ICS Magazine

Franchises: Avoiding Disappointment or Disaster

September 15, 2003

In general, a franchise is a legal right to engage in a particular business activity under the name, and using the processes of, a franchiser or parent company. Franchises can be attractive in that they offer a “turnkey” approach to entering into business, typically providing the franchisee with client referral lists, management support and advertising benefits, as well as supplying the franchisee with goods, services and equipment ready for market. The appearance of autonomy and the satisfaction of being one’s own boss also lend themselves to a franchise’s appeal.

For those who are not particularly well versed in sales techniques, franchises offer ready-made account referrals and marketing strategies. But beware franchising schemes, misrepresentations and speculative investing which may lead to the loss of precious start-up capital, a decline in operating capital or which deliver only marginal income. Some key points to consider when evaluating whether a franchise is right for you include…

Always read and understand the contract. If a proposed contract is too confusing, seek counsel. Some franchisers and franchising brokers prey on vulnerable targets, specifically small- and first-time business owners lacking formal training or experience.

Look for a reputable company with name recognition. If your potential franchiser is fairly new to an industry, get a copy of a franchise contract from a large franchiser with an established track record – such as McDonald’s – for comparison and education.

The franchiser must legally disclose certain information. The Federal Trade Commission regulates franchises, and federal law requires the disclosure of certain specific information to a potential franchisee. If your potential franchiser balks at providing this information, or claims to not have it available, consider it a red flag.

Here is what must be disclosed:

  • Your start-up and annual costs.
  • A description of the responsibilities and obligations of both parties following franchise purchase.
  • The existence of any legal action or litigation brought against the franchiser by its franchisees.
  • The identification of a minimum of 10 existing franchises within the geopolitical region of the proposed new franchise location.
  • The franchiser’s financial statement regarding its assets and liabilities.
  • The number of franchises terminated or not renewed the preceding calendar year.
  • The total number of existing franchises.
  • The qualifications and experience of the franchiser’s executive management.

    If a proposed deal is too good to be true – it isn’t. Consider whether promised income is exorbitant and reality based. What is the cost of purchasing supplies and materials from the franchiser relative to expected and represented profit? What is the cost of franchise fees and commissions? Contact other franchisees to inquire of their particular experience with this franchiser. Question the methodology by which the company has determined the earnings projections it boasts for its franchises. Do the demographics of a particular region realistically support the franchiser’s representations regarding projected earnings? What is the average lifespan of other franchisees in or near your proposed location?

    Get to know whom you are dealing with. Creating excitement and urgency for the potential franchisee closes the deal – and franchisers know it. Take your time and do your homework. Go down to your local municipal or justice court and look through case indexes to determine whether any small-claims suits have been filed against your franchiser (particularly by franchisees for breach of contract or fraud). Do the same at your county Superior or Circuit Court to ascertain whether larger monetary claims have been filed. You can review the actual court file to determine what specific allegations were made and how the matter was resolved. Other sources for investigation include your state’s Attorney General’s Office and the Better Business Bureau.

    Taking a day to conduct the proper due diligence can be crucial in helping you decide whether a particular franchise is right for you before you write that check.