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BUYING A SMALL BUSINESS

10 Common Mistakes of Prospective Franchisees
 

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1. Not reading, understanding or asking questions about the disclosure document. These documents are typically long, sometimes 80 pages, but it is very important that you read and understand each item, 1 through 23, of the Uniform Franchise Offering Circular (UFOC). As you read the document, keep notes on those areas that are confusing and unclear. While you may want your attorney's opinion, give the franchisor the benefit of the doubt and first ask its representatives to explain their understanding. Then check the remainder of your concerns with your attorney. Check the document's date. If it is current, you may want to request a previous document for comparison.

One of the most common problems between new franchisees and the franchisor is a misunderstanding as to responsibilities. Among other things, this can cause problems in meeting the schedule for Grand Opening dates. Read the disclosure document and the franchise agreement carefully as to your responsibilities. Also pay attention to the stated obligations of the franchisor, especially item eleven of the UFOC. Do not assume the franchisor is responsible for details of a particular support service. If it is not spelled out, get it in writing. List all of your concerns, and clarify which duties, obligations and responsibilities belong to whom.

2. Not understanding or having an inaccurate or incomplete interpretation of the franchise agreement and other legal documents to be signed. You and your attorney should carefully review the franchise agreement, the lease or real estate agreements, and any other contracts. First, make a list of questions to go over with your attorney, then present your concerns to the franchisor. Get the franchisor's clarifications in writing. There may be very little that you can change in these standardized agreements, but things can be added. There is no reason the franchisor cannot give you additional documentation to clarify something in the agreement that is confusing to you or your attorney.

3. Not seeking sound legal advice. Locate and retain an attorney, preferably one experienced in franchising.

4. Not verifying oral representations of the franchisor. You can avoid this mistake if you take the proper precautions. You may want to tape-record all your meetings with the franchisor. If you ask permission to do so, it is generally admissible in court if the need arises later. It also lets the company representatives know that you are tracking their words. You can do this politely, but if you prefer, take compendious notes of all your meetings. Later, review and summarize the details of your discussion, noting any items requiring clarification. Send a registered letter to the franchisor and a copy to the representatives memorializing your notes with a request for their response to any items you want clarified. Do not leave anything unresolved.

Due diligence also includes verification. If there have been any oral representations, of which you are uncertain, try to verify these with previous and current franchisees as well as through additional meetings with the franchisor. As stated in item 2 above, get anything orally promised in writing if it differs from other literature and the disclosure document.

5. Not contacting enough current franchisees. The section of the disclosure information on "Past, Current and Future Franchisees" is a valuable starting point for locating franchisees. It is imperative to discuss any concerns you may have with existing franchisees. If the franchisor gives you a tour that includes two or three franchisees, get back to them later and ask any questions that could have been confrontational or embarrassing if asked in front of the franchisor. Another important factor here is to find out whether the franchisor has introduced you to specific franchisees compensated for their help to solicit new franchisees. Ask them directly, then follow up with letter stating their answers to your questions. It is surprising how an inaccurate response might change once it is in writing.

Other than the franchisees introduced to you by the franchisor, to get a true picture, you can survey others listed in the disclosure document not versed in soliciting prospective franchisees. Find out from them if the franchisor has a reputation for honesty and fair dealing. It is of paramount importance to contact existing franchisees of the franchisor to verify their experience of the accuracy of previous disclosure documents. Also, ask their opinions of the accuracy and completeness of the current one. Further, you can solicit their help in verifying any other information not provided in the disclosure document.

When interviewing other franchisees, try to cover a large cross section of franchisees. Seek answers from those that:

  • Are in different locations,
  • Have one franchise,
  • Have multiple franchises,
  • Have been in business a long time,
  • Are still new,
  • Are successful, and
  • Are not doing so well.

For the latter, try to determine the reasons. Specifically, ask the franchisees if they feel that the franchisor exercises too much control, or not enough. Is the franchisor always willing to help? Has the franchisor held up its end of the obligations regarding ongoing support assistance and training?

Information from franchisees about their first year in business and their experience with the franchisor can be extremely enlightening. Under the FTC requirement, while the offering circular must disclose a list of existing franchisees, this record does not have to be complete. If you find the list provided to you is incomplete, ask the franchisor for a complete registry.

6. Not confirming the reasons for failed franchises. Locate some franchise outlets that are closed, sold, or have changed ownership to company-owned, and find out the reasons for their change of status. Contact the original owners and get their stories. If no two are alike, you may want to pay them less heed. If, on the other hand, there is a common story, the underlying problem may be something you want to avoid. Nevertheless, for fairness, get the franchisor's version.

7. Not having enough working capital. Make sure you have enough capital to cover every cost associated with the business including all pre-opening costs, enough set aside for your family budget, and enough operating cash for the business to make it through the break-even point.

8. Not recognizing the need for financing, not knowing how to make a proper loan request and not developing a true and accurate financial statement. If business accounting is not your forte, solicit the help of a good accountant.

9. Not meeting the franchisor's key management personnel at their headquarters and the field representative assigned to your territory. Quite often, the sales representative will do such a good job in building your confidence that you may not bother with trying to meet the other important personnel or traveling to the headquarters before signing the franchise agreement. Do not make this mistake. Meet the other franchisor personnel and verify the information provided by the sales representative.

After the franchisor defines your territory, also meet the field representative or district supervisor that will be working with you. It is important that your personalities are sufficiently harmonious to be able to work effectively together. Although you may not be able to determine this at first, you can find out the field representative's length of time on the job, training, and other experience levels. If you foresee problems, it is better to address them and try to work them out before you sign the agreement.

10. Not analyzing your market in advance. While the franchisor may help with site selection, it is still your responsibility to decide for yourself whether a particular location is desirable and promising. It is important to confirm the market for your product or service in this area.

If competition exists, there are several things to consider. Do the competitors have any weaknesses that you will be able to avoid in your business to capture more market? Are the competitors so strong that their market saturation may be hard for you to penetrate? If a local competitor dominates the market, entering it may turn into a competitive struggle that will increase your working capital requirement.

Also, evaluate your franchisor's marketing strategy; find out the amount of advertising and promotional dollars intended to help. Although helpful, it is not a good idea to rely totally on your franchisor for your market research. It is to your advantage to do your own market analysis and to develop your own marketing plan.

If your findings support a strong market for a "virgin" area, you may want your agreement to include a right of first refusal to buy additional franchised outlets in the subject territory before the franchisor considers other prospective franchisees. If you consider this, you will be under a timetable to expand according to the franchisor's goal. If you can not meet the stated expansion goal, you will forfeit the area.

If you are looking into a franchised area controlled by a subfranchisor, research the subfranchisor with the same determination and persistence you used evaluating the franchisor--maybe even more.

Copyright © 1999 Robert C. Rule

Last updated: Jan 1, 2000




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