Key Things to Consider When Looking for Franchise Opportunities - Tax Professionals Member Article By Dennis Jao
Posted by Dennis Jao

Key Things to Consider When Looking for Franchise Opportunities

Key Things to Consider When Looking for Franchise Opportunities

A down economy and the prospect of prolonged unemployment have led many workers to consider starting their own businesses due to the perceived safety, brand name, and established support structures; franchising is usually a popular option. In fact, instead of using their severance pay to pay off mortgages and other debts or to take vacations, people end up buying a franchise and starting a small business. An extra bonus is the prospect of being your boss and the ability to shake off the ups and downs of a successful business run.

The franchise industry has done a great job of selling its strengths—especially those with little or no experience running a business. But potential franchise owners/investors need to be clear about the risks they face when deciding to purchase a franchise. Here are some of the main things to remember:


Read the contract and everything in between

The contract you sign with the franchisor can be quite long and probably extremely one-sided - you buy the business model/brand from them and end up signing a contract that they wrote. Sometimes, the agreement is drafted such that if something is wrong at your end, that's your problem. And if something is wrong at their end, they will take the time to fix it. Of course, they want to succeed, more royalties for them, but you have no advantage over them if the ship starts to sink. So before joining a franchise, be sure to read the fine print, and it's worth hiring a good lawyer to ensure you have the maximum possible coverage (legal recourse) possible in case things go wrong.


The franchise guide is not a recipe for success.

Many buyers assume that buying a franchise "turn-key operation" will make up for their lack of management experience and skills. Well, like most things in life, it's a double-edged sword. The franchisor will indeed have policies and procedures documented with an amazing level of granularity. Still, these policies leave very little wiggle room when the money is NOT coming in. Specifically, your fixed costs are fixed. And your variable costs aren't as variable as you might think. For example, with most franchises, you must purchase your products from the franchisor, one of its subsidiaries, or a preferred supplier in most franchises.

Therefore, you cannot buy the best price on the products you sell because the franchisor does not allow you to do so. His argument is always the "quality factor." How can I ensure a consistent customer experience across all locations if franchisees buy different products from different vendors? A reasonable claim, but one that limits your ability to control one of the highest costs.

Salary is also a variable cost, but most franchisors require you to have a minimum number of employees on hand. A franchisee certainly doesn't want customers queuing because there is only one person in charge of the store, but it's not very profitable if you have the same number of workers on duty at peak times and in off-peak periods. Simply put, "turn-key" is great when you're making money, but it offers very little flexibility when you need it most, such as when you need to cut costs.


Don't expect to get rich overnight.

Most franchisees earn between $30,000 and $70,000 a year and work long hours. Sure, some stores generate six-figure revenue for the owner, but that's not the norm. After all, if a franchisee earns $200,000 at their store at the intersection of X and Y, the franchise company will open another store a few miles away to take advantage of that volume. Franchisors would rather have two stores earning $100,000 each than one store earning $200,000. This gives them better control. They don't like "strong" franchises, as they are seen as potential threats. The only way to make big money with a franchise is to:

  • Buy a good franchise business: few will be a resounding success

  • Get in early

  • Own several stores (four or more) conveniently located.


Location

A good location is presumably the most crucial decision when choosing a franchise. And competition between businesses of all kinds is fierce for these coveted places. Most franchisors do a traffic/volume analysis anywhere before they can start negotiating a lease. This is supposed to be for your benefit, but in reality, these are just statistics and do not guarantee profitable volume.


Have a plan B

Franchises can and do fail, so they need to have a plan B. Your small business franchise can fail despite your best intentions and unwavering commitment. The advertised failure rate is always so low for most franchisors because they don't have troubled stores reselling at a loss. Only stores that close completely count. So many stores are sold for free to new owners and are therefore never reported as failures.


Consider hiring professional help.

If you have bookkeeping experience and are comfortable reading financial statements, have a previous business, and have negotiated legal contracts, you may not need an accountant, insurance agent, or lawyer. But with some self-interest, you should have an attorney and other professionals review your financial health taxes and how they will be affected by your franchise agreement before signing a franchise agreement. 

Explore working in a store.

It's the best way to see how a franchise business works from the inside and if your personality matches the company culture.

 

Do a cost/benefit analysis.

Make a traditional pros and cons list. Draw a line to divide the sheet of paper, and on the one hand, write the benefits you get as a well-known brand, established market, training, recipes if it's a food franchise, staff guides, store design. On the other hand, list your costs and responsibilities, including franchise fees, the money you have to pay for marketing, markups on goods and ingredients the network requires you to buy, the share of sales you must realize in royalty.


Conclusion

All of this means that while buying a franchise may be a safer entry into a small business than doing it on your own; it may not yield a decent profit. Always have a backup plan if things go wrong. This includes maintaining existing professional skills and networks, emergency cash reserves, and an exit strategy/criteria, so you don't go bankrupt.

In conclusion, the best advice for anyone considering buying a franchise is to talk to some of the franchisees who are already in the system (without the franchisor, if possible) and find out about the challenges and business development that franchising offers. As with any business investment, there are definitely no guarantees, and it pays to be as prepared as possible before going into franchising.


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Dennis Jao
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