Choosing to buy a business franchise is a huge step. It’s exciting and can be very rewarding and lucrative.
However, you need to know what to look for when buying a franchise business. A franchise owner needs to protect themselves, their hard work and their investment. Here are several structuring red ﬂags to keep an eye out for when making this important decision.
First Time Franchise Owners
What to know when buying a business:
First-time franchise owners will find franchise opportunities in a wide range of industries. Choose an industry in which you have experience or, at least, are comfortable. You will need to know how to evaluate this business for value and sustained growth before buying in.
Learning how to evaluate a business opportunity in a particular industry takes time. Bottom line: take your time and do your homework.
Protecting Your Investment
As an entrepreneur, you’ve worked hard to build your savings. You’re ready to invest in a new opportunity, but you don’t want to lose your shirt in the process.
That’s why it’s important for first-time franchise owners to protect themselves. It’s important to know what you need to look out for in franchise agreements — the numbers, franchisee validation and ongoing support for your franchise unit from the franchisor — before you undertake the critical decisions leading to owning a franchise.
While there are many great opportunities you can find in the franchise space, here are key issues to watch out for–
Red Flags to Spot
1. Too good to be true: As they say, if something sounds too good to be true, it probably is. Beware of any franchisor who tries to sell you something that they claim is flawless – or a sure thing. While many business opportunities may be promising, you must proceed with caution – be realistic.
If a franchisor is not genuine about potential pitfalls in their industry, that’s a bad sign. Take into account how they react when you ask about potential weaknesses, failures or their competition in the market. Remember, this is an important business relationship — and it’s very important that you are comfortable with this venture going forward.
2. Rules or procedures that turn you off: Franchise ownership is unlike owning your own business. As a small business owner, you create most of the rules. This is not the case in a franchise system.
Franchisors have rules and procedures that you must adhere to avoid breaching the franchise agreement. You may be an entrepreneur at heart, and the franchisor may be interested in your ideas to make the product or services better. (Did you know that the “five-dollar footlong” sales pitch originated from a franchisee?) However, at the end of the day, the franchisor decides how products or services are to be delivered to the customer and you must “toe the line.” The franchisor’s doctrine will greatly control your decision-making choices and how you run your business. Do not be blinded by the excitement of the potential opportunity — the novelty will eventually wear off, so make sure you understand fully what you are agreeing to and are comfortable with the franchisor’s rules.
Remember, a franchise agreement is not usually negotiable. Uniformity is key for a franchise system, so understand all of your franchise agreement terms and be prepared to satisfy them.
3. AUV numbers: AUV is an acronym that stands for “Average Unit Volume”. In other words, it is the average annual sales that the franchise is experiencing across their franchise system. You’ll hear franchisors throw AUV around to convince you that they are successful.
It’s important to note if the AUV is high or low. While it’s not the only factor to consider, it is a very important one to consider. You should compare their AUV numbers to competitors in the same industry or market to be sure you are comfortable with where the franchise’s average volume of sale lies.
4. Beware of dissatisfied franchise owners: The most important piece of homework you can do is to reach out to existing franchisees to unearth troubled franchise systems. Are they satisfied? Successful? Are they happy with their experience so far?
Listen carefully and take notes – reach out to more than one franchise owner to get a balanced view. What advice do they have to offer? Pay attention to their point of view and what they are satisfied and dissatisfied with.
Prepare questions ahead of time and remember that their insight is invaluable –they also could be a valuable future asset to you in the event that you decide to go ahead with the investment.
Be sensitive to whether the franchisor is steering you toward their most successful and franchisor-friendly franchisees. To be fair, they may know of franchisees that have the time and are willing to freely and candidly share their experiences. Yet, they may have curated certain franchisees whom may give you an unbalanced perspective of the health of the franchisor’s system.
Also, if the franchisee you contact owns the rights to a territory near the one you may have in mind, they may have conflicting thoughts about whether to assist you in making the correct decision (perhaps they have ambitions to own that territory).
5. False and overstated promise alerts: Always remember that the franchisor’s goal is to sell you this opportunity. That’s buying a business 101. Their sales pitch is just that — a pitch. A franchisor will most likely highlight their most successful franchisees. They may lead you directly to them, encouraging you to contact them directly.
They aren’t going to highlight their lower-achieving or unhappy franchisees, obviously. So, keep this in mind. To get a complete picture, you need to reach out on your own through the list of current and former franchisees located in the FDD exhibit, which federal law requires to be disclosed.
To gauge your expectations, speak to the franchisor about what they feel is leading to the success (or failures) that their franchisees are experiencing before you invest. Remember, every franchise system will have a range of producing franchisees which is like the classic bell curve. So, ferret out the top performers and the average or low performers to develop a whole and realistic picture of the franchise system.
6. Support you will receive: There are many questions to ask when buying a business, such as: Does the franchisor fully support the franchisee? It’s a major red flag if a franchisor isn’t known to completely support their franchise investors. This is why research is super important.
Be sure to have a very clear idea on what the support should look like in your deal. Add these questions to your transaction checklist: Is the franchisor easy to reach/available? Do they offer ongoing training? Technical support? Do they truly care about their franchisees? (How did they handle the Pandemic when many franchisees struggled?)
Inadequate or non-existent support can be detrimental to a new business franchise. It is a deal breaker. You’ll need a proven franchisor to succeed, and with access to experts in the marketed field. Fully understand the support package provided in your deal before selecting a franchise. Ask many questions of the franchisor to get a clear idea, and look to see if these representations are mirrored in the FDD/ FA.
Finally, does the franchisor mainly rely on its current franchisees to support you? If so, red flag! Walk away.
Signing On the Dotted Line
Once you are comfortable with your potential new investment, it’s time to sign on the dotted line. This can be scary!
Try to see the franchise review process as an opportunity for forming a bond with the franchisor. You are starting something new — hopefully with great support and advice in tow. However, do not allow your business judgment to be clouded by the sales pitch.
We know this process is daunting, and we are here to help. Kilcommons Law will help you navigate this new venture with a clear eye, with as little stress as possible, and with your best interests at heart. We will make sure that you are comfortable in understanding your franchise responsibilities and, specifically, your (and the franchisor’s) contractual obligations.
Reach out to Kilcommons Law when deciding whether to purchase a franchise business. We want to see your investment of time and money lead to success for years to come.
© Kilcommons Law, P.C. 2023