Buying a Franchise

It is impossible to drive down any Main Street in America today without passing a franchised business. By 2011, over 50 percent of every retail dollar spent in the United States was spent in a franchise - automotive, beverage, hamburger, dry cleaning, or one of the other 65 industries which make up the franchised marketplace.

Internationally, franchising has become one of the great intangible exports for the United States. Franchisors have penetrated the iron curtain with a long list of industries including restaurants, retail, and service providers. The markets in unified Europe, the Pacific Rim, Mexico, the Middle East, Asia, South America, and even Africa are absorbing American-style franchising at an ever increasing rate. This export of business technology to the emerging markets is one of the great stabilizing social forces as jobs, services, and the supporting resources are created for those markets.

When a business licenses its trade name and operating systems to a third party in exchange for a payment, and exercises some control over the operation of the third party's retail unit, the business generally is defined as a franchise.

It is important to understanding franchising to recognize that McDonald's does not "franchise" hamburgers, nor does Midas "franchise" mufflers. What they both franchise is a business system - and it is that system that delivers the products or services. It is the entire method of doing business, the name, the product, decor, and methodology of delivery that is franchised.

While sophisticated investors are becoming a major force in franchise ownership, it has been the individual investing in a franchise opportunity that has fueled franchising's growth. These franchisees typically express their reason for buying a franchise as a desire to achieve the Great American Dream of financial security and independence. They see themselves as entrepreneurs.

Truly though, an entrepreneur or an independent person should never buy a franchise. If they want independence and the ability to be innovative, they should start their own business. For a franchise system to be successful, it is the responsibility of the franchisor to control the system and - - - - It is the responsibility of the franchisee to follow the methods laid down by the system.

The principal reason for the franchisor to exercise control is to protect the public's ability to rely on the franchisor's trademark as an indicator of the systems products or services, delivered consistently from location to location. Another reason is to protect the franchisees, which rely on the franchisor to ensure that other franchisees do not diminish the value of the trademark, and by extension the value of their franchises, and to keep the franchisor financially sound.

Your decision to purchase a franchise should be based upon two broad understandings:

FIRST: You should have an understanding of the advantages and disadvantages of franchising.

SECOND: You should have an understanding of the franchise you want, and how to evaluate it.

The public has become accustomed to a certain level of quality and consistency from brand name franchised locations. The established franchisor, through the trademark, provides the franchise with a customer base accustomed to shopping under the marks. It is this brand identification which makes it easier for new franchisees to compete with well established independent operators and against well established chain operations.

Franchisors survived their mistakes while developing their franchise and operating their prototype locations, and they can help their franchisees avoid making the same mistakes. Upon joining an established franchisor, franchisees receive comprehensive initial training in the operation of the franchise system, its product, services, and methodologies. The franchisee benefits from the operations manuals, site selection, store design, construction programs, and continuing system support which would not be available had they started independently. They not only have their franchisor as a seasoned partner from whom they can get answers, they also have the network of other franchisees who can provide added assistance in the continuing operation of their business.

In essence, many of the major stumbling blocks which could lead to failure are removed by the good franchisor. These franchisors prepare their franchisees for the business and then continue to support them.

A statistic often cited about small business failure is from The Department of Commerce, which estimated that over 80% of independent small businesses fail in the first five years. The International Franchise Association estimates that during the same five years only 5% of all franchisees fail.

"Failure," as commonly used in franchising, must be carefully understood by the prospective franchisee.

Business failure refers to the closing of the location's doors on a permanent basis. In a franchise system, statistics on failures do not included franchised locations which are repurchased by the franchisor and continue in operation as a company-owned location, or as a location resold and operated by a new franchisee, at times with a financial return to the original franchisee.

Franchisors will often acquire locations for strategic reasons, which may include a desire to operate more company-owned locations or because a franchisee is not performing to standards. Instead of terminating the relationship through litigation, the repurchase of a franchise may be the most attractive route. On the other hand, franchisees often sell or abandon their businesses because they have not received the rewards they expected, or for other reasons including retirement or the desire to change their life patterns.

Therefore, it is important when discussing failure rates with any franchisor that you ask about reacquisition and transfers. New FDD requirements in Item 17 will provide this information. Request the names of those franchisees involved in the transactions and determine for yourself why the businesses were sold.

This difference in failure rates is an impressive reason to consider in favor of buying a franchise. However, the Small Business Administration revealed in a recent study that the success rate for independent start-ups is similar to that of franchisees when the new business had adequate capital to support the business.

Independent businesses do not fail solely because of poor quality products or services. They often fail because they could not anticipate their capital requirements, and do not have the experience or resources to fully analyze the risks they face.

Capital adequacy is a function of business uncertainty and is the primary risk for new enterprises. Will the location they selected provide them with sufficient customers? Is the size of the location too large or too small? Is the rent too high? How many staff are required at what times of the day and how much should they be paid? Is the equipment selected the best for the operation and is the price for the equipment fair? These and hundreds of other issues must be considered and answered

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“I have known Michael for almost 20 years and he is as knowledgeable about franchising as anyone in the industry. His approach is pragmatic, creative and strategic. When I need guidance or advice in franchising, I go to Michael."

Peter Hoppenfeld, Principal
Peter Hoppenfeld, Attorney At Law

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