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What you need to know and do to be a successful franchisee

Franchisors must continue to keep the brand relevant and their systems strong in order to promote success.
Franchisors must continue to keep the brand relevant and their systems strong in order to promote success.

By Allan D.J. Dick

The decision to purchase a franchise may be the most important investment decision an individual ever makes. This article addresses the reasons why franchises can be excellent investments and how to avoid the many pitfalls that can turn the decision to invest into a life-altering disaster.

The four primary reasons for investing in franchise include:

  •  A reputable franchisor who has developed a concept in a line of business you are a interested in investing;
  •  A reputable franchisor who has already developed a known brand within that industry;
  •  A reputable franchisor that will provide all of the information and training you need to operate the business,  even if the business is new to you; and
  • A system that should generate financial success to the franchisee, assuming it is operated properly.

In exchange for providing the concept, system, support and knowledge, a franchisor receives money from the franchisee. This money is necessary to compensate the franchisor for the establishment of the brand and the system, and for its maintenance.

So far, these basics would suggest the bargain is imminently fair, because it is, as described. Reasonable. Franchising as a model for business expansion has proliferated internationally.

What then are the issues which prospective franchisees must address in order for their investments to have the best chance of success and to minimize the possibility of failure?

Franchisors take their fees off the top and not the bottom line

Although one would think franchisors are also interested in their franchisees’ bottom lines or they may not be able to sell franchises, these fees and other obligations are costs which a franchisee will have to pay regardless      of its performance, like rent and bank debt. Franchisors do not typically provide earnings projections. A prospective franchisee must do a tremendous amount of due diligence in projecting its own profit and loss results to be satisfied the financial model will work for it and justify the investment.

Franchise success is often dependent on the choice of location

In many systems, franchisees are not granted exclusive territories. This is a critical aspect of franchising. A franchisee must perform its own due diligence when agreeing to take a particular site. One should try to negotiate an exclusive territory or rights of first refusal. If a store does well, a franchisor will look to capitalize on the strength of the territory and may look to add a second location, which can be expected to cannibalize the existing store sales.

Franchised businesses do not operate themselves

As much as a franchisee believes it is investing in a ready concept and system, it is the franchisee that is most important to the success of any business. This requires 24/7 attention to the business. Franchisees must excel in all aspects of management.

It is critical that a would-be investor in a franchise educate themselves from the many publicly available resources on franchising.
It is critical that a would-be investor in a franchise educate themselves from the many publicly available resources on franchising.

Franchise businesses must evolve

Today’s hot concept may be tomorrow’s failed opportunity. Franchisors must continue to keep the brand relevant and their systems strong in order to promote success. Franchisees are typically completely dependent on their franchisors’ abilities and smart business judgment in this regard as they will have little ability to make changes on their own. In the meantime, the franchisee will be locked into long-term leases, employee obligations, franchise obligations, and bank debt.

A franchisee is also susceptible to a franchisor selling the concept or system to a third party, including private equity players, whose approach to the franchise system may be completely different from those of the franchisor when the business was purchased. Franchisees must anticipate and consider these realities as part of their due diligence. Ask questions, such as:

  • Where do you see the market in 10 or 15 years?,
  • Where is the system in terms of its growth stage?
  • What is your franchise’s succession plan?

Franchise agreements are one-sided in favour of the franchisor

On the one hand, this is important for purposes of a franchisor having the ability to keep a system intact. Every franchisee wants to know there is a system and a set of rules that are generally followed by all franchisees. A franchisee will be negatively affected if another is not operating properly. Conversely, the obligations on a franchisee are very strict and very controlled. Effectively, a franchisee is operating an established system rather than being an entrepreneur. The skill sets are very different.

Franchises are intended to be long-term jobs

The notion of franchising is that the operator will extract its return on investment (ROI) in the form of annual profits.  In due course, the franchisee will need to decide whether to renew the franchising contract—perhaps in five or 10 years, and potentially another 10, 15 or 20 years. Along the way, the franchisee may be required to continue to invest in the business; major renovations may be required from time to time as the concept evolves. If a franchisee wants to sell, it will face significant hurdles. Franchise transfers are controlled as to whom sales can be made and the price at which      the business can be sold for. Franchisees can attempt to negotiate around this problem, though, with the benefit of a professional.

Franchisees do not necessarily benefit from a franchise system’s buyer power

It is a fact that as a system grows, it is able to purchase inputs at better prices than are available to a single-unit operator. However, franchisees do not necessarily realize these savings. In fact, they may pay more for their inputs. They may also be purchasing products that may not be on par with what is available in the marketplace, depending on the wording of their franchise agreements. It is critical prospective franchisees understand how the system is operating in that regard when they look to join, but also what contractual provisions will affect their supply chain in the future.

It is critical that a would-be investor in a franchise educate themselves from the many publicly available resources on franchising.
It is critical that a would-be investor in a franchise educate themselves from the many publicly available resources on franchising.

Due diligence is somewhat complicated

A prospective franchisee should be able to determine what makes a franchise successful or unsuccessful from speaking to existing and former franchisees. In the case of the former, operating franchisees may not be truthful for fear of affecting the value of their businesses. In the case of the latter, the former franchisee may have been the reasons for its failure. Brands should be compared to one another in any given sector. A prospective franchise investor should also spend time in front of a good mirror. What is the investor good at, what does the investor enjoy doing, does the investor have entrepreneurial aspirations, can she or he follow systems? All of these questions can determine what type of system may be best for the would-be investor. There are services which help people assess their own aptitudes and interests and align those to existing franchise systems.

System marketing is very secondary to personal marketing

A would-be franchisee who expects the system’s marketing fund to translate into its unit’s success is likely misguided. Rather, a would-be franchisee should expect to promote its own business within its community through a combination of time and resources. A franchisee will also be controlled in how it markets locally. This aspect of franchising is typically underappreciated and should be discussed and negotiated specifically with the franchisor at the outset.

Investing in a franchise and being a franchisee is a complex undertaking

Fortunately, there are professionals who have made it their life’s work to understand the industry and who have networks of similarly situated contacts. It is critical a would-be investor educate oneself with the many publicly available resources on franchising and then establish a professional relationship with an experienced franchise accountant or lawyer. When a prospective franchisee considers the magnitude of the investment, and the consequences of making a good or bad investment decision on their lives and families, the decision to engage an experienced professional may be the most important investment decision the prospective franchisee may ever make.

Allan D.J. Dick is a partner at Sotos LLP, Canada’s largest franchise law firm serving local, regional, national, and international clients in the industry. The firm promotes its experience in the many industries in which franchising operates such as restaurants, hotels, automotive, supermarkets, personal services, professional services, home services, and cannabis, representing some of Canada’s largest franchisors, franchisee associations and individual franchisees. He can be reached at adjdick@sotos.ca.

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