Franchises come in all shapes and forms. But, from McDonald’s down to regional franchises, every restaurant franchisor and franchisee hook up for the same reason: to make money from a single restaurant idea. When it works, they form a symbiotic relationship, where each party works together while getting what they want individually.
Restaurant franchises are not independent restaurants and have different operational and marketing realities. At the center of the franchise system is an agreement between both parties that shapes their power relationship. In most circumstances, the franchisee is at a disadvantage compared to the franchisor. The franchisor has done the dance many times over, entering into many franchise agreements. Also, for most things, the franchisor calls the shots.
We will take the perspective of the first-time franchisee, discussing how to make an informed decision and covering the process that leads up to entering an agreement.
Unfortunately, many first-time franchisees do not understand the meaning and inflexibility of a franchise agreement, which tends to be long and complex. This is often because they haven’t done adequate research or received any professional advice. There is a reason why there is a mandatory 14-day cool-down period between when the franchisor issues the Franchise Disclosure Agreement, once called the Uniform Franchise Offering Circular (UFOC), before the franchisee can sign a contract. Many decisions that franchisees come to regret were made in haste. Making this big commitment shouldn’t happen without an accountant and a lawyer (one that you hired) explaining everything fully. Let’s be honest: some entrepreneurs are too independent to be franchise owners and work under the constraints of the franchise system.
When you have reached the decision-making stage, you shouldn’t have any unanswered questions. You should treat signing your name to a franchise agreement with the same seriousness that you would the decision to marry someone—except the franchise agreement might last longer. Franchisees have less flexibility and control than independent restaurant owners (although they do have a proven brand/product), so some soul-searching is necessary. Franchises tend to be successful because of instant name recognition, media advertising and a well-known product line.
Franchises in Plain Language
In the flood of legal language and marketing materials, prospective franchisees may not understand the basic relationship is between a franchisor and a franchisee. At its simplest, the franchisor gives a license for the franchisee to use their property (brand, products, etc.) in a controlled environment. The contract outlines an exclusive arrangement where the franchisor chooses what products and methods are used to run the franchise. In exchange for the name recognition and strategic assistance, the franchisee puts up the capital and manages the location.
Franchisees give up significant power for a proven brand and product. The franchisee compensates the franchisor throughout the life of the contract. After the initial franchise fee, franchisees pay royalty fees to the franchisor—based on profit or gross income. The franchise agreement expires after a certain period; 20 years is the industry norm. Once completed, these contracts are not automatically renewed, nor are they likely to be the same contract if the relationship continues.
As with any agreement where two parties’ interests may not be in sync, there is usually some minor conflict. The interests of a franchisor and franchisee, especially with aggressive discounting, may not align. That’s why it’s important to choose a franchisor who is willing to negotiate. There is a lot of money involved—from the initial franchise fee to setting up a location—so you want to proceed cautiously and find the right match.
Is a Franchise Right for You?
There is a seemingly limitless variety of franchises. Some are risky and need effective marketing. Some seem guaranteed to succeed, such as McDonald’s, Subway or Dunkin Donuts. Franchises look deceptively easy, but the truth is that you’ll be running a business for someone else who gets to decide important issues that affect your livelihood. Making money seems like a worthwhile trade-off, but years of playing second-chair could prove frustrating for someone with an entrepreneurial spirit.
Will a particular franchise keep you interested for 20 years? Will your passion for concept and brand wane? Ask yourself honestly whether running a particular franchise matches your skills and your work habits. You’ll face most of the headaches that independent restaurateurs have, and you’ll have to smile and keep working with a franchisor, even if you become dissatisfied with the relationship.
Choosing a Franchise
Unless your heart is set on a certain franchise (which still requires extensive research and long deliberation), it will be a complex task to compare different franchises unless you approach the process systematically. We suggest that you build a spreadsheet to organize the key information. The Federal Trade Commission, which regulates franchises (along with states), has helpful resources online that help you with your decisions. The FTC requires franchisors to share a Franchise Disclosure Agreement that gives you insight into the franchise. Go through it meticulously, and ask questions before signing—you’re agreeing to a long-term commitment.
Your Relationship with the Franchisor
Facts and figures don’t tell the whole story. Cooperation in franchise relationships are determined by individuals and a corporate culture. The reality is that you will have to work professionally with the franchisor and their staff. You can’t call it quits if you disagree because neither party can get rid of the other easily. Therefore, you should investigate what kind of people are employed by the franchisor. You should visit their headquarters, meet the people you would be working with and talk with other franchisees about their experience. Don’t hesitate to visit fellow franchisees (not in a neighboring territory) unannounced to get an honest perspective. Ask difficult questions, like what is their worst experience along with general, open-ended queries. You should be able to identify some realistic expectations of what it’s like to work with the franchisor after several years of give-and-take.
Find out what the company has planned over the next few years. You might be a little wary if the company has an aggressive sales approach. The arrangement should sell itself. Heavy-handed sales techniques could indicate a pushy company, a poor financial arrangement or a franchise that’s carving up territory into increasingly smaller areas. Franchise contracts are long and have lots of small print in the form of rules and regulations. It takes time to study the details and consequences of becoming a franchisee, so the franchisor should respect your process for making decisions.
Future Demand and Potential Profit
Buying a franchise involves estimating supply and demand in the future. Most people choose a franchise that is making money now, but trends change. Is the franchise a fad or a solid idea? With each prospective franchise, you have to systematically analyze the business prospects over the entirety of the franchise agreement. Here is how:
- You want to estimate (based on research, studies and experts) the future demand of the brand.
- Find out if the franchisor is expanding in a way that meets that demand responsibly. If the company is expanding too fast, there could be a competing franchise just a few blocks from your business.
- You want to study the demographic trends in your territory and whether your ideal customers are increasing or declining.
- Rapidly increase of your demographic target could mean lots of competition from your own franchisor and similar restaurants.
- You want to look for any worrisome trends in expenses (food prices, labor costs, taxes) that cancel any benefits of an increasing market.
Although facts are critical, don’t dismiss your business intuition. Talk it out with trusted mentors and associates to see if you are missing something obvious.
Competing against another franchise location is the dread of every franchisee. It benefits the franchisor to saturate the market more than it improves the franchisee’s situation. The only exception may be with a brand largely unrecognized in the region. Any franchisee wants to have a big buffer to ensure that they do not lose customers. The ability to expand territorially (and open more franchise locations) gives a franchisee future business opportunities. Owning multiple locations often provides efficiencies, such as sharing service vendors and providing emergency supplies from one location to the other. You might dread or support an expanding market, so researching how the franchise handles territory issues is a must. Find out if your territory is guaranteed and whether you have first choice of any neighboring territories that become available.
Support and Training
New franchisees will be overwhelmed without training and support from the franchisor. Unless a franchisee is very familiar with a franchise (like managing a location), a new franchisee will run into a lot of problems if they just receive a binder and are expected to train staff, meet design specifications, buy equipment, and find a location. You could be left with a binder and a prayer, hoping not to make costly mistakes. Find out how the franchisor provides support services. Are the support terms clearly defined in the contract? If not, these programs could easily fall victim to corporate cost-cutting plans.
The last thing to consider is the most depressing. What happens if the business fails? Is there a way to sell? What is the approval process? No one wants to consider failure, but having a clearly defined exit plan could prove life-saving if things go badly.
Taking the Final Steps
Your research and planning will help you decide. Check the internet, read the licensing agreement, hire an attorney and ask questions. Consider visiting a Franchise Expo. There are several around the country, including the International Franchise Expo in NYC, the West Coast Franchise Expo in the LA area and Franchise Expo South in Houston. There are also National Franchise and Business Opportunity Show events scheduled at different times and places.
At one of these conferences, you can see many franchise presentations to compare. Unlike directly contacting the companies, you’ll meet franchise marketing teams and not the people you’ll actually be working with as a franchisee, but the process can give a good idea of what to expect and allow you to compare lots of opportunities. Of course, you should bear in mind that the best sales force isn’t the same as the best franchise.
Another way to narrow your choices is using the services of a franchise broker. The problem is that franchise brokers are paid by the franchises, so there’s a conflict of interest. However, most brokers represent multiple franchises and will try to match you with the best fit for your needs. Regardless of salesmanship, marketing and recommendations, choosing a franchise is a personal decision that you have to live with, so research the promises and advice before committing to a franchise.