Before you buy…

What every potential franchisee should know before buying a franchise. JASON GEHRKE

By Jason Gehrke

Looking ahead to 2009, more people are expected to consider buying a franchise as the job market shrinks and unemployment grows.

To buy and operate a successful franchise requires more than just having the cash to pay for it. Potential franchisees must be prepared to do some hard yards to research and understand the business, the franchisor, and themselves in order to make the best possible decision.

Here are some key pointers:

What should I look out for?

This boils down to just three things; profitability, sustainability, and strong competent leadership. In good times, tough times, or anytime, these three criteria remain the same.

Of course it’s rare that a franchisor will make representations about profitability or concede that their business is anything less than sustainable. It is rarer still that a franchisor would claim to have anything less than strong, competent leadership, so these concepts all need to be tested by a potential franchisee’s own research.

If a potential franchise buyer is not prepared to invest the time to properly research what they are buying, then they must accept some or all of the responsibility if the investment fails.

How much time should I spend researching a franchise?

As a rule of thumb, I recommend that a first-time potential franchisee be prepared to spend at least one hour of research for each thousand dollars they are looking to invest in a business.

For a $200,000 business, that’s 200 hours of research, or five weeks full-time work. That might sound like a lot, but the saying that a fool and his money are easily parted might have been created specifically for those people who recklessly invest after making hasty, ill-considered decisions.

What sort of research should I do?

Such research might include (but not be limited to):

Reading for themselves ALL the franchise documentation provided (in addition to getting advice from experienced business, accounting and legal advisers).

Contacting the current franchisees in the system (these will be listed in the franchisor’s disclosure document).

Talking to the former franchisees who have left the system in the last three years (these will also be listed in the disclosure document).

Comparing concepts. There is usually more than one franchise concept servicing a market niche (however unique), so check out the worth of the competing offer.

Verify for themselves any statements or representations made by the franchisor, or issues raised when contacting current and former franchisees. This might include even spending time doing market research such as counting houses in a territory, searching ABS and other sources of statistical information, counting vehicle or pedestrian traffic and directionality outside a potential shopfront, or many other things.

Working part or full time for a period in a franchised store or territory to get a genuine feel for the business (in which case, the longer the better, and the one hour per $1000 invested rule can be extended). People who have worked in franchises before buying them increase their operational proficiency and become culturally acclimatised to the organisation, thus reducing the likelihood of a horrible “I wished I’d known this before” moment after the investment has been made.

Undertaking small business and franchise training courses and workshops. (The Franchise Advisory Centre runs a number of these, and various state and federal bodies as well as TAFE colleges conduct exceptional short courses for business intenders).

What are the best franchises in the current economic climate?

Established systems with a critical mass of profitable, satisfied franchisees will not only weather the current economic storm, they will come out the other side in top gear and quite possibly buy out or take market share from a competitor or two along the way. Furthermore, these systems will need to have dynamic and talented leadership teams, strong corporate governance, and enduring customer appeal.

Having said that, concepts such as “established”, “critical mass”, “satisfied”, “dynamic”, “talented”, “corporate governance”, and “enduring appeal” are subjectively assessed, and relative to the eye of the beholder. An evaluation of a system on these criteria might produce different outcomes for different people.

Cash businesses (or those with incredibly tight credit controls) combined with clever marketing and exceptional levels of customer service (and there are many examples of these in both service and retail franchise brands) that fit the above criteria will perform strongly in the next couple of years.

What about new franchises?

There is opportunity in adversity for any entrepreneur. New franchise concepts emerge in Australia at the rate of about 100 per year, however not all of these will be viable in the long run.

Businesses that help maintain the functionality and extend the life cycle of existing assets do well at times when people cannot afford to buy new assets. For example, home maintenance and renovation, vehicle rejuvenation and accessorisation etc, help extend the useful life of these assets when their owners can no longer afford to upgrade them for new homes or cars.

Concepts (mostly mobile services franchises) that trade time for money by providing services will still experience strong demand as their customers are likely to be working longer hours in jobs where they themselves will be expected to achieve more with less.

What should I be wary of?

The recently-unemployed, particularly those with sizeable payouts for years of accumulated service, holiday pay etc, are prey for unscrupulous operators. As the economic cycle continues to turn, the ranks of the unemployed looking to buy a job via franchising will increase considerably as corporate layoffs and downsizing becomes painfully common.

These people, most of whom will have never been in business for themselves before, may well make excellent franchisees. However their potential naïveté makes them particularly vulnerable to poorly-considered decisions, hastened by unnecessarily eager franchise salesmen.

Anecdotally, many new franchises based on flimsy concepts sprung up during the last recession and lured the recently-unemployed with the prospect of easy riches. Unfortunately, few of these franchisors and still fewer of their franchisees have survived today. The key lesson here is to undertake proper research. (See research hints above.)

It is also worth noting that although the last recession occurred before the franchising code of conduct was introduced (the laws that regulate the franchise sector), there is no amount of legislation that can adequately protect a franchisee from a hasty, unresearched and ill-considered investment decision.

Distributorships and licensed business opportunities are often advertised alongside franchises, but look, sound and feel the same as a franchise. No matter what they call themselves, if in the eyes of the law they are a franchise, then buyers are entitled to receive a disclosure document (containing a variety of important information as well as the lists of current and former franchisees critical for proper research), as well as a mandatory cooling-off period, recourse to mediation in the event of a dispute and so on.

The best way to distinguish between a legitimate franchise offering and something that is designed to separate an aspiring business owner from their cash is to educate yourself, and do your research. Only then can you make a balanced decision that takes into account your long-term interests.

Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout Australia. He has been awarded for his franchise achievements, and publishes Franchise News & Events, Australia’s only fortnightly electronic news bulletin on franchising issues. In his spare time, Jason is a passionate collector of military antiques.

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