A franchise relationship is a partnership between two parties. The primary party is the Franchiser. This entity owns a master group of similar business selling/providing the same product or service. The Franchiser sells a ‘Right’ to his name and his conditions in exchange for a royalty fee. The second party is the Franchisee. This business entity desires to use the name and the conditions set by the Franchiser to gain access to or expand his business customer base. In exchange he is willing to pay a royalty fee to the Franchiser.
In general the Franchiser is the controlling party in most relationships. It makes sense because they want and need to control the overall business. So right from the get go; IF YOU ARE THE FRANCHISEE, I WANT TO EMPHASIZE CAUTION. In general most franchise relationships are not good or fruitful relationships. So you need to ask yourself if you truly want a relationship that will most likely cost you more financial resources than you anticipate and/or you will get the feeling that you do nothing more than work for the Franchiser. So I write this series strictly to help the Franchisee. In my opinion, the Franchiser has the financial resources to take care of himself. You don’t. I’m here to enlighten you and to help you get a good agreement between you and the Franchiser.
So how does this relationship work? What does a potential Franchisee do to protect himself? What are other options?
The most important aspect of all of this is to make sure you do what you want to do in life. It is so important to be happy with what you do for a living. Don’t purchase a franchise because of the potential financial wealth it can bring, do this for your own happiness. If the franchise fits your long term desire, then it is possible you could have a match. I will tell you that it is unlikely, but there is a chance you could have a good relationship.
Once you have decided what you want to do, begin your research. Are there franchises in this industry? There probably is, so go ahead and get your information. Now begins the relationship issue. You need to remember that if it isn’t in writing, then there is no requirement for the Franchiser to comply. Many Franchisers make promises that they first off can’t keep and secondly are unrealistic in nature. So my suggestion is to get the Uniform Offering Franchise Circular from them. Many of the franchise organizations post their circular online. If they don’t, then this would indicate a warning.
Read the circular, take a day off, and read it again. Then begin to ask questions about each section of the circular. Now this is where I have some stories or caution I would like to express.
One of the areas is the capitalization issue. You see, they require you to have a certain level of capital to invest in this endeavor. They will charge for training, setup, materials, and the list goes on and on. Remember, they make money on these items too. Furthermore, there are hidden costs that many Franchisers don’t or won’t tell you up front. As an example, they may have a certain image via building modifications or signage or documentation, and once you sign the agreement, they could change this image and you are required to conform. Think about this for one minute, they are telling you how to present their product. If there’s a change in their marketing or product image, they will require you to modify your facilities as a function of compliance with the agreement. This could run into the tens of thousands of dollars. It is easy for them to spend your money! Failure to comply is met with penalties or some other fee. Worse yet, you will have very little chance of denying them this in a court of law due to your signature.
Other examples include franchisee group issues. Marketing is a significant financial example. Most franchise agreements require you to pay a percentage of your revenue to the marketing group to spend on mass and regional marketing. So for some Franchisees, this provides little to no benefit. All you are doing is spending money to help other Franchisees make money. This occurs more frequently than what many folks will confirm. In addition, you have little or no control over the marketing medium. I had a client that had to pay 2% of their revenue to the Franchiser’s auxiliary company that ran the marketing program. My client is on the west coast, and the program had greater benefit for the east coast. In addition, the marketing company was owned by the same man that owned the Franchise. He was in effect double dipping by getting salaries from both companies. To make matters worse, he had investments in the printing company that provided the marketing materials to the Franchisees. So to me, the man was triple dipping! Furthermore, if he was having issues with a particular Franchisee, he made sure the marketing dollars benefited the Franchisees that he had good, stable relationships. Most of it was marginal, but it too much of a coincidence to me.
At the annual franchise meeting where the Franchisees meet and discuss issues, voting isn’t done based on dollars of royalties, but on a one for one voting. So you could be contributing more to the cause but have same equal vote as the guy that is a poor performer and barely meets his requirements to participate. In effect, the poorer performer can control the outcome of the voting.
All of this is laid out in the Circular. This document is the controlling tool in how the relationship is going to work. One of the clauses will state that the adjudication process will happen in their state and not in yours. So if you go to court, you go to court there and not in your local circuit or federal court. Now you have to find an attorney there to help you. Do you think this is going to be cheap? Do you think you are going to win?
At the end of the day, this is a partnership relationship. To protect yourself; all the details should be in the agreement between the parties. You should get this agreement right away allowing you time to negotiate in a reasonable fashion over a period of several months. Please don’t think that you could get this done in two weeks or less. This is a long term commitment and you need time to fully understand the relationship, the terms and the cost to you.
The best protection is a good understanding of the agreement and evaluating the agreement from the worse case scenario. There are other options, you could purchase an existing operation, you could build your own operation although this may take more time, but it may be the best financial choice. There are still others. Over the next several articles I will offer advice on the types of questions to ask and what to look for in the terminology used in the agreement. I will finish with how to look at other options instead of a franchise. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my services as an accountant/consultant; click on ‘My Services‘ in the footer of this article.