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How a franchise differs from other types of business opportunities

Buying a franchise is just like buying a business, but with a difference. What is that difference? In the case of a conventional business, the seller is asked questions and he provides accounts. The buyer makes up his mind whether he would like to buy. There are “going rates” for various types of business, and after perhaps some haggling over the price a deal is struck. The buyer takes over the business and will run it in whatever way he thinks best, whether or not he has had previous experience of running any business.

In the case of franchising, there are a number of other very important factors to consider. As a franchisee, you will be entering into a long-term relationship with your franchisor in which you will have to rely on him to a large extent for the success of your own business. You will not be allowed to run your business in whatever way you think fit. You will have the obligation to run it precisely in accordance with your franchisor’s system.

You will find that there are four primary factors present in your business which would not be there if you were trading independently outside the franchise system. These factors are:

  1. the existence of your franchisor,
  2. the obligations to use its name and systems, and submit to its control,
  3. the risk of events occurring which are detrimental to your business without you being in a position to exert any influence over them (e.g. the business failure of your franchisor or actions by other franchisees which bring the business into disrepute), and
  4. the ability of your franchisor to continue to provide you with services of a standard which makes them worthwhile and valuable to the success of your business.

You can find yourself vulnerable in each of these areas and you must, therefore, be aware of these risks in order to be able to ask the right questions and make a sound judgement when you are assessing a franchisor. In this context, it is useful to review the most common causes of failure by franchisors.

1. Inadequate pilot tests
With a new concept, there is a danger that the franchisor has not pilot-tested his system sufficiently well to have proved its viability in the market place. The problem is that it is difficult to judge what represents sufficient pilot-testing. However, if there can be any general rule, it is that the testing should be for as long as is necessary for the franchisor to prove the viability of his system in a variety of locations and market conditions. One must also ensure, for example, that seasonal factors have been recognised and allowed for by the franchisor.

In reality, it can take a new franchisor two years to develop its system to the point at which it is ready to market the franchise. In assessing a franchise, one should take great care to ensure that the pilot-testing has been fully and thoroughly carried out. As interest increases in franchising, there are likely to be more franchises on offer where proper piloting has not been done. Without being able to prove that there is a fully tested and successful system, one could probably question whether, in fact, there is a franchise to sell.

2. Poor franchisee selection
It is a common tendency in the early days of a franchise for the franchisor to accept, as franchisees, people who are unsuitable. This occurs because a franchisor who has made a large investment in establishing his business can be under a great deal of financial pressure to make some quick sales, or because it has not at that stage been able to identify properly the qualities and characteristics which its franchise calls for in a franchisee. Poor selection inevitably brings problems which slow growth and divert the management resources of the franchisor away from other vital tasks.

3. The franchise may be badly structured
This can be the. result of inadequate pilot-testing, or the inability to anticipate likely problems. Structural problems lead to operational difficulties, and these in turn to financial problems and difficulties in managing a network of franchisees.

4. The undercapitalisation of the franchisor
Many franchisors fail to recognise that it can take three to five years to reach a point at which they achieve some profitability, depending on their healthy rate of growth. The franchisor will need the capital or access to capital to fund the shortfalls. Lack of capital is a particular additional handicap in franchises in which the franchisor supplies the products as this will tie-up capital in large inventories. Franchising is not a solution to its problems for a company which is in financial difficulty and it would be foolish to become involved with a franchisor whose business has such problems.

5. The franchisor may run its business badly
The fact that a business operates as a franchisor does not insulate it from business error, even though the franchise may have a basically-sound structure. A prospective franchisee, must therefore be prepared with a different set of questions from those which would be asked if one were buying a conventional independent business.

It must also be understood that just because someone is a franchisor it does not mean that its business cannot fail, nor does it mean that you and the other franchisees are protected from failure. However, a well-tested and structured franchise offered by a properly capitalised franchisor does provide the franchisee with a better prospect of success than he would have if he were to go into business independently.

It should also be appreciated that taking a franchise is not a substitute for hard work. To succeed as a franchisee, as in any worthwhile business venture, it will take a lot of hard work, complete commitment to the business, and the patience to allow time for the business to become established. There is no such thing in franchising as overnight riches or success.

In assessing a franchise opportunity, one must consider the following factors which are all of prime importance.

  • Examine the franchisor’s financial position in great detail. An accountant will be able to provide help. The prospective franchisee should satisfy himself that the franchisor has spent money on proving that his concept works in practice, and that he is adequately capitalised and financed to sustain the business in the future.
  • Check how thoroughly he has market tested the business.
  • Assess how well the system works in practice. Are the existing franchisees (if any) pleased with their businesses and the performance of the franchisor? Speak to existing franchisees – you choose those to whom you wish to speak. Don’t let the franchisor choose them for you.
  • Does the business have staying power, or is it based on something which is temporarily fashionable?
  • Do not buy a franchise from anyone other than the franchisor. Do not deal with franchise brokers, save for advisers who provide an introduction or advice on what is available in the market. Remember that they may be retained by franchisors in whose propositions they will try to interest you. They also tend only to be interested in making sales and are not around later when problems may arise.
  • Ask your solicitor to check the franchise agreement, preferably one who has experience in the field. The British Franchise Association has a category of affiliate membership which contains a list of solicitors with franchising experience. A franchisor needs to have controls in the agreement to ensure the uniformity of the system and the quality of its products or service. The agreement should be fair to you and the franchisor, and it should cover the services which you have been told you will get from it. However, by nature the contract will be one-sided in many respects.
  • Make sure that you appreciate that there is always the risk that you might not be successful in the business, despite the success of others. You may not perhaps be suited to the stresses and strains of being your own boss. Despite your good intentions you may not operate the system properly or show the commitment which is needed. Your family may find that the strain is difficult to live with, and put you under more pressure. Be sure that you and they can cope.
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