According to the 2011 Natwest/BFA Franchise Survey, the franchising industry is now worth £12.4bn, with the vast majority of franchisees (90 per cent) reporting their business as profitable.While this suggests that the franchising can provide a sound investment opportunity, there are risks. If you’re considering franchising a retail business, follow these eight rules:
Rule 1: Check out the financial position of the franchisorSurprisingly, and in many cases (well over 80 per cent), an individual makes a decision to invest without any real due diligence into the background of the retailer. On many occasions, we’ve been approached by franchisees that lost money as a result of entering into contracts with franchisors that were (1) financially unsound (having consistently made losses or failed to file proper accounts) and (2) dormant or non-existent companies. So, understand who you are dealing with and carry out a full company search on the firm you’re proposing to do business with.
Rule 2: Check out the people behind the franchiseA franchisor is only as good as the people that run the business. So you need to understand who you are dealing with and their track record in business. You should ask for a full CV and obtain appropriate references. Do these people have the right experience to run a franchise business properly and who will you be interacting with on a daily basis? What is the personnel structure of the franchise and who within that business is responsible for what? In the end, you need to be satisfied that these are people that (1) you can work with and (2) will help support and grow your business. Remember, once you sign the Franchise Agreement, your money will be in their hands and you need to make sure that it will be used wisely.
Rule 3: Understand the businessA franchisor will always have a well-prepared patter on its business and the benefits of its retail franchise. It is always best to prepare fully for that meeting with a list of key questions so that you can dig beneath the patter. These questions should aim to allow you to fully understand:
- Their business and systems
- Your role as a franchisee
- How much time you need to commit to the business
- The amount of your investment, including the working capital requirements
- Your likely returns from the business and the assumptions/basis for those returns
- Their current franchise base, including names/contact details and evidence of their average returns
- The percentage of franchisee failures/terminations and why they failed and/or were terminated
- The average duration of each franchise (including start date for each of the current franchisees)
Rule 4: Understand the numbersMost franchisors will provide projections on the likely returns for the business. These should never be taken at face value. Again, you need to dig deeper. You should always question the numbers and understand the basis for the projections. The BFA’s Code of Ethics requires an affiliated franchisor to show the basis for any projections and to state whether they are actual performance figures or average performance figures. It may well be that the figures are based on best performing franchisees rather than averages. In some cases, and after proper questioning, you may find that the numbers bear little resemblance to reality and have simply been plucked out of the air. We were recently involved in a dispute against a major franchisor that admitted its numbers were “theoretical” and not based on historical performance. You can only be accurate in your assessment of the likely returns if you have the information and documentation to be accurate on the quality (and basis) for the projections you are being provided with.
Rule 5: Speak to the franchise baseThe BFA’s code of ethics requires an affiliated franchisor to provide full details of all their franchisees (including contact details, terminations and disputes). You should approach as many of these franchisees as possible to get a more rounded view of the business and profitability.
Rule 6: Get the franchise agreement checked outThe Franchise Agreement will govern your relationship with the franchisor so you need to be satisfied that it will properly protect your position as franchisee. As a general rule, most Franchise Agreements are drafted in favour of the franchisor. Get it checked by an affiliated BFA lawyer.
Rule 7: Get your business plan checkedIs your business plan achievable and what will be your realistic net income (after all expenses) if you run the business? One of the key reasons that franchised businesses fail is lack of working capital to meet drawings and expenses, so you should always check that you have sufficient resources to meet the start up and running costs of the business. Speak to a financial specialist who can provide you with an independent view of the business opportunity.
Rule 8: Think clearly not emotionallyBuying a retail franchise will always be a step into the unknown. The key is not to get caught up in the emotion and excitement of the purchase. Make sure you take the step consciously having fully and accurately investigated, analysed and tested the quality of the opportunity presented and your ability to run that type of business. Andrew Pena is the director at Cubism Law
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