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How to Evaluate a Franchise Opportunity

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This post is part of a series called Buying and Running a Successful Franchise.
How to Find Good Franchise Opportunities
How to Decode a Franchise Disclosure Document and Franchise Agreement

If you’ve been following our series on buying and running a successful franchise, you’ll know that we’ve put a lot of emphasis on doing your research before buying a franchise.

But what does that research involve, exactly? That’s what we’re going to cover in this tutorial.

The first two tutorials were about understanding how franchising works, and generating a shortlist of promising opportunities. In this one, we’ll take you step by step through the process of researching and evaluating each opportunity on that list. We’ll show you how to assess the business plan, what questions you need to ask, what extra research to do, and we’ll list some common mistakes to avoid.

Before making a final decision, you’ll also need to read and understand the Franchise Disclosure Document (FDD) and the franchise agreement. These documents are so important that we’re going to cover them in a separate tutorial. For now, we’re looking at all the other research you can do beyond reading those documents.

Step 1: How to Evaluate the Business Plan

The first step is to understand the business plan you’re buying into. You should be able to gather a lot of this essential information from the franchisor’s website or from other materials they provide. 

At a very basic level, how does the business make money? If it’s a simple retail operation like a convenience store or fast-food restaurant, that should be pretty obvious, but franchises can cover a wide variety of business types. If you’re getting into a less familiar type of business, make sure you understand the basic model for generating profits.

Beyond that, you need to look at what makes that business unique. Imagine yourself running the franchise, and ask yourself how you would sell it to customers. If it’s a burger joint, for example, what makes it different from well-known brands like McDonald’s and Burger King? Is it cheaper? Better quality food? Better service? Why would a customer choose your business over another?

Check out the demand for the products or services you’ll be selling, and how well that demand is currently being served in your area. Sticking with the fast-food example, you could count up all the existing fast-food restaurants in the area you plan to open a franchise in, plot them on a map, and see what the coverage is like. Are there any areas that are poorly served? If there are already dozens of competitors, ask yourself if there’s space for your business to thrive. Visit existing restaurants and see how busy they are. Maybe even do some polls and customer surveys, asking people whether they’d visit your restaurant.

The success of a business, after all, is largely driven by the traditional laws of supply and demand. If there’s a large demand for your product or service, and little supply, you should thrive. If the balance is tilted towards the other end of the scale, you’re likely to struggle.

Look at how much money you’ll have to invest yourself, whether the franchisor will help with additional financing, how much you’ll have to spend on buying or leasing real estate and equipment, and what kind of support you’ll get in terms of advertising and marketing. You want to estimate how quickly you can break even, and gauge the long-term prospects for the business.

Step 2: Key Questions You Need to Ask

Beyond reading, of course, you need to ask lots of questions. Pay particular attention to the source of any numbers or profit estimates you’re given, and don’t be afraid to ask the franchisor for extra details. Here are some key questions to ask:

1. How Long Have You Been in Business?

A long track record is no guarantee of success, but it should at least give you some comfort. If the franchisor has been operating for decades, it’s more likely that the business model has been refined and improved over time. If it’s quite new, it’s not necessarily a red flag, but you’ll need to pay more attention to the background of the key executives, and be a bit more skeptical about any estimates or promises.

2. Can You Provide Earnings Estimates, and What’s the Basis for Them?

Often, franchisors will give estimates of how much you can expect to earn. But the Federal Trade Commission warns that the numbers can sometimes be misleading. So ask them to substantiate any earnings estimates—if they claim an average income is $100,000 a year, for example, is that figure inflated by a few very large franchise units, or is it truly what you can expect to earn yourself? How does the income vary by location? If revenue figures are provided, ask for profits instead—you want to know the bottom line.

3. What Training is Provided?

One attraction of franchising is the support offered by the franchisor to newbie franchisees. But the amount of training can vary widely, so you need to understand exactly what’s being provided. How long does it last, and what form does it take? Is there any additional cost, or is it included in the franchise fee?

4. What Controls or Restrictions Are There?

As we discussed in the first franchise tutorial in this series, franchises often place significant restrictions on what you can do, to enforce uniformity across the brand. Make sure you understand what these restrictions are. Will you be forced to buy particular products, or comply with design standards, and what will the costs be? Will you be restricted from offering particular services, or from operating in certain territories?

5. How Does the Marketing Work?

Another attraction of franchises is the ability to take advantage of a bigger brand with name recognition and marketing clout. But check the details of how marketing will work. Sometimes you’ll have to pay into a marketing fund, but the publicity may not directly benefit your business. So ask what’s provided, how much it costs, and whether it’s mandatory to keep paying in if you’re not seeing results.

6. How Do You Resolve Disputes?

You may not want to start a business relationship by asking a question like this, but it’s important to understand it. Disputes between franchisor and franchisees can happen for any number of reasons, and you need to know what the process is for resolving them. Also find out if there are any pending lawsuits against the franchisor.

As well as asking these questions directly, you can also research the franchise online, for example by checking with the Better Business Bureau to find out if there have been any complaints against it, or by checking out the articles and forum discussions on a site like UnhappyFranchisee.com or BlueMaumau.org to find out about any negative franchisee experiences.

Step 3: More Research You Need to Do

Once you’ve done your research and asked plenty of questions of the franchisor, it’s time to interview other franchisees. The franchisor may supply you with some references, but like any references or testimonials, they’re likely to have been selected because they’ll say something positive. So by all means contact the suggested franchisees, but also find some of your own.

A good place to start is with franchisee associations. Sometimes these are sponsored by the franchisor, but often they’re independent organizations, set up by franchisees to give them a way of communicating with each other and advocating for franchisees’ interests. Examples of franchisee associations are Domino’s Franchisee Association and National Jack in the Box Franchisee Association.

Contacting these organizations is a good way to get information on the state of the relationship between franchisor and franchisees, and to find out more about what you can expect. You may also be able to make contact with individual franchisees, so that you can interview them about their experiences.

Also check the Franchise Disclosure Document, which we’ll look at in more detail in the next tutorial. There’s a section in it where current and former franchisees are listed, so you can track people down that way.

And if you’re thinking of buying an existing outlet that was reacquired by the franchisor, the FTC says that the franchisor must tell you who owned and operated it for the past five years.    

Questions the FTC recommends asking former franchisees include:

  • How long they operated the franchise?
  • Where the franchise was located?
  • Whether they were able to open the outlet in a reasonable time?
  • Their total investment, including any hidden or unexpected costs?
  • How long it took them to cover operating costs and earn a reasonable income?
  • Whether they were satisfied with the cost, delivery, and quality of the goods or services they sold?
  • Whether the franchisor’s training was adequate?
  • Their satisfaction with the franchisor’s advertising program?
  • Whether the franchisor fulfilled its contractual obligations?
  • Whether the franchisee would recommend the investment?

Keep in mind that some franchisees may be wary about giving out too many details of their business, particularly if you’re cold-calling them. Think about how you’d feel in their shoes, and think of ways to make it easier for them to help you. If you’re asking about finances, for example, it may be better to ask generally how much you can expect to make as a new franchisee, rather than specifically how much they’ve made.

Step 4: Common Mistakes to Avoid

Buying a franchise can be a wonderful decision, but there are some pitfalls. Here are some common mistakes to avoid:

Being in a Hurry

The research we’ve outlined in this tutorial will take a significant amount of time. It’s not always easy to find all the information you need, and locating franchisees and getting them to talk to you can take patience and determination. And we haven’t even covered the Franchise Disclosure Document and franchise agreement yet.

But if you rush all of this due diligence and cut corners with the research, you may find yourself getting into problems. If you find that someone else is pressuring you to hurry before the great opportunity passes you by, definitely push back and insist that you need the time to do your own research.

Relying on Other People’s Opinions

With pretty much any investment, it’s dangerous to rely entirely on other people’s opinions. By all means get recommendations from people you trust, but ultimately it’s your money, your life, and your responsibility to get this decision right. Ask for the rationale behind any recommendation you’re given, ask for data and facts to substantiate it, and do your own research to verify it. If you’re being advised by an expert, be very clear about what that person’s motivation is, and whether it aligns with your own interests.

Buying a Good Franchise, But One That’s Not Right For You

The research you’re doing in this tutorial is not just aimed at helping you avoid bad franchise businesses. It’s also aimed at helping you find the franchise that’s right for you personally. You may come across a franchise that’s a wonderful opportunity for someone, but not for you. It’s important to return to the self-evaluation that you did in the previous tutorial, and compare your own goals and needs against what the franchise is offering. A franchise that offers big financial rewards but requires a huge time commitment, for example, would be a dream for some people, and a nightmare for others.

Looking for the Latest “Hot” Opportunity

Sounds exciting, doesn’t it? But remember that one of the main benefits of running a franchise is getting access to a proven business model that’s generated profits in good times and bad. A hot new opportunity means one that’s untested, and it adds to the risk you’re taking on. If you really want to do something new and exciting, why not launch your own startup?

Conclusion and Next Steps

Buying a franchise is a major life decision. Often you’re investing a substantial amount of money upfront, and also tying yourself into running a business for a period of up to ten years, with all the extra commitments of time, money and energy that such a decision involves.

It’s a decision that works well for many people, giving them greater financial freedom and independence. But it can also be a way to lose a lot of money if you rush into buying a franchise that turns out not to be right for you.

If you follow the steps outlined in this tutorial, you’ll give yourself a much better chance of success. You’ll understand the business plan completely, you’ll have asked all the right questions, and you’ll know what to expect from talking to existing franchisees. You’ll be ready to avoid some of the common franchisee mistakes, and buy a franchise that’s right for you.

But your work isn’t done yet. You still need to read and understand all the official franchise documents, particularly the Franchise Disclosure Document (FDD) and the franchise agreement. We’ll cover those in the next tutorial in our series on buying and running a successful franchise.

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