Introduction to Franchising & Franchise Due Diligencebbj.org › ... › 01 ›...

Introduction to Franchising &

Franchise Due Diligence

www.capstonefran.com • (314) 498-5953

What is Franchising?

Advantages & Disadvantages of Franchise

Ownership

Due Diligence:

Self-Evaluation

Franchise Evaluation

Our Agenda


What is Franchising?

The International Franchise Association

defines a franchising system as “[A]

continuing relationship in which the

franchisor provides a licensed privilege to

do business, plus assistance in organizing,

training, merchandising, and management

in return for consideration from the

franchisee.”


Product Distribution vs.

Business Format Franchising

Product distribution arrangements

Sell the products of the company

Use of trademark/logo

No business systems/processes

Examples: Auto dealerships and gasoline stations

Business format franchisors

Use of trademark/logo

Franchisor provides the franchisee with a method of operation, an

entire system for running the business.

May also contain elements of product distribution arrangements


Legal Definition

Three required components:

1. TRADEMARK: Franchisees distribute goods or services in

association with the franchisor’s trademark or trade name

2. FEES: The franchisee agrees to pay ongoing fees (royalties)

to the franchisor in exchange for ongoing support and the

right to use the system

3. CONTROL & ASSISTANCE: The franchisor exercises

“significant” control over, or provides significant assistance

in, the franchisee’s business operations


Franchisor/Franchisee

Relationship

FRANCHISOR FRANCHISEE

Owns Trademark or Trade Name Uses Trademark or Trade Name

Tests and Develops

Business Operating Format

Acquires Rights to Use

Franchisor’s Operating Model

Provides Support & Training,

Advertising & Marketing Assistance,

Site Selection Assistance, and

Financing

Receives Franchisor’s Support and

enjoys the opportunity to Expand

and Grow a Business

Receives Fees Pays Fees


Industries Where

Franchises Operate

Food/Beverage Automotive Education Home

Improvement

Packaging &

Mailing

Senior Care

Cleaning

Services

Commercial

Cleaning

Employment &

Staffing

Hairstyling Pet Care Healthcare

Marketing Management

ConsultingInformation

Technology

Health &

Beauty

Printing &

Copying

Signs &

Graphics


Single Unit Franchisee

A franchisee has the right to operate one franchise unit

Most franchisees enter the world of franchising by owning one unit

Territory:

The franchisee may have a protected or exclusive territory within which to

operate

Level of participation:

The franchisee is usually very involved with almost all operations


Multi-Unit Franchisee Franchisee purchases rights to open a multiple franchises in a given area

Production schedule that outlines expectations of when units/store will open

Territory:

Franchisee maintains territory rights provided that opening schedule is kept


Franchisee is very involved in the beginning stages of the first location ensure

success

Once several locations are open, the franchisee commonly transitions to

general management role and hires managers for individual locations


Area DeveloperTerritory:

Large metropolitan area, an entire state, several states or a country

Area remains exclusive as long as the master franchisee meets the

development schedule of franchises in the territory


Operates at least one unit with manager in place

Sells additional units in territory to other franchisees

May be involved in training and support of franchisees in territory

Functions as business consultant or coach to their franchisees

Shares in franchise fee and royalty payments made to franchisor


Advantages of Franchising

Proven System of Operation

Brand Recognition

Economies of Scale: Volume Purchasing Power & Collaborative Marketing

Ongoing Research & Development

Franchisor Support

Pre-Opening Support: Site selection, design & construction, financing, training, grand opening program

Ongoing Support: Peer community, marketing plans, operational troubleshooting, business coaching


Franchisee Must Conform to Franchisor’s Operating Model

Franchise Fee and On-going Royalties

Underfinanced, inexperienced, or weak franchisor

Franchisee and franchisor success are interdependent

Duration of the Franchise Agreement


Disadvantages of Franchising

Due Diligence: Self-Evaluation


Motives for Business Ownership


“If your goal is to replace the steady income

and daily routine of your current or last job,

trade this book in immediately for one on

improving your resume.”

Bennett, J., & Babcock, C. (2008). Franchise times guide to selecting, buying & owning a franchise. New York: Sterling Pub.

Motives for Business Ownership


Personal Satisfaction – I feel stuck, and I am looking for

a new career path

Autonomy – I want the freedom to make my own decisions

and set my own targets

Challenge – I want an adventure, something that will

challenge me to get outside my comfort zone

Role Model – I want to create something of my own and be

an example to others in doing so

Legacy – I want to build a business that I can pass to

children/grandchildren

Are You Prepared to

Own a Business?


I am mentally and physically prepared to meet the demands

of running my own business

I have a system of family and friends who are supportive of

my decision to become a become a business owner

I have the financial resources to start my business and

support myself during the often lean start-up phase

I am comfortable promoting myself and my business in the

community

Is Franchising Right for You?

“The franchisee’s job is to serve their customers to the bestof their ability consistent with the original intent of

the franchisor. The franchisor’s job is to maintain the

integrity of the brand and create processes, systems,

structures, products, marketing and other resources that

produce results far superior to any that one or two

franchisees could produce for themselves.”


Mathews, J., DeBolt, D., & Percival, D. (2006). Street smart franchising. Irvine, CA: Entrepreneur Press.

Is Franchising Right for You?

“Franchisees execute the system the franchisor provides. Great franchisees take that system and improve it: by

providing better than minimum customer service required; by

hiring quality people and providing them with training; and by

creating an atmosphere in their business that is palpably

better than expected by their staff, their customers, their

vendors, and the franchisor.”


Thomas, D., & Seid, M. (2000). Franchising for dummies. Foster City, CA: IDG Books Worldwide.

Are You Prepared to

Be a Franchisee?


I am eager to learn new skills and new ways of doing things

I am willing to accept guidance on how to operate my

business from the franchisor

I know how to execute a plan, even when I may disagree with

some aspects of the plan

I can let it go if the franchisor decides not to take my

suggestions on system improvements

What’s Your Type?


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Due Diligence:

Franchise Evaluation


Introductory

Webinar(s)

Franchise

Disclosure

Document

Franchisee

Validation

Discovery

Day

Additional Steps May Include Reviews

of Marketing Strategy, Training

Schedule or Funding Options

Franchise Discovery Process

Speaking with the Franchisor


Successful Franchising = Strong Systems and Processes

Is the Franchise Discovery process well-organized

with a clear path for education and evaluation?

Are you being sold or recruited?

Why do you think I would be a good fit for your system?

Why do you think I would be a successful franchisee?

The franchisor creates and refines the systems

What trends are likely to impact the business in the coming years?


Successful franchising requires strong support

As a franchisee, who would help me with marketing? How about HR

issues? Operational support?

Strong franchisors see their franchisees as partners

What will I hear when I talk to other franchisees about their experience in

the system? What will they say are the pros & cons of the system?

The best franchisors have industry & franchise experience

Tell me about the organization’s leaders and their backgrounds.

Speaking with the Franchisor



Introductory

Webinar(s)

Franchise

Disclosure

Document

Franchisee

Validation

Discovery

Day




Franchise Disclosure Document

16 C.F.R. Part 436: The Franchise Rule

All franchisors must produce a Franchise DisclosureDocument (FDD) for prospective franchisees

The franchisor may not enter into an agreement with aprospective franchisee until the candidate has had theFDD in his/her possession for at least 14 days


1. The Franchisor and Any Parents, Predecessors and Affiliates

2. Business Experience

3. Litigation

4. Bankruptcy

5. Initial Fees

6. Other Fees

7. Estimated Initial Investment

8. Restrictions on Sources of Products and Services

9. Franchisee’s Obligations

10. Financing

11. Franchisor’s Assistance, Advertising, Computer Systems, and Training

12. Territory

13. Trademarks

14. Patents, Copyrights and Proprietary Information

15. Obligation to Participate in the Actual Operation of the Franchised Business


FDD Table of Contents

FDD Table of Contents

16. Restrictions on What the Franchisee May Sell

17. Renewal, Termination, Transfer and Dispute Resolution

18. Public Figures

19. Financial Performance Representations

20. Outlets and Franchisee Information

21. Financial Statements (Most commonly referenced as an exhibit attachment)

22. Contracts (Most commonly referenced as an exhibit attachment)

23. Receipt

Exhibits

Audited Financial Statements

Franchise Agreement

Table of Contents for Manuals

List of Franchisees


Franchise Disclosure DocumentITEM 2BUSINESS EXPERIENCE OF FRANCHISE EXECUTIVES

Look for evidence of solid franchise and industry-specific experience

ITEM 3LITIGATION

Contains all litigation involving company and it’s officers Will reveal legal disputes between franchisor and franchisees

ITEMS 5, 6 and 7INITIAL FEES, OTHER FEES AND INITIAL INVESTMENT

Franchise fees, technology fees, royalties, marketing fund contributions

Estimated start-up costs

Be cautious around estimated requirements of working capital



ITEM 12TERRITORY

Exclusive territory Exclusive marketing area Non-exclusive territory

ITEM 19FINANCIAL PERFORMANCE REPRESENTATIONS

Not mandatory – 60% of franchisors now make some earnings claim Latitude in data source – read the footnotes to understand the reporting Validate information in conversations with franchisees



ITEM 20OUTLETS AND FRANCHISE INFORMATION

Shows all outlets opened, closed and transferred in most recent 3 years References full list of current franchisees in attachment to FDD

ITEM 21FINANCIAL STATEMENTS

Three years of audited financial statementsA financially weak franchisor is unlikely to offer needed supportAsk an accountant for assistance



Introductory

Webinar(s)

Franchise

Disclosure

Document

Franchisee

Validation

Discovery

Day






Everybody makes mistakes

What is the biggest mistake you made in your 1st year of operation? What

do you wish you knew before you started?

Make sure you have a good sense of the day-to-day

How would you describe the primary responsibilities of the owner of this

business?

Speaking with Franchisees

Successful franchising requires strong support

How would you rate initial training and ongoing support? What do they do

well and what could be improved?


Don’t forget the bottom line!

How is your business doing in relation to your original business plan?

When did you project you would breakeven? When did you actually

breakeven? Ask for specific numbers related to gross revenues, COGS,

labor, rent and other overhead.

Proper capitalization is key to success

How did your initial investment compare with the initial investment

projections as outlined in Item 7 of the FDD?

Strong franchisors help you develop your accounts

Are you getting good value for your marketing expenditures? How does

the franchisor help in your lead generation efforts?

Speaking with Franchisees


Introductory

Webinar(s)

Franchise

Disclosure

Document

Franchisee

ValidationDiscovery

Day






Meet the Executive Team who would be your partners in

business

Meet the Support Staff that would help you launch your

business and support you throughout the life of your

business

Ask any outstanding questions you may have

Gather the final pieces of data that will help you make your

decision

Meet The Team

Recommended Reading


Q&A


Thank you foryour time!

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