Looking to buy into a franchise? What you need
By Pauline Muindi | May 20th 2020
Setting up a business from scratch is a difficult task – which is why some entrepreneurs prefer getting into a franchise business.
The idea behind franchising is to acquire a proven, successful model that already works on every level, from branding and pricing to marketing.
Think of chain businesses such as KFC, McDonalds and Steers. A franchise business already has an existing customer base, which would take years or even decades to develop with an original idea.
In many ways, it is easier to succeed with a franchise business. In fact, one US study claims that 92 per cent of franchise businesses are still operational after five years – an impressive number compared to the 20 per cent national small business success rate.
But it is important to note that these figures have been disputed by a study from Wayne State University, which found that after four years, only 62 per cent of franchised businesses had survived, while 68 per cent of independent small businesses were still operating.
The study also found that franchises made lower profits than independent entrepreneurs.
Another study published in the Cornel Hotel and Restaurant Administration Quarterly found that from 1996 to 1999, chain restaurants consistently outperformed independent restaurants – with 57.2 per cent of chain restaurants out of business by the third year, as opposed to 61.4 of independent restaurants.
Although the success rate of franchises might remain a hotly contested topic, going into the franchise business might be a good decision.
To make the decision from a smart and calculated standpoint, you have to get the right information. Carefully consider all the potential pitfalls and perks before you sign on the dotted line and invest in a franchise business. Here are some of the most important things you should find out before buying into a franchise.
1. Calculate the estimated initial investment
Buying into a franchise doesn’t come cheap. Many of the big franchises require an entrepreneur to have access to a specific amount of money before they can even apply. For example, an international franchise such as McDonalds often requires that you have $2 million (Sh212 million) in liquidity to apply.
If you’re aspiring to open a franchised business, make sure you know the real cost of the initial investment. Don’t forget to factor in the costs of construction, equipment lease and security costs for a location. The figure that the franchisor has set might be underestimated, which can lead to disputes and losses.
While franchisors might only calculate up to three months’ worth of expenses, it is prudent to think of all the likely expenses for up to six months. Bear in mind that it might take as long as a year to become profitable.
Therefore, you should have access to capital that will cover business expenses for as long as six months and living expenses for as long as one year.
2. Investigate the franchise fees
There is a cost to every franchise. You will have to pay initial franchise fees and ongoing royalties and advertising fees. In addition to these, you might also have to factor in opening day expenses if the franchise headquarters require you to do special promotions to attract customers. It is important that you calculate all these expenses for yourself and make sure you’re able to handle them.
3. Dig for dirt
Has the franchise business you’re interested in been involved in potentially damaging scandals? What is their failure rate? Have they been sued by franchisees and why? Research to find all the unflattering information that the franchisor might not reveal to prospective franchisees.
There are numerous online resources you can use to dig up relevant information about franchises. You also have the right to ask for specific information and the documentation to prove it. Take time to go through the Financial Disclosure Document (FDD) where you will find information on bankruptcy filings, litigation, hidden costs and other information that wasn’t revealed initially.
It will also provide information about the franchise system, laying out all the requirements and restrictions included in the agreement.
Before getting into business with a franchisor, have an experienced franchise attorney review the FDD for you. He or she will help you understand the information in the document, highlight red flags, and answer your questions. They will also help you negotiate a franchise agreement that is favourable.
Don’t trust the franchise consultants too much. Most of them are paid salespeople for franchisors. They might be getting a handsome commission on every franchisee they sign on.
Ask the consultant to reveal any financial agreement with the franchisor up front.
4. Talk to other franchisees
Reach out to other franchisees to get their personal experiences working with the franchisor. Make friends with them and listen carefully to what they have to say about the franchise.
What kind of support do they receive from headquarters? Have they had any significant disputes? What are the pros and cons of the business? Would they go into the franchise again with all that they now know?
Aim to talk to at least 10 franchisees to compare experiences. Bear in mind that many small business owners are prideful and might not readily reveal their business-related struggles. Former franchisees might be more forthcoming with unflattering information about the franchise.
All said and done, however, you must be willing to work hard to be a successful franchisee. Franchises can be very profitable, but just like independent business ventures, they require a dedicated entrepreneur to see the best returns.
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