1. Earnings Claims.
This is what is referred to when a Franchise Company publishes financial information in an area of the Franchise Disclosure Documents, or FDD, commonly referred to as an: Item 19.
The term Earnings Claim also arises when someone, a sales person, consultant or broker, makes an “earnings claim”. This happens when someone quotes a dollar figure, whether gross or net, to a potential candidate if that information is not reported in the FDD.
The thing to be careful of with reported financials or earnings claims in a Franchise Disclosure Document is the process that the company used to calculate the numbers. I have seen many different ways of calculating an “average”.
Top third, mid third & bottom third. This is where a franchisor takes all of their Franchise owners and splits them into 1 of three categories. Top/Mid/Bottom. They then calculate the average gross or net revenues for each section. The thing to be careful of is that when reviewing these figures, most people think to themselves, “I will be above average” in owning my business. No one thinks to themselves “I am going to be in the bottom third of the system”. That just isn’t how people think.
I recommend taking the average of all franchises in that system.
Another way that some companies calculate & report an earnings claim is a Gross Profit instead of a Net Profit. But because people see the word “Profit” they sometimes think that is how much money they are going to make. This just isn’t accurate. Gross profit is prior to some expenses & taxes. Net profit is after all expenses and after all taxes. Please do not get confused when comparing gross & net profit figures.
2. Validation Ringers.
You are interested in a franchise, you talk to the company and find out you are qualified. They send you a Franchise Disclosure Package and tell you that you should talk to a few of their existing franchise owners. They give you the names & phone numbers of a half dozen people to call that already own the franchise.
STOP! These are generally what I refer to as Validation Ringers, meaning, these people are being given to you for a reason. When you call them, you will generally hear all good things. The act of giving you that information for the purpose of due diligence is not legal in the Franchise Industry. The Franchisor can not direct you to call certain people.
Included in the Franchise Disclosure Documents is a list of Franchise Owners & numbers. Call 5 or 10 of them at random in addition to the ones the Franchisor provided to you, if they did, if they didn’t, call as many as you can until you feel comfortable that you are hearing consistent things.
In my opinion a franchise company will provide you with specific franchise owners to call for one of two reasons. Number one, they are afraid that if you call random owners you will find out that the system isn’t as great as they make it out to be. Or two, they are pushing the sale forward quickly. By you calling a few of the “loaded guns” you will move through the process faster.
Either reason is invalid and illegal, a franchisor is not permitted to direct you on who to call when you are performing your validation/due diligence calls.
3. Interview/Process.
Franchising is all about following the system. Most Franchise companies don’t have a formal interview process where they sit down at a long table and you talk to the board of directors to get approved. A few do it that way, but in my experience it is a small number of companies that do it that way.
Most Franchise Companies use the research process as the main part of the interview. Their logic is that if you can follow the process of research then you would make a better franchise owner than if you can’t or aren’t willing to follow the research process.
If you can’t follow the research process properly they don’t feel you would be good at following a system. And that is what Franchising is all about, following the system.
Here is a generic process that seems to fit most companies, of course, each company is a bit different, but this will give you a basic overview of what to expect.
A. Initial conversation, this is usually with a sales person or consultant. The purpose of this call is for you to get your initial questions answered and for the Franchisor to determine if you are the type of candidate they want to work with. They also need to know if you are qualified for the franchise financially, so that will be covered on the first call too.
B. Application completion. In order to receive the Franchise Disclosure Documents you will need to complete a basic franchise application. This document does not obligate you to anything, it just lets the franchise know your background, financials, information all in writing. That way they can review it prior to mailing any proprietary materials to you.
C. Receive and review Franchise Documents. At some point you will receive the FDD package, or Franchise Disclosure Documents, these important documents include tons of information about the company, the contract, the requirements, your obligations, their obligations, a list of franchise owners, failures etc…
D. 2nd Conversation with home office representative to discuss questions on the Franchise Documents. Once you have completed step 3 above, you will have more questions for the franchise. This conversation covers those questions in detail.
E. Talk to existing Franchise Owners. This is one of the most critical parts of the process from a buyers perspective. Most franchise companies can not disclose an average earnings claim to you because that information isn’t reported in their FDD. However, existing franchise owners can tell you how much they are making, they can tell you what their challenges were and what to expect. You still can’t tell how much YOU are going to make, but this part of the research should give you an idea of some of the numbers and information outside of the sales guy at the home office.
F. 3rd Conversation with home office representative to discuss questions both directions. At this point, you should have more questions for the home office and they will start to ask you more questions too. Things like: How would you pay for the franchise, cash, financing, combination? What other information do you need? When can you visit us for a discovery day?
G. Visit home office for Discovery Day. This is usually a 1 or 2 day event that is designed to give a potential buyer the feel for the corporate culture. It lets you meet the people that you will be signing a contract with for the next 5, 10, 15 or even 20 years. Find out what kind of people they are, how do they talk in person, are they friendly, supportive etc…
H. Talk to a Franchise Attorney. If you choose to talk with an Attorney, we recommend talking to a Franchise Attorney. You wouldn’t go to a foot doctor to fix your heart, so you wouldn’t go to a general practice lawyer for franchise law either. Use a specialist, it is worth it. However, should you choose to talk with an attorney, make sure they understand their service is for Review & interpretation only, NOT negotiation. Most attorneys will try to get you to negotiate the contract and it does not work that way in the franchise world. If you want to buy the franchise, you have to sign the contract as is, eveyrone signs the same contract.
I. Make a decision to buy or not. Send in your initial payment for the franchise fee and start the real estate and financing process. These 2 things come after your purchase of the franchise.
This whole research from Step 1 through 9 takes about 2 months of time, so please be patient, it can be an arrdous process. It requires a time commitment, so make sure you are serious prior to starting your research.
The main purpose of this section was to outline the process and point out how important it is to follow whatever the process is, if you can’t do that, chances are the franchise company will not be interested in working with you to award you a franchise.
4. Talking to local franchise owners
As outlined in the previous section, at some point, you will start talking to existing Franchise Owners. Your initial inclination will be to talk to the local franchise owner in the next town over or even at the other end of your town.
Be careful when you do this, I have noticed a bit of resistance when I talked to existing franchise owners in my town about opening another location on the other side of town. Either they felt threatened because they thought I would take their customers or maybe they thought I would affect their ability to expand with other units, but either way, the answers I received were slightly different and a bit more hostile than when I called owners outside of my area.
I am not saying don’t do it, I do recommend it at the right time, but rather, take it with a grain of salt and compare for consistency with other franchise owners in similar markets outside of your area.
You also run the risk of that local franchise owner buying the territory to protect their expansion desires. So be cautious of running down to your local business and announcing that you are going to open another one nearby. Franchise owners can be a little territorial.
5. Fads.
Be careful when exploring the next “hottest” thing in franchising. Seems like every day there is a new franchise popping up. A lot of people think their concept is perfect for franchising because their friends and family tell them “You should franchise this”.
Fads can be dangerous. I always recommend working with a Franchise that has a proven track record. 5 to 10 years or more in business, 50 to 100 units or more is a good rule of thumb. I am sure there are some successful franchises that have less units and have only been around for a few years, but lets face it, you are looking at a franchise because you want to reduce your risk because they have a proven system right?
Well how proven can it be if they have 7 units and have been franchising for 1 year? I am not discounting growing markets or emerging industries, I am just saying, be careful. Make sure to perform your due diligence properly. If you are looking at a company that is just starting out in franchising, chances are there is a more established company that does the same thing, so at least compare the two different companies. If nothing more than for information sake.
Fads are just that, here and gone. Don’t risk investing your life savings and your time into a Fad type franchise. Make sure they have a proven track record and really dig into the demographics information. Take a look at where the industry was 5 years ago, where it is today and where it will be in 5 years.
6. Requesting information from a website.
When you request information from a franchise website about a particular franchise, did you ever notice how many more companies contact you than you originally requested? This is because of the dreaded “prechecked box”.
You enter your name, address, phone, email etc… into one form and click continue. But you missed the box that said: “By checking this box you agree to receive information from similar companies”.
What happens is that the website sells your information to a bunch of franchise companies. The more times they can sell your information the more they make, so they will precheck that little box for you on multiple opportunities.
Here is a real life test that I performed myself over a year ago. In July of 2008 I requested information from one company via an Internet franchise page. This type of Website had multiple opportunities on it. I setup a specific email address, used a fake name and used a phone number that was a voip number, so I knew that when someone called me or emailed me and asked for this particular name, that they had purchased my information from this website.
As of September 2009 I have received 27 inquiries. That means that my information was sold 27 times by that website. Now each time I receive the information I inform that company that they were sold bad information that was a year old, but my point is, be careful who you provide your information to, I always recommend working with a franchise specialist to avoid information overload.
A good Franchise Consultant can help you determine which franchise, if any, fit the business model and goals of what you are looking for in a business.