Franchise Articles II

BUYING A FRANCHISE – EVALUATING FRANCHISE DISCLOSURE DOCUMENTS AND FRANCHISE INVESTMENTS – TIPS AND AN FDD CHECKLIST FROM A FRANCHISE ATTORNEY, FRANCHISE EXPERT AND FORMER FRANCHISE OWNER

© 1990-2010, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

Buying a franchise is one way to own a business. Millions of people dream about the benefits of owning their own business. The independence of being your own boss. The security that no one can fire you. Enjoying a healthy income – and for the most successful – the accumulation of real wealth and prosperity to retire on. Unfortunately, the cards are increasingly stacked against a new business making it big – or making it at all. An endless stream of problems and challenges makes competition from large, sophisticated chains just too intense. Many new start-ups end as failures.

Franchise Opportunities: American Dream … Or Nightmare?
While franchise business opportunities represent a chance to get rich, they are also a chance to get stung – and stung badly. An alarming number of franchised operators make less than the minimum wage, working seven days, sixty to eighty hours a week, pursuing an expensive and elusive American Dream that turns into a nightmare. Since the ongoing franchise royalty payment comes right off the top, as a percentage of gross sales or a fixed minimum amount, the franchise company gets an assured revenue stream, even if its franchised units are operating unprofitably and are sold over and over again to new, unsuspecting buyers. The internet is filled with comments of the many people who lost $250,000 and more on concepts like eBay Drop off stores (iSold It), 30 Minute Fitness concepts, etc. Yet many of these companies continue to sell and resell franchises over and over again. How do they accomplish that? Because there are enough people who think they can “believe” their way to success, even with a concept or business that’s not working in the marketplace. Many second-hand, franchise resales fall into this category. As discussed below, in many cases franchise investment decisions are incredibly based on emotionalism, not on business logic or even common sense.

Ownership And Being Your Own Boss?
Pride of ownership and being your own boss are highly touted phrases by Franchise Coaches (Franchise Brokers) and in franchise recruitment ads. But these are more fantasy than reality. Although you get all the financial exposure, headaches and stress of business ownership, what do you really own? A franchise owner is merely licensing a brand name (trademark or service mark) for a limited period of time from a company that dictates every detail of business operations. So the real boss isn’t you, but the company that sells you their franchise rights . . . and sea of franchise obligations.

Equity Buildup?
But at least you’re building up equity, the ownership value of the business as a going concern beyond your investment of money, to compensate for all those years of hard work and long hours – right? Wrong – at least in the unique world of franchising. The franchise company reserves rights in the contract to acquire your entire business at below wholesale prices if their operational dictates are not followed precisely and when the contract ends. These acquisition rights provide for predetermined, asset-based valuations, like book or liquidation value. The valuation methods used provide bare minimum compensation (the used value of some file cabinets,fax machines, office furniture, etc.) and are not generally used to determine the selling price of any business.

Absolutely no compensation is paid for established goodwill, the value of a business that is generating $X in profit or cash flow every month after years of effort, investment and expense – thus eliminating the most valuable ownership asset. The franchise company picks up the entire business for pennies on the dollar, and can either operate it or sell it off again as a turnkey franchise with a goodwill (or bad will) factor. Of course, before the contract ends you may be able to sell your franchise to a third party for a sales price that includes an earnings-based valuation. But that’s possible only if:

(a) you can find a buyer who is willing to live within the complexities of a franchise relationship, and

(b) you happen to own a franchise that’s showing healthy profits.

What follows is a bottom-line franchise and FDD checklist and tips compiled by franchise attorney and franchise expert, Mr. Franchise, based on reviewing over 500 franchise disclosure documents and three decades of experience in the franchise industry – including ownership of a very successful franchise. These factors to consider in making a franchise investment will help you eliminate 95% of the companies you are considering. Then, you can concentrate your efforts on the 5% “cream” of the crop” companies that may deserve consideration.

This franchise FDD checklist assumes you’re suitable for and willing to live within the confines of a franchise relationship. It also assumes the franchise company:

(1) has itself successfully operated the concept being franchised for a sufficient period of time, and hopefully at multiple locations;

(2) is not plagued by franchise litigation and franchise lawsuits from disgruntled franchise owners;

(3) does not have unusually high franchise attrition rates (owners who have “left the system”); and

(4) has a balanced, fair franchise contract free from “boilerplate that bites”- otherwise known as fine print that’s not fine at all.

Let’s consider the franchise checklist and factors to consider before any leap into franchising.

INDUSTRY TREND

Is the franchise in a cutting-edge industry that is doing well currently and is projected to do well in the future despite any economic slowdown, such as the current economic recession?

TOTAL INITIAL FRANCHISE INVESTMENT

Don’t expect a franchise that requires a five-figure franchise investment to produce or have a six-figure income. As with most things in life, you only get what you pay for. On the other hand, don’t ever assume a six-figure investment will produce or lead to a six-figure income level. Be realistic and ultra conservative. Is the total initial franchise investment range disclosed in the FDD (including working capital) $150,00 or less; and the maximum investment less than $250,000? You can find good companies in this investment range if you take your time and look around.

One franchise owner in a relatively low investment and low operating cost window cleaning franchise said his biggest surprise was how long it actually took his franchise to be profitable. Going in, he thought it would take 12 to 15 months. It ended up taking twice that time. Fortunately, he had enough reserve savings to make it there, but declined to say what his actual franchise profits or income level were once he reached “franchise profitability.” If you’re operating just above the break even point and making less than minimum wage, is that anyone’s definition of success?

REAL BUSINESS

Is this a legitimate retail business operation, as opposed to a “work out of your home” business? The vast majority of work out of your home concepts produce marginal income at best, and no income at worst.

NORMAL WORKING HOURS AND DAYS; SUFFICIENT FRANCHISE INCOME LEVEL

Will the nature of the business operation allow a normal five-day, forty-hour workweek? Life is too short for the seven-day, sixty to eighty hours a week, workaholic lifestyle that destroys health, family and pocketbook in many franchises, especially food franchises. Financially, we’ve calculated the true hourly rate for franchise owners who work these workaholic hours. Not surprisingly, many are making far less than the minimum wage. One couple who operated a $250,000 pizza franchise in an upscale shopping mall were shocked to discover financial reality. They were making fifty cents an hour, each. Hardly an income level to recoup or justify the $200,000 franchise investment. Many more fast-food franchise operators make even less, or operate at a loss until their funds, stocks, retirement savings, home equity, etc. are completely exhausted. Buying a franchise in a non-food industry doesn’t necessarily improve the franchise profit picture. In a 2006 article “Mail Boxes Etc. Owners Fighting UPS Conversion,” a Mail Boxes, Etc. franchise owner who operated his franchise since 1993 reported profits for a typical MBE store like his were $16,000 per year after paying all expenses, including royalty and advertising fees to the franchise company. That calculates out to about $8.33 per hour for a forty-hour work week, approximately the wage of an entry fast-food worker. And most MBE store operators put in a lot more than forty hours a week.

And just because you’re a business executive making a six-figure income now, don’t ever assume this income level will be duplicated in a franchise investment just because the company “approves” your application where you’ve listed your current income. One such executive, despite a plethora of negative feedback from current and past franchise owners who’d lost everything, marched forward with her franchise investment in a 30-minute fitness concept for sale as a second-hand, established franchise. Despite her six-figure income, she didn’t invest a dime in professional franchise evaluation advice and stated she was taking a leap of faith, hoping to build her wings on the way down. Hoping to build her wings on the way down? Sound’s (and is) crazy, but this happens all the time. Due to the ploys of the franchise salesperson, too many franchise investment decisions are based on emotionalism. Prior business skills, business sense (and even common sense) are short-circuited. Needless to say, if this business executive made a similar investment decision for her corporate employer paying the six-figure salary, she would be promptly fired.

MINIMUM NUMBER OF EMPLOYEES

Can you operate the business with six or less employees? Managing dozens (or in the case of some fast-food operations – hundreds) of minimum-wage teenagers who are constantly quitting or simply not showing up for work is a royal pain in the ….. Well, you know what I mean.

LEASING AND LOCATION

For almost any retail business, the triple net lease of the location is the biggest financial commitment, larger than the total franchise investment. Yet, the typical real estate lease and its ramifications are not required disclosure in any Franchise Disclosure Document (FDD). For example, an estimate that you’ll need 2,000 sq. feet of space with expected rental of $5 to $10 a foot per month is normally disclosed in the Franchise Disclosure Document’s Item 7 initial investment table as Leased Real Estate $10,000 to $20,000. A footnote to the investment table may say “assumes 2,000 sq. ft. at $5 to $10 a foot.”

But, that’s only the beginning of a much longer story. The lease is normally a five to ten year triple-net lease. So, the financial commitment made when the lease is signed is at least $600,000 (at $5 a foot for five years) to $2,400,000 (at $10 a foot for ten years). And this doesn’t include substantial, additional fees, like paying your share of all of the landlord’s yearly property taxes, insurance, common area operating expenses, etc. More than just a warm, fuzzy feeling that somehow everything will work out is necessary. At stake are hundreds of thousands (or even millions) of dollars in financial obligations at stake, personal guarantees and other risks.

Key questions to ask here:

(a) is the franchise you’re considering one that can be operated in a low rent commercial business zone? If at all possible, avoid franchises requiring the costly expenses and triple-net leases of a visible retail storefront and the extravagant rent associated with areas of high foot traffic, like shopping malls. You will sleep much better at night.

(b) What’s your total financial commitment under the lease?

(c) Do you have sufficient liquid assets (or a willing, sufficiently liquid third party guarantor) to meet the landlord’s lease qualification standards?

If you don’t, you might as well forget about investing in the franchise. Or even worse, getting involved in a questionable franchise and business model, then realizing you’ve made a big mistake – and discovering you can’t get out – that you’re on the hook personally for a $500,000-plus lease obligation.

A related real estate variant is securing a lease with a sufficient term (with renewal options) to recoup your investment and make a profit. In July, 2005, an attorney in her mid-forties purchased an existing Cold Stone Creamery ice cream franchise for $375,000 believing it to be a “once-in-a-lifetime opportunity.” Trading her legal briefcase for an ice cream scoop, she attended the company’s 11-day Ice Cream University and assumed operations of the ice cream store. Turned out it was an opportunity – but only to inherit a store with numerous problems. These problems included (but were not limited to) a lease that would expire the following summer and a landlord who’d previously announced the lease would not be renewed. Rather than pay the $100,000-plus in relocation costs, the attorney returned to the practice of law. But she’s still paying off $350,000 remaining on the loan taken out to buy the once-in-a-lifetime franchise opportunity that turned into a big ice cream headache.

Although there was a franchise lawsuit pending, it’s yet another case of “franchise fever” – this time attacking a professional no less. Who would ever commit to paying $375,000 for an existing retail franchise without checking out the l-e-a-s-e? Sound’s like another bad attorney joke, but I can guaranty she’s not laughing. Business fundamentals were ignored or forgotten in the rush to acquire the opportunity of a lifetime. And I’m willing to bet not a dollar was spent on competent, pre-investment franchise advice from a franchise attorney.

IMAGE AND LIFESTYLE

How does deep-frying food, scooping ice cream, cleaning restrooms and firing employees fit the image of what you want to do for a living? Investing in a franchise will be the most important financial and psychological decision you ever make. Many prospective franchise owners fail to realize they’ll be wearing virtually every hat at some point, from salesperson to bad-debt collector, from firing employees to bathroom janitor. The franchise owner is usually the first one to arrive in the morning – and the last one to turn out the lights late at night. And forget about former corporate perks like paid vacations, paid holidays and sick pay. In their place, substitute financial pressures, unexpected events and money draining out of your savings and retirement accounts. Is the typical working day and responsibilities of the franchise you are considering a fit with your personal image and desired lifestyle?

TRUE FRANCHISE VALUE

Buying a franchise from a “blue chip” franchise company that has spent decades and hundreds of millions on advertising to develop their brand can make a lot of sense. These companies have “true franchise value” that compensates for the long-term disadvantages of ongoing royalty and advertising fund payments. Often these additional payments required in franchise relationships translate to the difference between earning a profit and operating at a loss. In unknown franchise chains with little or no brand recognition, you the franchise buyer are building their brand from scratch, and are saddled with severe, long-term competitive disadvantages.

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FRANCHISE BROKERS WHO FIND YOUR PERFECT MATCH?

Does the franchise opportunity you are considering have its own in-house marketing department, or does it utilize outside franchise brokers? The use of franchise brokers is a definite red flag. First, it indicates the franchise company is not very serious about who it lets into the franchise network, or even worse, they’re desperate to sell franchises. Second, franchise brokers – who often call themselves Franchise Coaches – receive a substantial commission up to 50% or more of the franchise fee you’re paying the franchise company. Franchise Broker Realities: (1) Their service is definitely not “free” despite these and other similar misrepresentations. It’s really common sense – how could anyone offer a “free” service and survive in business? Unfortunately, the common sense part of the brain tends to short circuit when the franchise brainwashing process begins. The simple truth is if you buy one of the franchises they’re hawking, your money goes to the franchise company, then into the broker’s pocket. If anyone ever calculated how much time they spend to collect their $15,000 or $20,000 commission, it’s probably a lot more than a brain surgeon earns. (2) Franchise brokers definitely do NOT have your best interests in mind. They will do or say whatever they have to in order to close a deal and earn their commission.

Many franchise brokers claim they will help find a franchise opportunity that is the perfect match for you – a customized franchise opportunity so to speak. In the beginning it sounds good. There’s some personality testing and review of your personal finances. At the end of the day, it turns out they only represent (and steer you towards) a handful of small franchise companies you’ve never heard of before. A detailed analysis often reveals these highly touted franchise opportunities produce mediocre or even below minimum wage financial performance. Yet franchise brokers don’t mention this, and individuals continue to rely on their recommendations, believing the broker represents them. Nothing could be further from the truth.

Many franchise brokers, if they don’t use the Franchise Coach label, call themselves franchise consultants. A franchise consultant is usually an independent adviser who offers advice to others (usually franchise companies or firms that want to franchise their business) for a fee. This makes their advice more impartial in theory as long as they are not compensated by third parties. Because they are not legally required to disclose actual or potential conflicts of interest, it’s important ask questions. For example, if you’re using a franchise consultant or franchise coach who is recommending the “best franchises,” are they paid anything by the companies on their list? This could be a commission, kick-back or consulting fee. As mentioned, many franchise brokers call themselves “franchise consultants” or “franchise coaches” to hide their true identity. So, make sure if you’re dealing with a franchise consultant or franchise coach, he or she is not really just a franchise broker in disguise.

CLOSING REMARKS

Remember, you are the only guardian when it comes to your franchise investment. It’s definitely an environment where the phrase “Buyer Beware” applies. So, before you sign on the line and make what will undoubtedly be the most serious financial and emotional commitment of your life, get all the facts and figures.

One couple invested $2 million in a new franchise company. Incredibly, the couple had not spent a dime on legal or business advice before investing $2 million. The once friendly franchise company had transformed into a formidable foe, poised to take over their franchise. Sadly, this happens too frequently in franchise investments. Decisions are made on fuzzy feelings and emotionalism. In an effort to save a couple thousand dollars, franchise investors risk homes, retirement savings, everything they have. Then they scratch their heads in amazement later on after inevitable and often horrific problems develop, wondering how they could have been so nearsighted.

Franchise Exit Strategy Finally, and this applies to franchise investments as well as investing in any business venture, develop a plan to succeed but also plan a franchise exit strategy that minimizes financial risk in case things don’t work out. Both plans need to be developed before the investment is made and contracts are signed. Be sure your franchise strategy reflects this planning aspect. Don’t wait until problems develop to begin thinking about a franchise exit strategy, like “how can I cancel my franchise agreement or get out of my lease?” By then it’s usually too little, too late.

MR. FRANCHISE BUYS HIS FIRST FRANCHISE

© 2003 – 2012, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

For the last three decades, as a franchise attorney, author, instructor and recognized, testifying franchise expert, I’ve helped firms enter the franchise industry – each striving to become the next “McDonalds” of their respective industries. Along the way, I’ve been blessed to meet and work with an interesting group of entrepreneurial founders. From apparel to water treatment, the franchised concepts have been incredibly diverse. Some interested me to the point where I considered buying a franchise myself. In two or three cases, talks were initiated to discuss the possibility, but never materialized. I just couldn’t find the precise set of criteria to satisfy my exacting requirements. After all, I had advised hundreds of prospective franchise buyers, and developed sophisticated radar for detecting the good, the bad and the ugly in franchise investments.

In May of 2002, my life changed dramatically as I took the plunge and became a first-time, franchise owner. I’d just completed a franchise development project for a San Francisco Peninsula company poised to enter franchising. They operated a very successful home improvement business that specialized in a unique niche. Targeting homes constructed in the 1960’s to the 1980’s having old, flat, ugly interior doors, the company replaced all interior doors in a home with new, freshly-painted raised panel designer doors, lock sets and hinges. Their advertising mantra was “Replacing America’s 1.16 Billion Interior Doors.”

After interviewing a couple interested franchise candidates who didn’t sign up, the company became concerned about selling its first franchise. Selling the first one is usually the most challenging task facing any new franchise company. There are no other franchise owners a prospective buyer can talk to about financial performance, training provided, ongoing support and other critical franchise relationship issues. Because of this void, selling the first one is difficult. After I was repeatedly asked when they could expect to sell their first franchise, my hand finally jumped up and I volunteered for the assignment. Our franchise agreement was signed May 22, 2002.

Let’s consider the major assumptions and factors I evaluated in making my franchise investment decision, and see how things worked out.

INDUSTRY TREND

As stated in the previous franchise article, a major issue is finding a franchise in a cutting-edge industry that is doing well currently and is projected to do well in the future despite any economic slowdown. From my experience in evaluating many hundreds of franchises, I observed the home-improvement industry was a stable segment at the time. Owners are always looking for ways to improve the appearance and value of their home.

Unlike other home improvement companies that concentrate on a single, high-ticket improvement, like a kitchen remodel, for example, that can cost $50,000 and more, the appeal for replacing interior doors was strong. For a couple thousand dollars ($2,000 to $5,000 on average), a homeowner can give, not just one room, but every room in their entire home a major face lift by replacing what we called their “old, flat, ugly doors” with new raised panel, designer doors. In the aftermath of the 9-11 attacks, and the country’s high security anxiety, I felt more people than ever would be nesting at home. A home typically represents the most valuable asset in a family’s portfolio. If the homeowner can be educated and motivated to improve the appearance and value of this asset, by making a reasonable investment, sales are easy.

Major home improvement chains, like Home Depot, realized this and were aggressively promoting interior door replacement. However, they were not organized to meet the needs of the target market in a cost-effective manner. I welcomed customers who asked “why shouldn’t we buy Home Depot’s $39 door instead of your $98 door?” The franchise company had discovered and perfected the “do-it-right” approach for this market, and loved competitive bids from the Home Depot and other large home improvement chains, as well as other licensed contractors and door companies.

While the Home Depot door was priced at $39, there was only one style available and it did not include painting or installation. Two different Home Depot contractors had to be involved, each charging hundreds of dollars each per door. Their painting was done at the customer’s home in the front yard or back yard. The end result was not only costly, but very poor quality. In comparison, our special “$98 per door, installed (includes disposal of your old door)” sold a lot of doors. While painting was extra, it was done professionally in the painting room at our warehouse, using three coats of paint and a $5,000 spray gun – the same one used in automotive detail shops. When customers compared the final numbers and quality, Home Depot and others were quickly eliminated.

In my estimation, all of this bode well for home improvements in general, and this franchise company in particular.

TOTAL INITIAL FRANCHISE INVESTMENT

The franchise company estimated initial franchise investment between $127,00 and $180,000 in its Franchise Offering Circular. Turned out, I came in below the low end of the investment range by being prudent. Including the $20,000 franchise fee and the $78,000 I used against a home equity line of credit, my total investment was just under $100,000. Incredibly, this was enough to get the business operational AND reach the critical break-even point where cash flow paid all the bills. As discussed in the other franchise article, reaching the break-even point in many businesses can take a year, two years or more.

Getting operational happened fairly quickly. From the time I signed the franchise agreement at the end of May, 2002, secured the warehouse-showroom in mid-July, completed improvements then training in August, and began operations like a rocket in the first week of September, about four months elapsed. We hit the break-even point in mid-October, just six weeks after taking our first job, and began to accumulate an ever-increasing balance in the business savings account.

When I sold the franchise a year later in September of 2003, the interior door replacement business was rocking and rolling. Residential home owners negotiated for position on our six to eight week waiting list to get their old, ugly, flat interior doors replaced with new raised-panel, designer interior doors and shinny lock sets. The new owner paid $236,000 for our franchise, and I received $235,000 after escrow fees. Subtracting the $100,000 investment left a tidy $135,000 profit. Not bad for operating the business exactly one year, and this didn’t include operating monthly income before the business was sold.

REAL BUSINESS

I operated a retail business with a storefront, as opposed to a “work out of your home” operation.

FRANCHISE MANAGEMENT EXPERTISE

The management team of the franchisor had no past achievement and experience in operating a franchise company. They had just started the franchise company and were learning on the fly. That was definitely a major risk and red flag. Weighing against this, I’d given them detailed seminars on how to operate a franchise company, pick the right franchise owners and manage franchise relationships based on my decades of franchise industry expertise. I had every reason to believe they’d follow my advice. And, because I was their very first franchise, I believed they would do everything it took to make the first one a success. My goal was to develop the first franchise from scratch, build it up, then either develop other franchises for them, or sell out – depending on what happened in the franchise relationship. I opted to sell out, and quickly, for the reasons discussed at the end of this article. Turned out, some of my assumptions were misplaced.

NORMAL WORKING HOURS AND DAYS; SUFFICIENT INCOME LEVEL

The nature of this business was a normal five-day, forty-hour workweek. Our business hours were 9A to 5P, Monday through Friday, initially. After talking with the owner of the second franchise in early 2003, I learned and copied his idea of a forty-hour work week, but spread over four, instead of five days.

Although this meant our crew needed to work four ten-hour days, they were very receptive to the idea. By starting on Monday and getting all door orders for the week installed by Thursday, everyone had a three day weekend every week, not just on an occasional holiday. Of course, I didn’t have to work ten hours a day. I arrived by 10 a.m. and usually finished by 4 p.m. – Monday through Thursday. Supervising four employees, working 24 hours a week and having 3-day weekends off every week – try finding that in another franchise!

What about the financial picture? Let’s take June of 2003, our tenth month of operations when we started interviewing a number of interested buyers. Sales were $47,000 less expenses of $35,500, left an income that month of $11,500. Of course other months varied, and the business was still in the start-up, development stage operating with only a single crew of four employees – but you get the idea. Using the results for June and multiplying by twelve for an annual result, we’d entered financial performance territory only enjoyed by a select few in the entire franchise industry (and within about $10k of the average income for a McDonalds at the time).

MINIMUM NUMBER OF EMPLOYEES

Remember my key question here: can you operate the business with six or fewer employees? When we started business operations in September, 2002, there were two employees – our contractor and a door cutter. A month later, I added a painter who doubled as a door installer. When the business sold a year later, the crew consisted of one part-time and three full-time employees.

LEASING AND LOCATION

The interior door replacement business operated from a low rent commercial business zone, so high square foot rent and triple net leases were never a concern. The 7,200 square foot warehouse and retail showroom I settled on in San Carlos, CA, with rent starting at $0.65 per foot the first year, seemed almost too big (and expensive) initially. Cutting a rental check to the landlord for about $5,000 every month, by far the biggest initial monthly operating expense, made my heart race. I kept thinking “is this whole thing going to work and how long will it take to reach the break-even point?” But, as things turned out the location was perfect. Because the franchise company had, what it considered, the do-it-right marketing approach (which I improved on, to survive) sales were never an issue.

Due to the size of the facility and nature of the interior door replacement business, three or four crews were possible and bringing them online, one crew (of three persons, each) at a time, would double then ultimately triple or quadruple sales. Also, because I was the first to enter the franchise system, I was awarded the very lucrative, exclusive San Francisco Bay Area territory that stretched from Palo Alto, CA all the way up to San Francisco, CA. Although I never expanded the business beyond a single crew, these next growth steps in the natural evolution of the business in such a prime territory were incredibly strong selling points. The new owner of our franchise ultimately took these next steps and with three crews enjoyed weekly sales of $30K to $35K – which is over $1.5 million per year. If he was able to maintain my same profit margin (25% even after paying 6% royalty plus 3% ad fund) that’s $375k. In 2003, that’s substantially more than an average McDonalds at the time made – $150k or so.

IMAGE AND LIFESTYLE

I didn’t need to flip burgers, scoop ice cream, clean restrooms or manage 100 teenagers who constantly quit or just didn’t show up for work. As a franchise owner, my principal job responsibility was creating and maintaining client relations. I placed ads designed by the franchise company, responded to customer phone calls, set up appointments, did estimates and sent out contracts. Most of my working time was spent driving to customer’s homes, meeting with them over coffee, taking measurements of all their interior doors, going over the options and explaining our one week production cycle – picking up their old doors on a Monday and installing their new doors by Thursday.

Back at the office, I’d enter the estimate information in our computer and generate a contract proposal. Then I’d email (or fax) the contract to the customer and wait for their deposit. About 70% of the proposals turned into jobs. Customers called back, gave me their credit card billing information, faxed in the signed contract and I scheduled their production week. By the time I sold the business in September of 2003, residential homeowners negotiated for position on our six to eight week waiting list to get their interior doors replaced.

I also ordered the new doors, lock sets, hinges, paint and accessories. Finally, I paid the bills. It was a very efficient business, great cash flow, no billing and no waiting for payment. As I look back, I saw some very nice homes and met some very interesting people. The pickup, production, painting and installation process was handled directly by our employees under the supervision of our licensed contractor, so I wasn’t involved in this aspect – although I did go out with our crew for about three months picking up and installing doors. That way, I understood the process firsthand, and this helped considerably in knowing how to bid jobs and cover contingencies in the contract.

TRUE FRANCHISE VALUE

I knew going in this franchise investment was not with an established ‘blue chip’ franchise company. After all, I had purchased their very first franchise, becoming the ground breaker, the pioneer – willing to accept a much greater degree of risk than subsequent franchise buyers. In return, I expected an adequate level of support from the franchise company. Every new franchise company, if it’s reputable, gives not only adequate, but extra support to its first franchise to compensate for that franchisee’s help in pioneering the new franchise system and the additional risk they’ve assumed. There’s also a self-interest in providing extra support – the future growth of the franchise network hinges on the success of the first franchise.

The ultimate test of franchise value came in November of 2002, and it was a real eye-opener. I was en-route, driving our box van, jamb-packed with doors, power tools, lock sets, hinges, etc., headed to our biggest installation job yet. Riding with me was our contractor, Scotty, who supervised our team and was our franchisor-approved manager. Everyone else was back at the shop, frantically cutting, sanding and painting the rest of the 100-plus doors scheduled for other jobs that week.

Knowing we had taken on the busiest week of our fledgling business, contractor Scotty complained all week about his wages, saying he wasn’t being paid enough. I’d explained, numerous times, our cash flow wouldn’t support any pay increases at the moment, that he’d only been working for us a little over two months, and his pay was exactly to the penny what he requested when we hired him. Scotty wasn’t listening and his complaints continued during our drive along El Camino Real to the client’s house. We were stopped at a red light, waiting to make a right turn when Scotty abruptly announced “I’m out of here, I quit.” Opening the passenger door, he jumped out, and walked quickly down the sidewalk of El Camino Real, leaving me stranded in a van that’s a bit larger than a UPS delivery truck. Scotty believed he was indispensable and his theatrics were nothing but a hardball, power play for money.

Looking back at all those freshly painted doors in the van, I knew there was no way one person could install them. I completed my turn, pulled over, and called our shop with my cell phone. Our main door cutter and best employee, Brian, confirmed what I already knew. He could leave and meet me for the install, but that would throw off our entire schedule for the week.

Then, I remembered something important. “That’s why I bought a franchise,” I thought to myself, “we’re in business for ourselves, but not by ourselves.” Surely the franchise company would know exactly what to do, and could help us, their very first franchise, deal with a problem that could cripple or kill my new business. They were just a short twenty-minute drive away, had multiple crews, etc. I called the founder, Mr. Interior Door himself.

The first thing Mike said, after I’d related my predicament was: “Do you think Scott will start a competing business?” I assured him that wasn’t even remotely possible. Starting a door business usually cost upwards of $350,000, requires a sizeable warehouse-showroom, power tools, delivery van and other things. Scotty, besides his personal tools, had no assets. He’d even moved into our warehouse from day one so he didn’t have to pay rent and lived paycheck to paycheck. It also turned out Mike, who interviewed Scotty and highly recommended we hire him as our contractor, forgot to ask him the critical question “Do you know anything about installing doors?” Answer, as we discovered, was a resounding “No.” Scotty’s contractors background and experience was in fabricating foundations for things like shopping centers. He knew as much about installing doors as we did.

I quickly redirected Mike to the purpose of my call and asked for his advice and H-E-L-P. Perhaps a couple of his door installers for the rest of the week, at my expense? Answer – no. What about one person for the rest of the day? Answer – no. What about one person for just a couple hours? Same answer – no. Incredibly, Mr. Interior Door said he couldn’t spare even a single person (including himself) for a couple hours to help out his first franchise that was in dire straits.

So, no help – but what about advice? Mike’s only advice: call all our customers, including the one I was en-route to, tell them we couldn’t make it this week and re-schedule all jobs forward to the next week. Since we’d already booked other jobs over the next two weeks, this would have been a disaster, not only to our cash flow (payroll, rent and supplier bills were due that week) but also for our customers who’d already scheduled time off work to be at their homes on the job dates.

That’s when franchise reality set in. I realized we were in business for ourselves . . . and by ourselves. After praying and thinking things over in the silent van, I called the shop and told Brian to meet me at the customer’s home for the installation. I figured at least we’d collect the $4,000 doing this job and just have to see about the rest of the week. By the time Brian and I finished the job, the day was over. We arrived back at the shop at 4 p.m. – quitting time for our construction workers. Our door jobs for the next day were not even close to being finished. The crisis was finally upon us. Should I follow Mr. Interior Door’s advice, call all our customers and try to reschedule for the following week?

I decided on a different approach. I held a little meeting, explained the situation, and asked our crew if they’d be willing to work overtime, so our new business wouldn’t go out of business. I also fully realized our crew’s concerns. They’d been working very hard that week to help us achieve our ambitious goal. Our team leader, Scotty, was history, and they all had families and responsibilities at home. Under normal circumstances I’d be up the proverbial creek without a paddle.

MANAGEMENT STYLE TO THE RESCUE

Fortunately, management style was about to pay off. From the very beginning I treated our crew like members of one, big family. It was a very extended version of theory “Y” management style I’d studied in my graduate business classes. Everyday, I bought lunch for everyone, and we ate together, discussing what was new in their lives as well as exchanging door stories. I also provided soft drinks, coffee and snacks throughout the day at the shop. On birthdays, I’d take the person out to a movie of their choice and dinner afterwards.

Luckily, there were only four employees, but every month I saw an ever-increasing total for these benefits on our profit and loss statement. Mr. Interior Door told me I was crazy to do this. But I knew if I ever needed the crew, they would be there for us.

This management style kept the business in business and on track that November. Everyone immediately agreed to work overtime. I ordered pizzas for dinner and they worked from 5 p.m. until 1 a.m. the next morning. This dedication repeated itself over the next two days, which is nothing short of incredible, given they all had to report back to work at 7 a.m. each morning. All jobs scheduled for that week were completed, all money was collected and all customers were satisfied. By the next week, the business was on track, humming along, and strengthened by overcoming the adversity.

WHY SELL SUCH A GREAT FRANCHISE?

Everyone always asks why I would ever sell such a great franchise. The short answer is the franchise company changed the deal. When I signed on, franchise owners either had to be a licensed contractor, or operate the business under a contractor’s license. That’s what the disclosure document said. Since I wasn’t a licensed contractor, I hired one (and ultimately went through three) and operated under their contractor’s license. Never a peep from the franchise company. Then one morning, I get an email from them “updating” their operations manual contractor policy for my franchise. The first part of the email said the franchise company’s new policy was the contractor’s license had to be directly under the Interior Door business name – in my case “Interior Door Replacement Company of San Carlos.”

At first glance, it didn’t seem like a big deal. I contacted Steve, my licensed contractor at the time, and asked him about doing this. He was very familiar with the process and said his California contractor’s license could be listed under three different companies. It was a process he called doing an RMO or Responsible Managing Owner. The key word in that trilogy is the last – Owner. It meant the contractor becomes an owner of the business – my franchise. Steve said because he knew me so well and we were “friends” almost like “family,” he would cut me a break and only take a one-third ownership interest in our franchise.

I just couldn’t continue operating the business if I had to take on an unexpected business partner and give up one-third ownership for nothing. That, coupled with the other part of the email saying I had to also hire the contractor on a full-time basis to directly supervise all jobs made the decision – I sold my franchise. It turned out to be auspicious timing. The franchise company was also changing yet another “policy” that would cost other franchise owners at least $40,000 to $50,000 a year off their bottom line.

When I bought the franchise, the operations manual (and training) specified a particular Panasonic answering machine with five voice mailboxes as the way to answer the phone after hours or if you happened to be temporarily out in the field, doing estimates at customer’s homes to get jobs. Jobs, as in that’s how you pay all the bills and hopefully make some profit. This was the way things were always done in the good old days, by the founders, Mr. and Mrs. Interior Door, and the franchise owners to date, all without any problems.

Now, the franchise company decided on what they considered a “more professional approach.” After all, it wasn’t their hard-earned money being spent frivolously. One email and instantly, every franchise had to have a full-time receptionist/office manager to personally answer the phone and be present, just in case a potential door customer happened to visit the showroom. Customer visits happened very rarely – less than 5% of our customers ever visited the showroom. Virtually everyone signed up based on the nice color photos shown during their in-home estimate.

When the salary, taxes, benefits, etc. of this new addition to the team are calculated, it takes another $40,000 to $50,000 right off the yearly bottom line. I didn’t see this happening either and selling the franchise became my top priority. Because I had the one-and-only lucrative, San Francisco Peninsula territory, and the necessary square footage for adding at least two more crews, finding buyers were never a problem.

As I was leaving the franchise network, another email specified yet another change. Franchise owners were being required to rip out the very nice carpet in their showrooms and replace it with . . . marble flooring.

SUMMARY

Looking back, I happened to be in the right place at the right time, was willing to take a calculated risk and jumped ship when policies started changing. I didn’t rush in, took a lot of time evaluating many factors, and kept emotions out of the franchise investment decision – thus avoiding the three mistakes made by most franchise buyers.

It was definitely an effort getting the business established, finding the right location, the right workers, and navigating a new business mostly on my own. But the challenges were a learning experience, and overcoming them was very rewarding. What I could not control was the capricious behavior of the franchise company. Headquarters made decisions that were not in the best interests of the franchise network, at least in my humble opinion. They just didn’t get the big picture. The franchise company possessed and exercised the power to change one’s entire economic destiny by clicking the send button on a single email, “updating” their franchise operations manual. These are realities and risks in any franchise investment that most don’t realize. I had to tinker with the business metrics of the franchise model in certain respects – with marketing and pricing, principally – but this was to ensure survival. Otherwise, I would have gone out of business and lost my entire investment. I wasn’t going to let that happen. Although I’ve advised hundreds of individuals and firms about the in’s and out’s of franchising, the insights gained and lessons learned in operating my own franchise and interacting with the franchise company retooled my knowledge of franchise relationships.

FRANCHISE BROKERS VS. FRANCHISE CONSULTANTS – DISTINCTIONS WITH A DIFFERENCE

© 2006 – 2008, Kevin B. Murphy, B.S., M.B.A., J.D. – all rights reserved

A franchise broker is a paid franchise salesperson. Many franchise brokers (who also call themselves a “franchise coach”) claim they will help find a franchise company that is the perfect match for your background and abilities, and that their service is free. In the beginning it all sounds good. There’s some personality testing and review of personal finances. At the end of the day, it turns out they only represent a handful of small franchise companies you’ve never heard of before. A detailed analysis often reveals these highly touted franchises produce mediocre or even below minimum wage financial performance. Yet franchise brokers don’t mention this, and individuals continue to rely on their recommendations, believing the broker represents them. Nothing could be further from the truth.

Franchise brokers receive a substantial commission up to 50% or more of the franchise fee you’re paying the franchise company. Franchise Broker Realities:

(1) Their service is definitely not “free” despite these and other similar misrepresentations. It’s really common sense – how could anyone offer a “free” service and survive in business? The simple truth is if you buy one of the franchises they’re hawking, your money goes to the franchise company, then into the broker’s pocket. If anyone ever calculated how much time they spend to collect their $15,000 or $20,000 commission, it’s probably more than a brain surgeon earns.

(2) Franchise brokers definitely do NOT have your best interests in mind. They will do or say whatever they have to in order to close a deal and earn their commission. It’s important to recognize this conflict of interest and realize their “advice” is anything but impartial. In fact, as discussed below, many franchise brokers call themselves franchise consultants or a franchise coach in a semantic attempt to disguise their true identity

A franchise consultant is usually an independent adviser who offers advice to others (usually franchise companies or firms that want to franchise their business) for a fee. This makes their advice more impartial in theory as long as they are not compensated by third parties. Because they are not legally required to disclose actual or potential conflicts of interest, it’s important ask questions. For example, if they are recommending the “best franchises,” are they paid anything by the companies on their list? This could be a commission, kick-back or “consulting fee.” Many franchise brokers call themselves “franchise consultants” or a “franchise coach” to hide their true identity. So, make sure if you’re dealing with a franchise consultant or a franchise coach, he or she is not really just a franchise broker in disguise. If you (and only you) pay them for their services that’s a sign of objectivity vs. if their services are “free” watch out!