The Most Important Question To Ask Before You Say “Yes” To A Franchisor

“If you had the chance to buy the franchise all over again, would you?”

That’s the single most important question to ask franchisees before you invest your money in a franchise.

It’s not the only important question

Granted, there are other “important” questions,and I tell you what they are in my free report: 92+ Questions To Ask Before You Invest In A Franchise, which you get automatically when you subscribe to this blog.

But asking franchisees if they’d do it all over again, knowing what they know, provides some of the best insight to help you make a decision before you invest your money.

Not all franchisors want you to ask it

To be sure, some franchisors don’t like it when you ask that question! If most of the franchisees answer, “No,” I can’t imagine too many of you saying “Yes” to that franchisor. On the other hand, people invest in franchises for all kinds of reasons — common sense doesn’t always prevail!

Also to be sure, some franchisors hope and pray you’ll ask that question because they know their franchisees will answer enthusiastically, “Yes!” And when that happens, your franchise sale is imminent. Of course, that doesn’t mean the sale should occur — but franchisee validation is one of the most convincing variables in franchise sales. If the existing franchisees say they’d buy it all over again, what could be wrong with the franchise?

Do franchisees like to prospects?

Prospects often ask me if I think franchisees lie. “Will they say Yes even when they really mean No?”

My response: “Of course!” That’s why it’s so important for you to talk to at least several franchisees before you invest your money. I think it’s a good idea to speak to at least a dozen franchisees.

How many franchisees should you talk to?

What if the franchisor only has a dozen franchisees?

Easy! Talk to all of them!

Six steps to help you question franchisees

Here are six steps to follow when you question franchisees:

1. Ask them all the same questions. Don’t ask different questions because then you won’t be able to compare answers.
2. You probably won’t have time to ask more than a couple dozen questions. Franchisees are busy people and may only speak to you by phone. Select your questions wisely. Make the questions pertinent to you and your situation.
3. Talk to franchisees who come from a background similar to yours. If you’re a teacher, talk to franchisees who used to be teachers. If you’re investing in an urban location, talk to franchisees in urban locations.
4. Don’t be afraid to talk about money. I know it’s not polite to ask people how much money they make, but the franchisees know that’s one of the reasons you’re questioning them. Tell the franchisees what you expect to earn and in what time frame. Ask them if that’s realistic. (My free report, mentioned above, provides more guidance on this topic).
5. Visit at least one franchisee. Go to work for a franchisee for a couple of weeks or in the evenings or weekends. Experience for yourself what it’s really like to operate the franchise. You might discover there are aspects of the business that don’t appeal to you!
6. In addition to franchisees, talk to vendors who provide products and services to the franchisees. How do they see the business? Growing? Declining? Of course, you’ll also question the franchisor and then discuss all the details with your accountant and franchise attorney.

Shopping for a franchise is hard work. But it’s much easier when you know which questions to ask. Begin with the most important question!

Photo image by:  Marco Bellucci

The Franchisor Spelled It All Out And Isabel Was Furious! She Screamed: “Do They Think Franchisees Are Robots?”

I guess she hadn’t ever read a Franchise Disclosure Document until this week. And she wasn’t happy!

I’m talking about Isabel. Crazy Isabel! She’s back. (Previous Isabel articles are posted at the end of this blog).

The franchisor spelled it all out

“Everything is in the franchisor’s favor!” she screamed, like she had just come through a nightmare.

“They tell you everything you have to do! It’s all spelled out: When you have to work. How much you have to work. How much you have to produce. What you have to wear. Where you can operate the business. What you can sell. How you can advertise. Who you can sell the business to . . . does it ever end?”

And the problem is?

I said nothing for a moment, giving the air time to clear.

Finally, I dared to speak.

“Do you really want it to end, Isabel?

“What?” she snapped.

No time to be sympathetic

I knew she expected me to be sympathetic — or at least hoped so. But come on. Really? We’re talking about franchising.

Business.

Money.

Risk.

This is serious stuff.

No one is forced to become a franchisee

“I said, ‘do you really want it to end?’” and I gave her no time to answer because, frankly, I didn’t care and I needed to make a point.

“Look, it’s called a franchise. It means: license. It means someone is going to license you to operate their business in a specific manner for a specific period of time, and possibly in a specific location. They’re going to license you the opportunity to use their brand, their trade dress, their marketing plan — you’re going to represent them, Isabel. And they have the right to tell you what you will and won’t do. Because they grant the license!”

You can always do it on your own

“But I want to be able to make decisions. . . .”

I cut her off.

“They know what’s needed to operate their business successfully. And if they don’t, then why are you talking to them? . . . We can assume, Isabel, that you don’t know how to operate their business successfully or — you’d go do it! . . . You can’t! Or you won’t! Or you don’t want to!

This isn’t about your right to make decisions

“Meanwhile, they don’t want to license people who are going to make decisions and take the chance those decisions will turn into costly mistakes . . . and then into failures. They don’t want failures . . . they want successes, and it’s a huge challenge for them to find people who will be successful — even when they have spelled it all out for them!”

I paused even though I didn’t want to. But I remembered that Isabel is the client and while I can get as excited as she can get about these issues, I didn’t want her to think that I was a raving nutcase, simply spewing franchisor gunk.

Why do you want to make decisions?

“Do I get to make any decisions as a franchisee?” she asked.

“Izz,” I started again, calmly this time, “do you really want to make decisions? Is that your goal? To make decisions?”

“No, of course not. My goal is to be a successful franchisee, operating a business that I find — in your words — both satisfying and profitable.”

Better that the franchisor make all the decisions for you

“Very good,” I said. “You’re a terrific student. So why are you hung up on making decisions? In fact, why aren’t you looking for the franchisor to make all the important decisions for you, assuring you of your success?”

“Because I don’t want to be a robot. I want to participate in the business. I want to make it mine,” she said, starting to get excited again.

Review basic franchise facts again

“I don’t want you to be a robot, either. Neither does the franchisor. But Isabel, let’s just get down to the basics. You don’t know how to build a satisfying and profitable business — at least not the type of business that you’re looking for. Is that fair to say?”

“Yes, that’s fair. If I knew how, I’d go do it on my own,” she said.

The franchisor invents the wheel

“Very good. . . . Meanwhile, there’s a franchisor who has figured it out, or at least claims to have figured it out. They’ve already built the business. They’ve made mistakes. They’ve lost money. They’ve invented the wheel. They’ve recruited and trained franchisees, some of whom are doing very well. So far so good?”

“Yes,” she said, “that’s all true. I think they’re a good franchisor, too. I like them.”

The franchisee spins the wheel

“And I bet they love their business. In fact, they love it so much that they want to protect it. They don’t want to trash it. They don’t want start-ups that quickly fizzle into failures. They want franchisees who will succeed. And they’ve learned that they need to spell it out, they need to teach and train and support the franchisees and show them what to do, when to do it, who to do it with, etc., in order for the franchisees to succeed.”

“I get it,” she said. “But it seems so oppressive.”

Success or oppression?

“Well, it may be. But if it’s also successful, you may be able to live with the oppression, if it’s really oppressive, and I don’t know that it is. The most successful franchisees I know never tell me that they feel oppressed! But they do feel grateful that the franchisor figured it all out for them, made and paid for the mistakes in advance of them, and gave them a Cheat Sheet, so to speak, that helped them make good decisions — the decisions that eventually led to their success and satisfaction.”

Suddenly it was quiet again. Isabel was letting it sink in.

Are they all like this?

“Are all franchise agreements like this?” she asked. “Do they all spell out what the franchisee must do?”

“Only the good ones,” I told her. “I would not encourage you to buy a franchise if they only gave you part of the formula for success. . . . And again, Izz, I’ve got to go back to this point: Maybe it’s not for you. Maybe you don’t really want to be a franchisee as much as you want to be a business owner who makes her own decisions, win or lose. That’s what you need to think about. . . .

Reasons why you should buy a franchise

“I thought we had covered that ground — the fact that a franchisor has the absolute right to decide what franchisees will do, when and with whom, and all the rest of it . . . and the franchisee’s job is to listen and respond and follow — never to re-invent the wheel. . . . If you think you can’t do that, or don’t want to do that, if you think that turns you into a robot, if it’s oppression, for cryin’ out loud, then do not buy a franchise.”

“I understand,” she said. “I do want to be a franchisee. I realize I don’t have the answers and I don’t have enough money to make costly mistakes.”

Only the franchisor’s reality counts

“But you may not be willing to trade off your reality for the franchisor’s reality. And Isabel,” I concluded, “the franchisor’s reality is the only reality that counts in franchising. Think about it . . . and we’ll talk again . . . if you’re still willing.”

“Of course I am,” she said. “You don’t scare me!”

For More Franchising With Isabel Blogs, Read:

Is Franchising Indentured Servitude?

Figuring Out What You’ll Earn As A Franchisee Even When The Franchisor Doesn’t Tell You

Figuring Out What You’ll Earn As A Franchisee Even When The Franchisor Doesn’t Tell You — Part II

Photo image by: striatic

The E-Myth Author, Michael Gerber: Who Buys Franchises, Why And What To Look For

Spent an enlightening Monday (yesterday) with Michael E. Gerber, author of The E-Myth, as well as numerous other best-selling business books, and we discussed franchising — why people buy them, why people sell them, why some work, why some don’t work, and (of special interest to me) what we might say and do collaboratively to help improve franchising for all parties. 

The E-Myth is our starting point

At 73, Gerber has more to offer than you or I can absorb in a day! If you’ve read The E-Myth then you know what I’m talking about. If you haven’t read The E-Myth I really don’t know what to say to you, other than, “Stupid, stupid, stupid!” (You’ll have to read it to get the chuckle that the rest of us just enjoyed).

If you haven’t read The E-Myth, just stop right now, go over to Amazon.com and buy it — let me check for you. Here you go: Click here. There are 369 used and new copies starting at $2.88! I assure you, once you read it, you’ll send me a check purely out of gratitude!

Stupid to buy a franchise without reading the book

The E-Myth is the most compelling, business-changing book you can ever possibly read. Don’t buy a franchise until you read it!

Back to my story. Driving to my hotel after lunch, Gerber says to me, “Do the people who buy franchises realize they are not entrepreneurs and that, in fact, they should not be entrepreneurs, and that, furthermore, no franchisor wants to sell a franchise to an entrepreneur.” It was really a statement, not a question. And, of course, I agreed with him.

Entrepreneurs don’t buy franchises

Entrepreneurs invent businesses, they don’t buy someone else’s idea, he continued to lecture me (and I’m attentive in his presence). That’s an important point. I know many franchisees who think they are entrepreneurs, and they’re not.

And thank God they’re not! It may make them feel better to think they are, but thank God they’re not!

‘Cause entrepreneurs screw up even more often than franchisees!

But that’s another story for another blog.

Here’s your mission when buying a franchise

Here’s my point today. It comes from Gerber through me.

Your Mission: As you’re in the hunt for a franchise to buy, look for one that has already solved the problems that an entrepreneur has to solve when starting up a business.

Avoid having to do the work of an entrepreneur

You don’t want to do the work of an entrepreneur! Not if you’re buying a franchise.

You want to find a business system that works. A series of systems, really. There should be a working operating system, a marketing system, a sales system, a system for hiring and firing people, a system for serving customers, a system for working with vendors, a system for inventory, a system for merchandising . . . . All kinds of systems.

Not all are created equal

Now here’s the thing: Many franchisors have yet to develop their systems. They may have one or two systems, but they won’t have all the systems you will need to succeed as a franchisee. Or they may have multiple systems, but the systems don’t work. Remember: All franchises are not created equal. Some are better than others!

McDonald’s — Gerber writes a lot about McDonald’s — works superbly because it is a series of systems. Look for a McDonald’s when you purchase a franchise.

And there’s more. (I told you, you can’t just spend a day with Gerber and absorb it all).

You must do it the franchisor’s way, thank God!

While you’re due-diligencing your way through franchise opportunities, look for the one that enforces compliance. You probably won’t like that — the more entrepreneurial you are, in fact, the less you will like that. But compliance is absolutely essential to the success of a franchise and to your success as a franchisee.

If only all franchisors enforced the rules!

There are franchisors who have systems, good systems, and the franchisees ignore the systems. That’s not entirely the franchisee’s fault. It’s mostly the franchisor’s fault. Sometimes the franchisor doesn’t understand that it’s a mistake not to insist that franchisees comply with the systems. Sometimes they don’t know any better. Sometimes they are too timid. Sometimes they are just gutless. Sometimes (quite often) they are managers and not leaders! It’s always, always, always a mistake to ignore compliance.

Enough for now. I’ll pick up with compliance at a later time and tell you why you should get on your knees and thank God that a franchisor insists that its franchisees comply with its systems.

For now, just find a franchise that has working, productive, satisfying, money-making systems. That’s the one to buy!

Gerber Is Seeking E-Myth Partners

. . . Know an entrepreneur who wants to dominate their industry the way Gerber has dominated small business development and coaching? He’s looking for E-Myth Partners! They will join him as co-authors on future E-Myth books. Soon there will be The E-Myth Attorney, The E-Myth Optometrist, and others to follow. Looking for The E-Myth Accountant, The E-Myth Bartender, The E-Myth Undertaker, The E-Myth Auto Dealer, The E-Myth Carpet Cleaner, The E-Myth Consultant, The E-Myth Broker, etc. Know someone who’s interested? Send them to me and I’ll make the introduction to Gerber. 

Read Another Blog About My Day With Gerber:
The F-Myth: Michael Gerber Explains Why Franchising Doesn’t Work For Entrepreneurs 

Photo image by: StevenGroves

“What Happened To That Thing They Called The ‘UFOC’?”

I hear this question quite a bit:

“What happened to the thing they called the UFOC, or Offering Circular? Why don’t they have that anymore?”

Well, they do!

UFOC is now FDD

But in July 2007, the U.S. Federal Trade Commission renamed the Uniform Franchise Offering Circular (UFOC) the Franchise Disclosure Document. The UFOC is now the FDD!

Since 1979, U.S. franchisors have been required by federal law to provide a disclosure document. It’s provided free and without obligation to qualified franchisee prospects. This is a good thing — and it’s one of the reasons for the success of franchising in America.

Important document to read, more than once!

The FDD provides much needed information to a prospective franchisee and it’s important to read it — perhaps several times — before you invest your money. It’s written, by law, in plain English, so if you can read at a 9th grade level, you’ll be able to understand (most of) what the document says. (Between you and me, when I buy a franchise, I still want my lawyer to review the FDD with me).

Along with the name change, the FTC included some other changes for the FDD:

First meeting between franchisor and prospect

Previously, the franchisor was required to provide a prospective franchisee with the disclosure document at their first “serious” meeting to discuss the purchase of a franchise. That was changed — good thing, because no one knew what “serious” really meant.

A prospect and a franchisor can now meet as many times as they choose, but the prospect cannot buy a franchise until he or she has had the FDD in hand for at least 14 calendar days. That’s a minimum number of days — so there’s plenty of time to review the document. (By the way, the number used to be 10 business days).

Franchise agreements issued 7 days in advance

An FDD will often include a franchise agreement, which is the document that the franchisor and franchisee sign. It’s the franchise license. Neither party signs the FDD, it’s just an explanatory document that precedes the franchise agreement, which, by the way, is written in legalese and requires an attorney to understand it!

Franchisors are required to provide a prospect with a final franchise agreement at least 7 calendar days before executing the document. (Used to be 5 business days).

Electronic delivery is now okay

Prospects can receive a FDD electronically, if the franchisor makes it available in a downloadable format. There’s no requirement to do so, but it’s much more efficient (and green!). Signatures are acceptable in a variety of ways including security codes, passwords, and electronic signatures.

Requires the franchisor to tell more

The FDD requires franchisors to provide data about sales, terminations and transfers of franchises — and that’s a good thing! It will help a prospect determine the longevity of franchisees in the network. If a high number of franchisees are exiting the network, the prospect will want to ask why.

But earnings claims are not required

Franchisors still do not have to make earnings claims, and critics say this is a major shortcoming in disclosure law. More franchisors are. in fact. completing Item 19 of the FDD, which provides financial performance data. However, even if the franchisor completes Item 19, make it your business to discuss your earnings potential with existing franchisees, and your advisors.

All and all, the FDD provides the key information that you need to evaluate a franchise investment. Take advantage of it!

Register now for free tele-seminar

. . . Register immediately for my free franchise tele-seminar: How To Buy A “Hot” Franchise And Not Get Burned!  Date is May 6, 2009, and you can subscribe while slots are still available . . . you’ll love the fantastic give-away. Read about it here.  

Photo image by: Dwonderwall

Figuring Out What You’ll Earn As A Franchisee Even When The Franchisor Doesn’t Tell You

Ecstatic Isabel called!

It’s been about ten days since I last heard from her (see Is Franchising Indentured Servitude?) and she couldn’t have been happier!

How much money?

“I know how much money I’ll be able to make as a franchisee even though the franchisor didn’t tell me — well the franchisor sorta told me,” she said into the phone without taking a breath.

“Wait a minute, Isabel. Either the franchisor told you or the franchisor didn’t tell you. Which is it?” I wanted to know, wondering if a franchise sales person had pulled the old back-of-a-napkin trick by jotting down a number that really doesn’t mean anything, but appears to be a nice annual income. “Does the franchisor’s disclosure document include a financial performance representation, or earnings claim? It would have been under Item 19 of the Franchise Disclosure Document (FDD).”

No to the legit financial info

“No. No earnings claim,” she snapped. “This stuffy franchisor doesn’t include any financial information under Item 19.”

“But you’re saying the franchisor ’sorta’ told you how much money you can make if you buy the franchise,” I continued. “That could be a serious violation of the federal franchise laws. I just want you to realize what you’re . . . .”

It’s a different story in franchising

She cut me off, “Come on, doc. You know that’s not how it works. These franchisors put the information out there. You just have to be smart enough to get it. And I am!”

There’s no doubt that Isabel is smart, but I don’t agree with her generalization about how things work in franchising. At the same time, I’m not naive. Some franchisors disclose information that they should not disclose. Some franchisors break the laws. And as I’ve said many times: All franchisors are not created equal.

Backing out the numbers

I was running low on time and patience so I said, “Please don’t make me work so hard, Isabel! How did you find out how much money you can make as a franchisee?”

“My accountant helped me,” she explained. “The franchisor’s financial statement (which is included in the FDD) shows how much royalty revenue the franchisor collected last year. I divided the number of franchisees into that sum and got the average royalty paid per franchisee. Then it was easy! I divided the average royalty payment by the royalty percentage, which is 6%, and that gave me the average franchisee’s gross revenue. And that’s what I needed to know. With help from some franchisees and the franchisor, I figured out the monthly costs. And based on the numbers, I can pay myself a six-figure income. Not right away, but eventually. That’s where I want to be financially. So I’m thrilled!”

Not everything may be what it seems

I am, too! Thrilled to be coaching such a serious student of franchising. But there are a few problems with Isabel’s analysis!

Maybe you’re a serious student of franchising, too, and you already know what the problems are? If so, I’d like to hear from you. 

Meanwhile, look for Part II of this blog in a day or so. Until then, do not buy a franchise based on Isabel’s story!

Register now for free tele-seminar

. . . Register immediately for my free franchise tele-seminar: How To Buy A “Hot” Franchise And Not Get Burned!  Date is May 6 and you can subscribe while slots are still available . . . you’ll love the fantastic give-away. Read about it here.  

Photo image by:  jordigraells

Veteran Franchisee Explains 3 Challenges Franchisees Face Today

Virginia Barbeque franchisee Ed Totanes recently helped me introduce franchising to a group of veterans in Washington, DC. Ed is a veteran who took advantage of the VetFran program, which helps veterans of the U.S. armed services buy franchises at a discount.

Challenges franchisees face

Ed said every franchisee (regardless of the type of business) is facing 3 primary challenges today:

1. Labor. Finding the right people is a challenge, in spite of high unemployment. Ed’s suggestion: Hire a veteran! If they’ve been through boot camp they’ve been trained and they know how to say, ‘Yes, Sir!’”
2. Money. Finding it, managing it and keeping it! “Cash is king,” Ed told the vets.
3. Marketing. Businesses don’t just develop, they have to be cultivated. You need a good marketing campaign. “That’s one of the reasons why I prefer a franchise,” he commented.

Advantage over civilians

Ed told the veterans that if they become franchisees they have an advantage over civilians. “The military teaches us to work hard and work as a team. Civilians don’t understand that,” he concluded.

Register now for free tele-seminar

. . . Register immediately for my free franchise tele-seminar: How To Buy A “Hot” Franchise And Not Get Burned!  Date is May 6 and you can subscribe while slots are still available . . . you’ll love the fantastic give-away. Read about it here.  

Is Franchising Indentured Servitude?

Crazy Isabel called.

Normally, Isabel isn’t crazy, but this morning — whew! 

She wants to buy a franchise. Has a pretty good idea which type of franchise she wants to buy, and she has the money — at least most of the money that she’ll need for a start up in this particular industry.

She’s done some homework, with a little help from me, and she’s collected information from targeted franchise companies. 

Plans derailed?

But today, she’s crazy (I mean that in a nice way, of course) because she read something that will derail her plans to buy a franchise. “If this is true,” she shouted, “I’d rather take my chances and start a business on my own.” 

She was screaming at me today!

She read on some Web site that franchising is little more than “indentured servitude.” While talking to me — screaming at me, really — she said I should have told her that she’d be nothing more than a “slave” as a franchisee.

“Why didn’t you tell me that?” she demanded to know. 

Uh . . . because I don’t believe it’s true.

Good enough?

I didn’t think so.

Here’s my take on the issue

Here’s what I told Isabel and what I will tell you if you ask the same question:

Don’t insult the slaves. They had no choice. In addition, don’t confuse slavery with indentured servitude. They mean different things. And you, my dear Isabel, you have a choice that neither slaves nor servants were afforded. No one is forcing you to buy a franchise. And if you do buy a franchise, no one is forcing you to buy this one or that one. You — and only you — get to choose. 

Want to hang up?

So if you’re going to continue talking crazy, it’s time we end our relationship!

She didn’t hang up, so I continued:

Furthermore, if you have even an inkling that it’s indentured servitude, then why would you bother buying a franchise? Forget it. Keep your job. I’m sure you have lots more freedom working for your employer! (Yes, that was sarcastic).

Franchising has limitations

And let me add this. I’ve owned several franchises. I enjoyed each experience, though some were more profitable than others (and some of the franchisors were better than others). Never once did I think of myself as a servant, but rather, I was in control of my destiny and in control of my operations to the extent the franchise agreement permitted me to be.

And since I knew, and agreed to, the boundaries of the franchise agreement, I had no issues with the franchisor’s controls. If you think those controls will be a problem for you, Isabel, then move along, stay away from franchising, it’s not for you. Don’t try to make it something that it’s not! (Watch this video now.)

Be careful of who you talk to!

Finally, Isabel, pay attention to who you’re talking to — or in this case, what you’re reading and who wrote it. Of all the successful franchisees I know — multi-millionaires included — I don’t know of one that would compare their franchise to indentured servitude. On the other hand, I understand why a failed franchisee would make that comparison. They gotta blame their failure on someone or something, and it’s surely not going to be the person they see when they look in a mirror.

Beware of some franchisors: the bad ones

Okay, I apologize for that last statement, because, in fact, there are bad franchisors who take advantage of their franchisees. They lie to them. They mislead them. They control them. They even try turning them into indentured servants.

But Isabel, all you’ve got to do is your homework and you’ll uncover the bad franchises before you ever make your commitment.

. . . When we finished talking she had settled down and had returned to the lovely, sensible Isabel that I’ve known now for several months. She’s off this week looking for earnings claims. I’ll let you know when she checks in with me again! 

Register now for free tele-seminar

. . . Register immediately for my free franchise tele-seminar: How To Buy A “Hot” Franchise And Not Get Burned!  I’m giving subscribers to my blog the first opportunity to sign up for the tele-seminar and get an unbelievable package of information about franchising — all free. Later this week I’ll begin promoting the tele-seminar to thousands of prospective franchisees and once the available slots are filled the tele-seminar will be closed. So this is your early notice — sign up now and take advantage of this opportunity. 

Photo image by: ruben van eijk

Franchisee: Are You Legally Obligated To Succeed When You Buy A Franchise?

What happens if you buy a franchise and—God forbid—you fail and shut down the business? Are you legally obligated to succeed?

You are if the franchise agreement says you are. What’s worse, you may be required to pay fees even after you’ve failed!  

What does the expectation of success mean?

Franchisors sell franchises with the expectation that the franchisee will succeed. Makes sense, doesn’t it? But let’s take a look at what that really means to both the franchisor and the franchisee.

Most franchisors can sell only a limited number of franchises in a given territory, i.e. the United States. Let’s just say the franchisor can sell 1,000 franchises in all of the USA. Once all 1,000 units are sold, the franchisor has nothing left to sell in the states. Yes, there are foreign territories to conquer, but that doesn’t matter. The franchisor has only a limited number of units to sell in the states and the franchisor’s domestic financial model is based on the anticipated performance of those units alone. 

The real value is not the sale of one franchise

So let’s say you buy one of those units. The franchisor now has one less unit to sell. And while there’s value in the sale,  i.e. you will pay the franchisor an upfront franchise fee, the real value is in the royalty stream that the unit is expected to produce year after year for the franchisor.

After covering sales commissions, marketing and legal fees, franchise fees are commonly re-invested in franchisees. The fees are used to reimburse the franchisor for the cost of training the new franchisee and providing initial support. While a $50,000 franchise fee looks like a big chunk of money—and it is—it may not include even a dollar of profit to the franchisor.

Royalties produce long-term profits

The franchisor’s profit is in the royalties, and the franchisor hopes to collect those royalties for years. In fact, the franchise agreement likely states that you are obligated to pay the royalties for a minimum number of years, commonly five to ten years, or the length of the franchise agreement.

Through the process of training you and helping you open your unit for business, the franchisor may only break-even, or could even lose money. The franchisor knowingly takes that risk because if you operate the unit successfully for at least five to ten years the royalty stream will produce tens of thousands of dollars, a good chunk of it profit to the franchisor. 

A failed franchise hurts the franchisor

Of course, if things don’t go well, you and the franchisor both lose money. The franchisor’s losses include money that was not recovered from initially training and supporting you, plus the loss of royalty dollars that your unit failed to produce. A closed unit also reduces the amount of operating dollars available to the franchisor to cover ongoing costs, and while it adds another unit to the franchisor’s sales inventory, it may impede the franchisor’s ability to sell franchises because prospective franchisees will become aware of the failure. 

Franchisee losses may be more than obvious

Your losses include all the money that you invested, including the franchise fee and all the start-up costs, such as payments to the landlord, professional advisors and suppliers. And unfortunately, your losses may not end when you shut down your business. 

Closing your unit may be a breach of the franchise agreement and may trigger the payment of liquidated damages. After taking the unit off the market and selling it to you, the franchisor expected you to succeed. Now that you’ve failed, and breached the contract, the franchisor may hold you responsible for ongoing fees, such as monthly royalties and advertising dollars, and for royalties dollars that were anticipated from your unit. These fees—along with other obligations that you may owe to a landlord, the equipment leasing company, the Yellow Pages, etc.—may amount to tens of thousands of dollars, burying you in a deeper financial hole.

By selling the business—even at a discounted price—you may be able to curtail these obligations, but that, too, depends on the franchise agreement and, of course, the successful sale of the business. There may not be a market for your failed unit, even at a steep discount. 

Be sure you understand the franchise agreement

No one buys a franchise with the idea that they’re going to fail, but failures occur. That’s why it’s important to review the details of a franchise agreement before you make a commitment to the franchisor. The best way to understand the agreement is to consult with a franchise attorney. The attorney may, in fact, be able to help you negotiate a better agreement, one that does not obligate you to liquidated damages, or at least holds the penalties for failure to a minimum.

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