Copyright International Franchise Association Jun 2005Why buy a franchise?
Franchising is an excellent way to be in business for yourself, but not by yourself, because the franchisor is always there to help. The franchise system, also known as the franchisor, provides a method of doing business that has been tested over time in the marketplace. The system provides its expertise, experience and continuous advertising and market support.
What is a disclosure document?
Every franchise system is required by the Federal Trade Commission to prepare an extensive disclosure document for each potential franchise purchaser. Perhaps no other business is required by law to provide as much information to prospective buyers as franchises. Over twenty different items of information about the franchise are included in the disclosure document. These items include information about the history of the company, required fees and investment costs, information about the franchisor, and any litigation in which he or she has been involved.
When you are given the disclosure, you will be asked to sign and date a statement that you received it. No monies can be taken by the franchise system for 10 working days from the time that you signed the disclosure. The 10 days affords you the time to study, evaluate and prepare your financing. (This time period may vary from state to state.) The disclosure document should be studied carefully.
What are the government regulations?
Federal regulations require every franchisor to prepare an extensive disclosure document and give a copy to any prospective franchise purchaser before he or she buys a franchise. Within the disclosure document are 20 different categories of information about the franchise, including many just mentioned. Required fees, basic investment, bankruptcy and litigation history of the company, how long the franchise agreement will be in effect, a financial statement of the franchisor, earnings claims (if the company makes them) ...all are presented in this disclosure document. But here again, the International Franchise Association (IFA) recommends that you have both an attorney and an accountant review the material.
Even though inaccuracy and misrepresentation carry civil and sometimes severe criminal penalties, there is no way to be absolutely sure. With the FTC disclosure document, however, fraud and deception are less likely, because at the very least, the franchisor has prepared and attested to his statement and has answered a variety of very important questions you can use to judge the offer.
The history and reputation of the company and its officers are also extremely important in this regard. IFA recommends that you carefully consider the information provided and evaluate the material with the assistance of your lawyer and accountant. Also make sure you talk to others who already have franchises from the company you're considering, and ask them to verify any information you question. Learn if they are "satisfied customers" of the franchisor.
Fifteen states (California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin) have enacted laws regulating the offer and sale of franchises. With the exception of Oregon, all of these states require the franchise system to register with the appropriate state administrator prior to the offer and sale of franchises. Through so-called "business opportunity laws," certain other states offer protection to "business opportunity" purchasers, these statutes may regulate the offerings of newer franchise companies whose trademarks aren't yet federally registered.
Each of these laws is designed to present essential information to a potential franchisee or business opportunity purchaser. It's up to a potential buyer to take advantage of this information and thoroughly investigate the offer. Companies lacking a federally registered trademark are clearly subject to Connecticut, Maine and North Carolina business opportunity laws.
What financial help is available?
One of the major challenges any potential franchisee will face is financing. Start-up costs for franchises range from a low of $5,000 to a high of more than $1 million depending on the type. In some cases the franchise system will assist with financing, but generally that is left to the buyer. Five steps will assist you in qualifying financially.
Step 1 - Determine your net worth.
Net worth is figured by determining your assets and liabilities. Most banks or lending institutions have a printed form to assist individuals in preparing this analysis.
Step 2 - Determine your credit potential.
Some loan officers recommend that potential buyers of a business carefully consider the four C's of credit:
* Credit Rating. This is a record of your credit history over the past few years. Poor credit history is the number one reason for many loans not being approved. Obtain a copy of your credit rating by asking your banker whom to contact.
* Capacity. Lending institutions will want to know if your business has the earning capacity to pay back the loan.
* Capability. Are you capable of managing the business you are under taking? What skills do you have that will aid in its success?
* Character. Have you demonstrated integrity in your business dealings?
Step 3 - Develop a business plan.
Before going to a lending institution, prepare the following in written form:
* A resume of your past business experience. (Include past positions held and any management experience.)
* An estimate as to what you expect your income and expenditures to be for the first year of your business.
* A marketing plan that outlines how you will generate business. (See Sample Business Plan outline in Step 5.)
Step 4 - Consider carefully the major sources of financing available to you.
* Friends and relatives.
* Bank.
* Second mortgage on home, savings and loan institutions.
* Borrowing against insurance, stocks and securities, or a loan from the Small Business Administration.
Step 5 - Select the most probable source of financing available to you.
* Take your business plan with you.
* Be prepared to discuss the four C's of credit.
* Have available your statement of net worth.
A Sample Business Plan Outline
A. A description of the business.
* Brief description of the franchise.
* Nature of the business.
B. An analysis of the competition.
* What other businesses will be your competition.
C. Reasons why this business will succeed.
* Location.
* Population factors.
* Other similar businesses that offer a comparison.
D. Methods for generating business.
* How you will sell your product or service.
* Special advertising or marketing methods.
E. An estimate of income and expenses for a 6-12 month period.
F. A resume of your past business experience.
How do fees and royalty payments work?
Most franchises-especially entire business system franchises-require monetary contributions by franchisees consisting of some or all of the following: an initial franchise or license fee; training costs (tuition and/or room, board and transportation) and on site start-up aid and promotion charges (some or all of which may be included in the initial franchise or license fee or may in whole or in part be separately stated); periodic royalties or service fees and an advertising contribution (usually payable monthly or weekly and based on a specified percentage of sales).
Sometimes there is a charge for centralized bookkeeping, accounting and data processing services. There may also be initial payments for premises, equipment, supplies and opening inventory, if acquired from franchisor. (If acquired from other approved sources, the payment for them is nonetheless part of your initial opening cost.) Get specific details on all cost items: amount, time of payment, financing arrangements.
Terms like "initial cost," "initial fee," "total cost" and "royalties" should be specifically defined and made quite clear to you. The terms "cash required," "initial cash required," "investment," "down payment" and "equity investment" mean different things in different offerings.
"Initial fees" probably do not include any equipment or product inventory down payment.
Make certain your investigation is complete and your understanding clear in the following areas:
a) Initial license fee.
* Is there one? How much is the total fee? Is it payable in a lump sum or in installments? If in installments, with or without interest? Is it refundable? Is it non-recurring?
* If the initial license fees are not the same for each franchise concurrently granted, on what factors are the differences based?
* Does an initial license fee include compensation in full for any or all of the following? Does it include use of the then current operation manual, training and start-up aid, including personal on site and promotional assistance, at franchisor's cost? It does not in many cases. The understanding should be clear, the contract explicit.
b) Continuing regular fees.
Are there periodic royalties? How much are they? How determined? In business format franchising, generally, there is a periodic royalty (usually payable monthly or weekly) commonly based on a percentage of sales.
* How and when are sales and royalties reported and royalties paid?
* Royalties are not only payment for use of a trademark and trade name (and, where available and applicable, other commercial symbols, patents or formulas) but may also constitute a fee for services to be performed by franchisors. If the periodic payment is in part a service fee, what on-going services are you to receive from the franchisor? Are accounting services included or available? Are they computerized? Will updated merchandising services, operating manuals and training be furnished without additional, or at nominal, cost?
c) Other fees.
What other fees and charges, if any, are payable (for example, advertising and promotion)?
d) Total cost.
Do not confuse "initial fees," "initial cash required," "initial investment" or "initial costs" with total costs. Initial cost or initial investment may require computation and inclusion of some or all of the following, in addition to initial franchise or license fees and royalties, concerning which inquiry should be made:
* Are you required to purchase or rent business premises? Who finds the site? What is its cost to you as purchaser or lessor? How is it to be financed, if purchased?
* Does "initial" cost or investment include an "opening" inventory of products and supplies; a down payment on equipment and fixtures; a lease security payment; or all or part of the franchise fee? What amount is attributable to each such item?
* Don't confuse down payment or initial cost with ultimate cost. What are deferred balances? Who finances any deferred balances? At what interest? If the franchisor doesn't, is help in finding a source of financing offered? Have you received commitment for financing offered? Have you received commitment for financing before committing yourself? May you seek competitive financing sources or is use of the franchisor or its designated source mandatory? (It should not be.)
* What, if any, are construction, remodeling and decorating costs, security deposits, if any, and initial equipment and inventory requirements costs?
* In determining total costs, check every aspect of the deal. Do not overlook the cost of finding, buying or leasing, and improving and equipping a business location, and obtaining zoning licenses for the operation at that location and the financing costs involved. In determining total opening costs do not overlook working capital and rent (where applicable), inventory, payroll, insurance and your own promotions and salary during the first year. Know what your monthly debt service will be under your deferred payments financing.
What is the FTC Franchise Rule?
It's a regulation issued by the Federal Trade Commission (FTC) which requires every franchise system to prepare an extensive disclosure document and give a copy to any prospective franchise purchaser before he or she buys a franchise. Within the disclosure document are 20 different categories of information about the franchise. Required fees, basic investment, bankruptcy and litigation history of the company, how long the franchise will be in effect, a financial statement of the franchisor, earnings claims (if the company makes them)... all are presented in this disclosure document. But here again, IFA recommends that you have both an attorney and an accountant review the material.
Want more information about how to acquire a franchise? Find it at Franchise.org.
My Research
