Do Your Homework Before You Sign A Franchise Agreement

We all know that you should do your homework before signing any legal agreement, but what should you be checking?  This article for August’s edition of Elite Franchise Magazine focusses on the questions you should ask when choosing a franchise network and how to spot some of the potential pitfalls before you sign up.

Due Diligence – It Pays to Do your Homework

Franchise Agreements are typically easy to get into, but difficult to get out of.  They usually involve a commitment of at least 5 years and will include restrictions that could impact on your future activities even after the agreement ends.  In view of this, it’s wise to do your homework and thoroughly investigate the franchise network before you sign up.  This month’s article considers the sorts of questions you should be asking and why need to ask them.

Questions about the Business Model

When you buy a franchise, you are essentially buying the recipe for operating a business, together with training and support to help you follow the recipe; so it’s crucial that you choose a recipe for a successful business, not a damp squib.  All the basic questions that apply to an independent start up business apply to a franchise business – questions about the product, the market, the competition and the customer will all need to be asked.

In addition, you will need to satisfy yourself that the business model has been fully tested.  Ask how long the business has been operating as a franchise and check whether it has been tested in similar locations with similar demographics to the area that you are considering.  A business which is successful in a busy, city centre location wont necessarily achieve the same results in a rural location.

How robust is demand for the products and services that the business offers?  A franchise that specialises in selling Christmas crackers will clearly experience seasonal demand and the business model will need to be able to account for that.  Similarly, if a product is the Next Big Thing, how will the business respond when the next, Next Big Thing comes along?  Is demand for your product or service likely to continue for years to come?

Questions about the Franchisor and the Network

The fortunes of a franchisee are inextricably linked to the franchisor and the other franchisees in the network.  Franchisees will be relying on the franchisor to give them good advice about how to run the business, so it is important that the franchisee knows who will be giving that advice and what their credentials are.

Knowing how many franchisees have joined or left a network can provide valuable clues as to the viability of the business.  Naturally warning flags will be raised if a significant number of franchisees have left in recent times unless the reasons for them leaving can be properly explained and justified.  Most networks will expect some leavers each year as franchisees retire having hopefully, made their money; however an unexplained or significant number of leavers may suggest that there are problems in the network.

Equally, be wary of a network that is growing too fast.  A network that is taking on a significant number of franchisees in a short space of time may point to a franchisor who is more interested in selling new franchises than he is in supporting the business owners he already has.  In addition, if the number of franchisees is growing, then the number of support staff at head office ought to be growing too, so ask about plans to recruit additional support staff.

The Finance Bit

You will need to make sure that the maths adds up.  This includes creating a business plan with a detailed cash flow forecast and profit and loss projection.  If the franchisor provides information to help with this, make sure you verify the figures independently.  Be clear on how the figures that the franchisor is providing have been calculated and remember that much of this data will be estimates, not fact.  It’s often helpful to create multiple versions of the business plan changing the figures each time so that you can see how sensitive the bottom line is if for example, costs turn out to be higher than anticipated or if you don’t achieve the level of sales you were hoping for.

Sources of Information

The franchisor’s glossy recruitment literature will provide a good starting point; but potential franchisees should never rely on this alone. Financial information in particular should be independently checked and verified.

A quick google search will be helpful in seeing the sort of publicity that the network attracts – good and bad.  The network you choose ought to have a buzz about it for the right reasons!

One of the most valuable sources of information will be the other franchisees in the network and potential franchisees should aim to speak to as many of the existing network as possible before they make their final decision.  Reputable franchisors will give potential recruits a list of all franchisees in the network and invite the potential recruit to choose who they would like to speak to.  Be wary if a franchisor will only let you speak to certain individuals or gives you a very short list of franchisees to call.

Plenty of Fish in the Sea

When it comes to franchising, there really are plenty of fish in the sea.  Potential franchisees can and should be discerning when it comes to choosing their network and there’s plenty of sources of information that are worth looking into.  Putting effort and research into choosing the right network for you could make all the difference between choosing the recipe for an impressive soufflé or an under-cooked disaster!