General Business and Finance Blog

How To Franchise A Business Phase One – Strategic Franchise Planning

Assuming a business is franchise-able (another topic), a successful how to franchise a business development program begins with developing a comprehensive strategic franchise plan – a foundation for franchising – to guide the new franchise company. Especially in the franchise industry, if you don’t plan for success, you set yourself up for failure. With 3,000 other companies offering franchises, more is needed than boilerplate legal documentation, an operations manual, invoice and handshake. A detailed, specific franchise strategic plan and framework must be developed that encompasses marketing, operations, finance and the critical support function. Intellectual property rights are also identified and protective measures taken. Using a franchise expert with an MBA and past successful franchise ownership experience is a best practice approach that will yield strong dividends.

How To Franchise A Business Phase Two – Franchise Documentation

If a company makes doing a good job at the planning stage its number one priority, franchise documentation is relatively straightforward. A franchise operations manual and franchise training program are developed, often from scratch, to impart business operating skills to the franchise owner as well as ensure uniformity of products and services. The franchise operations manual and franchise training program curriculum must be drafted or edited with a particular focus. Certain topics, chapters and policies used in manuals for company-owned locations, for example, are entirely inappropriate in a franchise environment, creating significant franchise liability issues for the franchise company.

Finally, after all of the above are underway, a Franchise Disclosure Document or FDD – similar to a securities (stock offering) prospectus, is prepared by a competent franchise attorney and registered with various regulatory agencies to comply with applicable federal and state franchise laws.

How To Franchise A Business Phase Three – Training And Implementation

The exciting implementation phase is where the sparks begin to fly as franchises are sold, the new franchise owners are taught and trained, and opening assistance is provided. It’s also when most new franchise companies make serious mistakes that haunt them for years or even decades to come.

The reason: most new start-up franchise companies have not been trained in how to properly operate their new business, nor can they afford to hire a six-figure, salaried person with franchise management experience. A better solution: provide new franchise companies with in-depth instruction based on three decades of excellence and experience in franchise industry best practices. Coupled with on-going, as-needed advice, this instruction is affordable, practical and will save new franchise companies tens of thousands of dollars initially and even more going forward (and, of course, not having to pay a yearly six-figure salary for franchise management experience).

copyright 1982-2009, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

Franchise operations manuals may seem daunting, especially for a company that has never written an operations manual before. Bewildered by the new business of franchising, with its legal requirements, franchise disclosure documents, operations manuals, training programs, etc., many companies delegate responsibility to a high-priced franchise consultant.

But using someone to write your franchise operations manual who knows literally nothing about your business, never makes any sense when everything is considered objectively. And, besides a hefty price tag of ,000 or more to write the manuals, using franchise consultants brings another, expensive result – legal risk. Here are some drafting tips and strategies from a recognized, international franchise expert.

Why Franchise Consultants Are Risky Business
Paying someone who knows nothing about your business, and having them learn it from scratch at your expense is really just common sense. Using franchise consultants for what is a relatively easy and straightforward task has never made any sense – except to the franchise consultants who charge exorbitant amounts to write an operations manual. It’s one of those little franchise secrets that the consultants don’t ever mention or discuss.

Using a franchise consultant to write a franchise operations manual also carries legal risk. The principal legal risk comes from including inappropriate topics, chapters and policies that are commonly found in company-owned, chain operations manuals.  If these are included, as they often are in franchise operations manuals, very significant franchise liability issues arise. Because the franchise consultants are not franchise attorneys or experts, they are entirely oblivious to this risk. They don’t know where the bullets come from in franchise litigation. As a testifying and consulting franchise expert, I routinely find franchise operations manuals drafted by franchise consultants and do-it-yourself manuals containing inappropriate chapters or topics. And, because they rely on boilerplate manuals used for other clients, where (hopefully) all instances of burgers, for example, are searched and replaced with tax returns, the end result is not only dangerous – it is also very mediocre. Giving a mediocre operations manual to a franchise owner who has invested hundreds of thousands (or in some cases millions) of dollars in your franchise model is definitely not the best way to start or ensure a smooth franchise relationship.

The Best Practice Approach To Drafting Franchise Operations Manuals
Besides the expensive and legally risky approach there is another, best franchise practice approach based on almost three decades of writing, editing and reviewing hundreds of franchise operations manuals. The essence of this approach is also common sense – letting the true expert in your business write the manual. Typically that person is the founder of the business, or a small team of management personnel who know business operations inside and out. While a franchise expert should be involved in the process, the expert’s role should be limited to a planning and editing capacity.

Three Easy Steps For Drafting A Franchise Operations Manual
The drafting process begins with planning and developing the Table of Contents for the franchise operations manual. This includes making sure all the appropriate chapters and topics are included, and the inappropriate ones are not. Knowledge of franchise management best practices is essential here, and that’s why a franchise expert’s input and planning is so important. Because most franchise operations manuals are incorporated by reference in the franchise agreement (which is a franchise industry best practice)  the franchise contract is also  reviewed.  Some operations-specific information may be inadvertently included in the contract by the attorneys, which is not a good thing. This needs to be moved out or appropriately amended.

The second step is giving the person(s) within your company who have drafting responsibility samples of operations manual writing styles, guidelines and instructions. With these, they can begin drafting each chapter of the manual using their extensive operational knowledge of the day-to-day, week-to-week, etc. aspects of your business.

The third and final step is having the franchise expert review each chapter as it is drafted and comment on the professionalism and sufficiency of the chapters from a franchise industry best practices and franchise operator perspective.

Summary
The first couple chapters are typically the hardest to draft, as you or your management personnel learn and apply operations manual drafting techniques under the guidance of a professional editor. But after that, it’s smooth sailing through the balance of the document. This approach produces a professional, easy to use and update franchise operations manual. It also ensures the most efficient use of resources and talent, and eliminates having to pay a franchise consultant ,000 or more for this relatively simple task. Whether or not a company ultimately franchises, the process of planning, documenting and implementing standardized operating procedures and systems via operations manuals, like blue chip franchise and non-franchised companies do, makes any firm operate more efficiently and competitively. In a franchise environment, it ensures consistent and uniform operations, helping personnel with different skills learn to perform tasks in a consistent manner throughout the franchise network. Finally, it’s important to realize the process of writing a franchise operations manual never stops. As the business model evolves, so must the operations manual – the ultimate reason why writing the manual yourself to begin with makes imminent common sense. As one franchise company executive observed “I found that not only was writing my own operations manual a cost savings; it was imperative.”

copyright 2008-2009, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

For further information, visit the Franchise Foundations website

Evaluating franchise attorneys and evaluating franchise consultants can seem a daunting task. But the firm a company selects to assist its entry into franchising, refine existing franchise efforts or make franchise opportunity investment decisions will have profound consequences. While asking for a list of references is one approach (and when is anyone ever dumb enough to provide a bad reference?) there are more objective criteria that are not dependent on selectively disseminated information.

By addressing the nine Franchise Questions, topics and subcategories of information discussed below, you will eliminate virtually 95% of the individuals or firms you are considering. Then efforts can concentrate on evaluating the 5% cream of the crop (especially franchise attorneys) that truly merit consideration:

A. FRANCHISE EXPERT:
The #1 factor in evaluating so-called expertise – are the principals really franchise experts? There are objective criteria to determine this:

(1) Have they qualified and been allowed to testify as a franchise expert in court and arbitration proceedings? Being involved as a franchise expert in the franchise litigation process gives a sensitivity and radar for detecting and avoiding future franchise problems.

(2) How many books on franchising have been written by the principals?

(3) How many franchise articles have been published in journals or magazines?

(4) What is their franchise-related teaching experience? (see topics E and F below)

(5) What is their depth of experience in the franchise industry? (see next topic below)

B. EXPERIENCE IN THE FRANCHISE INDUSTRY:
(1) Length of time the firm has operated exclusively in the franchise industry?

(2) Experience on both sides of the franchise fence – working with franchise companies (franchisors) as well as with individual investors (franchisees) who have purchased a franchise?

(3) Past experience principals have owning and operating a franchised business? This factor is absolutely critical. If the principals have owned and operated a franchise, they bring a unique perspective and radar for avoiding future franchise relationship problems from disgruntled franchise owners.

C. COMPREHENSIVE TRAINING & ONGOING SERVICES; CONTROL SYSTEMS:
(1) Can (and will) the firm train your personnel to operate and manage your new franchise company? Remember, you’re entering an entirely different business, one requiring new skills and abilities. If this topic is not addressed in detail, you might as well earmark the franchise fees received when you sell franchises for a future franchise litigation war chest;

(2) Will the firm help you review and update operational (franchise operations manual) and legal documentation (franchise offering circular) on an ongoing basis?

(3) Has the firm developed, and will they help you put into place, franchise marketing, sales control and legal compliance programs during the critical implementation (start-up) phase of your franchise program?

The existence of these programs is essential to ensure only the cream of franchise applicants are allowed to enter the network, and to create a series of documented files should a dispute arise in the future. Most of the legal risk in franchising occurs during the franchise marketing cycle when franchises are sold. If your company’s done a good job here with these programs, then you’ve eliminated most of the risk.

D. LEGAL: FRANCHISE ATTORNEY
(1) Is the law practice devoted exclusively to franchise law?

(2) Total number of franchise disclosure documents (formerly called franchise offering circulars) drafted and reviewed?

(3) Experience filing franchise registrations and working with state examiners in all 14-plus franchise registration states?

(4) Experience represeting franchise companies as well as persons buying a franchise? Knowing both sides of the fence is a tremendous asset.

E. ACADEMIC: UNIVERSITY & COLLEGE
Experience teaching franchise courses at graduate and undergraduate university levels?

F. ACADEMIC: PROFESSIONAL
Experience teaching franchise courses to franchise attorneys and general practice attorneys?

G. BLEND OF BUSINESS & LEGAL SKILLS:
Specialist franchise attorneys and law firms produce tight legal agreements (sometimes overly so leading to future franchise relationship problems) and usually adequate franchise offering circulars. Setting aside the overly tight contract issue, the problem is most franchise attorneys – franchise lawyers are not capable of making sound, strategic business decisions and providing practical, ongoing advice. Some franchise consultants, on the other hand, have good business sense, but lack the requisite legal skills. Questions:

(1) Does the firm have the proper blend of business savvy and in-house franchise legal expertise? It’s always a big plus if the franchise attorney also has an MBA. You can do a Google search with these twin attributes (franchise attorney MBA) and narrow the field considerably.

(2) Can the firm produce good legal documentation (franchise disclosure documents) and help you edit (or create) consistent operational documents (such as the franchise operations manual, training program, etc.) If your franchise agreement says “x” but your franchise operations manual or advertising materials say “y” about the same issue, be prepared to pay hefty franchise litigation fees and deal with franchise litigation attorneys in the future.

(3)Can the firm provide competent and practical ongoing advice in critical areas like effective franchise marketing, media decisions, interviewing franchise buyers, adopting the best franchise organizational structure, implementing a franchise advisory council, etc? Mistakes made in these areas can easily cost the franchise company tens, if not hundreds of thousands of dollars.

H. CONTRACT FAIRNESS:
Does the firm give you an option of choosing between:
(a) an hourly rate and
(b) a flat contract amount, where you don’t have to worry about accumulated hours and an unknown total amount?

I. RED FLAGS – BEWARE OF ANY OF THE FOLLOWING:

• Combination teams where one entity does one part of the project and another the other part. For example, a consulting firm does planning, and operational documentation, while an attorney “they know very well” writes the legal documentation.

• Or, a variant of the above, the company in the “fine print” of its contract, requires your attorney (who you obviously have to pay) to review and approve everything they do because the company (it says) is not rendering legal advice. Actually, by providing documents that affect legal rights, they are rendering legal advice, but in an illegal manner. It’s called the unauthorized practice of law. You end up paying two attorneys – yours and theirs. Besides the expense, it sets you up for future franchise problems. Their attorney represents who? The franchise packaging group, of course, and definitely not you. He or she is typically a recent law school graduate who hasn’t figured out what they’re doing is illegal and could cause them to lose their license to practice law. Besides that, they represent the franchise consulting group, whose interest is to churn as many franchise packages per year as possible. You end up with a bad franchise disclosure document and sloppy franchise operations manuals. To save time, the franchise agreement gets watered down so it’s easier to push through some franchise registration states. Some of the “t’s” may be crossed and some of the “i’s” dotted, but not most of them. The end product are documents that set you up for future franchise litigation difficulties.

• Firms that advise you to franchise your business, and they’ve never seen your business! You’d be surprised how often this happens.

• Firms that say they’ll write your franchise operations manual for you. How someone, who knows absolutely nothing about your business, could ever come close to anything but a mediocre product at best, is a frightening thought. The use of boilerplate manuals produced by consulting groups is yet another future litigation time bomb. You are the true expert in your business. With competent guidance and editing, you’ll be able to produce a professional and workable operations manuals, if you don’t have these already.

• Pricing quotes that seem exceedingly high or low (especially “do-it-yourself” franchise kits).

• If you are buying a franchise, BEWARE of any attorney recommended by the franchise company. Even worse, beware of franchise companies who say you don’t need to use an attorney. There are a couple of these online.

• Firms (or individuals) that have EVER been sued for fraud, misrepresentation, the unauthorized practice of law or violating any franchise law. DON’T FORGET TO ASK THIS CRITICAL QUESTION!!

©1990-2008, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

For more informaton, consult the Franchise Foundations website.

Millions of people dream about owning their own business. Having the independence that being your own boss brings, the security that no one can fire you, enjoying a good income – and for the most successful – the accumulation of wealth and prosperity. Unfortunately, the cards are stacked against a new small business making it big – or making it at all. An endless stream of problems makes competition from large, sophisticated chains too intense. Many new start-ups end as failures.

Buying a franchise represents a different approach to starting a business.  For an upfront franchise fee plus ongoing royalty payments, the parent company teaches its business model and methods to the franchised-operator who shoulders all operating and financial responsibilities of the outlet. Some statistics are impressive: it is said over 40% of all U.S. retail sales are through franchised establishments. While franchise giants like McDonalds, KFC, H&R Block and Radio Shack are familiar, household names, franchises are available in a wide range of industries. The list of 3,000-plus companies selling franchises span over 100 different industry categories.

American Dream … Or Nightmare?
But just as franchising represents a chance to get rich, it’s also a chance to get stung. An alarming number of franchised operators make less than the minimum wage, working seven days, sixty to eighty hours a week, pursuing an expensive and elusive American Dream that turns into a nightmare. Since the ongoing franchise royalty payment comes right off the top, as a percentage of gross sales or a fixed minimum amount, the franchise company gets an assured revenue stream, even if its franchised units are operating unprofitably and are sold over and over again to new, unsuspecting buyers. The internet is filled with comments of the many people who lost 0,000 and more on concepts like eBay Drop off stores (iSold It), 30 Minute Fitness concepts (Curves), The UPS Store, etc. Yet many of these companies continue to sell and resell franchises over and over again. How do they accomplish that? Because there are enough people who think they can “believe” their way to success, even with a concept or business that’s not working in the marketplace. As discussed below, in many cases franchise investment decisions are incredibly based on emotionalism, not on business logic or even common sense.

Ownership And Being Your Own Boss?
Pride of ownership and being your own boss are highly touted phrases in franchise recruitment ads. But these are more fantasy than reality. Although you get all the financial exposure, headaches and stress of business ownership, what do you really own? A franchise owner is merely licensing a trademark (or service mark) from a company that dictates every detail of business operations. So the real boss isn’t you, but the company that sells you their franchise rights . . . and sea of franchise obligations.

Equity Build up?
But at least you’re building up equity, the ownership value of the business as a going concern beyond your investment of money, to compensate for all those years of hard work and long hours – right? Wrong – at least in the world of franchising. The franchise company reserves rights to acquire your entire business at below wholesale prices if their contract is not followed precisely. The acquisition rights provide for predetermined asset-based valuations, like book or liquidation value. These valuation methods provide bare minimum compensation (the used value of some file cabinets, office furniture, equipment, etc.) and are not generally used to determine the selling price of any business.

Absolutely no compensation is paid for established goodwill, the value of a business that is generating $ X in profit or cash flow every month after years of effort, investment and expense – thus eliminating the most valuable ownership asset. Of course, you may be able to sell your franchise to a third party for a sales price that includes an earnings-based valuation. But that’s possible only if:
(a) you can find a buyer who is willing to live within the complexities of a franchise relationship, and
(b) you happen to own a franchise that’s showing healthy profits.

What follows is a bottom-line franchise checklist and tips compiled by franchise attorney and franchise expert, Mr. Franchise, based on reviewing over 500 franchise offering circulars and twenty-eight plus years of experience in the franchise industry – including ownership of a very successful franchise. These factors to consider in making a franchise investment will help you eliminate 95% of the companies you are considering. Then, you can concentrate your efforts on the 5% “cream” of the crop” companies that may deserve consideration. This franchise checklist assumes you’re suitable for and willing to live within the confines of a franchise relationship. It also assumes the franchise company:

(1) has itself successfully operated the concept being franchised for at least five years at multiple locations;
(2) is not plagued by franchise litigation and franchise lawsuits from disgruntled franchise owners;
(3) does not have unusually high franchise attrition rates (owners who have “left the system”); and
(4) has a balanced, fair franchise contract.

SOLD It – An American Dream That Turned Into A Nightmare
An example of a franchise company in trouble that failed to meet basic threshold standards is iSOLD It, an eBay drop-off store franchise. The company started its one and only company-owned store in November of 2003. Just weeks later, on December 10, 2003 they filed an application to sell franchises. The California Department of Corporations didn’t say “What are you thinking? You’ve only been in business a couple weeks, how can you even consider selling franchises?” Nor did they require this be disclosed as a risk factor on the cover page of the Franchise Offering Circular, as it should have. Disclosure responsibilities ultimately rest with the company (and its attorneys), and this will become one of many issues in future franchise litigation.

Instead, the Department simply collected its 5 filing fee and issued an order declaring the franchise registration effective the next day – on December 11, 2003. Then the magic of franchise marketing  took over. By 2006 the company had nearly 200 franchised drop off stores in operation and was touted by Entrepreneur Magazine as #1 in their list of “Top New Franchises for 2007” and #17 on their “Hotter Than Hot” franchise list. Entrepreneur Magazine, which requires franchise companies to submit their FOC’s (Franchise Offering Circulars) for supposed review each year before they’re listed, didn’t consider the high attrition rate (franchise owners leaving the system) or the fact that the audited financials in their FOC showed the company hadn’t operated profitably since 2004 as serious negatives and awarded iSold It the #1 listing for Top New Franchises of 2007. How did all of this happen? It’s yet another bizarre reality in the world of franchising.

The franchise company’s audited financial statements for the year ended 12-31-05 showed an operating loss of .1 million. Nine months later, in September of 2006, the net operating loss mushroomed to over million.

In its November 3, 2006 Franchise Offering Circular, the table in Item 20 disclosed a total of 10 franchise owners leaving the system, yet a hand count of Exhibit D-3’s “Former Franchisees” revealed a significantly different number – 44. A similar “discrepancy” exists about franchise transfers. Item 20 says 12 transfers whereas Exhibit D-3 discloses 27.

In a long overdue letter distributed to franchise owners on April 5, 2007, CEO Ken Sully painted a dire picture of an American Dream that had turned into a nightmare. Mr. Sully’s letter admitted the company has not been profitable since 2004 (according to the audited financials, the company showed its one and only operating profit of 6,286 in 2004 before the precipitous downward spiral of 2005 and 2006). Over 60 franchised stores have closed and many more are struggling for survival. Mr. Sully observed “Tragically, many individuals who believed passionately in the potential for the category have lost sizable investments, including homes and retirement savings.”

Lost homes and retirement savings? How could such a travesty happen? I counseled a number of persons considering an iSold It franchise and warned all of them against the investment. Fortunately, they followed my advice. The concept was never proven in the marketplace before franchise efforts began, violating the most basic Franchise 101 precept. I also felt the management team lacked strong franchise credentials and the five-day training program was woefully inadequate. Finally, the franchise company was operating increasingly in the red and had a high attrition rate (owners leaving the system). It didn’t take a lot of brain power to see this was an accident waiting to happen. I predicted the bubble would burst and, sadly, it did.

Common sense could and should have prevented so many people from losing so much. Unfortunately franchise sales persons appeal to emotions (passions and potential, to use Mr. Sully’s terms) and strive to keep common sense and business logic out of the buying equation. If a franchise company is able to obtain a ranking on a media list, the sale is even easier. Reprints of high rankings on lists, like Entrepreneur Magazine, are included in the package given to franchise buyers, who are lulled into a false sense of security and begin to stumble over each other in a rush to sign up before someone else takes their desired territory (another favorite closing technique used to sell franchises).

iSold It! amended its FOC at the end of May, 2007 to add some long overdue risk factor language to the cover page of its Franchise Offering Circular. Hmmmm… maybe they read my comments above and did a little research. The new FOC cover page risk factor language says their “franchise system is still new and unproven.” That’s very interesting. How can they say a franchise system, that’s approaching its fourth anniversary, is “still new?” Maybe they’re looking at things from a ‘how old is our universe’ perspective? The word “unproven” is another play on words. The system is most certainly proven in the sense that many people, to quote Mr. Sully, “have lost sizable investments, including homes and retirement savings.” So why not use this quote directly in their Franchise Offering Circular? Answer: can’t sell any franchises that way.

In an August 31, 2007 Business Week article, CEO Sully claimed it wasn’t necessary to disclose these risk factors in the FOC. His reasoning: “We told everybody that this is sort of like the wild, wild West” he says. “It’s a brand-new concept and nobody knew for sure where it was going.” Disclosure was added to the UFOC recently, he says, “because of the number of stores that weren’t understanding the complexity of the business.” Hello? You don’t tell your franchise investors after the fact what you were required to disclose in the FOC before they bought so they could make an informed investment decision. That’s the purpose of franchise disclosure laws. And claiming written disclosure of risk factors in the FOC is not necessary if a prospective buyer hears a salesman’s verbal wild, wild West story ignores franchise disclosure responsibilities and is really an admission the company failed in this regard. With its amended FOC, the company incredibly continues marching forward with franchise marketing efforts.

Now, let’s consider the franchise checklist and factors to consider before any leap into franchising.

INDUSTRY TREND
Is the franchise in a cutting-edge industry that is doing well currently and is projected to do well in the future despite any economic slowdown? Education and home-improvement services are stable categories. Food is over-saturated generally and, except in exceptional circumstances, is not worth the high investment, long hours, headaches and marginal income.

TOTAL INITIAL FRANCHISE INVESTMENT
In general, don’t expect a franchise that requires a five-figure initial franchise investment to produce a six-figure income. As with most things in life, you get what you pay for. On the other hand, don’t assume a six-figure investment will lead to a six-figure income level. Be realistic and conservative. Is the total initial franchise investment range (including working capital) 5,00 or less; and the maximum investment less than 0,000? You can find solid companies in this investment range if you’re willing to look around.

Don’t forget to consider long-term financial commitments, particularly the real property lease (see discussion below under “LEASING AND LOCATION”). Also, the working capital estimate (called “additional funds” in Item 7 of the company’s franchise offering circular) does NOT cover operations up to the break-even point. It only covers a short initial phase (usually only three-months) of operating costs As the break-even point (where revenues cover all operating costs) may not happen for one, two or more years, knowing only what it’s going to take to get you through the first 90 days is not helpful – in fact it may set you up for financial suicide. In many cases, reaching the break-even point can require more reserve funds than the total initial capital investment. Don’t ever forget the name of Item 7 in the Franchise Offering Circular: “Initial Investment.” If you don’t have enough reserve capital to reach the critical break-even point, your entire investment will go down the drain and franchise failure occurs.

One franchise owner in a relatively low investment and low operating cost window cleaning franchise said his biggest surprise was how long it actually took his franchise to be profitable. Going in, he thought it would take 12 to 15 months. It ended up taking twice that time. Fortunately, he had enough reserve capital to make it there, but declined to say what his actual franchise profits or income level were once he reached “franchise profitability.” If you’re operating just above the break even point and making less than minimum wage, is that anyone’s definition of success?

REAL BUSINESS
Is this a legitimate retail business, as opposed to a “work out of your home” operation? The vast majority of work out of your home concepts produce marginal income at best.

FRANCHISE MANAGEMENT EXPERTISE
Does the management team of the franchisor (the company selling you the franchise) have executives with demonstrated past achievement and experience in operating a franchise company (not just persons who have sold franchises)? If not, this is a big RED FLAG. Many companies enter franchising and fail to realize they are in a brand new business – one requiring entirely different management skills and abilities to navigate franchise relationships. A seasoned franchise management infrastructure must be in place. If the franchise management team lacks strong franchise credentials, or does not receive ongoing advice from qualified individuals, you might as well take a trip to Las Vegas with the money you’re intending to invest. Your chances of making vs. loosing money are roughly equal.

NORMAL WORKING HOURS AND DAYS; SUFFICIENT FRANCHISE INCOME LEVEL
Will the nature of the business allow you to work a normal five-day, forty-hour workweek? Life is too short for the seven-day, sixty to eighty hours a week, workaholic lifestyle that destroys health, family and pocketbook. Financially, we’ve calculated the true hourly rate for franchise owners who work these workaholic hours and discovered many are making far less than the minimum wage. One couple who operated a 0,000 fancy pizza franchise in an upscale mall were shocked to discover they were making fifty cents an hour each. Hardly an income level to recoup or justify the franchise investment. Many more fast-food franchise operators make even less, or operate at a loss until their funds, retirement savings, homes, etc. are exhausted. Buying a franchise in a non-food industry doesn’t necessarily improve the franchise profit picture. In a 2006 article “Mail Boxes Etc. Owners Fighting UPS Conversion,” a Mail Boxes, Etc. franchise owner who operated his franchise since 1993 reported profits for a typical MBE store like his were ,000 per year after paying royalty and advertising fees to the franchise company. That calculates out to about .33 per hour for a forty-hour work week, approximately the wage of an entry fast-food worker.

Another major shortcoming of disclosures in the Franchise Offering Circular is not telling you how much money the franchises in the network are making. Instead of answering what is the most important question in a franchise investment decision, the franchise disclosure laws make this “optional” for the franchise company to answer or not. If they do answer this critical question, it will be found in Item 19. But don’t hold your breath – more than 90% of franchise companies “decide” not to answer this question. It’s another bizarre reality in the world of franchising. Although they collect complete monthly (and in many cases, weekly) financial profit and loss statements from their franchise owners, and know exactly how much their franchises are making (or losing), more than 90% decide not to share this information before you buy one of their franchises. A number of franchise salespersons have told persons asking this question: “the franchise laws don’t allow us to answer that question.” Nothing could be further from the truth.

And just because you’re a business executive making a 6-figure income now, don’t assume this income level will be duplicated in a franchise investment just because the company “approves” your application. One such executive, despite a plethora of negative feedback from current and past franchise owners who’d lost everything, marched forward with her franchise investment in a 30-minute fitness concept. Despite her 6-figure income, she didn’t invest a dime in professional franchise evaluation advice and stated she was taking a leap of faith, hoping to build her wings on the way down. Build her wings on the way down? Sound’s (and is) crazy, but this happens all the time. Due to the ploys of the franchise salesperson, too many franchise investment decisions are based on emotionalism. Prior business skills, business sense (and even common sense) are short-circuited. Needless to say, if this business executive made a similar investment decision for her corporate employer paying the 6-figure salary, she would be promptly fired.

MINIMUM NUMBER OF EMPLOYEES
Can you operate the franchise business with 6 or fewer employees? Managing dozens (or in the case of some fast-food operations – hundreds) of minimum-wage teenagers who are constantly quitting or simply not showing up for work is a royal pain in the ….. Well, you know what we mean.

LEASING AND LOCATION
For most retail franchises, the triple net lease of the location is the biggest financial commitment, larger than the total franchise investment. Yet, the typical real estate lease and its ramifications are not required disclosure in any Franchise Offering Circular (FOC). For example, an estimate that you’ll need 2,000 sq. feet of space with expected rental of to a foot per month is normally disclosed in the Franchise Offering Circular’s initial investment table as Leased Real Estate ,000 to ,000. A footnote to the investment table may say “assumes 2,000 sq. ft. at to a foot.”

But, that’s only the beginning of a much longer story. The lease is normally a 5 to 10 year triple-net lease. So, the financial commitment made when the lease is signed is at least 0,000 (at /foot for 5 years) to ,400,000 (at /foot for 10 years). And this doesn’t include substantial, additional obligations to pay all of the landlord’s yearly property taxes, insurance, common area operating expenses, etc. With hundreds of thousands (or even millions) of dollars in financial obligations at stake, personal guarantees and other risks, more than just a warm, fuzzy feeling that everything will work out is necessary.

Key questions to ask here:

(a) is the franchise you’re considering one that can be operated in a low rent commercial business zone? Avoid franchises requiring the costly expenses and triple-net leases of a visible retail storefront and the extravagant rent associated with areas of high foot traffic, like shopping malls. You’ll sleep much better at night.

(b) What’s your total financial commitment under the lease?

(c) Do you have sufficient liquid assets (or a willing, sufficiently liquid third party guarantor) to meet the landlord’s lease qualification standards?

If you don’t, you might as well forget about investing in the franchise. Or even worse, getting involved in a questionable franchise and business model, then realizing you’ve made a big mistake – and discovering you’re on the hook personally for a 0,000+ lease obligation.

A related real estate variant is securing a lease with a sufficient term (with renewal options) to recoup your investment and make a profit. In July, 2005, an attorney in her mid-forties purchased an existing ice cream store franchise for 5,000 believing it to be a “once-in-a-lifetime opportunity.” Trading her briefcase for an ice cream scoop, she attended the company’s 11-day Ice Cream University and assumed operations of the ice cream store. Turned out it was an opportunity – but only to inherit a store with numerous problems. These problems included (but were not limited to) a lease that would expire the following summer and a landlord who’d previously announced the lease would not be renewed. Rather than pay the 0,000-plus in relocation costs, the attorney returned to the practice of law, but is still paying off 0,000 remaining on the loan taken out to buy the once-in-a-lifetime franchise opportunity. Although there’s a franchise lawsuit pending, it’s yet another case of “franchise fever” – this time attacking a professional no less. Who would ever commit to paying 5,000 for an existing retail franchise without checking out the l-e-a-s-e? Sound’s like another bad attorney joke, but I can guarantee she’s not laughing. Business fundamentals were ignored or forgotten in the rush to acquire the opportunity of a lifetime. And I’m willing to bet not a dollar was spent on competent, pre-investment franchise advice.

IMAGE AND LIFESTYLE
How does flipping burgers, scooping ice cream and cleaning restrooms fit the image of what you want to do for a living? Investing in a franchise will be the most important financial and psychological decision you ever make. Many prospective franchise owners fail to realize they’ll be wearing virtually every hat at some point, from salesperson to bad-debt collector, from firing employees to bathroom janitor. The franchise owner is usually the first one to arrive in the morning – and the last one to turn out the lights late at night. And you’ll need to forget about corporate perks like paid vacations, paid holidays and sick pay. In their place, substitute financial pressures, unexpected events and money draining out of your savings and retirement accounts. Does the typical working day and responsibilities of the franchise you are considering fit your personal image and desired lifestyle? You can experience some of this BEFORE you invest by working for a couple weeks in an outlet owned by one of the existing franchise owners.

TRUE FRANCHISE VALUE
Buying a franchise from a “blue chip” franchise company that has spent decades and hundreds of millions on advertising to develop their brand can make a lot of sense. These companies have “true franchise value” that compensates for the long-term disadvantages of ongoing royalty and advertising fund payments. Often these additional payments literally mean the difference between earning a profit and operating at a loss. In unknown franchise chains with little or no brand recognition, you the franchise buyer are building their brand from scratch, and are saddled with severe, long-term competitive disadvantages.

In these unknown franchise chains, you have to ask yourself a simple, common sense question. What value is the company giving you that you couldn’t learn on your own by working at one of their locations as an employee for a couple months? Franchise truth be told, what most unknown franchise companies are selling is just a business opportunity – teaching you how to get into a new business venture. But unlike a business opportunity seller that charges a one-time fee to help get you into business, they call it a “franchise” and charge ongoing royalty and advertising fees like they’re a McDonalds or other blue chip franchise company.

The reality is they’re not a McDonalds type franchise – not even close to one. In the majority of these lesser-known franchise chains, you’d be much better off starting an independent business on your own. You can learn most or all of their so-called “secrets” in the franchise interviewing process and by talking to (and possibly working a short time for) existing franchise owners.

FRANCHISE PROFITABILITY & “SUCCESS”
Dr. Timothy Bates’ study released in 1993 by the Entrepreneurial Growth and Investment Institute in Washington, DC (and another study published in 1996) was the first to compare start-up costs, franchise profitability and franchise failure rates for franchised vs. nonfranchised firms. In his analysis of some 7,270 firms over the test period, Dr. Bates found that startup capital for a franchised business averaged ,293 compared with average startup capital for nonfranchised firms of ,156. In 1987 nonfranchised firms reported average pre-tax net income of ,744 as compared to a loss of (-,548) for franchised firms. Dr. Bates concluded “Despite their larger revenues, much better capitalization, and their supposed advantages of affiliation with a franchisor parent firm, the franchisees lag behind cohort young firms in profitability and rates of survival.”

The franchise companies ignore both studies by Dr. Bates, pretending they never happened. Instead, other techniques are employed. For example, some franchise companies use misleading success statistics to sell their franchises. Their promotional materials say franchises generally enjoy a 90% success rate, compared to less than 20% for independent firms. These figures are based on unverified information supplied thirty years ago by a select, non-representative group of franchise companies. A full third of the companies receiving “questionnaires “ elected not to participate. There was no verification of any of the information supplied by the franchise companies, not even random, spot checking. Nor was any effort made to identify franchise companies who, along with the franchise owners in their chain, had gone out of business.

Even more recent “studies” saying nine out of ten franchise owners (90%) consider their franchise to be somewhat or very successful also suffer from serious methodological flaws. These were simply telephone surveys of franchise owners who were still in business and asked to say (with absolutely no definition of the term “successful”) whether they felt their business was “very unsuccessful,” “somewhat unsuccessful,” somewhat successful” or “very successful.” Franchise owners who had gone out of business or bankrupt were not included in the survey.

Even if terms are defined and a representative sample obtained, franchise owners can be a quirky group. Hence the need, as in Dr. Bates’ studies, for review of financial data. I remember evaluating an existing franchise for a client. I asked the current owner of the franchise if his business was successful. He said it was very successful. But his financial statements revealed a different picture. He’d never taken a dollar out of the business for himself, never made a profit in two years of operation, and was on the verge of bankruptcy. Another owner of a bakery franchise, interviewed by Business Week, says being successful in franchising means “adjusting your definition of success.” He says he makes a profit, but declined to say what it is, or if he’s ever recouped his 0,000-plus initial franchise investment. Incredibly, he insists he’s in business “for lifestyle reasons, not profit reasons.” Huh? Probably a quote from the company’s franchise recruitment materials. In the world of franchising “success” and “profitability” are very subjective terms.

FRANCHISE BROKERS WHO FIND YOUR PERFECT MATCH?
Does the franchise you are considering have its own in-house marketing department, or does it utilize outside franchise brokers? The use of franchise brokers is a definite red flag. First, it indicates the franchise company is not very serious about who it lets into the franchise network, or even worse, they’re desperate to sell franchises. Second, franchise brokers receive a substantial commission up to 50% or more of the franchise fee you’re paying the franchise company. Franchise Broker Realities: (1) Their service is definitely not “free” despite these and other similar misrepresentations. It’s really common sense – how could anyone offer a “free” service and survive in business? Unfortunately, the common sense part of the brain tends to short circuit when the franchise brainwashing process begins. The simple truth is if you buy one of the franchises they’re hawking, your money goes to the franchise company, then into the broker’s pocket. If anyone ever calculated how much time they spend to collect their ,000 or ,000 commission, it’s probably a lot more than a brain surgeon earns. (2) Franchise brokers definitely do NOT have your best interests in mind. They will do or say whatever they have to in order to close a deal and earn their commission.

Many franchise brokers claim they will help you find a franchise company that is the perfect match for you. In the beginning it sounds good. There’s some personality testing and review of your personal finances. At the end of the day, it turns out they only represent (and steer you towards) a handful of small franchise companies you’ve never heard of before. A detailed analysis often reveals these highly touted franchises produce mediocre or even below minimum wage financial performance. Yet franchise brokers don’t mention this, and individuals continue to rely on their recommendations, believing the broker represents them. Nothing could be further from the truth.

Also, many franchise brokers call themselves franchise consultants. A franchise consultant is usually an independent adviser who offers advice to others (usually franchise companies or firms that want to franchise their business) for a fee. This makes their advice more impartial in theory as long as they are not compensated by third parties. Because they are not legally required to disclose actual or potential conflicts of interest, it’s important ask questions. For example, if you’re using a franchise consultant who is recommending the “best franchises,” are they paid anything by the companies on their list? This could be a commission, kick-back or consulting fee. As mentioned, many franchise brokers call themselves “franchise consultants” to hide their true identity. So, make sure if you’re dealing with a franchise consultant, he or she is not really just a franchise broker in disguise.

FRANCHISE DISCLOSURE LAWS
The franchise disclosure laws, while requiring franchise companies to give you certain, limited information, don’t come close to protecting your interests. For example, as discussed above, Item 7 of the Franchise Offering Circular only requires an estimate of additional funds for 90 days as part of the investment information. But economic reality is you need to know the additional funds you’ll need to reach the break-even point, which can be years away, or your entire “initial” investment will go down the drain. You’d think this type of information would be required by franchise disclosure laws, but it’s not.

FRANCHISE REGISTRATION LAWS
Don’t ever assume that because a company has registered its Franchise Offering Circular in your state, someone at the state has approved or reviewed the document in your favor. Franchise registration is obtained by simply forwarding documents and paying a filing fee – period. In most cases, franchise offering circulars are given an extremely limited review to ensure state-specific disclaimers are present.

I remember filing a registration application for a new franchise company in a state with a reputation for being one of the “toughest” franchise registration law states in the country. After the three-week review period set forth in the statute had gone by, and not hearing anything, I called the examiner assigned to the application. After looking through his files, he finally found my client’s offering circular and application. He apologized for entirely misplacing the file and promised to immediately review the application and call me back. Ten minutes later, he called to say he’d finished and was making the registration effective that day. Ten minutes of review and the franchise company was given the state’s green light. This is not an isolated case – it happens all the time.

WHAT STANDARDS MUST A FRANCHISE COMPANY MEET TO SELL FRANCHISES; ARE THERE ANY REQUIREMENTS TO FRANCHISE A BUSINESS?
Incredibly, the answer is – none. There are no minimum standards or requirements to franchise a business except preparing a Franchise Offering Circular. It’s yet another bizarre reality in the world of franchising.

You and I could have no background in any business, form a new corporation or LLC, capitalize it with only , put together a Franchise Disclosure Document and file it with any franchise registration state. While the offering may be subject to an impound or escrow requirement because of the low capitalization (), we’d still get “registered” and be able to sell as many franchisees as we want.

In these 14 franchise registration states, we may not be able to receive any money until each franchise actually opened, but simply posting a bond would alleviate this difficulty in the franchise registration states. And in the vast majority of states there are no franchise registration laws, so we’d be able to sell franchises and collect fees with impunity once we compiled our Franchise Offering Circular. The federal FTC Franchise Rule doesn’t protect against this risk either – it only requires disclosure (i.e. provide a Franchise Disclosure Document) and has no registration component or minimum standards for franchise companies.

Basic investor protections and requirements found in both federal and state securities laws for over 50 years were never carried over to franchise investments. While most non-blue chip franchise companies could never even qualify to sell you a single share of stock in their company, they are entirely free to collect unlimited franchise fees, ongoing royalties, equipment and other purchases, as well as cause you to incur financial obligations totaling hundreds of thousands of dollars, or even millions in some cases. This isn’t information you’re likely to find in the glowing articles about franchising and franchise companies prevalent in the media.

CLOSING REMARKS
Remember, you are the only guardian when it comes to your franchise investment. It’s definitely an environment where the phrase “Buyer Beware” applies. So, before you sign on the line and make what will undoubtedly be the most serious financial and emotional commitment of your life, get all the facts and figures.

One couple I counseled after-the-fact, invested million in a new franchise company. The contract they signed gave them no right to terminate, no matter what the franchise company did or didn’t do. Of course, the contract gave the franchise company unlimited termination ability, a right it had exercised. The franchise company’s management team had no one with experience in running a franchise company. Incredibly, the couple had not spent a dime on legal or business advice before investing million. The once friendly franchise company had transformed into a formidable foe and was poised to take over their franchise. Sadly, this happens too frequently in franchise investments. Decisions are made on fuzzy feelings and emotionalism. In an effort to save a couple thousand dollars, franchise investors risk homes, retirement savings, everything they have. Then they scratch their heads in amazement later on after inevitable and often horrific problems develop, wondering how they could have been so nearsighted.

Another indispensable level of inquiry is whether you’re getting true franchise value and whether you’d be better off doing the business on your own. In the overwhelming majority of franchises touted by unknown companies, franchise value isn’t there and doing the same thing independently makes better economic sense and actually decreases the risk of failure.

Finally, and this applies to franchise investments as well as investing in any business venture, develop a plan to succeed but also plan a franchise exit strategy that minimizes financial risk in case things don’t work out. Both plans need to be thought through before the investment is made. Don’t wait until problems develop to start thinking about a franchise exit strategy – by then it’s usually too little, too late.

For more information, visit the Franchise Foundations Website.

© 1990-2008, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

Imagine opening 20 new business locations without having to foot the bill for real estate, equipment and development costs or taking on any of the risk. Even more, imagine finding managers to run all those locations, who are just as committed to growing the company as you, and you don’t have to pay them a dime. Finally, imagine that these managers will hire, fire and manage all employees as well as foot the bill for all operating costs and expenses. Sound far-fetched?

Not if you’re planning to enter the franchise industry, one of the fastest ways to grow a small business without breaking the bank. For many companies, franchising a business (or licensing) is a sensible way to achieve rapid, profitable growth without giving up any control or ownership. Going from a single location to a dozen in a couple years, or a hundred in ten years is possible and well-documented because franchise owner-investors put up all investment capital, shoulder all risk and assume all day-to-day operating responsibilities.

It’s expansion, using OPM – Other People’s Money. Also, the franchise company gets paid handsomely for teaching others the secrets of how to operate its business. First, there’s the up-front “membership” or franchise fee of ,000 to ,000 paid for using the brand name and operating methods. In addition, there are continuing royalties of 5% to 10% of gross sales for ongoing advice and consultation. In essence, a franchise development program allows a company to get out of the trenches and become a highly-paid general overseeing its soldiers. Long-term options are also attractive. Build an empire and relax, or let the franchise company be acquired by an increasing number of large companies that look for small, but growing franchise companies. According to the International Franchise Association, 900 new companies have franchised in the last three years.

ENTERING A NEW BUSINESS
A company planning to franchise must realize it is entering a new business, offering an entirely different service (training & support) to entirely new customers (business owner-operators). This new business requires different skills, abilities and expertise. In the new business of franchising, it is critical to develop effective evaluation, documentation, mentoring, training and consulting skills. Since these new skills are rarely present within existing personnel, an outside franchise expert is needed to train existing personnel and plan the transition. The first step involves determining whether or not a business can franchise, and if so, what needs to be developed. Next, strategic franchise planning is necessary to create a “blueprint” for successful expansion efforts. Experience shows that, just like a building, the foundation developed at the beginning will create lasting consequences affecting the relative success (or failure) of the entire venture. Legal (franchise disclosure document, franchise agreements) and operational documents (franchise operations manual, franchise training program) are prepared and drafted and finally a franchise registration process is required in some 14 states, depending on which state(s) the company sells franchises. These phases are discussed below.

THE FRANCHISE FEASIBILITY PHASE
An indispensable step before any franchise development program gets underway is an analysis of the concept and business model. Has the concept been sufficiently proven in the marketplace? How profitable are existing prototypes or company-owned outlets? Franchising will not solve existing problems, it will only intensify them – and usually at a serious cost to franchise investors. Franchising should not be viewed as a method to raise capital, expand a business that has existing problems, or a way to get rich quickly. There must be sufficient profitability in the business model so that royalty and other payments can be made and leave the franchise investor with a sufficient profit. With a franchise feasibility analysis, a determination can be made about:

(a) whether franchising or licensing expansion ideas should be pursued, postponed or abandoned; and
(b) assuming a positive result in (a), what needs to be fine-tuned or developed from scratch for the franchise program.

Besides determining if and when the business can franchise, the analysis should also include providing guidance and direction so as much of the groundwork as possible can be done by existing personnel. This has proven to be a very effective approach and significantly reduces franchise development costs. If the feasibility analysis is positive, the other phases discussed below follow. My twenty-eight years of experience in the franchise industry lets me share a valuable insight about franchise feasibility studies. Too many companies leap into franchising without doing a feasibility study, or if one is done it is performed by a franchise consultant or group that tells everyone good news – they’re all “franchise-able.” The vast majority of franchise feasibility studies I’ve done either identify areas that need attention before franchising makes any sense or tell the client to forget about it and pursue other options.

THE FRANCHISE STRATEGIC PLANNING PHASE
A successful franchise development program begins with a solid plan – a foundation for franchising. The long-term goal is to establish balanced, integrated, successful business relationships with qualified individuals who support the company’s goals and image. Creating an enduring relationship requires a comprehensive strategy that addresses all aspects of the franchise endeavor.

The starting point is a detailed analysis that covers:

(1) identifying profile characteristics of who will be the best franchise owners for the particular business;

(2) competitive positioning to make the franchise stand out from the other 3,000+ franchise companies;

(3) geographic scope – where and when will franchises be sold;

(4) analysis of the company’s organizational strengths and weaknesses relative to franchising;

(5) identifying the appropriate franchise organizational structure as well as staffing requirements and responsibilities; and

(6) structuring the franchise relationship for a balanced, win-win scenario.

What should emerge from this detailed analysis is a specific strategic plan and framework for guiding virtually all franchise efforts. Despite the long-term importance of the franchise planning step, too many emerging franchise companies enter franchising with no plan or planning – other than “let’s try and sell a lot of franchises.” They rush through (or neglect entirely) the strategic planning process, thereby creating future franchise litigation land mines that are ticking franchise lawsuits waiting to happen.

Often, this is because they only utilize the services of a franchise consulting firm or franchise attorney, where little or no attention is paid to critical strategic planning, operational and organizational issues. Normally, these firms draft “boilerplate” franchise disclosure documents, franchise agreements and franchise operations manuals based on a questionnaire completed by their client, who is presumed to have made all strategic decisions. The franchise documents are presented, along with an invoice and a handshake – hardly the ingredients for success in the new business of franchising.

THE FRANCHISE DOCUMENTATION PHASE
If the company has made doing a good job at the planning stage the number one priority, franchise documentation goals will be apparent. Proprietary and intellectual property assets (like operating techniques, customer information, recipes, formulas and methods) need to be identified and protected. A trade secret protection program is developed and implemented. The name, logo and tag lines should have been previously registered as trademarks or service marks.

franchise operations manuals
Franchise operations manuals and training programs are developed, often from scratch, to impart business operating skills to the franchise owner as well as ensure uniformity of products and services. The franchise operations manual and training program curriculum must be drafted with a particular focus. Certain topics, chapters and policies found in manuals for a company-owned chain, for example, are entirely inappropriate in a franchise environment, creating significant liability (lawsuit) issues for the franchise division.

I routinely find franchise operations manuals drafted by franchise consultants or do-it-yourself manual kitscontaining inappropriate chapters or topics. Not knowing where the bullets come from in franchise litigation, they proceed blindly ahead using “boilerplate” manuals where most (but not all) instances of “hamburgers” are changed to “tax returns.” The support aspect of the franchise relationship needs to be carefully considered, structured and reflected in the franchise operations manuals.

Deciding who writes the franchise operations manual is a relatively simple question to answer, yet many new franchise companies also fall into a trap here. Bewildered by the new business of franchising, with its legal requirements, franchise operations manuals, training programs, etc., they decide to “delegate responsibility,” usually to a high-priced franchise consultant who produces the operations manual and sometimes even the legal documents. Putting aside the practicing law without a license issue on the legal documents, does using someone to write your franchise operations manual who knows literally nothing about your business, ever make any sense?

The best practice approach, developed over almost three decades of my writing, editing and reviewing hundreds of franchise operations manuals is based on common sense. Let the true “expert” in your business write the operations manual. And who is that expert? It’s usually the founder of the business or a handful of your management personnel who know the business inside and out. It’s true, an outside franchise expert should be involved in the process, but this should be limited strictly to a planning and editing capacity – helping develop the overall Table of Contents, giving samples of writing styles and technicques, then reviewing each chapter after it’s drafted by you or your management team. This approach produces a professional, easy to use and update franchise operations manual. It also ensures the most efficient use of resources and talent.

franchise disclosure documents
Finally, and only after all of the above are underway, a Franchise Disclosure Document, similar to a securities (stock offering) prospectus, is prepared by competent franchise counsel and registered with various regulatory agencies to comply with applicable federal and state laws. This document can contain thousands of discrete disclosures within its twenty-three chapters and attached exhibits, and obviously needs to be prepared by a franchise attorney. Doing it properly and with a balanced and fair perspective can help keep the company out of the courtroom later. In addition, a franchise registration process is required before any franchises can be advertised or sold in those 14 or so states having a franchise registration requirement. Having one firm author, edit and review all documents is not only cost-effective – it also avoids inconsistencies that can plague the franchise company as franchise legal pitfalls in the future (see discussion below).

RECOMMENDATIONS
My twenty-eight years of experience has demonstrated that in order for a franchise company to get off to a good start, a heavy emphasis should be placed on strategic franchise planning to manage future franchise relationships as discussed above. Then, before the franchise program begins, management needs training in how to effectively operate a franchise organization. At a minimum, the following programs should be in place before franchise marketing efforts begin:

1. Franchise Lead Processing System (sm):
Two key considerations for all franchise companies engaged in franchise marketing are the careful screening of franchise applicants and adopting the proper media plan, schedule and budget. Only the cream of the crop should be allowed to join the franchise network. Eliminating applicants at the entry stage is far easier than waiting for inevitable and costly problems later on. An examination of franchise networks plagued by troublesome franchise owners (who often ripen into future lawsuits) shows a lack of planning and attention to this relatively simple concept. Given the unlimited personal liability risk inherent in franchising, companies neglecting this important concept, or those using franchise brokers, are simply asking for trouble.

Before franchise marketing efforts start, a company should adopt a customized Franchise Lead Processing System that includes instructing key personnel in:

(1) adopting the proper organizational structure;

(2) defining the appropriate profile characteristics of prospective franchise owners;

(3) developing effective interviewing techniques, marketing materials, procedures and checklists;

(4) using a series of tests and other measures to ensure that inappropriate candidates are disqualified before joining the franchise network;

(5) detecting (and then avoiding) red flags that arise in the franchise marketing cycle; and

(6) adopting the appropriate media plan, schedule and budget.

2. Legal Compliance Program (sm):
A franchise lawsuit can result if inconsistent or misleading communications occur when a franchise is first sold. Most of the legal risk is franchising centers around what happens during the marketing cycle: the twenty-three chapters of disclosures in the franchise disclosure document as well as who said what, and when. Defending any franchise lawsuit, even a frivolous one, can be enormous. Franchise companies involved in franchise litigation are shocked to discover they have fallen into a quicksand that swallows up time and money without limit. The cost of prosecuting or defending even a “small” franchise lawsuit can quickly exceed 0,000, and up. Exposure can run into the millions. Although one study of franchise disclosure documents indicated 27 percent of franchise companies have a history of franchise litigation (slightly greater than 1 in 4), the real percentage is much greater and probably north of 50 percent. This is because only pending litigation and final judgments must be disclosed in franchise disclosure documents. Most franchise litigation cases, like other litigation cases are settled, so they’re only required to be in the franchise disclosure document from the time they’re filed until settled. After that, they vanish without a trace. And whether the chances of getting sued in a franchise lawsuit and getting embroiled in franchise litigation is greater than 1 in 2 or 1 in 4, who wants to get involved in a time-consuming, stressful and expensive mess?

It is almost impossible to avoid potential franchise liability unless a genuine program of education and instruction is conducted with marketing personnel as well as middle and executive franchise management. An integrated Disclosure Compliance Program that specifies rules and expectations (including legal rules in selling a franchise), manages franchise disclosure documents and controls the dissemination of all information is absolutely essential. It is also one of the best investments a franchise company will ever make. For all of the above reasons, the use of franchise brokers is definitely NOT recommended. Their statements (or other actions) made to “close the deal” will make the franchise organization (and the personal assets of its officers) liable for violations of federal or state franchise laws. This also explains why the overwhelming majority of successful franchise organizations set up their own in-house franchise marketing department so that actions and statements made during the franchise marketing cycle can be monitored and controlled within the framework of a Franchise Sales Control System (sm).

3. Franchise Sales Control System (sm):
Franchise Sales Control is the other half of the entire compliance equation. While legal compliance specifies rules and expectations, franchise sales control is the mechanism for detecting gaps and inconsistencies. When detected, their causes can be identified and corrected before injuring the franchise effort. A Franchise Sales Control System should be designed with this in mind, and should include a variety of feedback mechanisms to monitor performance and retrieve pertinent information for review by management. This not only increases the effectiveness of franchise marketing efforts – it also greatly reduces the likelihood that sales personnel will deviate from established procedures in selling franchises. Finally, a well-designed Franchise Sales Control System creates a complete back up file for every franchise sold that will qualify as business record evidence in the event of a future franchise dispute. It also satisfies the legal requirement of various states that franchise companies maintain a complete set of books, records and accounts of franchise sales. Since most of the legal risk in franchising arises during the franchise marketing cycle, a comprehensive Franchise Sales Control System is the company’s best protection against the quicksand of franchise litigation.

4. Managing Franchise Relations:
As franchises are sold, the communication lines that develop between the parties will have a major impact on the success or failure of the ongoing franchise relationship. Controlling who is brought into the network through the steps outlined above is the critical first step. Once inside the franchise network, franchise owners must be taught to realize they are members of a system of mutually dependent outlets, each working for the better of the entire network. Developing an awareness of this concept early in the relationship and implementing a franchise feedback system will create a positive attitude, encourage innovative ideas from franchise owners, ensure timely royalty payments and prevent franchise relationship problems later on.

© 1982-2008, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

For more information, visit the Franchise Foundations website.

For the last twenty-eight years, as a franchise attorney, author, instructor and recognized franchise expert, I’ve helped firms enter and prosper in the franchise industry – each hoping to become the next “McDonalds” of their respective industries. Along the way, I’ve met and worked with an interesting group of entrepreneurial founders. From apparel to water treatment, the franchised concepts were also incredibly diverse. Some of them interested me to the point where I considered buying a franchise myself. In two or three cases, talks were initiated to discuss the possibility, but never moved forward. I just couldn’t find the precise set of criteria to satisfy my exacting requirements. After all, I had advised hundreds of prospective franchise buyers, and developed sophisticated radar for detecting the good, the bad and the ugly in franchise investments.

In May of 2002, my life changed dramatically as I took the plunge and became a first-time franchise owner. I’d just completed a franchise development project for a San Francisco Peninsula company poised to enter franchising. They operated a very successful home improvement business that specialized in a unique niche. Targeting homes constructed in the 1960′s to the 1980′s having old, flat, ugly interior doors, this company replaced all interior doors in a home with new, freshly-painted raised panel designer doors, locksets and hinges. Their advertising mantra was “Replacing America’s 1.16 Billion Interior Doors.”

After interviewing a couple interested franchise candidates who didn’t sign up, the company became concerned about selling its first franchise. Selling the first one is usually the most challenging task facing any new franchise company. There are no other franchise owners a prospective buyer can talk to about financial performance, training, ongoing support and other franchise relationship issues. Because of this void, selling the first one is difficult. After I was repeatedly asked when they could expect to sell their first franchise, my hand finally jumped up and I volunteered for the assignment. My franchise agreement was signed May 22, 2002.

Let’s consider the major assumptions and factors I evaluated in making my buying a franchise investment decision, and see how things worked out.

INDUSTRY TREND
As stated in the previous franchise article, a major issue is finding a franchise in a cutting-edge industry that is doing well currently and is projected to do well in the future despite any economic slowdown. From my experience in evaluating hundreds of franchises, I observed the home-improvement industry was a stable segment. People are always looking for ways to improve the appearance and value of their homes.

Unlike other home improvement companies that concentrate on a single, high ticket improvement (a kitchen remodel, for example, that can cost ,000 and more), for a couple thousand dollars (,000 to ,000), a homeowner can give every room in their entire home a major face lift by replacing their old, flat doors with new raised panel, designer doors. In the aftermath of the 9-11 attacks, and the country’s high security anxiety, I felt more people than ever would be nesting at home. A home typically represents the most valuable asset in a family’s portfolio. If the homeowner can be educated and motivated to improve the appearance and value of this asset, by making a reasonable investment, sales are easy.

Major home improvement chains, like Home Depot, realized this and were aggressively promoting interior door replacement. However, they were not organized to meet the needs of the target market in a cost-effective manner. The franchise company had discovered and perfected the “do-it-right” approach for this market, and actually welcomed competitive bids from the Home Depot and other large home improvement chains. In my estimation, all of this bode well for home improvements in general, and this franchise company in particular.

TOTAL INITIAL FRANCHISE INVESTMENT
The franchise company estimated initial franchise investment between 7,00 and 0,000 in its Franchise Offering Circular. Turned out, I came in below the low end of the range. Including the ,000 in franchise fees and the ,000 I used against a home equity line of credit, our total investment was just under 0,000. Incredibly, this was enough to get the business operational AND reach the critical break-even point where cash flow paid all the bills. As discussed in the other franchise article, reaching the break-even point in many businesses can take a year, two years or more.

Getting operational happened fairly quickly. From the time I signed the franchise agreement at the end of May, 2002, secured the real estate in mid-July, 2002, completed improvements then training in August, 2002, and began operations like a rocket in the first week of September, 2002, about four months elapsed. We hit the break-even point in mid-October, 2002, just six weeks after operations started, and began to accumulate an ever-increasing balance in the business savings account.

When I sold the franchise in September of 2003, our interior door replacement business was rocking and rolling. Residential home owners negotiated for position on our six to eight week waiting list to get their old, ugly, flat interior doors replaced with new raised-panel, designer interior doors and shinny lock sets. The new owner paid 6,000 for our franchise, and I received 5,000 after escrow fees. Subtracting our 0,000 investment left a tidy 5,000 profit. Not bad for operating the business exactly one year, and this didn’t include operating monthly income before the business was sold.

REAL BUSINESS
I operated a retail business with a storefront, as opposed to a “work out of your home” operation.

FRANCHISE MANAGEMENT EXPERTISE
The management team of the franchisor had no past achievement and experience in operating a franchise company. They had just started the franchise company and were learning on the fly. That was definitely a major risk. However, I’d given them detailed seminars on how to operate a franchise company and manage franchise relationships based on my twenty-plus years of franchise industry expertise, and had every reason to believe they’d follow my advice. And, because I was their very first franchise, I also believed they would do everything it took to make me a success. My goal was to develop the first franchise from scratch, build it up, then either develop other franchises for them, or sell out – depending on what happened in the franchise relationship. I opted to sell out.

NORMAL WORKING HOURS AND DAYS; SUFFICIENT INCOME LEVEL – FRANCHISE PROFITS AND FRANCHISE PROFITABILITY
The nature of this business was a normal five-day, forty-hour workweek. Our business hours were 9A to 5P, Monday through Friday initially. After talking with the owner of the second franchise in early 2003, I discovered and copied his idea of a forty-hour work week spread over four, instead of five days.

Although this meant our employees needed to work four ten-hour days, they were very receptive to the idea. By starting on Monday and getting all door orders for the week installed by Thursday, everyone had a three day weekend every week, not just on an occasional holiday. Of course, I didn’t have to work ten hours a day. I arrived by 10 a.m. and usually finished by 4 p.m. – Monday through Thursday. Supervising four employees, working 24 hours a week and having 3-day weekends off every week – try finding that in another franchise!

What about the financial picture? Let’s take June of 2003, the tenth month of operations when I started interviewing a number of interested buyers. Sales were ,000 less expenses of ,500, left an income that month of ,500. Of course other months varied, and the business was still in the start-up development stage operating with only a single crew of four employees – but you get the idea. Using the results for June and multiplying by twelve for an annual result, I’d entered financial performance territory only enjoyed by a select group in the entire franchise industry.

MINIMUM NUMBER OF EMPLOYEES
Remember my key question here: can you operate the business with six or fewer employees? When we started business operations in September, 2002, we had two employees. A month later, we added another. When the business sold a year later, our crew consisted of one part-time and three full-time employees.

LEASING AND LOCATION
Our interior door replacement business operated from a low rent commercial business zone, so high square foot rent and triple net leases were never a concern. The 7,200 square foot warehouse and retail showroom we settled on in San Carlos, CA, with rent starting at .65 per foot the first year, seemed almost too big (and expensive) initially. Cutting a rental check to the landlord for about ,000 every month, by far the biggest initial operating expense, made my heart race while I thought “is this whole thing going to work and how long will it take to reach the break-even point?” But, as things turned out, our location was perfect, sales were never an issue, and we hit break-even just six weeks after operations started.

Due to the size of the facility and nature of the interior door replacement business, three crews were possible and bringing them online, one crew at a time, would double then ultimately triple sales. Also, because we were the first to enter the franchise system, we selected the very lucrative, exclusive territory that stretched from Palo Alto, CA all the way up to San Francisco, CA. Although we never expanded the business beyond a single crew, these “next steps” in the evolution of the business in such a prime territory were strong selling points. The new owner of our franchise ultimately took the next steps and with three crews enjoys weekly sales of K to K – which is over .5 million per year.

IMAGE AND LIFESTYLE
I didn’t need to flip burgers, scoop ice cream or clean restrooms. As a franchise co-owner, my principal job was creating and maintaining client relations. I placed ads designed by the franchise company, responded to customer phone calls, set up appointments, did estimates and sent out contracts. A lot of my working time was spent driving to customer’s homes, meeting with them over coffee, taking measurements of all their interior doors, going over the options and explaining our one week production cycle – picking up their old doors on a Monday and installing the new doors by Thursday.

Back at the office, I’d enter the estimate information in our computer and generate a contract proposal. Then I’d email or fax the contract to the customer and wait for their deposit. About 70% of the proposals turned into jobs. Customers called back, gave me their credit card billing information, faxed in the signed contract and I scheduled their production week. By the time I sold the business in September of 2003, residential homeowners negotiated for position on our six to eight week waiting list to get their interior doors replaced.

I also ordered the new doors, lock sets, hinges, paint and accessories. Finally, I paid the bills. It was a very efficient business, great cash flow, no billing and no waiting for payment. As I look back, I saw some very nice homes and met some very interesting people. The pickup, production, painting and installation process was handled directly by our employees under the supervision of our contractor, so I wasn’t involved in this aspect – although I did go out with our crew for about three months picking up and installing doors. That way, I understood the process firsthand, and this helped considerably in knowing how to bid jobs and cover contingencies in the contract.

TRUE FRANCHISE VALUE

I knew going in this franchise investment was not with an established ‘blue chip’ franchise company. After all, I’d purchased their very first franchise, becoming the ground breakers, the pioneers – willing to accept a much greater degree of risk than other franchise buyers. In return, I expected an adequate level of support from the franchise company. Virtually every new franchise company gives not only adequate, but extra support to its first franchise to compensate for that franchisee’s help in pioneering the new franchise system and the additional risk they’ve assumed. There’s also a self-interest in providing extra support – the future growth of the franchise network hinges on the success of the first franchise.

The ultimate test of franchise value came in November of 2002. I was en-route, driving our box van, jamb-packed with doors, power tools, lock sets, hinges, etc., headed to our biggest installation job yet, with our contractor, Scotty, who supervised our team and was our franchisor-approved manager. Everyone else was back at the shop, frantically cutting, sanding and painting the rest of the 100-plus doors scheduled for other jobs that week.

Knowing we had taken on the busiest week of our fledgling business, contractor Scotty complained all week about his wages, saying he wasn’t being paid enough. I’d explained, numerous times, our cash flow wouldn’t support any pay increases at the moment, that he’d only been working for me a little over two months, and his pay was exactly what he requested when I hired him. Scotty wasn’t listening and his complaints continued during our drive along El Camino Real to the client’s house. We were stopped at a red light, waiting to make a turn when Scotty abruptly announced “I’m out of here, I quit.” Opening the passenger door, he jumped out, and walked quickly down the sidewalk of El Camino Real, leaving me stranded in a van that’s a bit larger than a UPS delivery truck. Scotty believed he was indispensable and his theatrics were nothing but a hardball, power play for money.

Looking back at all those freshly painted doors in the van, I knew there was no way one person could install them. I completed my turn, pulled over, and called our shop with my cell phone. Our main door cutter and best employee, Brian, confirmed what I already knew. He could leave and meet me for the install, but that would throw off our entire schedule for the week.

Then, I remembered something important. “That’s why I bought a franchise,” I thought to myself, “we’re in business for ourselves, but not by ourselves.” Surely the franchise company would know exactly what to do, and help us, their very first franchise, deal with a problem that could cripple or kill the new business. They were just a short twenty-minute drive away, had multiple crews, etc. I called the founder, Mr. Interior Door.

The first thing Mike said, after I’d related my predicament was: “Do you think Scott will start a competing business?” I assured him that wasn’t even remotely possible. Starting a door business usually cost upwards of 0,000, requires a sizeable warehouse-showroom, power tools, delivery van and other things. Scotty, besides his personal tools, had no assets. He’d even moved into our warehouse from day one so he didn’t have to pay rent and lived paycheck to paycheck.

I quickly redirected Mike to the purpose of my call and asked for his advice and H-E-L-P. Perhaps a couple of his door installers for the rest of the week, at my expense? Answer – no. What about one person for the rest of the day? Answer – no. What about one person for just a couple hours? Same answer – no. Incredibly, Mr. Interior Door said he couldn’t spare even a single person (including himself) for a couple hours to help us out.

So, no help – but what about advice? Mike’s only advice: call all our customers, including the one I was en-route to, tell them we couldn’t make it this week and re-schedule all jobs forward a week. Since we’d already booked other jobs over the next two weeks, this would have been a disaster, not only to our cash flow (payroll, rent and supplier bills were due that week) but also for our customers who’d already scheduled time off work to be at their homes on the scheduled dates.

That’s when I realized we were in business for ourselves . . . and by ourselves. After thinking things over in the silent van, I called the shop and told Brian to meet me at the customer’s home for the installation. I figured at least we’d collect ,000 doing this job and just have to see about the rest of the week. By the time Brian and I finished, the day was over. We arrived back at the shop at 4 p.m. – quitting time for our construction workers. Our door jobs for the next day were not even close to being finished. The crisis was finally upon us – should I follow Mike’s advice, call all our customers and try to reschedule for the following week?

I decided on a different approach. I held a little meeting, explained the situation, and asked our employees if they’d be willing to work overtime, so our new business wouldn’t go out of business. I also fully realized our employee’s concerns. They’d been working very hard that week to help us achieve our ambitious goal. Our team leader, Scotty, was history, and they all had families and responsibilities at home. Under normal circumstances I’d be up the proverbial creek without a paddle.

MANAGEMENT STYLE TO THE RESCUE
From the very beginning I treated our employees like members of a family. It was a very extended version of theory “Y” management style I’d studied in my graduate business classes. Everyday, I bought lunch for all employees and we ate together, discussing what was new in their lives as well as exchanging door stories. I also provided soft drinks, coffee and snacks throughout the day at the shop. On birthdays, I’d take the person out to a movie of their choice and dinner afterwards.

Luckily, I didn’t have that many employees, but every month saw an ever-increasing total for these benefits on our profit and loss statement. I questioned myself about it, thinking Mr. Interior Door only provided employee meals once every couple months for a special occasion. But I realized if some day I really  needed them, they’ll be there for me.”

This management style kept the business in business and on track that November. All employees immediately agreed to work overtime. I ordered pizzas for everyone for dinner and they worked from 5 p.m. until 1 a.m. the next morning. This dedication repeated itself over the next two days, which is nothing short of incredible, given they all had to report back to work at 7 a.m. each morning. We completed all jobs scheduled for that week, collected our money and all customers were very satisfied. By the next week, the business was on track, humming along, and strengthened by overcoming the adversity.

SUMMARY
Looking back, I happened to be in the right place at the right time, and was willing to take a calculated risk. I didn’t rush in, took a lot of time evaluating many factors, and kept emotions out of the franchise investment decision – avoiding the three mistakes made by most franchise buyers.

It was definitely an effort getting the business established, finding the right location, the right workers, and navigating a new business on my own. But the challenges were a learning experience, and overcoming them was very rewarding. Although I’ve advised hundreds of individuals and firms about the in’s and out’s of franchising, the insights gained and lessons learned in operating my own franchise and interacting with the franchise company retooled my knowledge of franchise relationships.

© 2003-2008, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

For more information, visit the Franchise Foundations website

Franchise Disclosure Documents (FDD) under the FTC’s new Franchise Rule continue to be a good concept in theory. Unfortunately, reality plays a more important role and reveals an entirely different picture.

Here are some of my observations, based on twenty-eight plus years of experience in the franchise industry as a franchise attorney, franchise expert and former franchise owner. During this time, I’ve drafted, reviewed and negotiated over 500 Franchise Disclosure Documents.

Franchise Disclosure Goals

Franchise Disclosure Documents or FDD (formerly known as Uniform Franchise Offering Circulars) are a document containing twenty-three chapters of information. These disclosures are intended to give prospective franchise buyers enough pre-sale information so an intelligent franchise investment decision can be made before long-term contracts are signed, money changes hands and sizeable financial commitments are made. In most cases, a franchise investment has long-term financial consequences. It means putting everything on the line – savings, retirement accounts, home equity, etc. With all this at stake, it’s easy to see why the disclosures in the FDD are so important.

Aura Of Credibility

Attached as exhibits to the FDD are the franchise company’s audited financial statements, franchise agreement, and a list of operating (and departed) franchise owners. If the company elects to make a franchise “Earnings Claim,” that information will be set forth either in Item 19 or attached as another exhibit. The entire document is quite lengthy and can exceed several hundred pages. In certain states (known as franchise registration states like California, New York, Illinois, etc.) the FDD makes reference to being registered with the state. All these formalities creates an aura of credibility. Many franchise buyers assume a regulatory agency has reviewed and approved the franchise offering. Unscrupulous franchise companies engage in blatant misrepresentation, referring to their franchise registration with a state as that state’s “stamp of approval.” Nothing could be further from the truth.

Franchise Registration Realities

First of all, registration of a company’s Franchise Disclosure Document only means they’ve paid a registration fee to a governmental agency and submitted their document. There are no standards a franchise company must meet before it can sell franchises, such as business experience, financial stability, operating a successful prototype for a certain period of time before franchising, etc.

Business Experience And Financial Stability?

You and I could have no experience in a business concept, and never operated a prototype. All we have is an idea to franchise, letting other people (franchise buyers) risk their savings, homes, etc. to see if our idea pans out in the marketplace. All we need to do to franchise is put together a Franchise Disclosure Document, and capitalize our new franchise corporation or LLC. Let’s say we don’t want to risk anything ourselves, so we decide to capitalize our new franchise corporation with only . After producing an audited financial statement (showing cash and stock issued for ), and including this financial in our Franchise Disclosure Document, we’d be able to sell franchises with impunity and collect our ,000 franchise fee every time we sell a franchise.

Franchise Registration States

Of course, in the U.S. there are about 14 franchise registration states where we’d have to pay a registration fee and file the document with the appropriate state agency. But that’s just a rubber stamp and no registration state will refuse to register our franchise offering. Because we’re “thinly capitalized” these states may require an escrow condition where we don’t receive the franchise fee until the franchisee opens for business. Or these registration states may just say we can’t accept payment of the franchise fee until the franchisee opens, and require a simple amendment to our franchise agreement to reflect this condition. That’s the trend here in California and the bottom line is we’d get “registered.”

Even franchise examiners (who are usually attorneys) in registration states issue registration renewal orders to franchise companies who have been operating a couple years and whose audited financial statements say (in an brief footnote): “Since its inception, the franchise company has incurred a net loss of $ X million. These and other factors indicate substantial doubt the Company will be able to continue as a going concern.” Translation: the auditors are saying the company’s ready to go broke. Result: Not to worry, the franchise examiners issue renewal orders allowing them to sell franchises to unsuspecting buyers. It’s not right, in fact it’s outrageous, yet it happens.

Franchise Non-Registration States; FTC To The Rescue?

In the balance of the non-registration states (36) we’d be able to sell franchises with impunity and no regulatory oversight. Of course, there’s the Federal Trade Commission’s FTC Franchise Rule that applies in all states. But this only requires producing a franchise disclosure document – FDD. There’s no registration process with the FTC and they rarely get involved in franchise complaints. A 1993 government report found the FTC acted on less than 6% of all franchise complaints. The U.S. General Accounting Office reports that franchise complaints to the FTC from franchise owners increased ten-fold from 1997-1999. This dramatic rise is profound considering complaint data was only available through June 30, 1999. Since 1998, according to the FTC’s website, only one franchise enforcement action was taken against a franchise company. There’s just not enough money or resources available to the FTC, a situation that will only grow worse in the current economy.

My point here is registration of a Franchise Disclosure Document with a governmental agency only means the franchise company paid a filing fee and forwarded its document. There is no due diligence undertaken by examiners in a registration state. So the real guardian of the franchise investment must be you – the franchise investor. Because of the complexities of franchise agreement provisions and offering circular disclosures the need for competent, professional advice is critical. Many of the critical disclosures are required only in a table, where the relevant contract sections of “boilerplate that bites” are listed, without going into any “details.” If you’re not a franchise attorney looking for red flags, it easy to get duped.

Breakeven Point

Returning to the Franchise Disclosure Document, critical business information is NOT disclosed in the document, principally due to lobbying by the franchise industry. For example, the time it takes to reach the break even point – where revenues cover expenses – is not required disclosure in any franchise disclosure document. A bank would never loan money without this critical financial milestone, yet franchise companies let franchise buyers invest hundreds of thousands of dollars, often mortgaging their homes and tapping into savings and retirement accounts. What type of financial milestone must franchise companies disclose before franchise buyers risk what is often everything they have? The relevant disclosure, Item 7, only requires an estimate of what is called “Additional Funds,” a 90-day estimate of working capital needs. Because many new franchises can take a year, two years or more to reach the break even point, knowing only what it’s going to take to get you through the first 90 days is not helpful – in fact it may set you up for financial suicide. If you don’t have enough working capital to reach the break even point, which can be a year or more down the road, your entire franchise investment will go down the drain.

Financial Performance Of Other Franchise Owners

Another major shortcoming of disclosures in the Franchise Disclosure Document is not telling you how much money the franchises in the network are making. Instead of answering what is the most important question in a franchise investment decision, the franchise disclosure laws make this “optional” for the franchise company – they can tell you if they want to. If they decide to answer this critical question, it will be found in Item 19. But don’t hold your breath – more than 90% of franchise companies opt not to answer this question. It’s another bizarre reality in the world of franchising. Because they require complete monthly (and in many cases, weekly) financial profit and loss statements from their franchise owners, the franchise companies know exactly how much their franchises are making (or losing). But more than 90% decide not to say anything before you buy one of their franchises.

Asking Current Franchise Owners

Of course, current franchise owners are a potential source of information and a list of these are found in an exhibit to the Franchise Disclosure Document. My experience is most franchise owners exaggerate their financial performance or decline to share their finances with a stranger. Many of them I’ve spoken with over 28-plus years claimed they were making good money, when a studied examination of their financial statements revealed they were either losing money or operating at or below minimum wage performance. One couple invested 0,000 in a pizza franchise and were desperate to sell it eighteen months later. Their financial statements showed they were making about .50 (fifty cents) per hour. Fortunately, my client promptly lost interest in buying the franchise after listening to my analysis. The incredible thing is I discovered the franchise was subsequently sold to another person who operated the business for a year then filed for bankruptcy. There are many more examples of these franchise nightmares. Franchise “resales” where unprofitable franchises are sold over and over are another bizarre reality in the world of franchising.

Copyright 2007-2009 Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

For more informatiion, visit the Franchise Foundations website.

What’s the difference between franchising vs. licensing a business? The starting point in the franchising vs. licensing a business analysis is to consider the legal aspects, then the business aspects. In considering the legal aspects, begin with the following premise that applies to both options. If you put someone into business (or allow them to use your business name/mark) this transaction will normally be a regulated activity, subject to substantial penalties for noncompliance.

This guiding legal principle, coupled with the business aspects of selling a franchise vs. a license (discussed below) will answer most franchise vs. license questions. Advice from a competent franchise attorney is indispensable.

BACKGROUND OF FRANCHISE & BUSINESS OPPORTUNITY LAWS
Why does regulation exist? The government, due to documented past abuses where tens of thousands of individuals lost all of their net worth by investing in nonexistent or worthless business endeavors, has devised two principal consumer protection mechanisms:

(1) franchise disclosure-registration laws; and
(2) business opportunity laws.

The thrust of these laws is to require sellers to give potential buyers enough pre-sale information so informed investment decisions can be made before money changes hands, long-term contracts are signed and sizeable financial commitments are undertaken. Under federal regulations, a Franchise Disclosure Document (FDD) covering twenty-three individual chapters and a hundred or more pages in length must be prepared and given to every potential buyer at least 14 calendar days before any contract is signed or money paid.

It doesn’t matter what terms are used by the parties in contracts or other documents to describe their relationship. For example, the contract may call the relationship a license, a distributorship, a joint venture, independent contractors, etc., or the parties may form a limited partnership or a corporation. This is entirely irrelevant in the eyes of governmental regulators, in particular the Enforcement Division of the Federal Trade Commission (FTC). Their focus is not on semantics, but on whether a small number of defining elements are present or not. Today the industry is subject to a complex web of regulations that differ from the Federal level to the state level and differ widely from state to state.

Firms or individuals that say calling it a “license” dispenses with legal regulations are delusional and wrong for at least three reasons:

(1) Common Sense – if it was really that easy, everyone would would be doing it that way. The 3,000-plus companies that are franchising are not stupid. Many of them can afford the best legal talent available. It’s not a coincidence they’re all franchising and not licensing;

(2) Even if the relationship is not regulated under franchise law, business opportunity laws (discussed below) will apply, and complying with these will be a lot more expensive than going the franchise route; and

(3) Any analysis must include federal as well as applicable state laws.

This all reminds me of some financial planners who still advise clients filing U.S. income tax returns is not required under their interpretation of the U.S. Constitution. It just doesn’t work that way. Actually it only works until the IRS catches up. The “licensing avoids franchise regulation” spin (which, not surprisingly, is not accepted in the legal community) also only works until the company gets caught. The logic (not) goes something like this: licensing arises under contract law, not franchise law and therefore franchise law doesn’t apply. Sound’s just like the “you don’t have to file a tax return because tax laws don’t apply” argument.

Here’s a real life example. A “licensing attorney” prepared a dealer license agreement and ignored the FTC Franchise Rule disclosure requirements. The dealers became disgruntled and hired a litigation attorney who sued the company, not surprisingly, for selling illegal, disguised franchises. It cost the company 0,000 to go to trial in federal court to answer the question “Is this contract a franchise?” It’s always a very expensive question to answer. Trying an end run around the franchise disclosure laws by calling it a “license” may be a cheaper way to go initially. But it’s not a question of if you will be caught, the only question is when. Be prepared to spend mind-boggling amounts down the road when the disguised franchise is challenged for what it really is.

In a 2008 case, Otto Dental Supply, Inc. v. Kerr Corp., 2008 WL 410630 (E.D. Ark. 2/13/08) another disguised franchise vs. a license was at issue. The licensor claimed it sold just a license, not a franchise and the franchise laws didn’t apply. It made a motion for summary judgment to have the case thrown out of court. The federal Eastern District Court ruled against the licensor and ordered the case onward. It said whether or not the license was really a franchise was up to a jury to decide. Juries apply common sense to the simple defining elements of a franchise. They are not swayed by semantic arguments like “licensing arises under contract law, not franchise law and therefore franchise law doesn’t apply.” Another expensive franchise vs. license learning lesson.

This is not to say licensing a business isn’t a viable option in foreign (out of U.S.) transactions where U.S. laws don’t apply – but these are a very small minority. Most transactions and contracts cover U.S. activities and residents, so the franchise vs. license question is an easy one to answer. Even inside the U.S. there are some cases where calling the relationship a “license” makes sense. Years ago, a company selling education franchises to university professionals called their contract a license. To comply with applicable laws, a full franchise disclosure document was prepared and registered. For strictly marketing reasons, the “franchise agreement” was called a license agreement within the franchise disclosure document.

The list of required defining elements is quite short, and although certain franchise exemptions and exclusions are available, the franchise statutory framework was designed to pigeonhole these relationships into either a franchise or business opportunity box. Normal license agreements contain certain “control” provisions (right to audit, require reports, mandate suppliers, etc.) and the presence of ANY control or assistance provision (operations manual, training, site or other assistance) is enough to satisfy these elements of the Rule. In fact, the title of the FTC Rule says it all: “Disclosure Requirements & Prohibitions Concerning Franchising and Business Opportunity Ventures.” So, the focus must be on which box is better to use, not on how to avoid using either box.

THE FRANCHISE BOX – REGULATION BY THE FEDS
Let’s consider the franchise box. Under FTC regulations that became effective in 1979 a thick document (now called a Franchise Disclosure Document) must be prepared and given to prospective buyers for a minimum of 14 calendar days before any money is paid or contracts are signed. This document now contains 23 items or chapters of information, as well as current financial statements and a copy of the actual contracts used.

As mentioned, this document is designed to give prospective buyers enough pre-sale information about the company, its financial condition, the proposed contract, investment requirements, trademark rights, exclusive territories, etc.,so informed decisions can be made before long-term contracts are signed. For companies that attempt to disregard federal law, the FTC Act authorizes the Commission to recover civil penalties of up to ,000 for each violation of its Rule, plus injunctive relief, consumer redress (obtaining complete refunds, canceling contracts), etc. Because each sale can involve multiple violations of various regulatory provisions, these fines can be substantial and far outweigh the cost of doing it right the first time.

Selling a disguised franchise (an illegal franchise) as a “license” can be the most expensive mistake a company ever makes. One need only consult the franchise registration filings of various states to see the significant number of companies that fall into this trap. They started out selling “licenses,” operating under misguided advice, in a vain attempt to save money. Then, they either get sued for selling an unregistered or illegal franchise. Or they finally get competent legal advice that what they’ve really sold are disguised franchises, even though they were called a “license.” The governmental agencies require them to offer full rescission rights (cancel the license, refund all money that’s changed hands) to all persons they’ve sold “licenses” to. Defenses like “we didn’t sell a franchise, we only sold a license” or “it’s a license and a license arises under contract law, not franchise law” just don’t work and never have. In the end, they pay a lot more to have it done the way it should have from the very beginning. And for those disguised franchise owners who usually exercise their “let’s get out of this license contract” rights given to them by the regulatory agencies, the sellers end up putting them into the business for free plus having to refund all the money they paid. Not a pretty picture.

STATE REGULATION OF FRANCHISING
Because regulation of franchising is at the federal and state level, the effect of state regulation must also be considered. The FTC Rule sets minimum standards and applies in all states, unless a particular state sets higher standards, and then that state’s law applies. In 1971, eight years before the FTC Rule went into effect, the State of California was the first to enact a franchise disclosure-registration law where a franchise registration process is required before franchises can be offered (i.e. advertised) or sold. The California Franchise Investment Law was in response to a wave of consumer franchise complaints. Other states soon followed California’s lead, leading to a situation where franchise companies had to follow different rules in each franchise registration state.

To alleviate these difficulties and achieve a uniform format, a group of Securities Commissioners from various states adopted a Uniform Franchise Regulation, effective in 1977, known as the Uniform Franchise Offering Circular (UFOC) format. All states requiring franchise registration followed the UFOC format, a thick document also containing 23 chapters of information. None of these states accepted what was then known as the FTC’s Basic Disclosure Document. To ease the obvious predicament created by UFOC vs. FTC format, the FTC allowed companies to use the UFOC format as an alternate to its Basic Disclosure Document. In 2007, the FTC adopted its own version of the UFOC format, known as the Franchise Disclosure Document or FDD. The FDD format is the required format in all states beginning July 1, 2008.

FRANCHISE BOX SUMMARY
Bottom line on the franchise box: By preparing a single franchise disclosure document (at a cost of about ,000), a company satisfies the federal requirement and is positioned to offer and sell franchises throughout the United States. Although certain state-specific information and disclosures may be required in the minority of states having a franchise registration-review process, this can normally be accomplished in a couple of extra hours per state.

THE BUSINESS OPPORTUNITY BOX
Now, let’s consider the business opportunity box. At the state level, there are approximately 24 states that regulate and register business opportunities. Unlike the franchise box, there is no such thing as a uniform business opportunity disclosure format. Business opportunity rules and registration requirements differ in each business opportunity state. Many of these states also have a “cooling off” period, usually a couple days after the sale where buyers can change their mind for any reason and receive a full refund.

For a company that’s going the business opportunity route two different documents may need to be prepared and provided: the FTC’s Basic Disclosure Document (if the business opportunity fits the FTC’s definition of a business opportunity) and a state’s more abbreviated business opportunity disclosure document. Also, different timelines may need to be observed: the FTC’s 14 calendar days before, and a business opportunity state’s cooling off period after.

Bottom line on the business opportunity box – if you’re an attorney with a business opportunity or “licensing” client, get ready for hundreds of billable hours, you’ve just landed a big one. But, if you’re the business paying the legal bills, it’s going to be a lot less money to go the franchise route. Prepare a single, Franchise Disclosure Document, register in a state or two as expansion efforts begin, and you’re essentially done.

There are also other factors to consider in the franchise vs. business opportunity analysis, including liability issues (definitely a greater risk in the franchise arena) but these are beyond the scope of this article, which is not intended to offer legal advice. Companies should consult with competent, informed legal counsel about the specifics of their particular situation before making any decision.

THE BUSINESS ASPECTS OF FRANCHISING VS. LICENSING A BUSINESS
The business aspects of the franchise vs. license and business opportunity options are relatively straightforward. It all boils down to image from a marketing standpoint. From a credibility standpoint, does your company want to stand toe to toe with the likes of McDonalds, Radio Shack, H & R Block and other franchised household names? These are the mental images formed in the mind when an average consumer hears the word franchise, along with familiar, highly advertised slogans like “being in business for yourself, but not by yourself,” “complete training,” “support where and when you need it,” etc.

This, coupled with the complete package of training, start up and ongoing support services offered by franchise companies, makes a franchise a more attractive commodity in the eyes of the prospective buyer and an easier sale. The same applies to firms that first sold “licenses” then switched to selling “franchises.” These companies report they attracted considerable interest and far more inquiries when offering “franchises” compared to when they offered “licenses.” So, even from a business standpoint, the franchising vs. licensing a business question is easy to answer. In addition, and as discussed above, a “license” is almost always a franchise in disguise, a ticking bomb creating significant legal issues if the FTC Rule (and corresponding state franchise registration laws) are not followed.

THE BUSINESS ASPECTS OF FRANCHISING VS. BUSINESS OPPORTUNITIES
Business opportunity ventures, when compared to franchises, suffer from definite image problems that translate into difficult marketing issues. If you ever need proof of this, just attend any business opportunity show or expo. You’ll see a host of fly-by-night opportunities such as worm breeding in backyards, exotic plants raised in glass bowls, condom vending machines (not a bad idea these days) and the like all promoted by fast-talking, high pressure salespersons. Does your company really want to be associated with these companies and the reputation they project? Poor image, coupled with the fact that business opportunity ventures typically provide little training and no ongoing support, make them a much more difficult sale to prospective buyers. In a business opportunity, the buyer is just thrown a ball, and it’s entirely up to them how to run with it.

CONCLUDING REMARKS
From both a legal and business perspective, the franchise vs. license choice is an easy one to make. Doing it right the first time will save money and significant legal headaches down the road. The individuals prevalent on the internet who claim (via very unprofessional-looking websites) that merely calling the relationship a “license,” are only selling a future lawsuit. They are not looking through the lens of an expert with almost three decades of experience who has seen first-hand the havoc these “disguised” franchises cause. Instead, they are attempting to make easy money – at your expense. From the most basic, common sense perspective, if it looks like a Duck, talks like a Duck and walks like a Duck – . . . it’s a Duck.

© 1990-2009, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved.

Because his money is involved, a prospective franchisee must be extremely careful in scrutinizing franchise offers. He should have a ready set of questions that the franchisor must be able to answer convincingly and show basis for his replies. Some of the important questions to ask a franchisor are:
How long has the franchisor been in the business? How many franchises are there at present? How many have failed? The answers to these questions will give the franchisee an overview of the business and its present franchise network.
Specifically, what will the franchisee get from paying the franchise fee? The franchise fee is usually a large sum of money paid to the franchisor once the agreement is signed. Therefore, it is important to know the advantages that the franchisee will be getting in return.
How intensive and effective are the initial and continuing training programs of the company for opening and running the franchise unit? The quality of the training programs of the company for start-up operations and running the business smoothly will determine the ease or difficulty with which the franchisee will run his unit.
What support services can the franchisee expect from the company on an on-going basis in terms of helping him deal with problems that may crop up in the course of the business? Continuing support from the franchisor is essential for the unit to run as projected. The franchisor must be able to enumerate in detail the support services that the company will provide in a variety of scenarios wherein the franchisee is confronted by different problems relative to the business. These problems may concern labour, customer complaints, equipment breakdown, and stock shortage.
Is the central management transparent in the appropriation of pooled funds for advertising and promotions? Did the past marketing programs of the company have a positive effect on sales? Part of the unit’s revenues is paid to the franchisor for the company’s advertising and promotions, therefore, the franchisee must know how well the company handles this fund and if its past marketing programs helped boost sales for its franchisees.
Is there a guarantee from the franchisor that the quality of the products and services offered by suppliers through him will be consistent and delivered promptly? The reliability of suppliers will be a big factor in the successful operation of the business. Hence, it is important that the franchisor is willing to guarantee the dependability of his suppliers and the quality of their products and services.
How long will it take the franchisee to recoup his investment? Naturally, every franchisee is very keen on knowing the company’s projection on this matter. The franchisor’s estimate must be supported by documents giving credence to his projection. However, it would be wise for the franchisee not to merely take the franchisor’s word for it but to research on the matter with other franchisees.
How well has the company studied the marketplace in terms of the ideal number of franchises in a given area to ensure the success of each? Is there a guarantee that the company-owned unit will not compete with the franchises? If it does, what will the company do? There are instances wherein the mother unit directly or indirectly competes with its franchise perhaps due to lack of a proper market study. In any such case, the company must be prepared with a viable solution that will be beneficial to both parties.
How receptive is the company to the idea of adapting its products and systems to the culture and preferences of the market in a given location? If the franchisee is considering a business site wherein the culture and preferences of the people are markedly different from that where the mother unit and other franchises are located, it would be detrimental to the success of the franchise if the company will persist in strictly adhering to its original product line.
A franchisee must carefully list the questions before arriving at the final decision. The aforementioned questions are only some of the most basic among the crucial questions that a sensible franchisee must ask. The manner by which the franchisor answers them can help determine the level of his sincerity. In addition to asking the franchisor, the franchisee will be able gather valuable insight into the actual state of the franchise from the other franchisees themselves. More often than not, they are more than willing to share their problems, frustrations, and advice. Asking the right questions will certainly help the prospect make the right decision

There are many advantages to Franchising. When you buy into a trusted name, take on its fame and programs, you can be sure to have a business that people will recognize quicker than a start-up mom and pop-type business. In fact, it’s one of the most common business expansion tools. Not only this, but entering into Franchising is like entering into a family: there are other people there who will help you with everything from day-to-day operations of your business to buying your business’s equipment at the lowest price possible.
One of the biggest advantages of Franchising is the draw of the brand name. People recognize brand names, and because of this, the name of a business is worth quite a bit. People come to trust names they see again and again because they associate this frequency with quality and consistency. Soon, people become loyal to certain brand names. Franchising helps develop a brand name’s worth by upping the number of businesses popping up around the world.
Buying into a franchise is smart because it will make dealing with banks easier. A bank is more likely to give you money if they know you’re investing in something that has found success before. Additionally, if people know the name of the franchise, it will make it easier to attract customers to your establishment.
Another great plus to Franchising is that a person doesn’t have to market their business or learn how to do such things as accounting or distribution: The business’s model is already firmly in place. Many statistics say that as many as 90% of new businesses fail in the first few years because it’s hard to get the business generating funds while learning the ropes of what works and what doesn’t work. A franchise’s model is proven – it’s why people what to buy into the business – and it makes it easier to keep your business afloat. Once you’re in charge of a franchise, you’ll have a manual that explains the business’s ins and outs and will make day-to-day operations easy as pie.
When it comes to a franchise, it’s easier to buy your equipment and materials because people know the name. The other folk involved in the franchise system will be a great support system when it comes to buying materials. Additionally, one of the biggest advantages of Franchising is that you don’t have to spend as much on marketing and publicity: the more franchises there are, the more publicity you’ll receive. The sheer number of businesses helps establish a brand’s credibility.
Ultimately, there’s less risk involved with opening a franchise, and this is perhaps Franchising greatest advantage. Though the cost may be high to buy into a well-respected name, the possible rewards are much higher. As always you need to ensure your research is done in a manner which means you have all the facts in place, doing your due diligence will ensure that not only the franchise is right for you but that it is one that is going to be value for money too.