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

“Daddy’s Got Money!” . . . Bad For You. Worse For Franchisor. Ugly For Daddy. But Happy Graduation!

Watch my new video on evaluating franchise opportunities.

On several occasions while I was the CEO of HomeVestors, and on on many occasions in the last 30 years while advising people who buy franchises, someone was buying a franchise using “Daddy’s money.”

Most of the time it wasn’t a good idea. Lots of times these deals occurred right about the time of college graduation. 

He doesn’t want to teach after all

“My son,” a dad told me not long ago in my office at HomeVestors, “is about to graduate from college and he doesn’t really want to be a teacher after all. I think real estate investing makes a lot of sense . . . [at least it did at the time] . . . and so we’re here to buy him a franchise.”

Dad just wanted to help his kid

While Daddy talked, I watched Son, and in this particular meeting, Son demonstrated all the signs of fear and disinterest. Clearly, this was Daddy’s idea and not Son’s. Quite often it happens that way. Dad (or Mom) wants Son or Daughter to achieve success and they are willing to invest money to “help” them.  

It happens the other way, too. It’s Son or Daughter who’s eager to buy a franchise, and they need their parent’s money. 

A trip abroad might be a better gift

My advice: Proceed with caution! Investing in a business may seem like the ultimate graduation gift for your child, but it may turn into a financial and family disaster.

Can I tell you of any success stories where a parent put up money for a son or daughter to buy a franchise?

Many kids do succeed in franchising

Absolutely. Lots of them! Especially of parent and child working together. It’s very common in franchising, and many companies can brag about these stories.

But no one talks about the failures . . . and there are many of them, too. No one talks about them because the deal was bad for the kid who lost money and probably self-esteem; bad for the franchisor who had to work through the issues related to a failing and ultimately failed franchise; and ugly for Daddy because he thought he was doing a good thing and instead lost his money and possibly alienated his child and other family members, too. 

Here’s how franchising works best

Franchising works best when the buyer/operator uses his or her own money, or at least shares responsibility for the money. It also works best when the operator really wants to be the operator and understands what that means. The kid who graduates from college and realizes he doesn’t want to teach after all, isn’t necessarily ready to run a franchise. At least it should be his or her idea!

7 steps that could help you and your kid

If you’re considering putting up money to buy a franchise for your child, here are 7 steps to consider:

1. Ask your child to sell you on why he or she should own and operate the franchise. What’s the motivation? How deep runs the desire? How great the commitment? I know it’s your kid, but be objective! What’s the chance of success? You don’t want your kid to fail any more than your kid wants to fail. 
2. Require a business plan, which you will approve. If running a business is your expertise, it’s okay to help your child create the business plan. Seek other assistance. Local colleges offer courses on creating business plans. Get your accountant involved.
3. Require a payback plan. Charge interest for your money. The Bank of Mom & Dad expects to be paid back. Require to see how you’re going to recover your investment, profitably.
4. Tell your child to go to work for a franchisee. It may be for only a week or three, but getting experience in a franchise unit could prove helpful. Your child may decide, “I don’t really like retail,” or “I don’t think I want to be in the food business,” or, “I didn’t realize how tiring it is to be in a truck most of the day.” This experience may at least help them decide the type of business they want to own and operate.
5. Request an endorsement from a franchisee. Tell your child, “Convince one of the existing franchisees that you’re the type of person who will succeed at this business and ask them to write you a letter of recommendation.” Make sure the franchisee has achieved success in the business! A franchise operated by a parent/child combo would be ideal for this assignment. 
6. Attend Discovery Day. The franchisor most likely conducts free orientations where prospects learn more about the franchise. Go along and participate in this experience. You and your child will learn the details related to operating the business and you’ll be able to assess the likelihood of your child succeeding at this business. It may be difficult, but you need to be especially objective now.
7. If you agree to make the investment, look after the business. Take a seat on your son’s or daughter’s advisory board. Monitor decisions and progress. 

Sound too much like being a parent?

If these ideas seem too restrictive for you or your child, think twice about what you’re doing! Because there’s a pretty good chance that if you don’t take these restrictive measures, this “gift” isn’t going to work out!   

You’re taking a greater risk when you put up the money for someone else to own and operate a business. So protect your money. More importantly: Protect your kid!

Watch This Video!

Also Read:

Whose Opinion Counts When You Interview Franchisees?

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

Suddenly, Isabel wasn’t so ecstatic! (Don’t go any further until you read Part I of this story).

And how I hate to be the bearer of bad news, especially when I’m working with someone who’s paying me money. She thought she knew she could pay herself a tidy six-figure income after buying and operating a particular franchise, but she just didn’t have the right numbers.

Clever deduction, but it wasn’t reliable

So I let her down gently.

“Isabel, good work,” I said in reference to the handiwork she had performed on the franchisor’s revenue stream. Most franchise prospects don’t even think about backing out the numbers the way you did. They expect the franchisor to tell them what they can earn, and when the franchisor refuses, they’re mystified. But you took matters into your own hands and that says a lot about the kind of franchisee you’re going to be.”

Isabel’s enthusiasm abounds

“I’ll be a great franchisee,” she assured me. “I am a hard worker. If I’m in love with a product, I can sell it. I can sell this franchise, too!”

“Okay, okay, I understand,” cutting her off before she started selling me. She’s one of the most enthusiastic people I’ve worked with in a long time. “But Isabel, there are a few holes in your deduction.”

The holes in the deduction process

“I figured you’d say that,” she shot back. “My accountant wasn’t too happy about the process, either.”

“Do you understand why?”

“Yes, of course. I know I don’t have all the information I need because the franchisor won’t give it to me!”

Simple math leads to a simple number

“Exactly,” I continued, ignoring the latter part of what she said. “You divided the sum of royalties paid to the franchisor by the number of franchisees that were in the network. And that led you to determine how much money the average franchise generated and from that you figured you could pay yourself — eventually — more than $100,000 a year.”

“And I still believe that’s right,” she emphasized.

“It may be,” I said, “but you can’t count on it based on the numbers you used. First, not all of the franchisees were part of the network for all 12 months.”

What does average really mean?

“Better yet, doc” she said, reverting to her familiarity with me. “There were fewer franchisees generating that royalty revenue than the number I used. So the average revenue is actually higher!”

“You’re quick, Is!” I can be familiar, too. “But look, not all of the franchisees paid the same percentage of royalty. Most probably paid 6%, the number you used, but some may have paid as little as 4%. Others may not have paid any royalties! So you can’t get the number you’re after with the numbers you have to work with.”

You need to get as close as possible

“But I think I got pretty close!”

“You may have,” I said.

“Why won’t the franchisor just tell me that I’m pretty close? Or why won’t they just tell me what I’m going to earn and we could move on?”

“Come on. You know the answers. They’re not going to violate the law.”

Most will not make an earnings claim

“They don’t have to if they’ll file an earnings claim!”

“You’re right,” I calmed her down. “But most franchisors choose not to. It doesn’t mean it’s a bad deal. But it does mean you’ve got to work harder to get at the financial information. And you’re doing a good job of it, Isabel.”

“What do I do now, doc?”

Franchisees are likely to help

“Take your information to a franchisee,” I told her. “Show the franchisee your financial handiwork. Ask the franchisee to listen as you work through your logic and numbers.”

Franchisees will respect a prospect who has worked hard to figure out the projected financials. And, of course, franchisees are not prohibited from sharing financial information with prospects.

Talk to as many franchisees as you can

“You may want to talk to several franchisees, and that’s how you’re going to get a confirmation for your work,”I said. “If you’re off base, they’re going to tell you, and they’ll show you how. Ultimately, they’re likely to tell you how much money they earn and then you’ll know if this business makes sense for you — at least financially.”

“I’ll do it,” she said.

And with that our consulting session ended.

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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!

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. . . 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.  

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How To Detect If A Franchisor Is Covering Up Failures. Seasoned Sales Pro Offers Guidance.

Jason Killough

All franchise networks lose franchisees, but prospective franchisees should investigate the how and why of these departures.

The normal exit patterns

Franchisees leave a franchisor’s network in one of 3 ways:

1. They transfer their license, or re-sell their business. They may sell to a new franchisee, an existing franchisee, or even the franchisor.
2. They willfully terminate their franchise license, or the franchisor terminates it. Many terminations are “mutual” agreements between franchisee and franchisor, and for various reasons. With a “mutual” termination the parties agree to go their separate ways without blaming each other!
3. They do not renew their franchise license after the current term,  or the franchisor decides not to renew it.

How many left the system?

“Before you buy a franchise,” advises Jason Killough, a consultant with  The Entrepreneur Authority (TEA), “it’s important that you know how many franchisees left the system, and why. It’s not always a bad thing that franchisees left the system, but it could be.”

U.S. franchisors are required to disclose the names of all franchisees who left the system whether they transferred, terminated, non-renewed or were bought by the franchisor.

How do you get at this information?

Look at Item 20 of the Franchise Disclosure Document, which the franchisor is required to give you, without obligation or fee.

Look out for net losses

“One number you want to know is how many new franchises did the franchisor sell?” continues Killough. “Hopefully you will see that the franchisor lists more new franchises vs. transfers, terminations and non-renewals. If the franchisor did not have positive net growth, that could be a red flag. It’s especially important in that case to understand why more franchisees left the system than joined.”

How do you get that information?

Three ways:

1. Ask the franchisor. That’s who knows! And the franchisor should be willing to share that information with you. Ask your franchise sales representative for details. If it’s difficult to get this information, or you can’t get it, that’s another red flag.
2. Ask franchisees. They know! They may not know the details, but they know. Ask them why more franchisees left than joined.
3. Ask the franchisees that left the system. Their names and contact information will be included in the FDD. It’s often difficult to get these folks to answer their phones — often times they want to forget a bad memory. Or it may be they agreed not to talk when they mutually terminated. Be persistent about contacting them. Ask other franchisees to help you find them.

Dig deep and find out the reasons

Killough says, “If you see a high number of transfers, be sure to dig deeper to find out why. A franchisee might get an offer he can’t refuse, and that’s a good reason to transfer. Or he may have sold for personal reasons, including a divorce or a death. On the other hand, the franchisee may have transferred because he wasn’t making money, or he was unhappy with the franchisor.”

Always push for explanations, and don’t buy if you don’t feel comfortable.

“Churning” may be the real story

Some franchisors may be “churning” franchises. They aggressively buy back franchises to save a termination, or they find willing buyers, sometimes at a loss to the original franchisee. “From a franchisor’s perspective, transfers (or re-sales) are always better than terminations,” explains Killough. “With a transfer, the franchisor is not decreasing their franchise count. Word of caution: Find out if a franchisor is hiding behind an actual failure by transferring or churning franchises.”

Buying a re-sale may be for you

Sometimes you can get a better deal buying a transfer instead of a new franchise. Plus, you don’t have to start the business from scratch — it already exists. On the other hand, if the previous owner ran down the business and gave it a bad reputation, you may have to spend an inordinate amount of money to revive it, and then still fail. Proceed cautiously.

“Go into your evaluation of a franchise with your eyes wide open,” advises Killough. “The more research you do, the better equipped you will be to make an informed business decision.”

Jason Killough is based in North Texas. Prior to TEA, he sold and supported franchises domestically and internationally for I Can’t Believe It’s Yogurt, Jani-King, ASI Sign Systems, Pizza Inn, 24seven Vending and HomeVestors.  

Whose Opinion Counts When You Interview Franchisees? 5 Steps To Help You Decide!

Got 3 minutes? View my new video about evaluating franchisee interviews.

As you do your homework to determine which franchise to buy (or if you should buy one at all), you’ll likely hear a variety of opinions and comments shared by existing franchisees. Your challenge now: Who to listen to?

Making sense of what franchisees say

Whose opinions count the most when you’re interviewing franchisees?

Here are 5 guidelines to help you interview franchisees and make sense of what they say:

1. All franchisees are not created equal. Some are better than others. A few are better than most. Interview the best!
2. Interview franchisees at all levels of the network so that you get the total story. But spend most of your time with the top performers and money makers. Ask the franchisor, other franchisees, and members of the Franchise Advisory Council for the names of these franchisees.
3. Get most of your information from franchisees who you admire. Even at the top, not all franchisees are created equal. It’s important to learn about their beliefs and lifestyles. The guy who makes the most money may not be the type of person you want to be!
4. Every franchise network has a bottom 25 percent — this is where franchisees end up when they don’t work the system, or they make other blunders that may be related to the franchisor’s inability to help them succeed. But probably not. Avoid spending too much time at the bottom — and while you do, expect to hear negative comments and whining.
5. Interview award winners, but keep in mind that they may not be franchisees you’d admire. And just because they won an award doesn’t mean they made a profit. Be sure to ask! Award winners are usually franchisees who implement the system — and that’s how you turn an opportunity into a business.

Who are you talking to?

When I served as CEO of HomeVestors, prospects would occasionally tell me they weren’t buying one of our franchises because of what they had heard from the existing franchisees. I would ask the prospect, “Which franchisees did you interview?” And most of the time, the franchisees were in the bottom 25 percent of our franchise network.

“What do you care what franchisees in the bottom 25 percent say about this business?” I’d ask the prospect. 

You can usually ignore the bottom performers 

Quite often, the prospect didn’t know who they were talking to! They were surprised to find out that they had interviewed the worst performers. Again, I’m not suggesting you ignore all the negative comments you hear from franchisees. But, unless you hear the negatives over and over again, I think you can ignore most comments from bottom performers.

If the best performers share the same negatives as the bottom performers, that’s worth exploring. Maybe there’s a deficiency that the franchisor needs to correct. 

Work your way to the top of the network

Unless you plan to end up in the bottom 25 percent of a franchise network, stay away from it! Listen to the franchisees at the top!

And by the way, that advice also works for existing franchisees. Watch who you’re talking to! Bottom performers aren’t going to help you rise to the top.

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. . . 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 today 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. 

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Why Are You Buying A Franchise? . . . Really?

“You don’t need to invest all that money to get into the pizza business,” the advisor told his client/friend. “You make the greatest pizza I’ve ever tasted. Far better than anything those franchises offer. You don’t need to pay them all that money upfront, and then — my God — you’ve got to pay them nearly ten percent of your revenue for the rest of your life. Don’t buy a franchise!”

Expect to hear that advice

I invented the above scenario, but it’s real nonetheless. Franchise prospects almost always hear something similar to it. If it’s not about pizza it’s about cookies or chicken or services of all kinds. These passionate commentaries are often shared by accountants, lawyers, family members, or friends — people who mean well, but don’t always understand the real story.

If you’re thinking about buying a franchise, chances are you have met, or you will meet, one of these “advisors.” And when you do, make sure they understand the real story behind why you are buying a franchise. Even better, make sure you understand why you’re really buying a franchise. It doesn’t matter much what the “advisors” think, although I can understand why you’d like them to be on your side — you may need their help, financially and otherwise.

Understanding why people buy franchises

So what is the real story? Why do people buy franchises?

Because, look, there’s some truth to that fictionalized scenario I posed earlier. Some people can indeed make or provide better products and services than some franchises serve up. So who needs a franchise? If you can bake, fry, grill, make something — anything — better than what the marketplace offers today — if you can provide a better service — why do you need to buy a franchise?

Several good reasons, and here’s the first

In a word, I’ll tell you why: marketing.

One of my favorite cousins in Ohio made the greatest pizza ever. You got a whiff of her pizza baking and you thought you were in Italy. One bite and it was over. Never again would you buy pizza from anyone else.

So why did her business fail?

Miss this and your business fails

Because she didn’t know how to market her pizza. It was the world’s greatest pizza, no doubt about it, but she didn’t know how to sell it. She didn’t have a brand. No presence. No home delivery. No knowledge of how many slices of pepperoni to put on a large pie and make a profit upon selling it. Didn’t know where to advertise. Or how. . . . There were countless other issues all related to the operations of the business. Ingredients, recipes, how to mix it, fix it, bake it, serve it — no problems there. She just couldn’t market it!

How much better off she would have been had she just bought a franchise!

Know what you know

So when your “advisor” tells you that you make the greatest whatever, or you provide a better service, you can accept the compliment for what it’s worth. And even though it’s true, if you know that you don’t know how to market your product or service, then that’s why you’re buying a franchise. It’s what you know that matters.

Your accountant, your lawyer, your family members, your best friend — they do not know! You do. Tell your accountant to give you financial advice, not business advice. Tell your lawyer to give you legal advice, not business advice. And tell your family and friends — nicely, of course — to keep their advice (unless they are successful business owners).    

It’s a good reason, but not all franchises provide it

Marketing know-how is a very good reason to buy a franchise. . . . providing, of course, that you buy into a franchise that knows how to market and how to teach its franchisees to market! (Sadly, many do not).

Marketing isn’t the only reason for buying a franchise. More reasons are coming in future blogs!

Register now for free tele-seminar

. . . Register immediately for my free franchise tele-seminar. 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. Next 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. 

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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.

Photo image by: crazytales

Like It Or Not: Franchising Comes With No Guarantees. Accept It Before You Buy!

One thing you need to understand before you buy a franchise: It never, ever comes with guarantees.

Do you know of any business methodology that does?

Systems make franchises work

Franchising isn’t a business. It’s a method of distributing products and services. The method is defined and supported by a system. How well the franchise will perform depends first and foremost on the quality of the system.

Franchisees make systems work

The next most importance factor is the franchisee’s desire, ability and willingness to follow the system. A quality system in the hands of a dedicated franchisee usually spells success.

But there are no guarantees

However, there are other issues that must be considered when you buy a franchise–issues that you cannot control:

1. The economy. Had we only known in 2006 what we’d face in 2008 and 2009 — most of us–franchisors and franchisees–would have made different decisions about our franchises.
2. The market. Interests and demands change. Suddenly, there’s no market for your product or service.
3. Changes at the corporate office. The new management team isn’t nearly as good as the old management team–they manage, but they don’t lead. The new ownership isn’t nearly as vested in the franchisees as was the founder–they make promises and don’t deliver. When changes occur at the corporate office, they may negatively impact your business, or at least your relationship with the franchisor.

Any one or a combination of these issues can turn a thriving, satisfying, profit-producing franchise (or business) into a disaster.

Can you accept this risk?

That’s a risk you must be prepared to accept before you buy a franchise.

If you can’t or don’t want to, here’s my best advice–and I suggest you take it: Keep your job! . . . Or get one. A job may not be satisfying and it may not pay enough money — but if you’ve got one, or can get one, it’s safer than buying and operating a franchise.

Most of you who are reading this blog won’t be sidelined by this advice. You’re not going to keep your job or get another one. You’ve done that and it didn’t work. You’re going to buy a franchise–but now you know that risk is inherent in the methodology.

Accept it!

Photo image by: Flattop

Franchisees: Just Churning Businesses Or Are They Turning Out Profits?

Franchisors in the United States are required by federal law to tell prospective franchisees how many franchises they sold and retained from year to year. That’s good information for anyone who wants to buy a franchise. But it’s not enough information to help you determine if the franchisees are operating profitably. And that’s what you really want to know.

You might assume that because the franchise company shows more franchises in its network this year than it had last year that the franchisees are making money, and you could assume they’re profitable. But you could be mistaken. And if so, the franchisor doesn’t have to tell you otherwise. It’s only after you invest your money, open your business, and operate it for several months that you find out no one is making any money!

Are you thinking: That no good franchisor? Well, not so fast.

Franchisors don’t always know

Crazy as it sounds, franchisors don’t always know if their franchisees are operating profitably. Yes, they should know, but they’re not required by law to know. And, while they won’t admit it, some may not want to know, especially if it’s a new concept that has yet to catch on, or if the upfront costs are so expensive that it takes a year or longer just to break-even. The franchisor may be content so long as the franchises continue to sell, which they will if it’s the “hottest,” “trendiest,” “sexiest,” or some other useless “est” that catches the eye and the checkbook of people who buy franchise opportunities.

Franchisees don’t always know

Crazy as it sounds, franchisees don’t always know if they’re operating profitably, either. They’re busy! They’ve got a business to run, customers to tend to, employees to train, vendors to talk to, a franchisor to satisfy . . . they’ll wait for their CPA to tell them if they made money. Meanwhile, they’re getting by, paying the bills, paying the landlord, paying the employees, and paying themselves what they can, but never enough to feel that it’s worthwhile.

Now, those franchisees who know they are profitable, well, some may not want their franchisor to know for fear the franchisor will increase royalties, or impose additional fees. Or worse: Tell the IRS!

And those who know they’re not profitable, some of them don’t want the franchisor to know for fear of losing their franchise license. If they can keep their license, they figure they’ll eventually turn a profit; otherwise they may at least be able to sell the business at a loss.

Franchisees don’t always tell all

For all these reasons and others, franchisees don’t always tell the franchisor everything!

Besides, franchisee profit or loss is ultimately the business of the franchisees, not the franchisor. Granted, good franchisors understand that if franchisees aren’t profitable the franchisor won’t be profitable–for long. But not every franchisor is a good franchisor.

That’s why it’s the business of the prospective franchisee to find out if franchises are just churning, or actually turning out profits.

Some franchisors volunteer profit information

Recent U.S. franchise laws have made it easier for a prospective franchisee to learn about the financial performance of a franchise company. Franchisors can voluntarily release this information in their Franchise Disclosure Document (FDD), which they must give at no cost to prospective franchisees. However, the majority of franchisors choose not to voluntarily release this information, and for many reasons, some of them, in fact, good reasons (which I’ll discuss at another time).

So what do you do if the franchisor won’t provide you with the information you need to determine if the franchises are just churning, or if they’re actually turning out profits? 

Good relationships lead to better information

How about: Don’t buy the franchise!

That’s probably not what you wanted to hear. So how about: Develop a relationship with at least one franchisee who will help you get the information. Two to three franchisees are even better!

Chances are pretty good that if you don’t know me and I call you by phone and ask, “How much money are you making?” you probably won’t tell me. Even if I tell you I’m hoping to buy a franchise, like the one you own, you probably won’t reveal too much information by phone. You might spend some time talking to me, answering questions in generalities, but when I get down to profit and loss issues, and I want details, you’re probably going to politely stall that conversation–“Gee, I don’t know, my accountant takes care of all that”–and get off the phone as soon as possible.

But if I make an appointment to visit you, or I offer to buy you breakfast, you’re likely to be more receptive. Once we meet and you see that I’m a serious prospect and that I’m asking good questions, you may be open to a second meeting at which you, and/or your accountant, will share profit and loss information with me.

And that’s how you get the information you need.

Be careful: you may need more info

Even then, it may not be enough information. It could be the franchisee you met with got lucky and made a profit in spite of himself. Or he invested more money than you can invest. Or he had more help. Or a better location. Or the franchisor gave her a once-in-a-lifetime deal.

So when you meet with franchisees, make sure you are comparing apples to apples. “If I open in this kind of a location, and I invest this much money, and given that I have this particular background, and I’m willing to follow the operating system, as you have done . . . do you see any reason, Ms. Franchisee, why I can’t succeed like you?”

Remember: One franchisee’s experience still may not be enough for you to make a good decision. You may need to repeat this scenario a couple of times until you’re confident that this particular franchise is the right one for you and your money. 

I know it’s time consuming. But there are no other good choices. You must be willing to invest the time. And if you’re going to invest thousands of dollars, possibly your life savings, isn’t it worth the time? 

One last point: There are many franchisees who are just churning, without even knowing it, putting in time until they have to sell at a loss or close their business. And they’re in nearly every franchise network–even the good, brand-name networks. At the same time, profit-generating franchisees abound. I can’t tell you they are in every franchise network, or that they are in the network you’d like to join, but you will find them if you ask. 

Photo image by: Borman818