4 Tips For Prospective Franchisees (and one bonus)
If you have ever thought about becoming a franchisee, you may have wondered what types of questions you should be asking of the franchisor and of yourself. Most provisions in franchise agreements are not negotiable.
1. Deep dive into the FDD. The FDD is designed for non-lawyers as a way to decode the franchise agreement. Most people still see it as a complex legal document. But, it is written to be straight forward. Key areas to examine first are Item 5 (initial fees), Item 7 (estimated initial investment), Item 8 (restrictions on products and sources), and Item 19 (financial performance representations). All of these sections have the information that is most important for making the decision about the quality of the franchised business. If you feel good about the key areas mentioned, then review the other areas to make sure there are no issues. (This is where a franchise attorney is helpful.)
2. Call current franchisees. In Item 20 of the FDD, there is a section for contact information for current and former (within the last year) franchisees. Contact several of these franchisees and ask them any questions that you have about the business and the franchisor. Keep in mind that these franchisees are busy running their own business. However, if you are polite, they will likely get back to you with answers.
3. Have good vibes with franchisor. Typically, the franchise sales process includes the franchisee sending financials, which leads to the franchisor sending the FDD. Then, there are a series of phone calls or meetings to cover specific topics. Then, there is typically an in-person discovery day at the franchisor’s corporate office. Make sure that you get to know your franchisor as well as you can before signing. If you have a bad feeling about working with the franchisor, you should walk away from the opportunity.
4. Understand your pro forma. Your success is based on your profitability which is created by executing the business model. In Item 19 of the FDD, the franchisor will publish financial information. Ideally, this information will include costs as a percentage of sales. For example, if you are looking at a restaurant FDD that says the average sales are $1 Million and the average food and labor cost is 62%, you should be able to input other costs and determine how profitable the business will be. For cost items that you are not certain about, contact existing franchisees or ask the franchisor.
BONUS: Know your long-term strategy. Why are you buying a franchise? Are you basically buying a job where you can be your own boss? Are you looking for passive income? Are you hoping to scale and open 10 locations and then sell it? Different plans require different courses of action. I recommend going into the deal with a long-term play in mind. When you think about your long-term plans, make sure the contract does not stop you from executing them (through non-competition covenants, for example).