Questions you have to ask

By Sarah Stowe | 06 Nov 2015 View comments

When an enthusiastic buyer signs on the dotted line and looks forward to opening up his or her franchise there will have been a host of questions thrown around in discussions about the business. Some franchisors are tough on their potential franchisees and put them through their paces before accepting them into the fold, others are less stringent and embrace new blood with enthusiasm and an open mind.

For the franchisee with a huge financial and personal commitment to make their new business a success asking questions of themselves and the franchisor is never a waste of time; it serves to clarify issues and to add a sense of objectivity to what can be an emotional period.

After all, everyone buys a franchise to make money so the overall agenda has to be to achieve financial goals and to ensure the choice you make will suit you and your ambition.

QUESTIONS TO ASK THE FRANCHISOR

1. What is your vision and strategy for the brand?

When franchisees are conducting the necessary due diligence on their franchise system of choice, it is far too often focused solely on the numbers, suggests David Stafford, executive consultant at DC Strategy. While thorough financial analysis is undoubtedly a necessity, so too is an understanding of where the franchisor intends to take the brand and system over the short, medium and longer term.

Think about where the brand is positioned today and how that is changing over time; find out what additional products and/or services the franchise intends to introduce; consider what competitive pressures might bring about changes to the brand and franchise strategy; look at what trends are evident in the domestic and international markets that might have an effect on the franchised brand, its position, products and overall strategy; and find out what initiatives or action the franchisor is taking to address these issues. Thorough diligence means more than the numbers; it must include consideration of all facets of the franchised business.

2. What ongoing costs are going to be paid to the franchisor?

Most commonly, these will be one or a combination of royalties, levies, charge backs, upgrades and mark-ups, writes Jason Gehrke of the Franchise Advisory Centre.

Royalties: these are a regular payment for the use of the brand, intellectual property, and for the business and technical support services provided by the franchisor. These may be expressed as a percentage of gross turnover (often ranging from five to 11 per cent) or a fixed dollar amount. Royalties are paid on a weekly, fortnightly or monthly basis depending on the franchise system.

Levies: often used to generate income for the system’s marketing fund, and where this is expressed as a percentage of turnover can range from one to eight per cent. The marketing fund pays for a base level of advertising activity for the system (such as catalogues, radio and print advertising, point of sale materials), however individual franchisees are often expected to augment this with their own local area marketing (LAM). LAM funding may even be expressed as a percentage of gross turnover (say one to two per cent) and be a contractual spending requirement of each franchisee.

Chargebacks and conferences: as franchise systems evolve and introduce innovations for their franchisees, not all of these can be paid for by the original royalty structure. Often there are additional costs, known as chargebacks. These can be for the use of new or upgraded software or IT systems, usually expressed as a monthly charge. Franchisees may also be required to pay a contribution to the cost of the national conference, which may be as much as $1000 or more each year.

Upgrades: franchisors may introduce an upgrade program during the life of a franchise which may require a franchisee to invest in new signage, fixtures and fittings. The cost of such an upgrade can be tens or hundreds of thousands of dollars, depending on the type of franchise.

Mark-ups and rebates: where franchisees are required to buy goods or services from the franchisor, the franchisor may apply a mark-up to the price. This may be unavoidable if the franchisor is the only possible supplier of the item. If there is a range of potential suppliers and exact quality is the same, franchisor mark-ups may generally be lower than those of other suppliers.

Rebates are payments made by suppliers to franchisors based on a percentage of franchisee purchases from those suppliers. This may be viewed as a form of franchisee payment to the franchisor, even though it is paid via a third party, the supplier.

Many franchisors receive rebates from suppliers. The list of suppliers who pay rebates are required to be disclosed to a potential and renewing franchisee in the franchisor’s Disclosure Document.

3. What ongoing support will you give me?

Many potential franchisees are a little disappointed when they read through their Disclosure Document and franchise agreement (if in fact they bother to do so), writes Garry Williamson from The Franchise Centre. In our experience the franchisor can be very vague about the amount of ongoing support the franchisee will actually receive.

Of course the franchisor is all smiles and happy to give verbal indications of ongoing support but is only legally tied to what is in its key franchise documents. In fact we are seeing an increasing trend for the franchisor to charge for ongoing training yet they have a vested interest in providing field support to their franchisees to help them increase their weekly sales.

We are also often asked by potential franchisees; ‘what should I look for in determining whether the franchisor is professional’ and our answer is to make sure the franchisor does commit in writing in their franchise documents to monthly field visits and lots of meetings with all their franchisees. In fact the sharing among franchisees at meetings co-coordinated and run by the franchisor should be a tremendous source of spreading operational info.

4. What are the backgrounds and qualifications of the key people?

This particular question can often be overlooked by enthusiastic, would be, franchisees especially if they are dealing with an experienced sales team from a franchisor. Yet it is one of the many critical issues to investigate advises Geoff Langham of The Franchise Alliance.

The franchisor’s background should ideally be in the business they are franchising or a similar business, unless this is a corporate, multi system franchisor. They should be able to display an in-depth knowledge of the product/ service and the issues which affect the marketing of it. They must show that they understand and deal appropriately with the matter of people management in the franchisor role, and also be able to demonstrate how they are dealing with the current financial issues facing business.

The field service officers must be able to show they understand the operation of a franchise outlet and all of the matters franchisees have to deal with.

5. What protection do I get if the business becomes insolvent?

Tony Garrisson is a principal in the franchising division of legal firm Mason Sier Turnbull. He writes, the Franchising Code of Conduct provides for a franchisor to terminate the franchise agreement if a franchisee becomes insolvent but there is no such provision for the franchisor’s insolvency. So you need to look carefully at your franchise agreement to see whether the franchisee has a right incorporated to terminate if the franchisor does become insolvent.

We have seen examples recently of some franchise systems going into administration. If this occurs, the administrators are effectively appointed as officers of the company and they are bound to act in the interests of all creditors. There are more complex issues where the bank may wish to appoint a receiver and manager to protect its interest.

Typically, if the franchisee owes money to the franchisor there will be competing interests with the bank wanting to realise its security and the administrator’s attempt to resuscitate the business.

There may be issues with suppliers and if monies are owed to suppliers, there may be concerns relating to supplying products that could be at risk. These are only some of the issues that need to be looked at if a business becomes insolvent.

6. What happens if I cannot work in the business?

Whether operating an existing franchise or buying a new franchise business, you need to plan for the unexpected, advises Katarina Klaric, partner at Stephens Lawyers and Consultants. Poor health, illness or death in the family, and divorce are some ways that the operations and profitability of the business may be affected and could lead to ultimate closure.

Businesses that require the owner’s involvement in the day to day operations are at the highest risk if the owners can no longer work in the business. But such risks can be avoided by careful planning and risk minimisation strategies.

For starters take out insurance cover tailored to your needs. Consider insurance that covers loss of income or profits, the costs of paying for someone to manage your business in your absence and other business costs that may be incurred.

Seek expert advice to ensure that you are adequately protected. Check your franchise agreement to see how it deals with the issues and if it provides you with adequate protection. Ask the franchisor if there any provisions in the Agreement which prevent or restrict you from re-structuring the ownership of the franchise business.

Discover whether the Agreement allows you to appoint a third party to manage or operate the franchise business. Find out if the Agreement allows the franchise business to be sold in the case of poor health, death or changed circumstances and if so, whether there are any restrictions on the sale.

Does the Agreement allow you to terminate the franchise where you can no longer operate the business and if so, what are the consequences of early termination? Do you have to pay an early termination fee to the franchisor? Do you have continuing obligations to the landlord or leasing company for premises or equipment that you have leased to operate the business? Have you taken out loans to purchase the franchise business and how will these be repaid?

Check if the Agreement allows for the franchisor to take over the operation and management of the business during your absence and if so, at what cost. And does the Agreement require the franchisor to buy back the franchise if it cannot be sold to a third party?

QUESTIONS TO ASK YOURSELF

7. Have I got confidence in the financials?

The Disclosure Document provided by the franchisor has to identify all the costs involved in establishing a franchise and any ongoing payments such as royalties and marketing fees, explains Bill Lockett from the Franchise Systems Group. However many of them will not provide information as to how much money a franchisee could make.

While this is reasonable as the results will depend for the most part on the efforts of the individual franchisee, it does not help the prospective franchisee. Many franchisors believe that if they provide financial projections, they could be leaving themselves open to litigation down the track if the results don’t match. The safest solution is to ask the franchisor to supply actual results from their existing network as they can’t be taken to court for telling the truth.

Some of the majors are good at this as they can provide the information across a wide cross section of the business, for instance metro and regional franchises and do not need to identify specific locations.

To be sure that this information is relevant you should be doing your due diligence by contacting existing franchisees and asking them if they have been happy with the results and how they compare with what you have been given. The more franchisees you contact the better as the first one you contact may not be typical of the whole network.

In addition you should seek advice from a franchise consultant or accountant who is experienced in franchising as they have generally accumulated a wealth of knowledge about the financial performance of different sorts of franchise systems. Ideally they will have an outline of a franchise financial model, which will enable you to draw up your own budget and business plan.

This would ensure that you were aware of the commercial viability of the franchise and would certainly impress the franchisor if you went back to them with your own financial plan.

8. Can I afford this franchise?

Talk with an accountant, suggests Grant Garraway of The Franchise Shop. They may generally be crusty old individuals but they are about to become your best friend. If you cannot do this yourself have them build you a profit and loss spreadsheet model that allows you to change the key numbers. Then you can understand what happens if interest rates go up.

You can look at how much could the sales go down by for the business to still be OK.

How much money can you borrow? That will depend on the value of the assets you can offer as security, generally your home, and what repayments the business profits will allow you to make.

Remember that a lower purchase price does not mean lower risk. You also need to ensure you have allowed sufficient working capital to get you through the start up period of your new business. Can you cope if it starts a little slower than you planned?

Finally, question your personal risk profile. It is likely to be that the older you are the less risk you can afford as there is less time to make up any losses.

9. Can I see myself working in this franchise for five years?

If you don’t answer “yes of course I can” when posing this simple question to yourself then maybe you should reconsider franchising as an ownership option, cautions Dean Salomone of Franchise Careers.

Unless of course you have a bigger and broader plan of being a multi site operator and will line up managers to run the day to day affairs.

One of the potential benefits of being granted the right to operate a franchised business for a defined period is that as a small business owner you can plan your direct involvement/input in the business from years one to five (there most common term) based on your personal goals and expectations.

When talking with new franchisees from a myriad of brands over the past nine years and the topic of business planning is brought up I always suggest reversing your plan and asking yourself one of the most important questions you should ever consider when planning: how do you plan to control the business to satisfy your personal needs?

So here are a few hints and tips which may make your decision a little more objective:

Do you want to actively be involved in the day to day operations of the business in year five? If the answer is no, then consider if you have a structured succession plan to ensure a smooth transition from you to an employee/manager of the business.

Will you sell the franchise before the end of the term? This comes with its own challenges as it’s not as straight forward as selling a non franchised business. If the answer is yes, then make sure you have thoroughly thought through the following points: will the way that successful long term franchisees operate their business on a day to day basis stimulate you?

Are you prepared to make the sacrifices they appear to be making? Look at the quality of ongoing learning and development initiatives your potential franchisor provides and consider if they will meet your needs right up to year five?

Probably the most subjective question you can ask yourself is ‘does the very nature of the franchise brand I am considering suit my personality?’

I know it may sound simplistic but never lose sight of the fact that you should love what you do for work; the dollars will take care of themselves as long as you have enjoyment and passion.