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May 3, 2010 ADVICE SQUAD

Franchise facts | Look beyond the brand when considering buying or becoming a franchise

“Advice Squad” is written by members of the Maine chapter of the Association for Consulting Expertise, a trade organization of 88 consultants around the state. This issue’s column is written by Bruce Wildes, president and owner of Acadia Business Advisors LLC in Cumberland.

Franchising a business you own or entering the market as a franchisee can be a smart move for businesses in the service and retail sectors. While impartial data showing success rates of franchises versus independents is somewhat limited, a franchisee typically buys a business model that’s been proven to work. Franchisees also get some training and ongoing support.

Of course, that doesn’t guarantee success. The key player is the operator. Making a go of it ultimately rests there, but the franchisor can significantly influence the franchisee. Selecting or creating a strong franchise system is critical, and size does not equate to strength.

According to research conducted by PriceWaterhouseCoopers for the International Franchise Association, more than 900,000 franchised establishments generated more than $880 billion in direct economic output in 2005, growing some 40% between 2001 and 2005. While franchises have taken a significant hit recently, along with much of the economy, PricewaterhouseCoopers forecasts that the number of franchises will expand 2% to 901,093 in 2010.

A business owner considering expansion under a franchise or business license model should consider a few factors:

  • How much control do you want to maintain within the additional locations?
  • Is your business model easy to replicate?
  • What is the value you provide the owner/franchisee over competitive franchise systems or independents in their industry?
  • What is distinct or unique about your business?
  • What do the financials look like for all parties concerned?

 So, what constitutes a franchise versus a business license? Franchising is regulated — with varying degrees of strictness — at both federal and state levels. Business licenses are not regulated. However, if a licensing arrangement meets the definition of a franchise under federal or state law, it is considered a franchise.

Federal law defines a franchise by three criteria: licensing of a trademark; payment of a $500 fee or more from the date an agreement is entered into until the franchisee has been open for six months or more (inventory purchased for resale is exempt from the $500 limit); and the franchisor’s right to exert significant assistance or control over the franchisee.

If you are considering purchasing a franchise business, consider:

  • How much control do you want to give up to be part of a franchise system?
  • How well do you play by the rules determined by others?
  • How strong is the franchise system, including the brand, training and ongoing support? 
  • Is the franchisor more focused on selling franchises or creating successful ones?
  • Do you make a good soldier? Military-trained people often make the best franchisees. They understand risk and they know how to follow the rules.

Possible pitfalls

You may think the brand is critical when considering a franchise. Actually, what really counts are the system, the financial strength of both parties, continued training and support from the franchisor, and alignment of culture between parties.

An effective operator with a good but relatively unknown franchisor can take a brand into a new market and develop a going concern. Signal88 Security, a company I represent in New England, has ballooned to some 50 franchisees across the country in about 18 months. Most of the franchisees are meeting or exceeding sales projections within the first six months, and clientele are raving about the services.

At the same time, the landscape is littered with well-known franchisees whose businesses have failed. Take the case of a recent client of mine, who owns multiple units of a well-established national restaurant franchise. The client was profitable, but the franchisor focused more on increasing the number of franchisees instead of creating a strong base.

The result: tremendous shrinkage in their system as franchisees struggled with higher-than-average costs of operation compared to their competition, largely due to higher franchisor fees for products, services and royalties. What’s more, the franchisor curtailed marketing programs and other support typically generated from those fees. A good system allows franchisees to make a healthy return on investment so they will be more willing to reinvest in additional units, further reducing overhead and support costs for the franchisor while also increasing the royalty income stream.

Whether you’re a business looking to expand or an individual who wants to buy a business, be prudent and enlist the help of professionals. A buyer can hire a franchise consultant without fees to help assess the best options and resources available. A business looking to expand can enlist one at minimal cost to sort out options, revenue potential and costs.

 

Bruce Wildes can be reached at 877-456-4197, ext. 700, or bruce@acadiabiz.com. Read more Advice Squad at www.mainebiz.biz.

 

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