Evaluating Franchises

The success rate for franchise-owned businesses is very high. According to studies conducted by the U.S. Department of Commerce from 1971 to 1987, less than 5 percent of franchised businesses failed or were discontinued in each of those years. However, success is not guaranteed. One of the biggest mistakes that you can make is to be in a hurry to get into business. If you take shortcuts on your evaluation of a potential business, you might neglect to consider other franchises that are more suitable for you. Don’t be pressured into a franchise that is not right for you. Although most franchise operations are managed by reputable individuals, as in all industries, some are not. Also, some franchised businesses are poorly managed and financially weak. Resist pressure to purchase before you complete a thorough investigation.

This publication is designed to assist you in investigating your options. It includes the questions you should ask to adequately evaluate the business, the franchiser, the franchise package and yourself as a franchise owner.

WHAT IS FRANCHISING?

A franchise is a legal and commercial relationship between the
owner of a trademark, service mark, trade name or advertising
symbol and an individual or group seeking the right to use that
identification in a business. The franchise agreement governs the
method for conducting business between the two parties. Although
forms of franchising have been in use since the Civil War,
enormous growth has occurred more recently. By the end of 1990,
more than 500,000 franchised establishments in 60 industries
achieved gross sales of over $700 billion dollars and employed
7 million full- and part-time workers. Industries that rely on
franchised businesses to distribute their products and services
touch every aspect of life, from automobile sales and real estate
to fast foods and tax preparation.

In its simplest form, a franchiser owns the right to a name or
trademark and sells that right to a franchisee. This is known as
product/trade name franchising. In the more complex form, known
as business format franchising, a broader and ongoing
relationship exists between the two parties. Business format
franchises often provide a full range of services, including

* Site selection.
* Training.
* Product supply.
* Marketing plans.
* Financing.

Generally, a franchisee sells goods or services that are supplied
by the franchiser or that meet the franchiser’s quality
standards.

BENEFITS OF A FRANCHISE

There are a number of aspects to the franchising method that
appeal to prospective business owners. For example, easy access
to an established product and a proven method of operating a
business reduces the many risks of opening a business. In fact,
U.S. Small Business Administration and U.S. Department of
Commerce statistics show a significantly lower failure rate for
franchised businesses than for other business start-ups. The
franchisee purchases not only a trademark, but also the
experience and expertise of the franchiser’s organization.
However, a franchise does not ensure easy success. If you are not
prepared for the total commitment of time, energy and financial
resources that any business requires, you should stop and
reconsider your decision to enter the franchise business.

INVESTIGATE YOUR OPTIONS

As in all major business decisions, nothing substitutes for
thorough investigation, planning and analysis of your options.
This publication is designed to help you systematically review
the possibilities and pitfalls of the franchised business you are
considering. Use the questions below to guide your research and
cover all the bases. Read the entire publication before you begin
to gather information.

What Is the Business?

Determine whether the business opportunity would be a successful
venture on its own, apart from the benefits offered by the
franchiser.

* Is the product or service being offered new or established? Does
the business require special skills or aptitudes that you may
lack? Do you feel strong motivation for producing the product or
providing the service?
* Does the product meet a local demand? Is there a proven market?
* Who is the competition?
* If the product requires servicing, who bears the responsibilities
covered by warranties and guarantees? The franchisee? The
franchiser? If neither, are service options available?
* What kind of reputation does the product or service enjoy?
* Are suppliers available? What reputation do they enjoy?

Who Is the Franchiser?

Visit at least one of the firm’s franchises. Ask for a list of
all of the firm’s current franchises and make sure that you
select the one to visit. Avoid calling those names recommended by
the franchiser. At the very least, the franchiser must provide
you with the names of 10 franchises in your prospective market
area.

When you meet with the franchisees, observe their operation,
discuss expenses and ask how well the franchiser supports the
franchise units. Does the franchiser actively promote and market
the products or services of the franchise? You should determine
the reputation, stability and financial strength of the
franchiser.

* How long has the franchiser been in the industry? How long has
the firm granted franchises?
* How many franchises are there? How many in your area?
* Examine the attitude of the franchiser toward you. Is the firm
concerned about your qualifications? Are you being rushed to sign
the agreement? Does the firm seem interested in a long-term
relationship, or does that interest end with the initial fee?
* What is the current financial condition of the franchiser? Check
the franchiser’s financial statements in the disclosure document.
If the franchisees are paying their upfront fees
but not their royalties, this may indicate that franchise units
are being sold to investors but that they fail to open or perform
too poorly to pay royalties.
* Who are the principal officers, owners and management staff? What
is each person’s background? How much experience in franchising
do they have?
* Compare sales promises with existing documentation. Be certain
that the sales presentation is realistic and that major promises
are clearly written into the contract. Be alert for exaggerated
claims and pressure tactics.
* For newly established franchises, make sure the franchiser has
registered the company’s trademark. If not, the company’s name
and logo may have to be altered, forcing you to change your
market identity after you have established yourself.
* Verify earnings claims and compare them with other business
opportunities. Investigate all earnings claims carefully.
Earnings claims must (1) be in writing; (2) describe the basis
and assumptions for the claim; (3) state the number and
percentage of other units whose actual experience equals or
exceeds the claim; (4) be accompanied by an offer to show
substantiating material for the claim; and (5) include certain
cautionary language. Treat this opportunity like any other
investment. Does the franchise offer the return you require? If
not, you may want to look at a different business.
* What is the legal history of the franchiser? Have any of the
executives been involved in criminal or civil actions? Is any
litigation pending, particularly involving any restrictions on
trade that may affect the franchise?
* Is the franchise a member of the International Franchise
Association (IFA)? If not, why not? The IFA has a strict code of
ethics that must be met before a company can become a member.

What Is the Franchise Package?

Bring all your information and resources together as you examine
the contract. Think carefully about the level of independence you
will maintain as a franchisee. How comprehensive are the
operating controls? Be very clear about the full costs of
purchasing the franchise. Involve your attorney, accountant
and/or business advisor as you examine these questions.

* What is the full initial cost? What does it cover?
___ Licensing fee?
___ Land purchase or lease?
___ Building construction or renovation?
___ Equipment?
___ Training?
___ Starting inventory?
___ Promotional fees?
___ Use of operations manuals?

* What ongoing costs are paid to the franchiser?
___ Royalties?
___ Ongoing training?
___ Cooperative advertising fees?
___ Insurance?
___ Interest or financing?

* Are you required to purchase supplies from the franchiser or a
designated supplier? Are the prices competitive with other
suppliers?

* What, if any, restrictions apply to competition with other
franchises?

* What are the terms covering renewal rights? Reselling the
franchise?

The Disclosure Document

The Federal Trade Commission (FTC) requires sellers of franchises
and other business opportunity ventures to provide prospective
investors with the information they need to make an informed
investment decision. It also requires that all earnings claims be
documented, that the information investors receive be complete
and accurate and that investors have adequate time to consider
and evaluate the disclosures before making any final purchase
commitment. All required information is given to prospective
investors in the form of a franchise disclosure document, which
must be furnished at least 10 business days before any purchase
may occur. This document includes 20 important items of
information, such as

* Names, addresses and telephone numbers of other franchisees.
* A fully audited financial statement of the seller.
* The cost required to start and maintain the business.
* The responsibilities you and the seller will share once you buy a
franchise.
* Litigation involving the company or its officers, if any.

Again, use your professional support to examine all of these
issues. Some of the contract terms may be negotiable. Find out
before you sign; otherwise, it will be too late.

PERSONAL ASSESSMENT

Perhaps your most important step in evaluating a franchise
opportunity is examining your own skills, abilities and
experience. The ideal franchisee is a creative, outgoing person
who is eager to succeed, but not so independent that he or she
resents other people’s advice. You must be able to balance your
entrepreneurial initiative with a willingness to comply with the
business formulas used by the franchiser. Remember, a successful
partnership between a franchisee and franchiser involves a mutual
understanding of each other’s values and achievements.

Determine exactly what you want out of life and what you are
willing to sacrifice to achieve your goals. Be honest, rigorous
and specific. Ask yourself: Am I qualified for this field

* Physically?
* By experience?
* By education?
* By learning capacity?
* Financially?

Ask yourself how this decision will affect your family. Do they
understand the risks and sacrifices required, and will they
support your efforts? Beginning a franchise business is a major
decision that does not ensure easy success. However, an informed
commitment of time, energy and money by you and your family can
lead to an exciting and profitable venture.

OBTAINING PROFESSIONAL ADVICE

You should consult a franchise attorney, an accountant and/or a
business advisor to counsel you and go over the disclosure
document and proposed contract. Their advice will help you make a
realistic and sound decision. Remember, the money and time you
spend may save you from a major loss on a bad investment. Also,
see the information resources in the appendix.

APPENDIX: INFORMATION RESOURCES
U.S. Small Business Administration (SBA)

The SBA offers an extensive selection of information on most
business management topics, from how to start a business to
exporting your products.

This information is listed in “The Small Business Directory”. For
a free copy contact your nearest SBA office.

SBA has offices throughout the country. Consult the U.S.
Government section in your telephone directory for the office
nearest you. SBA offers a number of programs and services,
including training and educational programs, counseling services,
financial programs and contract assistance. Ask about

– Service Corps of Retired Executives (SCORE), a national
organization sponsored by SBA of over 13,000 volunteer business
executives who provide free counseling, workshops and seminars
to prospective and existing small business people.

– Small Business Development Centers (SBDCs), sponsored by the SBA
in partnership with state and local governments, the educational
community and the private sector. They provide assistance,
counseling and training to prospective and existing business
people.

– Small Business Institutes (SBIs), organized through SBA on more
than 500 college campuses nationwide. The institutes provide
counseling by students and faculty to small business clients.

For more information about SBA business development programs and
services call the SBA Small Business Answer Desk at 1-800-8-ASK-SBA
(827-5722).

Other U.S. Government Resources
Many publications on business management and other related topics
are available from the Government Printing Office (GPO). GPO
bookstores are located in 24 major cities and are listed in the
Yellow Pages under the “bookstore” heading. You can request a
“Subject Bibliography” by writing to Government Printing Office,
Superintendent of Documents, Washington, DC 20402-9328.

Many federal agencies offer publications of interest to small
businesses. There is a nominal fee for some, but most are free.
Below is a selected list of government agencies that provide
publications and other services targeted to small businesses. To
get their publications, contact the regional offices listed in
the telephone directory or write to the addresses below:

– Consumer Information Center (CIC), P.O. Box 100 Pueblo, CO 81002
The CIC offers a consumer information catalog of federal
publications.

– Consumer Product Safety Commission (CPSC)
Publications Request
Washington, DC 20207
The CPSC offers guidelines for product safety requirements.

– U.S. Department of Agriculture (USDA)
12th Street and Independence Avenue, SW
Washington, DC 20250
The USDA offers publications on selling to the USDA.
Publications and programs on entrepreneurship are also available
through county extension offices nationwide.

– U.S. Department of Commerce (DOC)
Office of Business Liaison
14th Street and Constitution Avenue, NW
Room 5898C
Washington, DC 20230
DOC’s Business Assistance Center provides listings of
business opportunities available in the federal government. This
service also will refer businesses to different programs and
services in the DOC and other federal agencies.

– U.S. Department of Health and Human Services (HHS)
Public Health Service
Alcohol, Drug Abuse and Mental Health Administration
5600 Fishers Lane
Rockville, MD 20857
Drug Free Workplace Helpline: 1-800-843-4971. Provides
information on Employee Assistance Programs.
National Institute for Drug Abuse Hotline:
1-800-662-4357. Provides information on preventing substance
abuse in the workplace.
The National Clearinghouse for Alcohol and Drug Information:
1-800-729-6686 toll-free. Provides pamphlets and resource
materials on substance abuse.

– U.S. Department of Labor (DOL)
Employment Standards Administration
200 Constitution Avenue, NW
Washington, DC 20210
The DOL offers publications on compliance with labor laws.

– U.S. Department of Treasury
Internal Revenue Service (IRS)
P.O. Box 25866
Richmond, VA 23260
1-800-424-3676
The IRS offers information on tax requirements for small
businesses.

– U.S. Environmental Protection Agency (EPA)
Small Business Ombudsman
401 M Street, SW (A-149C)
Washington, DC 20460
1-800-368-5888 except DC and VA
703-557-1938 in DC and VA
The EPA offers more than 100 publications designed to help small
businesses understand how they can comply with EPA regulations.

– U.S. Food and Drug Administration (FDA)
FDA Center for Food Safety and Applied Nutrition
200 Charles Street, SW
Washington, DC 20402
The FDA offers information on packaging and labeling
requirements for food and food-related products.

For More Information
A librarian can help you locate the specific information you need
in reference books. Most libraries have a variety of directories,
indexes and encyclopedias that cover many business topics. They
also have other resources, such as

– Trade association information
Ask the librarian to show you a directory of trade associations.
Associations provide a valuable network of resources to their
members through publications and services such as newsletters,
conferences and seminars.

– Books
Many guidebooks, textbooks and manuals on small business are
published annually. To find the names of books not in your local
library check “Books In Print”, a directory of books currently
available from publishers.

– Magazine and newspaper articles
Business and professional magazines provide information that is
more current than that found in books and textbooks. There are
a number of indexes to help you find specific articles in
periodicals.

In addition to books and magazines, many libraries offer free
workshops, lend skill-building tapes and have catalogues and
brochures describing continuing education opportunities.

——————————————————————-
While we consider the contents of this publication to be of general
merit, its sponsorship by the U.S. Small Business Administration
does not necessarily constitute an endorsement of the views and
opinions of the authors or the products and services of the com-
panies with which they are affiliated.
——————————————————————-
All of SBA’s programs and services are extended to the public on a
nondiscriminatory basis.

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SMB Reviews
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SMBReviews is committed to providing small and mid-sized business owners with the information and resources they need to select the best service or product for their company.

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