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Tuesday, February 24, 2015

Do Your Homework before Buying a Franchise

While buying a franchise may look like an easy way to become an entrepreneur, it’s not risk free. Before jumping in, make sure you know the costs, the company’s rules and restrictions, and how much you can afford to spend—or lose.

When the HMO where Steve Garrett worked as a pharmacist wanted to do some cost cutting, it decided to outsource its pharmacy department. At 50 years old, Garrett found himself looking for a new job and competing with younger people who had more education than he had. At the same time, he had just gone through a difficult period of procuring hospice care for his father and finding assisted living for his mother. He thought about going back to school and getting more credentials, but, at 50, “Do I want to spend time and money to do that?” the Seattle resident asked himself.

Garrett’s situation mirrors that of many older adults who, for a number of reasons, find themselves out of jobs and in a labor market that’s not especially welcoming to aging workers, and questioning what they want to do next. For Garrett, a Certified Senior Advisor®, the solution was to buy a franchise that could address the problem he had encountered with his parents—how to assist those looking for senior care—while utilizing the clinical training and relationship-building skills he learned as a pharmacist. Plus, he would be able to work from his home, and avoid the expense of renting an office.

When you (the franchisee) buy a franchise, you are becoming part of a business (the franchisor) that has proven successful (Subway, for example). For this advantage, you’ll pay an initial fee, an ongoing franchise royalty fee from sales and possibly other fees, such as rentals and equipment. For comparison, buying a Denny's franchise will cost you $2 million, while Subway's franchise fee is $15,000 and Mr. Rooter, the plumbing service, costs $29,500.

Running a franchise means you create your own job and become your own boss rather than waiting and hoping for someone to hire you. If you can match up with the right franchise, you can use some or all of the skills you have accumulated in your work history, such as managing people or being an entrepreneur—and, for some, like Garrett, even combine your job with your passion, such as helping seniors.

But experts caution that buying into a franchise has many downsides as well, and that the buyer should beware. In most cases, owning a franchise is less intimidating than starting your own business, but there’s still a risk. Franchises range from well-known and established businesses such as McDonald’s and SuperCuts to smaller ones like the one Garrett bought—CarePatrol, which works to help clients find safe and quality options for senior living. Almost any business you can imagine has franchises: for example, fitness, pet care, auto repair, dry cleaning and personal services.

The Federal Trade Commission offers a consumer guide for those contemplating buying a franchise. Here are some highlights:

Help with Starting a Business
One of the advantages of buying a franchise is using the established company’s format or system and utilizing the name recognition that comes with the company name, rather than having to start from scratch to establish a reputation. In addition, many franchisors offer some kind of assistance, such as help in finding a location for your outlet, initial training, an operating manual and advice on management, marketing or personnel.

For example, if Garrett had started his own business, he would have had to build his own website, but CarePatrol already has a Web presence and provided him with Internet referrals and training and support staff to help him set up the business. Instead of having to do his own research on different assisted-living facilities, CarePatrol already vetted various ones.

Your Costs
Besides the initial franchise fee, which will range from several thousand dollars to several hundred thousand dollars (and may be nonrefundable), you may incur significant costs to rent, build and equip an outlet and to buy initial inventory. You may also have to pay for operating licenses and insurance, a “grand opening” fee to the franchisor to promote your new outlet and contribute to an advertising fund.

The monthly royalty fees can be based on a percentage of income, a fixed amount or combination of both. Garrett’s fixed amount includes a percentage fee of the placement income, if his placement (or lead) comes from the franchisor. For example, a franchisor lead could be an online search that directs clients to CarePatrol’s corporate call center, which does the initial vetting of the clients. If potential clients qualify, the call center then directs them to Garrett.

Franchisor’s Restrictions
For many entrepreneurs, one of the disadvantages of running a franchise is that the franchisor controls many aspects of the business and does not allow the franchisee much freedom in coming up with new and different ideas.

To ensure uniformity, franchisors can, among other rules, pre-approve sites for outlets, impose design or appearance standards to ensure a uniform look among the various outlets, restrict the goods and services you sell, dictate hours, demand that you use certain accounting or bookkeeping procedures and pre-approve signs, employee uniforms and advertisements. A franchisor may limit your business to a specific territory, so that you do not compete with other franchisees for the same customers, which could hurt your ability to expand or move to a more profitable location. When you end your relationship with the franchise, noncompete clauses prevent you from using the knowledge you’ve learned to open a similar business.

Your Financial Situation
Because you might borrow the initial investment money or withdraw it from a retirement fund, you risk losing money and/or endangering your retirement. For this reason, experts say you need to closely examine your financial abilities to pay the costs associated with the franchise, as well as your ability to endure a period of time where you are establishing your business. Ask yourself:
  • How much money do I have to invest?
  • How much money can I afford to lose?
  • Am I purchasing the franchise alone or with partners?
  • Do I need financing? Where’s it coming from?
  • What’s my credit rating? Credit score?
  • Do I have savings or additional income to live on while I start my business? 
To avoid borrowing money and going into debt, Garrett used part of his 401K retirement funds to structure a C corporation, although the downside is that he is risking his retirement funds. He was fortunate in that his partner’s income helped give him time to build up the business.

Starting your business may take several months. Estimate your operating expenses for the first year and your personal living expenses for up to two years. Compare your estimates with what other franchisees have paid and with competing franchise systems. An accountant can help you evaluate this information.

Do Your Research
One of Garrett’s strongest pieces of advice to others who want to buy a franchise is to “do as much research as possible and then do more.” He started out by using online search engines, which break down the franchise search into areas of interest (e.g., health care and food service), price (e.g., $10,000 to $50,000 fees) and location. From there, he did his own research on different franchises and worked with a broker, because he wanted to vet the franchise. Because brokers are paid by the franchisor, Garrett said he took the broker’s advice with a grain of salt. He also reached out to other franchise owners for lessons learned, including one in his area who had been established for three to four years.

Franchise brokers, who also refer to themselves as business coaches, advisors, referral sources or sales consultants, typically direct you to opportunities that match your interests and resources. A broker also may help you complete applications and the paperwork to consummate the sale.

Although couched in legal language, a company’s Uniform Franchise Offering Circular offers valuable information. Request one from potential franchises of interest. The circular contains vital details about the franchise's legal, financial and personnel history, including annual revenues per location, expectations for franchisees and names of former franchisees.

The Internet is another font of information, including “The Best and Worst Franchises to Own,” Inc. Check out the sources listed at the end of this article.

Government resources include your state office that regulates franchising (it may be the Office of the Attorney General); the Federal Trade Commission, which enforces the Franchise Rule and publishes a number of business guides; and the Small Business Administration (SBA), which provides more than 30 blog articles covering franchise tips and best practices.

Garrett got help from the SBA and SCORE, a nonprofit organization partnered with the SBA, which provides free business mentoring services.

For Garrett, the experience of owning a franchise has been both good and bad. “I feel less anxious than a year ago when I was disappointed in the job prospects in pharmacy,” he says, and his new career has given him more flexibility in caring for his and his partner’s 12-year-old daughter. However, “at this point, I was hoping to have more placements; that part is disappointing. The industry in the Seattle area is competitive.” His new business involves building relationships—with health-care providers, doctor’s offices, skilled nursing offices, etc.—and that takes time.

“When you’re younger, it was all about keeping up with the Joneses,” Garrett says, “but as you get older, instead you look at what makes you happy and fulfilled.” After decades spent getting his degree and working in his profession, he asks, “Where did it get me?” At least in his second career, he notes, “I can do something I’m passionate about.”

“Want to Buy a Franchise? Ten Reasons Not to Do It,” NOLO Law for All
“How to Buy a Franchise,” Wall Street Journal
“Franchise Businesses,” Small Business Administration
“Reasons You Should Buy a Franchise (and Reasons You Shouldn't),” Feb. 27, 2013, U.S. News & World Report

Do Your Homework before Buying a Franchise was featured in the January 2015 Senior Spirit newsletter. 

Blog posting provided by Society of Certified Senior Advisors