If considering the purchase of a franchise (or any other business for that matter), you’ll soon encounter the term “due diligence.”
It’s defined as, “a comprehensive appraisal of a business by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential.”
It’s important, too, when buying a franchise. Startup expenses can be considerable. To begin, you’ll incur professional fees for an attorney and an accountant. Depending on the kind of business you’re buying, there may be costs for business licenses, insurance, inventory, equipment, rent, signage, and worker training, not to mention building out a store or office if opting for a brick-and-mortar operation. While not always required, purchasing your own real estate can be a significant, separate expense.
Other initial expenses are those associated with your grand opening including advertising and promotional costs. And, after you open, you’ll have to contend with maintenance, rent, salaries, supplies, utilities and other ongoing expenses — including interest if you have a loan.
Now consider the franchise itself. Most franchise fees run from $50,000 or $75,000 to $200,000 or more to get started. These cover the right to use the brand name, logo and more. Your commitment can be lengthy. Some franchise agreements run for as long as 20 years. Ongoing royalties usually range from 4 to 8 percent of gross revenues and often include a regular assessment for advertising (2 to 4 percent).
Another financial factor? Your opportunity cost. If it’s a business that requires purchasing land and building a structure, you could be “out of pocket” for up to a year (or more) before any revenue rolls in!
Beyond dollar and cents, your satisfaction is also at stake. A franchise often represents your dream to own a business and operate it your own way — subject, of course, to the rules of the franchising organization.
In short, it’s an opportune time to look closely before you leap. And, that’s where due diligence comes in. Here are some best practices that will guide your efforts:
• Interview current franchise owners. You’ll want to ask them how are their business is doing? How long did it take to turn a profit? How supportive is the franchising organization? And, what’s their work-life balance? Answers to these questions (and more!) will help you decide whether to pursue a franchise opportunity.
• Reach out to former franchisees. No longer “part of the system,” previous franchise owners will be a key source of information—and perhaps more candid insights. What’s their opinion of the parent company? Why did they sell their franchise? And, did the franchisor offer any assistance with an “exit strategy?” After all, someday down the road you may be looking for similar help.
• Visit the franchisor’s headquarters. This is your chance to learn first-hand about any support systems in place to help franchise owners. Equally important, you’ll gauge the franchisor’s interest in you, their responsiveness and professionalism. It’s a great time to determine if you’ll be a good fit for them and if they’ll be a good match for you. As part of this key step in the due diligence process, you’ll also want to arrange visits to several franchise locations.
During your visit, be sure to consider the culture of the operation. Just like any organization, each franchising company has its own culture. Some are highly ridged, accepting of little input from franchise members and adhering to very strict policies and procedures. Some buyers welcome the structure while others will feel comfortable in a more open, flexible environment where franchisees are given more latitude to make some decisions on their own.
Another important consideration is the franchise leadership team. Have they spent time “on the front lines” working in the industry they represent? Or, or are they strictly administrative professionals who know a lot about franchise documents and compliance but have very little understanding of the business their owners are engaged in on a day-to-day basis?
• Review franchise documents personally. Should you engage an attorney to review the Franchise Agreement (and Franchise Disclosure Document), even when most franchisors say they’ll allow no changes to the documents? Many would advise doing so, especially if you enlist one who has who has seen lots of Franchise Agreements. They can tell you if the agreement is standard or point out anything that might be unusual or severely restrictive. It doesn’t mean you won’t sign the agreement, but it will help you understand what you are signing up for.
Of course, you won’t want to leave it to your lawyer alone to evaluate these documents. Read them from cover to cover. Take notes. Ask questions. And, gain a complete understanding of franchise royalty rates, territorial rights and more. If you join the system, these are terms and conditions you may be living with for years, if not decades!
• Compare a franchisor’s documents to others. If considering several franchise opportunities, weigh the Franchise Agreements and Franchise Disclosure Documents against one another. Even if evaluating only one opportunity, see if you can obtain documents from other systems — perhaps through your attorney. Doing so will help you determine which terms are most favorable … or if any are unusual enough to raise caution flags.
• Examine the franchisor’s Financial Statements. These will be included as part of the parent company’s Franchise Disclosure Document. If you’re not thoroughly familiar with reading and understanding Financial Statements, enlist the assistance of an accountant — preferably one who’s experienced with small businesses or, better yet, with a franchised operation.
• Consider all franchising opportunities. Even you’ve dreamed of owning a specific franchise, it’s smart to evaluate other options. Another similar franchise organization may offer better support. A once-promising industry may be in decline with diminishing prospects for growth, giving you pause. And, with thousands of franchises from which to choose, there are likely more than a few you’ve not yet considered. Some of the more unusual ones specialize in anger management, beef jerky sales and crime-scene cleanups!
A final tip? Take your time and use the due diligence process to find out as much as you can about the best way to fulfill your dream of owning your own business. By touching all the bases early on, you’ll gain confidence that your ultimate franchise purchase decision is the one that’s best for you!
