10 steps to freedom – How to buy a franchise

Far too many people jump into franchises without due consideration of the risks and a thorough assessment of the implications in both the short and long term, writes David Stafford, Executive Consultant at DC Strategy .

Given the contractual nature of the franchising relationship, it is crucial prospective franchisees thoroughly evaluate the business opportunity and the franchisor before committing to buy into a franchised business.

1. Set your limits

Assuming you have an open mind on what particular type of business you would like to operate, the first consideration in buying a franchise is what can you afford?

With more than 1100 franchised systems on offer in Australia, the prospective franchisee is faced with a seemingly endless range of opportunities. Assuming you've already culled out those systems which don't interest you, those for which you aren't suited or those that demand operating constraints you're unwilling to meet, the first step in filtering this range of potential opportunities is to be realistic about the amount of money you are prepared to commit to establishing the business and the working capital required in the start-up phase.

Here, the savvy investor will determine what hen afford and then commit to no more than that - just like the rules at an auction, set your limit and stick to it.

2. Filter the list

You need to get your list of potential franchises down to a manageable level - say, four to six at this stage. Take a good look at the list you have - do you really see yourself operating each of those businesses? What is each of the systems like? Ask yourself these questions:

• Do they look good?
• Have they proven their ability to secure quality locations?
• Are current franchisees profitable?
• Are they seen in the media?
• Are current franchisees happy?
• What is the marketing and advertising program like?
• Do they have strong relationships with the banks?
• Do they have company-owned operations?
• Do they listen to and learn from their current franchisees?
• Do they have a clear vision and aggressive growth plan?

Understanding how each of your potential franchisors stacks up against these criteria is an important step in selecting the right franchise for you.

3. Test the numbers

By this stage you should have contacted your target franchisors and secured a first meeting or, hopefully, some financial details about the offer. You may be asked to sign a confidentiality agreement.

Regardless of the information the franchisor provides, you must develop your own view of the financial aspects of the business. There is no substitute for a thorough understanding of the establishment costs, revenue potential and operating expenses.

Your assessment should be cautious – err on the side of understating revenue and overstating expenses to gain a conservative view of the business. Most importantly, have your accountant either develop this view for you or test your evaluation critically. Where do the pitfalls lie? Have you thought of all the operating costs? Have you listed all the establishment costs?

4. Interview franchisees

There is perhaps no more telling test of a franchise system than to speak with a range of current franchisees. Don't just limit yourself to those suggested by the franchisor, they will undoubtedly pick all the happiest they can find. Speak top a range of franchisees and quiz them; are they happy? Would they recommend this franchise to their friends and family? Would they sign up again what they now know? What support does the franchisor provide? Is the franchisor reasonable? Are they willing to listen?

5. Make your application

Most franchisors will ask you to submit a formal application form. Be wary of those who don't; it's a sign they don't care about who becomes a franchisee. Take your time with any application. If you have to hand write it do so carefully. Be honest and forthcoming with information, don't evade or mislead; the savvy franchisor will find you out and that will be the end of your application.

You may be asked to pay an application fee of some kind. Make sure you receive a receipt for the fee and a written assurance that the amount is fully refundable until you sign a franchise agreement. This is most important as it will test if the franchisor is aware of its obligations under the Franchising Code of Conduct.

6. Look into the legals

At this stage you will most likely be provided with a pro-forma copy of the franchise documentation. If you receive only a precis of the franchise agreement ask for a full copy. If the franchisor won't provide one then walk away.

There is simply no reason a quality franchisor would not provide you with a full pro-forma of the franchise agreement. You should engage a specialist franchise solicitor to review the proposed agreement, disclosure document and any other documentation the franchisor provides. There is no value in engaging a non-specialist to review the franchise agreement because such agreements are, by the nature, substantially different to ordinary business contracts. A specialist advisor is a must. It's a worthwhile investment.

7. Check the disclosure

The franchisor is required to provide you with a copy of its current Disclosure Document under the Code. The contents include such items as the intellectual property being licensed, the business backgrounds of the franchisor's directors and key officers and a range of information about the costs you may be required to pay.

Check out the directors and officers thoroughly. Are they members of the Franchise Council of Australia? Are they trustworthy people? Do they have backgrounds which would be of value to the business? How long have they been in business? Your solicitor will be able to review the disclosure along with other legal documentation provided by the franchisor.

The franchisor is obligated under the Code to advise you to seek independent legal, accounting and business advice prior to entering into a franchise agreement. In fact, you will be required to sign a statement that the franchisor has advised you to do so.

While your accountant and solicitor will provide you with specialist view-points, it is highly valuable to seek independent business advice. This can be very broad ranging and help you identify issues or questions to pose to the franchisor. Independent evaluations are highly worthwhile and can bring another perspective to your decision making.

8. Establishing finance

Some franchise systems are accredited with major banks. This means the banks have done their due diligence of the franchise system and may be prepared to finance part of your establishment costs against the business. Be careful here though. You don't want to exceed the limit you set for yourself originally. Test the financials again to see if the business can sustain the loans required to fund the initial capital costs.

9. Check out the site or territory

If the franchise you are seeking has a defined site or territory, you should thoroughly examine the site and/or territory on offer (if one is offered to you at this time). The franchisor must provide you with details of the site or territory if it has previously operated a franchised or company owned business there.

Visit the location and drive the surrounding area - don't simply rely on the address on a map. Does it have the right visibility? Is it among complimentary businesses? Where are the competitors? Is the traffic enough to justify your financial projections? What is the condition of the premises? What do the socio-demographics look like?

Most likely, you will have to approve the site as a condition of your franchise agreement. Therefore, you should be satisfied it will do the job.

Don't let your emotions take over; far too many franchisees accept supposedly good sites simply because they fall in love with them. They don't take the time to test whether the rent is too high for the projected sales rates for example.

10. Question, question, question

A quality franchisor will be willing to answer all your questions and provide you with enough information on which you can make a fully informed decision. Don't fail to ask simply because you think the question is stupid, ask it anyway. You must be comfortable with every aspect of the business, so ask, ask, ask and keep on asking until you are satisfied.

Only after you have completed all these steps should you contemplate signing either an offer to franchise or a franchise agreement. To sum up:

• Set your limits - know how much you can comfortably afford
• Filter the list - which opportunities are a good fit with your objectives and skills
• Test the numbers - and err on the conservative side
• Interview current franchisees - they are an excellent source of information about the franchisor
• Make your application - make it as thorough and accurate as you can
• Look into the legals - obtain quality, specialist advice to review the proposed documents
• Check the disclosure - what are the backgrounds and qualifications of the key people
• Establish finance - evaluate the various banks with whom the franchisor is accredited
• Check out the location - is it truly a good site - be objective - don't fall in love with the area
• Question - ask all the questions you want, until you are satisfied you understand.

Remember, it's your responsibility to understand the business and make a fully informed decision.

This article appears courtesy of Franchising Magazine