
About the Author
Franchise Zone is published by Entrepreneur Media SA. It offers advice and franchising opportunities in South Africa.

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