Last time we talked about the pros and cons of franchising your business. In this post, I’ll cover the things your business needs to do before you are ready to franchise.
1. Strong Unit Level Economics/Proof of Concept. The number one thing that any prospective franchisee wants to know is “how much money can I make?” (Sidebar: never answer that question other than saying “Please see Item 19 of the FDD.”) The place in the Franchise Disclosure Document where you publish historical financials for your business is Item 19. You need to build a record of strong financials to be able to share. You should have at least two, preferably 3 or 4 locations before you sell a franchise. This will help to show that you have proof of concept because you will have already opened multiple locations and gone through the process multiple times.
2. Have an Operating Manual. The first thing you need to do is to get an operating manual in place. The operating manual covers all of the details about how the business should be run. It is a best practice in small business to create an operating manual even if you have no interest in franchising. (Businesses with operating manuals sell for higher valuations.) Once you start to franchise, the operating manual becomes the law. If franchisees don’t follow it, negative consequences happen. A clear, well-written operating manual helps franchisees follow the rules.
3. Have a Training Program. When you hire new employees at your existing location, do you have a clear onboarding process? You’ll need to scale that process across the brand for franchisees too. While it is not required, I highly recommend video training and quizzes through services like Trainual because they can be easily tracked and automated online. You need detailed training materials, including materials for employees who will be training other employees.
4. Have Business Systems. Systems can cover a lot of area. A system is any recurring process that the business follows. For example, a franchise may have a graphic design submission system, a quarterly profit and loss review system, a franchisee apparel and merchandise system, and a point of sale system, for example. Of great importance in any franchise is that all of the data must flow up to the franchisor so that they can understand the numbers at the franchise level and macro level. One important business system that every franchisor should have is a company intranet. (I have used Papyrs for years and highly recommend them, though there are many others.)
5. Establish Vendor Relationships. If you do not yet have vendor relationships in place, you will need to think about how your new franchisees will receive supplies and inventory. The franchisee must follow the franchisor’s rules when it comes to selecting vendors. But, the franchisor must identify vendors who are acceptable in the franchisee’s area. As the amount franchisees increases, the vendor deals tend to get better.
6. Understand Brand Marketing. You need to have a clear understanding of your brand. What is the core demographic? What are the main messages of the brand? The marketing channels that you have had the most success with in your current business are likely ones that you will continue to use in the franchised business. Franchisees pay an advertising fund that the franchisor administers and controls, usually with (non-binding) oversight from a franchisee advisory council.
7. Trademark Your Business Name. Ideally, you need to have a federal trademark to franchise your business. If you have a trademark, you can easily stop competitors from using your name. Also, when the franchise relationship ends, you can stop the franchisee from using the trademarked name. Franchising without a trademark is not recommended.
Next week, I’ll cover legal considerations for running a franchise – always sure to be a fun time!
1. What It Takes To Run A Franchise – Legal Considerations
Last time we talked about the 7 things you need to do before starting a franchise. In this post, I’ll cover the things your business needs to do to “be legal” as a franchisor.
1. Franchise Agreement. You will need to draft a franchise agreement to offer franchisees. When I started D.P. Dough Franchising, LLC after we bought the brand from the founder, there was a 7 page license agreement in effect with franchisees. I knew that I needed a real franchise agreement. I looked at franchise agreements from four top competitor brands and chose the provisions in their agreements that were more franchisee friendly (since big franchisor terms are notoriously not franchisee friendly). You will need to think about how you want to handle every situation in a franchise agreement. Do not use a template agreement that you found on the intranet. Franchise Agreements need to be very specific to the franchise business.
2. Franchise Disclosure Document. The Federal Trade Commission requires all franchisors to have a Franchise Disclosure Document (the “FDD”). The FDD has 23 sections, each of which covers a different specific topic related either to the business, the ownership, or the franchise agreement. (The franchise agreement itself is part of the FDD. But you must finish the franchise agreement first before you can write the FDD.) The FDD is usually hundreds of pages long. The initial FDD and Franchise Agreement can take anywhere from 25-100 hours. It all depends on how experienced the attorney is and how much help the client provides. With lawyer rates around $300, the initial FDD can easily be in the $20,000-$30,000 range. (This is not what I charge. It’s just what I have found other lawyers charge.)
3. Audited Financial Statements. One of the requirements in the FDD is to have audited financial statements. Luckily, for start-up franchisors, you the Federal Trade Commission does not require a year one audited financial statement (that requirement starts in year 2). However, pretty much all registration states now require audited financial statements before you even file for approval. You’ll need to budget around $10,000 per year for audited financial statements.
4. Special FDD Franchise Sales Rules. There are 3 rules you need to know about the FDD: 1) you need every franchisee to sign Item 23 and give you a copy, 2) you have to wait 14 days between when you sent the FDD and when the franchisee signs the franchise agreement, and 3) you are not permitted to discuss financial performance at all other than stating the information that is published in Item 19 of your FDD.
5. Enforcing Franchisee Compliance. You will need to have a strategy from day one for how you will handle non-compliant franchisees. I highly recommend having more options than just 1) sending a demand letter (basically a warning letter) or 2) terminating the franchise agreement. I view those options as akin to having a water gun or nuclear bomb as your weapons of choice. Those are not good options. It is much easier to enforce franchisee compliance by having some other intermediate punishment for franchisee non-compliance. Ultimately, you will need a lawyer for dealing with franchisee issues that escalate. But, you can avoid u many of those issues by having consistent communication with your franchisees and building trust over time.
All of the above considerations are in addition to the basic, day-to-day legal issues a franchisor encounters, such as franchisee renewals, vendor agreements, etc.