To Franchise or Not to Franchise

Over the last few months, we've discussed a variety of things. We started out with talking about what the three pillars are to build a solid foundation under any kind of business that you want to run. we've talked about your skill sets, how to examine yourself, how to determine what skill sets you need to learn and which skill sets you need to hire out and bring into your organization. 

And we've talked about consumer direct marketing, and that's a way, with no investment, you can actually build a business that can give you residual income for the rest of your life. But today, we're going to look at something that you do have to put money into, and often it's hundreds of thousands of dollars to get started. 

And that's the subject of franchising. And I think you'll be amazed at how many different things you have to take into consideration before you jump into this way of doing business. 

Transcript

Episode 12 - To Franchise or Not to Franchise 
 

Roger: Over the last few months, we've discussed a variety of things. We started out with talking about what the three pillars are to build a solid foundation under any kind of business that you want to run. we've talked about your skill sets, how to examine yourself, how to determine what skill sets you need to learn and which skill sets you need to hire out and bring into your organization. 

And we've talked about consumer direct marketing, and that's a way, with no investment, you can actually build a business that can give you residual income for the rest of your life. But today, we're going to look at something that you do have to put money into, and often it's hundreds of thousands of dollars to get started. 

And that's the subject of franchising. And I think you'll be amazed at how many different things you have to take into consideration before you jump into this way of doing business. So let's get started. 

Announcer: You are listening to the Mastering Business Basics podcast, where we discuss how to build a solid foundation under your small business to improve your chances of success. And now, here is your host, Roger Pearson. 

Roger: The biggest advantage of, buying a franchise that you're going to be able to sell goods and services that already have an instant name recognition. 

Everybody knows what McDonald's is or Burger King is or Taco Bell is. And so you have that recognition coming up front. But, there's a lot of things you need to take into consideration before you say, "Oh yeah, I'd like to own one of those businesses. That would be great." Because not all franchises are created equal, and probably some of them are slated for failure before they even start, and that's unfortunate. So you need to be able to investigate and you need to be able to evaluate a franchise opportunity. 

I mean, a franchise enables you, the investor or the franchisee to operate a business. You pay a franchise fee, you get a format or a system developed by the company, the right to use the franchisor's name for a specific number of years, and for their assistance. For example, the franchisor may provide you with help in finding a location for your outlet, initial training and a operating manual, and the advice on management, marketing or personnel. 

During my decade of working in the restaurant business, for instance, I had the opportunity to manage some franchises and of course, the first thing they did was, send me to one of their other stores, and go through a training program. 

Unfortunately, it was not a very comprehensive training program, but because I had worked every position there was in the restaurant business, I knew how to run a restaurant. And so I just looked at the way they wanted me to present their product, and I adapted it to that knowledge. 

Unfortunately, a lot of people get into a franchise and they don't know the basics of that business to start with. And so that's really at a disadvantage because you can't depend just on the training that that company's going to give you. You have to have, business basics. You have to have some business skills going in. 

Or if you're just investors , you better be very sure that the people you hire to manage your franchises for you know that business and have a record of being successful in that business or you're going to put yourself behind the eight ball just to start out 

Now, owning a franchise comes with, there's defined costs, there's franchisor controls, and there's also contractual obligations that you have to deal with that you're not going to have if you're running your own small business that you've started yourself. 

For instance, the cost in exchange for the right to use the franchisor's name and benefit from their assistance, you're going to pay some or all of the following things, and you have to take this into account. You're going to have an initial franchise fee. Your initial franchise fee will typically range from tens of thousands of dollars to several hundred thousand dollars, and a lot of times it's non-refundable. 

If you don't make it work, you're not going to get your money back. And you could also face significant costs to rent, to build, to equip an outlet, and to buy initial inventory. And you may also have to pay an operating licenses, insurance, and a grand opening fee to the franchisors to promote your new outlet. 

That can add up. There's going to be continuing royalty payments that you have to make to the franchisor, and it's based, usually based on a percentage of your weekly or monthly gross income. typically, you must pay royalties for the right to use the franchisor's name even if you're losing money. They have to be paid first, and a lot of people don't realize that. 

You may have to pay royalties for the duration of the franchise agreement, even if the franchisor doesn't provide the services it promised. And even if you decide to terminate your franchisee's agreement earlier, you're still on the hook for those negotiated fees that you agreed to upfront 

You may also have to contribute to an advertising fund. Some portion of the advertising fees may be allocated to national advertising or to attract new franchise owners rather than to promote your outlet. So you're helping the company promote the entire chain. You have to take that into consideration. And to ensure uniformity franchisors usually control how franchisees conduct business. 

These controls significantly restrict your ability to exercise your own business judgment. Some of the things a franchisor may control is your site approval. Many of them retain the right to approve sites for their outlets, and they may not approve a site you want. Some franchisors conduct extensive site studies as part of the approval process, and a site they approve because of this actually may be more likely to attract customers, so you need to listen to it. You just can't be stubborn about it . And that's why that's usually written into the contract someplace, that they have to approve the site. 

They may impose design or appearance standards to ensure a uniform look among all of the outlets under their name. And some require periodic renovations or design changes. Complying with these requirements can also increase your cost. I know we have a Taco Bell here, and in the last ten years, I've watched them remodel it twice to come up to modern signage and everything. And so that's a cost you have to put money away for. And they also may restrict the goods and services that you sell. 

For example, if you own a restaurant franchise, you may not be able to make any changes to your menu. if you own an automobile transmission repair franchise, you may not be able to perform other types of automotive work like brake or electrical system repairs. They may require you to operate in a particular way. For instance, they may dictate the hours you're open. They may have to have pre-approved signs, the employee uniforms, the advertisements. in some cases, they demand that you use certain accounting or bookkeeping procedures. 

And a franchise advertising cooperative may require you to sell some goods or services at specially discounted prices. I see that at Subway all the time. They're always advertising special discounted prices, and you have do them. That can affect your profits. 

Or they may require you to buy supplies from their approved supplier, even if it's more expensive than what you could get elsewhere. It doesn't seem fair, does it? But some of them require that. They may limit your business to a specific location or sales territory. That's one of the most common ones. If you have an exclusive or protected territory, it may prevent the franchisor or the other franchisees from operating competing outlets or serving customers in your territory. So in some ways, that helps protect you, but it may not protect you from all the competition by the franchisor. For example, the franchisor may have the right to offer the same goods or services in your sales area through its own websites, catalogs, or other retailers or competing outlets of a different company-owned franchise. 

'Because you have, company-owned franchises like, KFC and, and Taco Bell are the same company, or Carrabbas, Bonefish Grill, and Outback are the same companies. I've seen a lot of times that, they'll put, Carrabbas right next door to an Outback. And if they're both owned by the same franchisees , that would be okay. But what if they're owned by different ones? Then you've got competition for the same company right next door to you. You know, these are the things you have to look at if you're going into franchising. 

Now- The franchise contracts only last a number of years. And it's always stated in the contract. And you can lose the right to your franchise if you don't comply with the contract. You won't have a right to renew unless the franchisor gives you that right. I know, I've worked with H&R Block for the, oh, almost quarter century now. And the first few years, I was actually working for a franchise of theirs. 

And when the time came up for renewal, the company just decided not to renew them. And of course, they're not going to tell you the reasons, but they found a way that they just, "No, we're not going to renew them." And the company took over all of the outlets and made them into company stores. And the franchisees were out.  I'm sure that he got a severance or something for it. But, of course, they don't publish that stuff. But that can happen. That can absolutely happen. They can come in and take over. That's something you have to watch out for. 

A franchisor can end your franchise agreement, for a variety of reasons, including your failure to pay royalties or abide by performance standards or sales restrictions. They'll find a way if they really want to do it. I mean, they usually give you a chance to cure an occasional failure to comply , like making one late payment . But they still keep the right to terminate your franchise for other failures. So I mean, you've really got to toe the line, and you've have to understand your obligations if you're going to get into this line of work. 

And the franchise agreements actually can, run as long as twenty years. They're not automatic, like I said, and at the end of the contract term, they may decline to renew or may offer a renewal that doesn't have the same terms and conditions as your original contract. For example, a franchisor may raise the royalty payments. They may impose new design standards and sales restrictions and reduce your territory. Any of these changes may result in higher cost to you, reducing your profits, and provide more competition from company-owned outlets or other franchisees. So those are the things you have to take into consideration. 

So the question is: Is a franchise right for you? 

Now, before you invest in a particular franchise system, you have to think about how much money you have to invest, your skills, and your goals. You have to be brutally honest with yourself because we're talking about hundreds of thousands of dollars here. 

That's a lot of money. So as far as your investment goes, you have to ask yourself some of these questions. How much money do you have to invest? How much money can you afford to lose? Are you purchasing the franchise alone or with partners? Do you need financing? Where will you get it? What's your credit rating and your credit score? 

Do you have savings or additional income to live on until your franchise opens, and you hope becomes profitable? They actually recommend that you have at least two years' worth of living expenses put away, just in case that your franchise has problems. You're not worrying about paying the bills or paying the rent or paying the mortgage. 

You have to look at your abilities. does your franchise require technical experience or special training or education? For example, auto repair, home and office decorating, or tax preparation. What skills can you bring to the business? What experience do you have as a business owner or manager? You need to have these things. These are some of the things I try to teach people to prepare them for opportunities like this. 

And what is your reason for buying a particular franchise? Okay. Do you have a specific minimum annual income that you need to make? You have to look at that. Do you want to work in a particular field, or are you interested in retail sales or performing a service? How many hours can you work? But more importantly, how many hours are you willing to work? Do you intend to operate a business yourself or hire a manager? That's a biggie. Will franchise ownership be your main source of income or supplement to your current income? Are you in this for the long term? And would you like to own several outlets? Are you willing to let the franchisor be your boss? 

I mean, to really, really be profitable, I think most people that get into franchising, their goal is to own multiple outlets. And, I've known several, people that, have owned McDonald's. I had a relative that did. He owned eight of them. He was very successful, but it took him a lot, a lot, a lot of work to do that. There was another one here in town that I think they owned twenty-five, and it was very profitable. And when you get time to retire, and you go to sell those established businesses, you can walk away with a lot of money. 

So it's worth the effort. You just have to determine whether it's worth the effort for you because it is a lot of work, and you put a lot on the line. 

But if you decide to do this, how do you find the right opportunity? How do you start doing your research to find the right opportunity? And the first thing is always the franchisor's websites to find information about their franchise. But there's many other ways that you can find out about them, and by all means, you should do this. 

But, let's look at some of them. The first thing is to look at local outlets. It's always a good idea to visit franchised outlets in your area and talk to the owners about their experience with a particular franchisor to see how they've been, treated. 

Try to get hold of a franchise handbook if you can.  A franchise opportunities handbook is usually available from a library, or you can even find them online nowadays, and it's going to list available franchises by type of business and provide basic information about each franchise. And you can use a handbook to find a franchise if you don't know the type of business you want or to see which franchises are available for the type of business that you're interested in. And there's a lot of them out there. 

You could attend a franchise exposition. Yes, they do have them. And this allows you to see and compare a variety of franchise possibilities at one time. They all have their booths set up, and they're all willing to talk to you about their franchise opportunities. But before you attend, you should research the kind of franchise that may best suit your budget, experience, and goals. This is why it's so important to look at yourself as well and answer those questions first. when you find an industry that appeals to you, ask a lot of questions and take your notebook along because you're going to want to make a lot of notes about all of these so that you go back and research them even more. 

Some of the questions that if you go to an expo you should ask, for instance, are how many franchise outlets are there and where are they ? What are their territories? What's the initial franchise fee? What are the additional startup costs? Are there continuing royalty payments? How much are they? What management, technical, or other support does the franchisor offer? What control does the franchisor impose? How long has the franchisor been in business? 

Exhibitors may often offer you incentives to attend a promotional meeting to discuss the franchise in detail, and these meetings can be another source of information and give you a chance to raise questions. But they may also expose you to high-pressure sales tactics. So be prepared to walk away from any franchise opportunity and promotion that does not fit your needs. 

They also have franchise brokers. They sometimes call themselves like business coaches, advisors, referral sources, or sales consultants, and they often advertise on the internet in business magazines offering to help you select among various franchise options. 

Typically, a broker, just like somebody trying to sell you a house, this broker's trying to sell you a business. they review the amount of money that you have to invest and then they direct you to opportunities that match your interest and your resources. A broker may also help you finish applications and paperwork to complete the sale. 

They often work for franchisors and are only paid if a sale is made, thus the high-pressure sales gimmicks that you may come across. So before you decide on a broker, consider whether you need a broker's services or you can just get enough information by shopping online or reading trade magazines or using the internet. The information is out there. You just may have to work for it a little bit to find it all or use your friendly AI. That's amazing how much time that saves. 

So some franchise brokers may claim to be able to match you with the perfect opportunity because they represent a wide range of business sellers, and that may be true or not.  You should ask how many franchisors the broker represents. A broker who represents only a few franchisors will give you limited suggestions. And some franchise brokers may claim they will suggest only those franchises that meet certain standards. You may think this means that your risk is limited because the broker weeds out poor investments, but in fact, brokers represent any franchisor willing to pay them a commission for a sale. 

A broker who does that might direct you to a franchisors that's failing or doesn't have a strong history. As long as they get paid, they don't care, and there are those unscrupulous people out there. So you should ask a broker how he selects the franchisors to represent and ask to see the selection criteria and how many franchisors the broker has recently turned down. These are some interesting questions. And the answers you get for these type of questions is going to determine whether you want to do business with that person or not . 

Now, some brokers earn a flat fee regardless of the price of the franchise they sell. Others earn a commission based on the cost of the franchise, and these brokers may steer you towards a more costly franchise to just increase their commission. And who pays the broker and how the payment's calculated? I mean, you should find out whether the broker earns a commission based on the cost of the franchise. If he or she does, consider whether the broker's suggesting a higher priced franchise in order to earn a larger commission 

And to convince you to buy a particular franchise, a broker may talk about how much money you can make. Well, these claims may be true or not true, you know, and they could be misleading. For example, the figures may be based on earnings in an area where there's a high demand for the franchisor's goods and services, or the claim may be based on outdated industry data .  In some instances, earnings claims may use gross sales figures. When you consider likely expenses, you may find the actual earnings to be far less. And because earnings representations may be misleading, franchisors usually don't allow their sales representatives to make claims about sales, income, or profits unless the claims are included in the franchise disclosures that the franchisor must give you. Brokers are interesting. But you should only view them as fact-finding missions, not as ways to make a decision. 

Now, purchasing a franchise is just like any other investment. It comes with risk. Buying stock on the stock market comes with risk.  You're making an investment in a business. So let's talk about some of the things that you have to consider, if you're going to go into the franchise world. For instance, demand. I mean, is there a demand for the franchisor's products or services in your community? is it a seasonal product or is it year-round? Could you be dealing with a fad? I don't know if any of you remember Pet Rocks or Hula Hoops, but they were around, they were very, very popular, and suddenly they just faded away. You don't want a franchise that does that. Does the product or service generate repeat business? And that's where the money is, repeat business. 

You don't want to sell something that somebody only needs every ten years. That would not be good. Is the franchisor's name so well-known that it's going to bring in customers, or will you have to create a market for a franchise? You know, I see a lot of franchises coming into the area here, and they started out in North Carolina, they started out in Texas, and they have great name recognition there, but they have none here yet, and so you have to help build that.  That could be a detriment to your goals of creating a successful franchise. You're going to have to help build that reputation. 

You have to look at the competition. What's the level of competition nationally, regionally, or locally? I mean, how many franchise and company-owned outlets are in your area? Does the franchise sell products or services that are easily available online or through a catalog? Nowadays, that's a death toll. 

Look at what happened to Bed Bath & Beyond. People just went online instead of going into the store, and they're no longer around. How many competing companies, including competing franchises, selling similar products or services at a similar price? There's a lot of burger joints. Some are going to make it, some won't. 

And are these companies well-established or widely recognized in your community? That goes back to name recognition, whether you have to build it or whether it's already there and you just have to maintain it. So that's important. Sometimes franchises just go totally out of business. They just close up shop. Well, what happens if, the franchisor just files bankruptcy and goes out of business? What happens to you? And so these are some of the things you have to consider too, and you have to look at the documentation for them. 

There's been a lot of them. Most of it's because of poor leadership. You know, you've heard of Blockbuster, no longer around. Quiznos, Roadhouse Grill, Burger Chef, they were all great franchises at one time, but the leadership of the franchise just was lousy. They mistook the market, or they were just terrible businesspeople, and they ended up ruining it. They made stupid decisions, just stupid decisions, and, they went out of business. And then all the franchisees are stuck with stores. Well, what happens now? 

And you're going to want to find all this information we've talked about in the required disclosure document. And one of the other little things that you have to find out from the required disclosure document is whether the franchisors has a federally registered trademark. I mean, That's one of the first things they should do, because if it doesn't, a company using the same mark in your area could force you to change the name or mark of your outlet at your expense. 

And that, that would be a bad thing . And it's also a good idea to check whether consumers or franchisees have filed complaints against the franchisee or franchisor with the regulators, the Better Business Bureaus or local consumer agencies , You should also consider what training and continuing support does a franchisor provide? Does the training measure up to the training provided by other franchisors in the same type of business for workers in that field? So you should compare different franchises of the same industry that you want to go into. 

Just don't take one that sounds good. You need to actually sit down and compare them. Do your homework. You need to know what backgrounds the current franchisees owners have, and is your education experience or training similar? Another thing you should consider is that most franchises were started out by someone who initially, owned their own business, and they became very successful selling goods or services, before they decided to franchise it. 

But there's no guarantee that just because you're a successful entrepreneur running your own business that you can successfully manage a franchise system. I mean, they're two totally different animals. So you need to find out how long the franchisor has managed a franchise system, and do they have enough expertise to make you feel comfortable?   If the franchisor has little experience managing a chain of franchises, take promises about guidance, training, and other support with a proverbial grain of salt because it's not necessarily going to be true. 

Another thing I've seen is that a franchise that grows too fast is probably not a good thing because if it grows too fast, it may not be able to support that many franchisees with services it promises. 

So let's say you've narrowed it down to one or two franchises that you believe you would be interested in doing. The next thing you need to do is you need to ask those franchises for is something called the Franchise Disclosure Document, or FDD for short. And what it does is it gives you all of the federally mandated information for you to make a decision on whether you want to do business with this franchisor. 

And it has twenty-one sections to it, giving you a broad range of information. And usually they can give this to you on paper, they can send you an email, they can send you it to a webpage. 

The first section of the FDD gives you information about the franchisor's background, and it tells you how long they've been in business and their likely competition. It lets you know if there's any legal requirements unique to the franchise business, like a requirement to get a special license or permit. And this will help you understand the cost and the risk you will take on if you purchase and operate this franchise. 

Item two gives you the business background of the executives of the franchise system and describes their experience, so you should pay attention to their general business backgrounds, their experience in managing a franchise system, and how long they've been with this particular franchisor. You don't want something that the executives are like a round robin. 

So the third item goes into litigation history. This is one of the most important parts of the entire FDD because it tells you about prior litigation, whether the franchisors or any of its executive officers have been convicted of felonies involving fraud, violations of franchise law, unfair or deceptive practices law, or they're subject to any state or federal injunctions involving similar misconduct. 

You want to make sure that the people running this are good, honest, law-abiding citizens and that it can also show that franchisees are dissatisfied with its performance. You know, it should also say whether the franchisor has sued any of its franchisees during the last year. That may indicate common types of problems in the franchise system that you may not want to deal with.  For instance, if a franchisor sued their franchisee for failing to pay royalties, it could be because the franchisees weren't successful or weren't willing to or able to make their royalty payments. These are things you need to know. 

Number four is bankruptcy, and by law, they have to disclose whether the franchisors or its predecessors, any of its affiliates, or any of its executives have ever been involved in a recent bankruptcy. Might be interesting to know. 

Items five through seven deal with initial and ongoing costs. And, these are the costs that are involved in starting and operating a franchise, including the deposits or franchise fees that may be non-refundable or cost for initial inventory size, equipment leases, or rentals. And it also explains ongoing costs like royalties and advertising fees. 

But there's some things you may want to ask in addition that it doesn't spell out, like what are the grand opening, are there initial business promotions, the business and operating license needed, the product or service supply costs, the real estate and leasehold improvements needed, the required equipment that you're going to have to buy, such as computer systems or security systems, what kind of training there is, what's going to be the cost of that, what's the cost of business insurance, and what's the cost of compliance with local ordinance like zoning or waste removal, fire, or other safety codes, or maybe even employee salaries. What's the going salary they advise paying? 

So you'll need to investigate other initial ongoing costs that aren't described in five to seven. And there's other costs such as accounting or legal help. And lawyers and accountants are not cheap either.  So you have to take those into consideration that may not be spelled out initially in these items five through seven. 

And eight through 12 go into the supplier territory and customer restrictions of the franchise agreement, and they tell you what suppliers you must purchase your goods from, the goods or services that you may offer for sale, where and to whom you can sell the goods and services, the use for internet to sell services or goods to customers within and without your territory, and the right of the franchisor or other franchisees to use the internet to solicit customers or to sell in your territory. 

These kind of restrictions may limit your ability to exercise your own business judgment when operating your outlet. So do they violate the way you want to do business? That's the basic hit if you have a business background, and hopefully you do if you're going into a franchise. So if the franchisor does not limit the territory where each franchise can sell, I mean, the franchisor or other franchisees just may compete for you for the same customers by establishing their own outlets or selling through the internet catalogs and telemarketing. 

So you need to look at all this just to say, "Okay, what's my competition going to be, or am I going to have any competition if I buy this franchise?" 

Item 11 goes into the franchisor's advertising and training, and it includes important summaries of the franchise system's advertising programs and the initial ongoing training that they're going to provide. 

It talks about the advertising, what they're going to help provide you to advertise this new business that you're buying into. And you should really ask whether the franchisees have any control over how the advertising dollars are spent. That's kind of important. If all the franchisees and company outlets contribute equally to the advertising fund, and you need to find out if the franchisor gets a commission or rebate when it places ads. 

And if there's a rebate, who benefits? Do you get any of the rebate, or does the franchisor just keep all of those nice rebates? And you should really get into the percentage of how they use your advertising funds that you're going to have to pay them. And mean, what percentage goes to administrative costs? What goes to national advertising? Goes to advertising in your area? What percentage goes to selling more franchises or what is just miscellaneous expenses? If they're spending the majority of that advertising money you're giving them on other things other than advertising in your area, then you may want to think twice about this. They're not going to give you that much help. So you need to know those things. 

You need to know about training. I mean, you're all going to have initial training, but is there ongoing training that you need to know to run a successful franchise? Or is there a continuing program for advertising to help you build your business? 

So item 17 is all about renewal, termination, and dispute resolution. First, it states whether you can renew your franchise at the end of the term, and if you can renew, what you must do to qualify for the contract to be renewed, and whether fees and other contract terms may change.  It explains, what, your obligations would be to the franchisor after termination. For instance, after a termination, restrictions in the contract will typically stop you from operating any business that would compete with your prior franchise when they give it to somebody else if the new business is within a specified distance of your prior outlet. 

There may be restrictions that prevent you from operating a new business within a specified distance of any other outlets of the franchise. And these restrictions usually last about up to three years And it could also describe what you have to do if you want to sell your franchise to another franchisee . What restrictions does the franchisor have on that? Do they have to approve who you sell it to first? Those are all spelled out there also. 

Another really important section of the FDD is Section Nineteen. It contains the claims the franchisors chooses to make about the sales or earnings of its franchises for which there's a reasonable factual basis. Now, the franchise rule doesn't require a franchisor to provide sales earnings information, but most do because they want to look good to you. 

But any claims they make about sales, income, or profits must be in item nineteen. That's where you're going to find them. So no other spoken or written financial performance claim can be made if it doesn't appear in number nineteen. But there's two exceptions, okay? One is if, uh, a franchisor may provide the actual records of an existing outlet you're thinking of buying from somebody else. 

And the second instance is the franchisor may add to the information in item nineteen. For example, they may provide information about the possible performance at a particular location or under particular circumstances. Get down to the nitty-gritty stuff. That's the only changes they can make there. 

Item twenty provides charts, I love charts, showing growth and owner turnover in the franchisor system, okay? If the charts show more than a few franchised outlets in your area have closed, transferred to new owners, or transferred to the franchisor for company stores, there may be problems with the franchisor support or because the franchises aren't making money. 

And so that, that's going to throw up some red flags . So don't skip the charts. You need to read them Now you should look for also there's information in this section about current and former franchisees that I think is important. You should look at the required, disclosure of contact information for current franchisees and franchisees who have left the system during the last fiscal year. 

And it's going to give you contact information there, so you can go talk to these people. And talking to these people may be the most reliable way to actually verify all the claims the franchisor is making to get you to buy the franchise. You should visit or phone as many of them as possible, chat about their experiences. Some current franchisees may be reluctant to talk to you if they're having problems. If that's the case, just call somebody else. 

And then some franchisors actually give you a separate reference list of franchisees to contact. And to ensure you get the full picture, you may want to contact a number of franchisees listed in the disclosure document and some on the separate list. 

Now, you want to talk to some franchisees who have been in business just over one year, because those are the ones that are in the best position to tell you what their total investment was, whether they were able to open their outlet in a reasonable time, whether they were satisfied with the franchisor's training, opening, assistance or advertising, whether the franchisor provided ongoing help and assistance, whether they've been able to break even. 

And then you should also talk to some that have been in business at least five years. Now, these people, you should ask them how long it took them to break even and earn a reasonable income or recoup their investment. Uh, whether the franchisor is providing the services and assistance it promised and fulfilling its contractual obligations. If there were any problems, If they would invest in another outlet, whether they're satisfied with the advertising program of the franchisor, and whether they were satisfied with the cost of and quality of goods and services they must buy from the franchisor, its affiliates or its approved suppliers. 

It's even worth tracking down former franchisees using the contact information in item twenty. Although some of them may have signed confidentiality agreements that prevent them talking to you. Prior owners can tell you the problems they had, whether they broke even or made a profit, how long they operated the franchise and, their business background, and then most importantly why they left the franchisee system. And there's some franchisors that'll actually buy back failed outlets and list them as company-owned outlets. So if you're thinking about buying an existing outlet that, um- the franchisor acquired from a prior franchisees, you may ask to see the financials showing the outlet's actual operating expenses. 

And they must tell you who owned and operated the outlet for the last five years. That's the law. If it's a franchise that has had several owners in a short time, well perhaps that location isn't profitable or the franchisor hasn't supported the outlet as promised. So contacting as many of the previous owners over a wide range is probably the most important thing that you can do in determining if you want to spend your hard-earned money with this company or not. 

There's also franchisees associations that you can get important sources of information from, and that's listed. 

The last item, item twenty-one, is all about financial statements, and they have to provide you with the three most recent audited annual financial statements. And if you're not good at reading annual financial statements, and most business people are not, to tell you the truth, uh, you may want to hire an accountant to help you go through that and explain what it all means. So they can help you understand things like what the growth was, if it has a growth plan, if it makes more of its income from royalty payments from successfully existing franchises, or make more money just by selling franchises, and if they devote enough funds to support its franchise system. 

And in all this documentation, there's a couple things you really need to, I think, pay attention to. First of all, if they're listing net profits on there, they don't have access to the franchisee's net profits. They only have data about the company-owned stores' net profits. And so that's, that's not a good metric for you to go by because it's-- I mean, the company-owned outlets, they may have lower cost because they can buy equipment, inventory, or other items in large quantities at lower prices, or they may own instead of lease their property. And leasing property is very expensive in this day and age . And earnings may vary with the geography where it's at. If a franchisor provides franchisee sales and income figures, well, you need to see the supporting data where the franchises were. Where's that data coming from? And the FDD should state whether there are geographic differences between the franchisees whose earnings are reported or your likely location. 

And you have to keep in mind that franchisees have different skill sets and educational backgrounds. The success of some franchisees doesn't guarantee success for all. The bigger the business background coming into a franchise, the better your chances are for success. I don't believe that a franchise is for somebody that hasn't run another business first and seen the problems that it entails. 

Now, after reading all that information and trying to decipher all that information and talking to accountants, whoever you need to talk to, to understand, make sure you understand it, the one thing that you're still going to want to know is what are the potential earnings out of all this work and all this investment I'm going to make?  What are the potential earnings? And a franchisor isn't required to disclose information about potential earnings or sales. But if it does, the law requires it to have a reasonable basis for the claim it's made and includes the claim in item nineteen of the FDD. Now, if it makes a claim that has a reasonable basis, they also must disclose the source and limitations of data that support the claim on any important assumption on which the claim is based. 

So you have to be sure to ask the franchisors for written substantiation that supports the claim. I mean, they're required to provide it if you ask. They may not give it up, but if you ask, by law, they're required to give you the substantiation to back up what they're claiming. And again, that's where you may want a accountant to help you go through all of that substantiation documentation. But when you can review the earnings claims, you have to consider a couple of things. I mean, is the earnings claim typical for a franchise in this system? Suppose that a franchisor claims that the franchisees in the system earn fifty thousand dollars a year. The claim may be deceptive if it doesn't represent the typical earnings of franchisees. 

The FDD should tell you how many franchisees the franchisor has, how many it surveyed to get that figure, and the number and percentages of franchisees who reported earnings at the level claimed. So you can break it down. Averages don't tell you anything. You could have a, a half a dozen really, really good franchises and a half a dozen really, really bad ones, but when you average them out, it sounds pretty good in the middle. If a franchisor claims that its franchisees earn an average income of seventy-five thousand dollars a year, for instance, that tells you very little about individual franchisees performed. 

I mean, using an average figure may make a franchise system look more successful than it really is because the high incomes of just a few very successful franchises can inflate the averages of all of them. So it doesn't tell you anything. It really doesn't. And if they're telling you gross sales, well, that doesn't really tell you much either.   I mean, they don't tell you what the actual cost or profits are. So gross sales is nothing. I mean, if your expenses are equal to your gross sales, you haven't made any money, so what good is that figure either? 

The earnings also may be based on geography. I mean, if a franchisor provides, sales and income figures, you should ask if any supporting data came from, franchises in your area. And the FDD should state whether those are geographic difference between the franchisees earnings are reported and your location.  You have to look at that. So all these figures can be so deceptive unless you really look at them the right way. And you have to keep in mind that franchisees have different skill sets and educational backgrounds. And the success of some of them doesn't mean the success for all. It depends how much of a business background they come into the franchise with. And whether they know how to hire the right people or not. There's a great, great difference in that also.

So before you sign that finance agreement, realize that the disclosures could change between the time you receive the first FDD and the time that you're ready to sign the finance agreement, because you're doing a lot of research in the meantime. And so they may have updated that FDD each calendar quarter, and they have to update it at least yearly.  So you have the right to ask for a copy of the latest FDD information before you sign it and go through it and see if it's substantially changed from the prior one that you started out this whole process with before you sign your name on the dotted line. that's the law. They may have had changes in their management and their training systems. 

Who knows? But you need to know, what kind of changes they made that may affect you, that you weren't really, originally aware of when you started this whole process of evaluation. Now, I realize this was a whole lot of information, and I've gone a little longer than normal probably, but there's a lot to consider. 

I mean, you're giving away hundreds of thousands of dollars to somebody. And by the time you build the buildings and buy all the equipment and hire all the people and pay for the advertising and pay for all the fees, it's a big investment. But it could be very, very lucrative, and it could make you a lot of money in the long run , especially if you have multiple outlets. But you have to make money on the first one before you're going to have the money to buy the second one and the third one and the fourth one to really set yourself up for life. 

So I hope this helped. If you have any questions, you may contact me if you'd like. All this information is going to be in the show notes, and it's also out at my website, under, the classes there. 

I have a class on all of this stuff, and you can read through it. And, you may want to read it more than once because there's a lot of information here. But if you're thinking of franchising, good for you. Franchising isn't right for me. I prefer kind of consumer direct marketing and helping people that don't have the money to invest change their lives for the better So until next time 

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