Assessing a Small Business Franchise Opportunity: Assumptions You Should Never Make (Part 2)

Posted on November 11, 2009
Filed Under Franchise Opportunities | 2 Comments

 

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“The Franchise Disclosure Document provided me with extensive detail, including costs, of running this business — based on those details, I know I can turn a profit from this thing.”

When you are researching a prospective franchise business, you are provided with a pile of paperwork. Pages upon pages of official-looking documentation that details your upfront and ongoing costs and other issues particular to the business. This documentation is prepared by lawyers and filed with the state. And still, believe it or not, that documentation may be entirely misleading.

Operating and start-up cost estimates can be particularly problematic. Since the franchisor can’t legally give you detailed income statements and balance sheets for every franchisee, you get averages and ranges. If you don’t think carefully about how far off an average can be from true experience, your franchise business may be sunk before you even open the doors. On top that, the franchisor may not be diligent about collecting information from every single franchisee in the system. In reality, the most successful franchisees are the ones most likely to report their information. This would skew the range away from being credible and reliable.

Also remember that the franchisor is trying to sell you something, in the same way a car salesman wants you to buy a car. So if that franchisor can get away with leaving certain details out of the FDD/UFOC, you can bet those details will be left out. If the franchisor can get away with presenting numbers in their most favorable light, you can bet that will happen too.

Of course, I speak only from the experience of having purchased one franchise. The FDD I was given was strictly a marketing document, filled with questionable facts and over-arching assumptions. There are many who would disagree with this characterization of the FDD, but I stand by my experience. Other franchisors may be far more concerned with pitching an accurate representation of the franchise business — I don’t know. But it never hurts to be too careful.

Steps to take

So if you can’t trust the documentation, what can you trust? Well, here’s what you need to do:

  • Analyze the ownership changes in the system
  • Interview existing franchisees
  • Do your own research

The franchisor has to disclose the composition of ownership within the franchise system. Start by reviewing how many operating franchises have been sold to new franchisees as well as how many have been taken over by the franchisor. Ask your franchisor to detail any ownership changes that occurred after the FDD/UFOC was printed. If you see a rash of ownership changes within a short period of time, consider this a red flag. Be particularly concerned about franchises that became corporate-owned — as this means the franchisees likely gave up and walked away from their investment.

At some point in the process, you will have the opportunity to contact and interview existing franchisees. Take these interviews seriously. Ask detailed questions about the support they receive from their franchisor, their margins, the time it took to reach stability in the business and so forth. Question the franchisee about expected and unexpected business challenges and successes. Always ask the franchisee what she would do if she had the opportunity to buy or not buy the business again. Note that the franchisees do not have to disclose detailed financial information to you, so be tactful and polite in your question-asking.

Be concerned if your prospective franchisor tells you what questions to ask or wants to limit your interviews to certain franchisees.

Finally, you need to do some independent research to verify the cost data put forth in the FDD. Check on the cost of retail or office space as well as business insurance, permits, and any other expenses that may vary by location.

It also doesn’t hurt to search for the franchise on BizBuySell.com. If you see dozens of franchisees trying to sell their businesses at dirt cheap prices, start asking questions.

Next up, why you should never assume the franchisor is wholly motivated to make you successful.

Comments

2 Responses to “Assessing a Small Business Franchise Opportunity: Assumptions You Should Never Make (Part 2)”

  1. Tom Stanley on November 11th, 2009 4:30 am

    I was on Yahoo and found your blog. Read a few of your other posts. Good work. I am looking forward to reading more from you in the future.

    Tom Stanley

  2. forex robot on November 19th, 2009 7:46 pm

    great post as usual .. thanks .. you just gave me a few more ideas to play with

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