In this video, Minnesota franchise attorney Aaron Hall explains the factors that can indicate a successful franchise; one which you may want to buy into. When looking into buying a franchise, it is important to identify:
- What are the initial fees to buy into the franchise?
- What are the ongoing fees?
- What kind of support is offered to franchisees?
If you are looking at starting a business, you can be overwhelmed by how many different franchises are out there and which ones you can buy into. T Hey have so many different prices, they have different styles, and approaches. Everyone says that theirs is a unique approach.
But, I would look to a couple things:
- What are the fees required to buy in
- what are the ongoing fees
- what kind of support do they provide to you as a franchisee as you are running your business.
Do you have people to call on if you are having challenges, do they have marketing materials already prepared that you can utilize, or are you going to have to develop this on your own. Is the franchiser going to do marketing for you?
Here is another question, can you do marketing on your own?A lot of franchisers control so closely their brand, that everything you do has to be run through them, or maybe they prohibit it outright, which means if you want to have your own website, too bad you’re prohibited from doing that, if you want to have your own Facebook page, too bad. Well that can be frustrating because you want to be able to build your own brand in your own area. You want people to be coming to you and not having all your time and advertising dollars going to build the national brand. And it is fine, sometimes that is how it’s going to be. McDonald’s for example, if you do any advertising, it’s going to be promoting the national McDonald’s brand. But, McDonald’s also provides a lot of support in exchange for what you are paying. So the key is identifying what you are getting out of the deal? What are you giving up as far as money and time? And then is that a fair relationship?
With some franchisers it’s going to be a great deal for you. With others, I have seen some terrible deals. I have recommended to many people that have come to me, don’t get into this franchise, you are giving them everything and the franchiser is giving you very little. So it really takes analyzing it closely and with a professional who is experienced in franchises, to identify whether this is actually a good deal for you.
It probably makes a lot of sense to spend a lot of time analyzing the particular industry you are looking to get into. What are the characteristics of that industry that lend itself towards success or failure? So if it is a personal services firm, it is going to be a lot of networking and you are going to have to ask yourself, do I enjoy networking? Am I seen as a thought leader among my friends and family? Do I have a network upon which I can connect myself and connect this new franchise opportunity. Is it going to require a lot of sales? Do you like sales? Or is it going to be a couple strategic partners and if so, can you establish those relationships early on? Maybe even before establishing a franchise.
One thing that might be helpful, depending on the type of franchise, is go to some of your target market. In other words, the market you would be targeting when you’re working that franchise, and get to understand them, their concerns, their interests, their needs, and whether they would be receptive to a franchise like this. For example if you are looking at selling or having a McDonald’s, you have a pretty large market, but you could start going to people in a certain geographic area where you are looking at being located and asking them, do you think it would make sense to have a McDonald’s here? If you are going to be selling components to a particular industry, you can go to those company owners and say, would you consider buying these components? Why or why not? Maybe they are overpriced, maybe the brand doesn’t have a good reputation, maybe there are other issues in the industry that would prevent them from buying from you. It would be nice to know that in advance and you can often identify problems or opportunities by talking with your target market before you have invested that large amount in buying into a franchise.
Video Transcripts
My name is Aaron Hall. I’m a business attorney regularly dealing with franchise issues. Often people who are looking at buying into a franchise hire me to analyze the franchise agreement, the state disclosures, and to generally scrutinize the franchise opportunity to make sure that before they sign on the dotted line, they understand what they’re getting into.
The purpose of this video is to answer frequently asked questions regarding buying into a franchise. Franchisors come in a couple of different categories. Typically a franchisor is either making a significant amount of money on the front end by selling the franchise, or on the back end, or over time I should say, by the monthly payments that come in. And then of course you have hybrids, but it’s important to understand that those are the two different models, and ideally you want to see a franchise opportunity that has both components.
The reason is that best aligns with the economic realities of the opportunity. In other words, the franchisor has upfront costs with training you and getting you set up and so it makes sense that you share that cost. And then the franchisor has ongoing costs in supporting you, and so it makes sense that you share that cost.
Here’s the problem. If the cost is too much up front, what incentive does the franchisor have to support you over time? They all ready got all their money. Here’s the problem with the expensive cost over time, it just adds up and that is a lot of money to be paying out on a monthly basis. Now between the two, that’s not the worst option, but I like to see kind of a combination which reflects the upfront costs.
It’s also important to know that there are big a franchise brokers, FranNet for example, a FranChoice I believe is another one. These companies typically get paid on the front end, and typically it’s 30, 40, maybe $70,000 for selling you a franchise. Typically they will target executives who are preparing to retire or have retired. They’re kind of tired of corporate America. They’ve had this entrepreneurial bug within them and they want to build their own business, but they don’t want to start from scratch. They say, “You know what? I’m in my 50s, I’m in my 60s, I want to give it a good goal for five, 10 years and then look at selling the business or passing it on.” So typically these franchise brokers target executives who are preparing for the excitement of entrepreneurialism.
Now the problem is often running a franchise is rolling up your sleeves and getting dirty, and so that can be quite a transition. It’s also a high degree of risk that you often don’t see in corporate America. At least risk that you yourself are facing, because typically when you sign these franchise agreements, you’re signing with a personal guarantee. Meaning not only is everything in the business at risk, but whatever you’ve saved up is at risk.
Now, I recommend that clients thoughtfully consider do they really want to sign a personal guarantee? Franchisors often will insist on that, but you can push back with some of them. Franchisors will also insist on your spouse signing a personal guarantee. I highly discourage that. There’s no reason a spouse needs to be on the hook for your liability. I get it, franchisors want as many people to be liable as possible, but that’s not in your best interest. And frankly, if the business goes under, it makes sense to have a spouse who can at least keep paying the bills and at least has some assets there. You don’t want to sink both ships because where are you going to live then? How are you going to handle a situation where you both end up going bankrupt? So personal guarantees and spousal guarantees are important considerations. The fee structure is an important consideration.
The other thing to look at is how are you going to get out? What’s worst case scenario? What’s best case scenario? Often both of those scenarios are really bad for you as the franchise buyer. Here’s what I mean.
If things don’t go well, you can’t pay the franchisor. That means you’re going to get stuck with their fees, their cancellation fees, you’re on the hook for all the breaches of contract and you typically are on the hook for their legal fees as well. That’s expensive. Not only did your business fail and you lost everything you put into it, but now you’re personally liable for all the legal expenses that the franchisor suffered.
Now let’s say the business goes really well and you want to sell it. Well, unfortunately, most franchise agreements say that you can’t sell it without the franchisor’s permission. They have a right to charge fees to the person who’s buying it from you, and the person who’s buying it from you has to agree to the current franchise agreement in existence at that time. And typically there are some other requirements on there.
In many cases, franchisees who I’ve worked with who want to sell their business, they can’t sell them because it’s not economically viable. The buyer say, “Hey, I’m really interested. I’d love to buy the business.” But because of all of the fees and costs that have to be paid to the franchisor, the buyer says, “I can’t afford this. It doesn’t make good economic sense.” And then what happens?
Well, typically a franchise agreement says that you can’t stop the business and then immediately start competing. There’s a noncompete agreement there. Typically it’s between two and three years, so you can’t stop the business and avoid paying the franchisor by reopening under another name. So what do you do? You can’t sell it, you can’t stop it. You have to close it down, and typically the franchisor has a right to take all of the assets and continue to run the business.
So let’s look at this. The franchisor has a financial interest in this business being canceled by you, terminated by you and handed over to them. And if you sell it, they have a lot of fees as well. So the problem here is that a lot of franchisees who buy a business think, “Hey, I’m going to build this and sell it someday. That’ll be my retirement nest egg.” Unfortunately it doesn’t pan out that way. These are some of the big picture issues, some big economic issues and big risks.
When I work with clients, I analyze the franchise agreement and talk with them about the specific considerations, clauses and provisions that might be problematic for them. I also share with them whether there’s room for negotiation based on what I’ve typically seen in negotiating with franchisors and what their options are. Perhaps some creative ways to make this deal work.
I’m Aaron Hall. For additional information or if you have other questions, feel free to see the link below and you can see how to contact me.
