Know What You Are Buying

Having never made a penny of profit after four years of being a H20 Plus franchise owner, and with my savings virtually depleted, I got lucky. It was 14 years ago this month that I was weighing the pros and cons of investing in what appeared to be a promising franchise opportunity called H2O Plus. I got lucky because H2O Plus agreed to sever my franchise agreement and all obligations associated with it; most importantly, assuming the remaining five years of the lease agreement for which I was personally liable.

While many reading this are likely confused at my perception of good fortune, it is precisely these readers who can benefit most from this article.  For it attempts to provide them insight on some of what should be fundamental steps of any prospective franchisee, but are often underestimated or overlooked altogether.  You see, due to the way franchise contracts are structured, H2O Plus was under no obligation to take over my money-losing obligation, assume my lease, or assist me in any way.  Their willingness to takeover my store and assume its obligations saved me from a likely next step of bankruptcy.

So what does all this have to do with identifying the best franchise opportunities in the market?  Simply this: Before signing any franchise contract, you need first to understand what it actually means to buy a franchise - what your franchisor will and will not provide you, your (usually very limited) rights, and the obligations you are assuming.

What do you get when you buy a franchise?

When you buy a franchise, what you are really doing is leasing the right to sell a particular company's product or service using their trade name and logo(s).  That's all.  While many support measures, from training, to insight on running an efficient operation, to marketing and promotions are commonly provided, franchisees are often surprised and disappointed by the minimal value of what they actually receive. 

Lesson: Know what you are buying before you commit.

Smart move:  Your best source of due diligence on this is always to speak directly with as many current franchisees of the company as possible.  I recommend 10, from a broad geographic range, and never less than six unless they simply do not exist.  Get detailed answers from them on the questions below.  Listed first are general questions to ask about the business, followed by specific questions to ask regarding Training and Field Support.  Questions on what support you will receive should also be created for Marketing, Promotions and Sales, Human Resources training, Technology (computer and P.O.S. (point of sale) systems), etc.

General Due Diligence Questions

• About how many hours per week do you dedicate to your franchise business?
• How would you describe your relations/communications with your franchisor?
• Is your franchisor supportive of you communicating with other franchisees?
• Is the franchisor fair with you in resolving any grievances?
• Are territories equitably granted?
• How would you describe the initial and ongoing training provided by your franchisor?
• How well does the franchisor anticipate future trends in how it evolves and markets products and services?
• How satisfied are you with your franchisor's spending of any royalty fees you pay?
• In what ways could the parent company most improve?
• Is your income A) more, B) less or C) about what you expected prior to opening your business? (If the person you are asking is open to it, try to get specific numbers).

• Prior to opening your franchise, what did you most underestimate (e.g., necessary working capital, stress level, hours required, start-up costs, etc.)?
• If you could turn back time to the day you signed your franchise agreement, would you make the same decision to buy your franchise?

 Training and Field Support Questions

• Where is training conducted?
• What is the training's duration?
• Does it fully prepare you to successfully operate your business?
• What training do you wish you had been provided?
• If training is held at the franchisor's headquarters, who pays transportation and lodging costs?
• If training is held locally, who pays transportation costs for Corporate to fly in?
• Is there a fee for training? If yes, how much? If no, is there a maximum number of employees eligible before being charged a fee?
• What type(s) of ongoing training will me made available? At what intervals? Is there a fee?
• What type of field support is provided?
• How many field support staff are dedicated solely to franchisees?
• How often will field support staff visit your location?
• What is the turnover rate of field support staff?
• What typically occurs during their visits?
• How are training & new materials provided to existing franchise owners?

What rights and obligations will you have as a franchisee?

The Uniform Franchise Offering Circular, otherwise known as the U.F.O.C. and, as of July 1, 2008 the Franchise Disclosure Document, details the terms of your franchise agreement.  This includes fees, royalties, and obligations of both the franchisor and franchisee.  In theory, its terms should mirror those of the franchise agreement, which is the contract you ultimately sign when purchasing a franchise. 

Section nine of the FDD details the obligations of the franchisee, from compliance standards to insurance, remodeling, audits, post-termination of agreements, etc.  One thing to be mindful of in this section is that it is most often worded such that you are agreeing to at all times to be in compliance with the franchisor's policies and procedures as they may change from time to time.  If your franchisor changes its logo, color scheme, packaging, etc., you will be required to as well, often at a significant expense.  Upfront leasehold improvement costs are often upwards of $150,000; if your franchisor changes its store displays and color scheme two years after you open, you may very well be required to change right along with them, most likely bearing all the associated costs.

Section 11 of the disclosure document details the obligations of the franchisor both prior to your business start as well as during its operation. The wording of this section is always interesting, and should be scrutinized carefully. It begins "Except as set forth below, we need not provide any assistance to you".  And they mean it.  As you might expect, this section conveys a wealth of important information that you must understand before making the decision of whether to purchase the franchise.  Distill it carefully to identify what the franchisor will provide, but also what they are not responsible to provide.  Among other things, this section includes whether the franchisor will assist with:

• Negotiation for purchase or lease of your site
• Products and/or services to be offered
• Pricing
• Procedures for internal controls
• Administration of and conditions for advertising
• Hardware and software requirements, etc.

Lesson: If you are considering investing hundreds of thousands of dollars, taking on the obligations of business ownership, and signing a document that will commit you to a relationship that is generally 10 years in length, it is wise to invest in an attorney who specializes in franchise law.  After reviewing your contracts, a good franchise attorney will assure you have a full understanding of all of your obligations and the controls and constraints placed upon you by these agreements.  As well, they will work to ensure you're getting the fairest contract possible. The smaller and "hungrier" the franchisor corporation, the greater your likelihood of negotiating changes. Larger franchisors are more apt to make only make minor concessions.  Regardless of what size franchisor you're dealing with, it is vital that your attorney possesses expertise specifically in franchise law as there are many nuances to it.

Smart Move:  Educate yourself upfront and possibly save yourself time, money and heartache by making it your very first step to read Beguiling Heresy: Regulating The Franchise Relationship, by Paul Steinberg and Gerald Lescatre. This publication is the definitive insight guide on the inadequacies of current franchise regulations. It was written by an attorney and former franchisee of Subway, and is the most illuminating reference on franchising I have seen. Check with your local law library for availability.

Related reading:

Identifying the Best Franchise Opportunities

Gary M. Kowalski is author of the book "The Franchise Ratings Guide: 3,000 Franchisees Expose the Best & Worst Franchise Opportunities".  He has neither been a franchisee nor been affiliated with any franchise company since five years prior to writing his book.