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10 Common Mistakes of Prospective Franchisees

Another oldie but goodie article for franchisees from Inc in 2000, abbreviated below:

1. Not reading, understanding or asking questions about the disclosure document. As you read the document [UFOC], keep notes on those areas that are confusing and unclear. While you may want your attorney’s opinion, give the franchisor the benefit of the doubt and first ask its representatives to explain their understanding. Then check the remainder of your concerns with your attorney….

One of the most common problems between new franchisees and the franchisor is a misunderstanding as to responsibilities. Among other things, this can cause problems in meeting the schedule for Grand Opening dates.

2. Not understanding or having an inaccurate or incomplete interpretation of the franchise agreement and other legal documents to be signed. You and your attorney should carefully review the franchise agreement, the lease or real estate agreements, and any other contracts. First, make a list of questions to go over with your attorney, then present your concerns to the franchisor. Get the franchisor’s clarifications in writing.

3. Not seeking sound legal advice. Locate and retain an attorney, preferably one experienced in franchising.

4. Not verifying oral representations of the franchisor. You may want to tape-record all your meetings with the franchisor. If you ask permission to do so, it is generally admissible in court if the need arises later. It also lets the company representatives know that you are tracking their words…Send a registered letter to the franchisor and a copy to the representatives memorializing your notes with a request for their response to any items you want clarified.

5. Not contacting enough current franchisees. …find out whether the franchisor has introduced you to specific franchisees compensated for their help to solicit new franchisees. Ask them….has the franchisor held up its end of the obligations regarding ongoing support assistance and training?

6. Not confirming the reasons for failed franchises. Locate some franchise outlets that are closed, sold, or have changed ownership to company-owned, and find out the reasons for their change of status. Contact the original owners and get their stories.

7. Not having enough working capital. Make sure you have enough capital to cover every cost associated with the business including all pre-opening costs, enough set aside for your family budget, and enough operating cash for the business to make it through the break-even point.

8. Not recognizing the need for financing, not knowing how to make a proper loan request and not developing a true and accurate financial statement. If business accounting is not your forte, solicit the help of a good accountant.

9. Not meeting the franchisor’s key management personnel at their headquarters and the field representative assigned to your territory. Meet the other franchisor personnel and verify the information provided by the sales representative… also meet the field representative or district supervisor that will be working with you.

10. Not analyzing your market in advance. it is still your responsibility to decide for yourself whether a particular location is desirable and promising…Do the competitors have any weaknesses that you will be able to avoid in your business to capture more market? Are the competitors so strong that their market saturation may be hard for you to penetrate? If a local competitor dominates the market, entering it may turn into a competitive struggle that will increase your working capital requirement…find out the amount of advertising and promotional dollars intended to help…Although helpful, it is not a good idea to rely totally on your franchisor for your market research…you may want your agreement to include a right of first refusal to buy additional franchised outlets in the subject territory before the franchisor considers other prospective franchisees.

About Ryan Knoll

Attorney and advisor with an interest in franchising. Feel free to email me comments and questions on the "Contact Us" page.

2 comments

  1. I would suggest that the most accurate source of information should come from former franchisees but you will have to work to get an unbiased view.

    Confidentiality agreements
    Often, franchisees are compelled to sign this type of agreement either at renewal or at termination of a franchise agreement. I have also seen them presented at anytime during the relationship.

    You should ask all current and former franchisees: Have you signed a confidentiality agreement?

    Clever investigating franchisees will ask if the former franchisee’s spouse had signed a “gag order” also. A former investor’s reluctance to have you talk to their spouse is not a positive sign.

  2. In my opinion, a prospective franchisee should contact as many *former* franchisees as possible, to obtain their opinion as to why they failed. The franchisor will probably blame former franchisees for their own failure (e.g., “They didn’t follow the plan”), and it is only by contacting former (failed) franchisees that a prospective franchisee may gain meaningful insight into potential pitfalls. Among those:
    – Geographic area (a franchise’s success may be partially dependent upon what region of the country it’s in).
    – Capitalization (the franchisor’s representation of capital required may be low).
    – Employees (especially in the service sector, finding competent employees may make or break a franchise)
    – What startup assistance does the franchisor provide? (INCLUDING employee hiring.)
    – Does the franchise have any company-owned locations? (Is it in touch with the reality of the marketplace?)
    – Are franchisees able to communicate directly with each other? (Does the franchisor provide contact info?)

    I have discovered that pride is a factor in some failed franchisees willingness or ability to be perfectly candid and honest. I have personally spoken to two franchisees–one failed, one failing–who have said they were determined to “hang in there” simply because of pride. They could not accept considering themselves a “failure”, even though their failure may have been largely attributable to deficiencies of the franchisor or the franchise model.

    ALWAYS remember the franchisor has a financial interest in hiding failures–but a prospective franchisee should aggressively seek them out.

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