Franchising is not for everyone. It calls for long hours and lots of patience. More often than not, prospective franchisees go down the wrong path because they did not do their due diligence in advance of acquiring the franchise. Having counseled many franchisees in their quest to become part of a particular franchise system, I have always stuck by the mantra that there is no such thing as doing enough due diligence or background checking, particularly in situations involving a new franchise system. Having said this, two new clients came into my office a few weeks ago wanting to join a new franchise system. They had the science and technical background that would appear to coordinate well with this franchise system. I was emphatic in advising them that getting a successful franchise off and running, however, requires a lot more than having the requisite interest in the franchise itself. As it turned out, and after going through the Katz Law Group comprehensive franchise checklist, my clients decided not to join that particular franchise system after considering some of the following points:
1. Make sure you know how much it's going to cost you. You must consider all fees associated with the start of your franchise system. How much is going to cost you to get all the necessary permits, licenses, and approvals to start your operation? What is the specific franchise fee for entering the system? You will also need to purchase the requisite amount of insurance as otherwise required under the applicable franchise agreement. In all likelihood, you will have to lease space in order to conform to the specific requirements of store build-out, display, and appearance required by the franchisor.
Remember, very, very few franchise systems allow the franchisee to operate out of their personal residence. In addition, there will be legal, accounting, and consulting fees that you will have to pay. In the case of accounting and consulting fees, I would urge each of you to make sure that you have an accountant and/or business advisor to assist in explaining in detail to you the specific costs and fees involved in this project both in terms of the fees required as part of joining the franchise as well as all outside fees. They can review the financial information provided by the franchisor in the form of financial statements, auditor's report, balance sheet, and all other documents which reveal the financial stability of the operation. In most cases, your consultant will want to conduct an audit of the franchisor's books and records. You cannot rely solely on the representations of financial condition presented in the franchise documents.
2. It will be hard to establish the financial viability of the organization if you are entering a system without many franchisees or without a proven track record. Of course, if you get into a new system early the franchise fee is less money and the availability of more territories exists. At the same time, however, as in this recent matter in which I was involved, my client was going to be the first franchisee in the system. As a result, it became more incumbent upon my clients to find out as much as possible about the background of the founder. All founders like to champion their successes. Few emphasize failure. As counsel for any prospective franchisee, I am as interested in seeing whether the founder has had any insolvencies, bankruptcies, assignments for the benefits of creditors, and/or judgments as in viewing any of his successes. Make sure that you get access to as many public records on the franchisor as possible. Make sure that you ask the franchisor for as much information as you need in order to establish a certain comfort level.
3. You should always remember and the franchise circular makes it very clear that the franchisor is not providing any guarantees of success with the opening of any franchise.
4. In opening any franchise, it is imperative that you create a separate legal structure to run the franchise. This will require a detailed review of the current structure, of course, and a discussion of a few key ownership questions. The question of whether to incorporate a business under an LLC or S Corp will be something to discuss with your legal and financial advisor. Under no circumstances, however, should you consider opening the business as an individual.
5. One of the key areas for any franchisees is to do an inquiry of the professional and financial track record of the franchisor. Do the principals of the franchisor have sufficient industry experience? Does the franchisor thoroughly screen its franchisees? If there are other franchisees, it is incumbent that they are contacted to discuss these issues. As a rule, talking to present franchisees is an excellent way to get insight into the operation of the system.
6. A franchisee should always consider the larger economic picture in deciding whether the industry selected is a good one for such an investment. Is there a demand for the product or service both now and in the future? How will the larger economy affect the product or service that I want to franchise?
Engaging in any franchise relationship is complicated, time-consuming, and expensive. For these reasons and more it is incumbent upon a prospective franchisee to do its homework as to any franchise system. At the Katz Law Group, we have counseled many businesses in this area as to whether joining a franchise system makes sense for them and, in some cases, advising the client not to join the system for a host of different reasons. We have developed a precise and comprehensive franchisee checklist that covers everything you need to consider. If you need legal assistance opening up a franchise, please call us at 508-480-8202 to see how we can help you.
