With many long-time franchisees nearing retirement age and prices down due to the economy, now is a great time to buy a franchise.
“It’s a golden opportunity to take advantage and buy a proven concept at half the cost that you could have bought it a couple yeas ago, and even for less than you could build it today,” says Brad Saltz, CPA, the director of restaurant services at SS&G Financial Services, Inc.
When buying a franchise, Saltz says that there are many things you need to consider, from finding something you like doing to lining up the financing to do it.
Smart Business spoke with Saltz about the steps you need to take before jumping into the franchise business.
How important is it to find a franchise opportunity that you’ll enjoy doing?
It is very important, as owning your own business is unlike any other type of occupation. The number of hours and personal commitment are typically much more than people realize.
There are two basic ways to run a franchise — buying yourself a job or hiring someone else to run it for you. When you are buying yourself a job, it is beyond a full-time commitment, which many people do not fully understand. The second situation, when a franchisee expects to buy a business, hire someone and head to Mexico for vacation, is often misjudged. Anything that can go wrong with a franchise may go wrong, and it requires a lot of hands-on participation in every aspect of the business.
Potential franchisees tend to underestimate the time requirement and overestimate their ability to grow. They often have very unrealistic growth expectations — ‘I’ll open one store every three months’ — which is extremely difficult. Slow and steady wins the race in terms of franchisees.
How can a potential franchisee learn about opportunities before making a decision?
Everyone who is interested in investing in a franchise should start with the franchise disclosure document (FDD). The Federal Trade Commission requires that all franchisors provide the FDD to prospective franchisees immediately upon introduction. Every prospective franchisee should read the FDD in its entirety, as well as go over the document with their advisers who are experienced in the franchising industry.
The FDD contains hundreds of pages with information you need to know. Included in the document are a full description of the concept, all the locations, the age of locations, the history of new stores, closed stores, transferred stores, how many stores are owned by the franchisor and franchisees, and where they are located. It also has a description of what the requirements will be, the cost to open, what the royalty will be, required advertising, whether you are required to buy product from the franchisor, the history of the franchisor and the key individuals, and whether they have ever been in bankruptcy, among other things.
How important is it to involve advisers?
It is absolutely critical. There are a lot of quality attorneys and accountants, but you need someone who really understands franchising to help you gain an in-depth understanding on a particular franchise, help you put together a realistic game plan and tell you how available financing will be and what type of capital you really need. Entrepreneurs often have optimistic expectations, which are not usually realistic. They frequently undercapitalize and expect to grow much faster than they are really capable of growing.
Once a franchisee decides to move forward, how does he or she secure financing?
Financing is really tough these days, but credit is available if you are realistic and can put a sufficient amount of equity into the business. If you buy a franchise with a proven track record, the banks are usually more comfortable lending money.
Right now, the equity that a bank will require — and really, common sense should always have dictated — should be in the neighborhood of 30 to 50 percent of the cost of the business. You should also count on another $50,000 of reserve capital. In the past, the credit community was willing to lend 80, 90, even 100 percent of the cost, so people entered into situations with very little equity in the business, which meant there was no cushion. That is no longer the case.
How can franchisees increase their chances of securing financing and succeeding at the business?
Go with the tried-and-true franchises, the ones that have been around many years. They are very stable, and they tend to provide good returns year in and year out. Most entrepreneurs tend to gravitate toward the newer ideas, but the failure rates with a new idea are much higher.
The trick is to not buy a franchise at the front or back end of its business cycle. Look at franchises that have enough stores to show that the concept is successful in multiple markets across the country. They are proven, have established sales, and are much easier to finance. And for most of the large franchise groups, even in recession, sales have held up very well, which makes franchising a vastly overlooked opportunity right now.
