Tags: , , , , ,

Investing in a Franchise? Do These Things First.

2016-06-08

Minyang Jiang

By Joe Tagliente

If you’re thinking of not only investing in a franchise, but becoming the owner and operator of the franchise as well, you want to be involved with something you really enjoy.

For example, if you love automobiles, you should be looking at a quick auto service franchise like Jiffy Lube. If you like serving and helping people, particularly the elderly, a senior care franchise like BrightStar Care would be something to consider. And if you love food, then any of the various food franchises out there would be a good option.

Your prior experience and interests are wonderful indicators of what type of franchise you’ll want to pursue. But just because a franchise appeals to you personally, doesn’t mean it’s the right fit for you and your money. That’s why you’ll need to properly vet the franchise beforehand. Here are four important things to analyze and evaluate before becoming a franchisee.

Related: Franchise Agreements And Franchise Disclosure Documents: What You Need To Know

First Things First: Crack Open the FDD

The first thing you want to do is contact the company that you’re interested in becoming a franchisee with, and get their franchise disclosure document, which lays out all the information that comes with the franchise agreement. You’ll want to study that closely, especially Item 19, which is the complete financial disclosure of the franchise company for the franchisees. Item 19 provides detailed information on costs, earnings and other factors that could affect the potential financial performance of your franchise.

That document will also contain a list of all the current franchisees that are operating. As someone who’s a perspective franchisee, I can look at it and say, “Okay, here are some franchisees that are in my area. I want to reach out to these folks.” Of course, you’ll want to communicate with the prospective franchisor that you’d like to contact these franchisees and talk to them about their experience working with their company.

Really good franchisors will not only approve such a thing, but they’ll actually encourage you to contact their franchisees, because the best thing for the growth of a franchise system is to have strong franchisees who will go out and praise the gospel of the system that they’re operating.

Talk to a Range of Franchisees

When you’re reaching out to franchisees, you should try to speak to folks with varied size and time in the system. For instance, Arby’s has been selling franchises for 50 years, so if you were deciding to buy an Arby’s franchise today, you’d want to sit down and talk to somebody who’s been a franchisee for decades and has a large number of stores, but you’d also want to talk to someone who’s fairly new to the system and is like, “I just bought my first Arby’s franchise six years ago, and I’m about to open up my second store.”

This will give you a really good understanding of the long-term and short-term experiences of being a franchisee for a particular system. You’ll want to ask those people, “What prompted you to invest into this franchise and what other franchises were you considering when you finally concluded that this was the brand for you and you wanted to be part of this community?”

If you have a good feeling about what it’s like to become a franchisee after talking to two or three different franchisees, you’ll be a lot more comfortable moving forward.

How To Analyze a Franchise Before Investing

Something that has helped me a lot is what I call a “side-by-side analysis.” This involves getting two or three franchise concepts that are in the same space and comparing the potential costs and returns of each one.

Let’s imagine that you’re considering becoming a hamburger franchisee in one of the hot new burger franchises that are out there. You have an opportunity to invest in Five Guys, BurgerFi, and Wahlburgers, but you’re not sure which is the right one for you. So, you do your due diligence by analyzing all the information in the FDD, you visit stores, and you talk to franchisees. You should also do research on the Internet and collect anything you can possibly find, because there’s a ton of useful information out there.

Now, take all the information that you’re getting from these franchises and put it into a very basic spreadsheet with three columns. On the top is each franchise you’re considering, and then on the left-hand side are the various bits and pieces of data that are critical to consideration, like development cost, franchise fees, royalties, advertising fees, the number of restaurants that are out there, and average sales per square foot.

(Click image to download full-size version.)
investing in a franchise

Get all this information on paper, and then analyze it side-by-side. Are there any special circumstances with fees? In other words, does Wahlburgers charge an extra fee for buns above and beyond the cost of the buns? You cannot gather too much information when doing this research. And if any of it is difficult to come by, or you ask the franchisor for information and they’re either A) hesitant to give it to you, or B) they don’t know the answers, that should be a red flag.

Look for Advantages

The final thing I would advise potential franchisees to look for are any special opportunities that might provide a compelling advantage for you to become part of that franchise brand. I teach franchising at Boston University as an adjunct professor, and one of my groups of students came to me and said, “We’re going to do a project on Denny’s, to be an area developer for Denny’s franchises.” And I said, “Okay, tell me what is so compelling about Denny’s.”

Well as we speak, Denny’s is offering a special area development opportunity to new franchisees, where if they commit to a particular number of stores, they get reduced fees — franchise fees, royalty fees — over a period of time, which amounts to a significant amount of capital that can be saved. Denny’s is a strong brand, and they’ve shown significant growth in their sales and number of units, and their unit economics have gotten stronger every year.

That creates a compelling opportunity for someone to decide, “All right, let me take another look at Denny’s.” It adds a little pizazz to an otherwise unsexy brand. And I hope the people at Denny’s who are reading this don’t get offended, because I love Moons Over My Hammy

Does the Corporate Leadership Have Your Back?

The companies and brands that successfully launch and grow franchising programs all have one thing in common: They are obsessed with the success of their franchisees. They want their franchisees to get rich operating their business, and tell all of their friends about how rich they’re getting so that they can promote the sale of additional franchises to other people.

The really successful franchising companies commit to having a great training program and manual of operations. They commit to having a real estate department that helps franchisees analyze great sites to build new stores, and they commit to having wonderful marketing people that will help the individual franchisees at a local level while they’re developing brand exposure programs on a more global level. The successful franchises invest the time, people, resources, and energy to get those things done.

When you have franchisors that have an “us against you” relationship with their franchisees, they tend to have either stagnant growth or no growth at all — and then they’re surprised why their franchises aren’t taking off. I think the most egregious example of that is Quiznos, which was a successful sandwich concept that people seemed to love. They were having no problem selling franchises and ramping up new stores, but at some point, the Quiznos corporation decided to mandate that their franchisees buy all of their supplies directly from Quiznos. Once they controlled the supply chain, they increased the prices of those supplies in a very aggressive fashion and gouged their franchisees. Although Quiznos as a corporation was making money, their franchisees were suffering, and a number of them went bankrupt.

On the other hand, really good franchisors work very hard to support their franchisees. Having been a Burger King franchisee, I know that when sales for the chain were slumping, Burger King committed extra dollars towards promotions and national marketing programs in order to increase sales. They reengineered and retooled the kitchen layout and equipment so that restaurants could be operated with fewer employees, and on smaller footprints, thereby reducing operating and development costs which lead to increased profitability.

Bonus Tip: When Comparing Franchises, Return on Investment Matters More Than Costs and Fees

A high entry cost or high franchise fees shouldn’t automatically scare you away from investing in a franchise. What’s more important is the return on investment you’ll get as a franchisee, based on the sales and the cash flow that come from the operation.

For example, if you’re a McDonald’s franchisee, investing in a new restaurant will cost you between $1 million and $2 million, and then if you include royalties, advertising fees, training fees, and rent, you could be looking at 12% to 15% or more of your top line going to McDonald’s.

But the thing is, the average McDonald’s does $2.4 million in annual sales and produces a ton of cash flow. And so, a lot of franchisees say, “I don’t mind making that investment and giving them that much of my top line, because these things always make money and I know I’m going to make the returns on the back end.” McDonald’s also has really sophisticated support systems, which helps ensure that when you open one of their restaurants, it will be very successful.