Starting a Franchise without Getting Burned
Get professional advice before sinking your savings into a brand-name franchise, and talk to an owner
Q: What is the current status of the economy for franchised restaurants?
A.S., W. Va.
A: More than half a century after local hamburger and doughnut stands turned into national chains through franchising, the concept is alive and well -- and has spread beyond the food industry into tax preparation, travel service, dry cleaning, and home-based businesses that offer everything from kitchen-cabinet refinishing to tennis lessons. The basic business concept -- local owners handle daily operations, while the franchisor concentrates on marketing and building the brand -- has proved popular. "Franchises now span 75 different industries and contribute $1 trillion annually to the U.S. economy. About 40% to 50% of that would be in the food service sector," says Terry Hill, spokesman for the International Franchise Assn., a trade organization claiming 30,000 franchisees and franchisors as members.
Franchised operations are a growing share of every segment of the food service industry, according to Technomic, Inc., a food-industry consulting firm based in Chicago. Nearly 75% of the top 100 food-service chains use franchising to grow. Although a handful of the leading fast-food companies have nearly saturated markets, new concepts keep springing up.
The franchise market may be doing well, but experts warn naive entrepreneurs who think a nationally known brand is a surefire moneymaker that they are headed for disaster. You must do your homework and get professional advice before sinking your savings into a franchise. "I've seen the damage it can do to a family, when a 40- or 50-year-old drops $50,000 into buying a franchise that they think is a sure thing and then loses it," says Gary Anderson, a business broker with West Coast Commercial Credit in San Diego. "They'll never save that much money again."
Many would-be entrepreneurs believe that franchises are foolproof. They have the same failure rates as any other small business, Anderson says. "People go to franchise shows, and they get all excited about a new idea when they haven't ever worked in a restaurant a day in their lives. And they're not hooked up with an accountant, so they don't do the due diligence with the financial statement that they should." You must take the franchisor's financial-disclosure statement to an accountant, get an attorney to review the franchise contract, and have an exit strategy right from the start.
It's worth noting that many franchisees are actually companies that run a number of restaurants and have significant financial resources. They're not really small businesses.
Don't take the franchise company's word as gospel. Get the straight story on what it's like to own a company's franchise directly from another owner, advises Ron Paul, president of Technomic. "Regardless of what information the company provides, go to the other stores and speak to the owners in person. Get good legal advice regarding the terms of the franchise agreement, particularly in terms of encroachment. What protection do you have, if any, from the franchisor deciding to open another store a mile from you?" Paul says. If you've never worked in a restaurant, do so before you get involved in a food franchise. It's a good reality check. "A restaurant can be seven days a week, open for breakfast, lunch, and dinner. If the dishwasher doesn't show up, you may be in there doing the dishwashing. Make sure you understand that," he advises.
Keep in mind -- from the beginning -- that franchise contracts are finite and will be renegotiated after a set term, usually 10 years. "Franchising is not like owning a home. It's more like renting an apartment. At the end of your term, the franchisor sets a new contract in front of you, and if you don't like it you have very little input or negotiating room. The contracts have gotten more onerous as time goes on, and they're presented on a take-it-or-leave-it basis," says Susan Kezios, president of the Chicago-based American Franchisee Assn., which represents 16,000 franchisees operating 30,000 units. "If you're going to buy a franchise, don't sign a lease for longer than the term of your contract. Don't take out a loan that extends longer than your contract. If you don't want to sign a new contract, you don't want to have obligations that force you to," she says.
Michael Seid, a franchise consultant based in West Hartford, Conn., says that choosing the right franchise is equally important. "Understand that a lot of it has to do with your brand. If you have a burger place, you'll be fighting Johnny Rocket's, Fat Burger, and lots of others," he says. He advises clients to consider buying an established franchise location rather than starting a new one. "There's a history in an established restaurant, a knowledge of the trends, the sales activity, the existing customer base. Plus, you don't have to fight the cost of buildout so you can be up and running six months to a year-and-a-half earlier. And if you buy an existing location, you might be able to buy an older contract with better provisions to it."
Would-be franchisees can educate themselves at the Web sites of industry organizations such as the International Franchise Assn., www.franchise.org, and the American Franchisee Assn., www.franchisee.org.
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