What It Takes to Franchise Your Business

Chris Bjorklund: You’re listening to the AllBusiness podcast. I’m Chris Bjorklund. If you’re getting this through iTunes and RSS feed or an online streaming-media player, you can hear interviews with other experts at AllBusiness.com.

Bjorklund: When does it make sense to grow your business by turning it into a franchise opportunity? AllBusiness has asked two top franchising experts to help you think that through. Nick Bibby, a consultant on the development of franchise systems, and Warren Lewis, a legal expert on franchising, will be talking with me about what it means to franchise your business, how to determine if you’re suited for franchising and what kind of help you might need getting started. Franchising your business might be one way to grow your company but a lot of people really don’t know what that means. Nick, can you help us out with that?

Nick Bibby: Sure. I think when you get down to the bottom line of it, Chris, and you reduce franchising down to its very business essence, franchising is simply another form of distribution. Does that make sense?

Bjorklund: Yeah, yeah. So in other words, you’re sort of starting another business that’s going to further spread your products and services?

Bibby: Yeah, that’s true. And as a channel of distribution, I think that the entrepreneur or the business owner has a decision to make and that decision is essentially, “Do I grow my business by teaching other people how to implement my concept or do I grow my business by opening other company-owned units?” In other words, a chain of company-owned operations and I think that’s the essence, that’s the basic question.

Bjorklund: Warren, how about you? Do you have something to add here?

Warren Lewis: Yes, as a franchise lawyer when companies come to me and want to franchise, I look at two things. One, are they ready to go into a new business? Because, for example, if they’re operating a jewelry store, the dynamics of operating that store they know very well. They’re experts in it. But they need to be flexible so that they can go into franchising, which is very different. They’re going to be dealing with legal requirements, accounting requirements and long-distance relationships, which is very different from operating a jewelry store. The other is they need to be tolerant for the legal requirements that they’re going to have to comply with in franchising because franchising is a regulated activity with the federal and state governments.

Bjorklund: How do you know if your business is suited for franchising? I mean, when you look online and you see all the possibilities, I mean, there are popcorn stores and chocolate stores, there’s tire stores. But then there are as many individually owned companies that really aren’t suited for franchising because actually the market maybe saturated. So how do you know if your own company is suited for franchising?

Bibby: Well Chris, that’s an excellent question and I think the best way to break it down and you’ve asked the question appropriately, I think so, is my business franchisable or not? But I think the question has to be answered in two different ways. Number one, realize that there are nearly 100 different business segments that exist in franchising and by segment I mean a focus like an instant print shop, computer repair, pizza, dry cleaning, those would be different segments and every segment that is represented in franchising is also represented in individual phases. Now there are some businesses that are national in scope that would not lend themselves to franchising. That would be part A of the answer. Part B of the answer lies with the individual and it goes back to what we just talked about earlier, which is, should I own company-owned units or should I franchise in order to grow the business? Warren?

Lewis: Well when I talk to a potential franchiser, I want to know if the core concept that they’re dealing with is solid. Is it fresh? Is it new? Is it something that can stand up to competition? So if they haven’t had that, do they have some new twist that they’ve added to their business so that they will stand out in the marketplace and it needs to be profitable. I’m not a consultant. I’m a franchise lawyer but if I’m working with a potential client, if they’re trying to franchise a company that isn’t new, fresh or profitable, that’s a very difficult road for them to travel. So they need to have a good core concept so that they can then be able to expand it to help other people to make money.

Bjorklund: How important is it, Nick, to assess the competition?

Bibby: Another good question, Chris, but it’s kind of like going to any intersection where you find food or fast food or a burger franchise. On the other three corners you’re likely to find the same concept and a different brand. So I think that it’s the old story that competition is good. Now, there are certain franchise systems and Warren has worked on these at a pretty deep level in what we call encroachment within a system, you could have, within a given system, you could have too many units within a territory but that’s generally an issue or a problem of the franchisor not understanding the demographics required to support a unit. I know you’re asking a little bit different question in terms of, you know, is there room for one more Mexican food franchise and that’s a good question. But that really does become an individual analysis to be done by each prospective franchisor. What do think, Warren?

Lewis: I agree and a lot goes to teachability also so that even though it may be a great business concept that you have, can you teach it to others? Can you systematize it and can they then teach it to people who work for them? Some businesses are very unique to a particular location and others are teachable and can operate all over the country. So you’re looking at that also.

Bjorklund: Nick, can you talk about a couple of examples of maybe a type of business that you would not be able to teach others?

Bibby: Sure, I think, let’s just back up on that for one second because you initially asked what kind of businesses might not be franchisable and I think that’s a very appropriate question. I like to see a franchise that is territory specific. In other words, you can pretty much determine by zip code or population, business count, what it’s going to take to support another unit within that system. Now, if you have a national company, let’s use the example of a national mailing house. They sell mailing lists, they print and they mail for direct mail for clients. That business would not be even a good candidate for franchising because each franchise unit would be fighting the other one that’s dominant across a huge territory known as this country. Does that make this sense?

Bjorklund: Uh-huh.

Bibby: Also it’s very problematic having a franchise that requires specific or unique licensing. And let’s just use medical practice. When you get into specific licensure then you’re asking for trouble. Generally, franchised concepts that are easy to understand, as Warren said, teachable and can be defined by a specific geography make the most sense for franchising.

Bjorklund: So how do you begin to think about whether your own business is ready for franchising, Warren?

Lewis: Well, you need to know that your business is on solid ground. If it is still struggling, if it is new, if you still don’t know the ups and downs of the business and how to deal with those ups and downs, you’re not ready for franchising yet. But if you’ve been in business for a reasonable amount of time, for example, if you started a restaurant, maybe you have two or three restaurants in a territory, you would have then some experience in terms of expanding the concept whether it works in different locations and managing people long distance. So that would be a good candidate for franchising. And you need to have systematized the business. And the other thing is that you need to be able to get out of the kitchen and what I mean by that is I had a client come to me and they had a restaurant and whenever they would talk to me, they would be in the kitchen cooking or whenever they would send papers to me, it would almost smell like the kitchen. That is not a good prospective franchisor. They have never learned to get out of the kitchen. When you franchise, you’re going to stop operating your restaurant, for example, and you’re going to have to start going out, meeting people and teaching other people how to operate the business.

Bjorklund: So some people don’t realize that they literally have to get away from the counter and start, as you said, networking, talking to lawyers, going to meetings and they have to be away from their core business.

Lewis: Absolutely, either they have to get away from the core or they need to hire someone who isn’t part of the core business.

Bjorklund: I would imagine this could start affecting the business that you’re already running.

Lewis: Absolutely, you may end up selling that core business to someone else so that you can focus on franchising. It’s very difficult to operate a shoe repair store in the morning and then sell franchises in the afternoon. The dynamics are different. The timing is different. The thinking is different. So it’s difficult to be both. So you generally, when you go and franchise your business, end up picking one area, either franchising or the core business and that’s your focus and then you hire other people to handle the other.

Bjorklund: I would imagine, Nick, that some of these people again that are good at running a restaurant or a shoe repair maybe aren’t so good at the sales end of franchising.

Bibby: Well, I have my own perspective on that issue and I have run into so many prospective franchisors over the years who are afraid of the sales process and they feel that they should use brokers or salespeople to sell their franchises. My take on this is that unless the franchisor is willing at least initially to undertake all aspects of the business, they will never fully understand what their franchise is about. And let me just not only agree with Warren’s comment but let me sum up his idea of working yourself out of the job. You may be expert at running that restaurant but you must elevate, move yourself out of the restaurant and become a franchisor. You are no longer in the restaurant. You are in the franchising business and the restaurant is the vehicle that puts you in the franchising business. Those that cannot wrap their minds around another layer, another level wherein they become the mentor, the teacher, the coach, the counselor, those who cannot adopt those skills, those who do not naturally have those skills should really, in my opinion, shy away from franchising and to be 100 percent candid with you, I tell most people who call me, there are many, not to go forward with the concept of franchising their business.

Bjorklund: You find that they haven’t done that sort of personal check-in about whether they are suited for franchising?

Bibby: I find that most people do very little personal checking in any aspect of their life, let alone franchising, and that’s why we have so many difficulties around us, but with that said, it’s not only the personal checking, it’s the result of the personal checking. For example, if a business owner, an entrepreneur has a mentality of employer-employee, you do what I tell you, I set the rules, they’re probably not a good personality to assume the role of franchisor. If the franchisor does not have the inherent values of mentoring and coaching and helping and training, which is all franchising is about, franchising is about moving my concept to new locations under different management and different ownership and seeing that it works equally well in different places under different management. So if the ownership does not have that inherent quality of servitude and helping, they probably are best served looking at another model for growth.

Bjorklund: I would imagine that if they don’t have the ability to maintain the positive relationships and supportive relationships with the franchisees, this could lead to a huge mess.

Bibby: I’ll let Warren comment on that because he and I have had various discussions on that subject.

Bjorklund: Warren, you take it.

Lewis: Well let’s assume that you’re operating an auto repair facility. Your customers are people who come in with cars and who need help. And so you have a certain type of relationship with those customers and it’s a fairly short-term relationship although they may come back from time to time. But when you go into franchising, your customers are franchisees. These are people that you go into business with. They’re in business themselves and they need your help on a continuing basis and they’re going to be working with you over 10 or 20 years. So it’s the dynamic is very different and also they’re not at the location where you are. So you’re having to support them creatively, helping them to come out with new marketing ideas, new product and service ideas, and you’re helping them on a day-to-day business to deal with software issues or other operational issues. It’s a very different relationship than dealing with the auto repair customer.

Bjorklund: So who should help you if you’re thinking about franchising your business? I mean, what is step one, Nick?

Bibby: I think that the very first step, what we would refer to as a franchise feasibility study. Let me make like something very clear. Most people in the business of franchise consulting are actually brokers and you don’t want to be using a broker because a broker is involved in the side of selling the franchises. You want service development consultants. Those consultants who work on helping businesses transform into a franchise offer. And also, as a caveat when we talk about franchise feasibility, oftentimes, franchise feasibility can be used to sell the business owner on the idea of a franchising so the consultant you absorb takes a fee. I’m being very candid in those comments but that is reality. True franchise feasibility will help the business owner decide whether the financial model is applicable to franchising, whether their concept is timely and should remain timely, whether it’s geographic specific or what geography is its specific group, and whether the franchisor or the prospective franchisor actually has sufficient adequate personality traits to operate successfully as that trainer-teacher-franchisor.

Bjorklund: What kind of up-front costs are we talking about to get help, whether it’s from a consultant, a lawyer, an accountant, whatever services you need, I mean, what kind of investment are you looking at if you want to franchise your business? Just...

Bibby: Let me jump on that first and then let Warren, because Warren and I have done so many of these jointly. Let me just say that, Chris, it is not an either/or what you’re going to invest in, an accountant or a lawyer or a consultant or a graphic designer or a trainer. It’s all of those things. And I will say this--and I’ll let Warren certainly have the final word because we’ve experienced it so many times together--this is not a decision that should be made and attempted on the cheap. It is, and I can quote you a dollar figure. You’re not going to franchise anything successfully for under $80,000 or $100,000 and that is really tightening it up like a drum but the worst thing--and I’ll leave it at this and let Warren finish the comment--but the greatest stories of failure are being among those people who think that their entrepreneurial skills, the skills that made them successful in their own business will somehow translate into self-performance and franchise success without any outside help. It is the sure way to the poorhouse and the courthouse. Warren?

Lewis: OK, from a slightly different angle, if you’re looking to franchise your business, you are an expert in your business. But if you’re going into franchising, you’re going into a new business and you’re doing it quickly, often you want to do it faster. You want to become an expert franchisor faster than you ever became an expert at restaurants or some other type of business. So you want to do it quickly and effectively and economically. So you absolutely need a team of professionals. In my experience, and similar to Nick, absolute minimum would be $50,000 to $75,000 but it’s more in the range of $100,000 to $200,000 as a cost or working with a franchise consultant, a franchise lawyer such as myself. You will need to have an accountant do an audit of your business and you’re going to need to bring in writers and training people and graphic artists to spruce up your business so that it’s useful to other people and it looks good as a franchise.

Bjorklund: So somewhere in the neighborhood of $75,000 to a couple of hundred, $50,000 maybe to $200,000.

Lewis: Right and that doesn’t take into account hiring new people or paying commissions or advertising on the internet. So those are in addition. But I’m just talking about the core consulting or professional assistant that you absolutely have to have if you’re going to have a good system in place, good legal documents in place and know your obligation.

Bjorklund: Let’s talk about some of the most important business decisions that you have to make when you’re considering franchising. Nick, you want to talk about fees?

Bibby: Well, let me comment in general regarding fees. Obviously we can’t get into specifics because we’re not talking about a specific thing. First of all, there is not just one fee. You start out with the basics of what is a franchise fee. That would be the franchisee’s cost of entrée in gaining the training, use of the trade address, perhaps an exclusive territory but that should be determined by a franchisor with regard to what is actually costing the franchisor to bring the franchisee in and that means what did it cost to advertise, to market the franchise and find this particular candidate or franchisee. What are the costs of training? What are the real costs of bringing in a new person, a new franchisee? And then of course, the next most common or most well-known fee would be the royalty fee. And those can be a flat fee paid monthly to the franchisor or more traditionally, royalties would be a percentage of gross sales of the business but these are issues that are discussed over a long period of time and in my case as a franchise development consultant, my first series of discussions last about three months before the strategy including fee structure is developed. So it is not something where you look at a competitor and say, “Well they’re charging 5 percent of gross sales and their franchise fee is $15,000, I guess I’ll copy that.” Wrong. We have to look at your operation, what it’s costing you, what you need to be profitable and we actually workshop until the franchises work.

Bjorklund: It sounds like every project is pretty much a custom project.

Bibby: If you attempt to do franchising all cut from the same cloth, you are not only not creating a quality franchise for yourself, you’re doing a disservice to any potential franchisee.

Bjorklund: Warren, what else should we be looking at in terms of a key business decision?

Lewis: Well, I think the most important business decision when you consider going into franchising is to select professionals carefully. You need, any professional you work with whether it be a franchise consultant or a franchise lawyer or a manual writer, you should ask for references, you do diligence, ask for 10 references. Call at least five of those references. Don’t just rely on the person’s website or marketing materials to determine whether you’re going to work with that professional. Because you want to work with someone, even though you don’t want a cookie-cutter approach and you do need custom help, you want someone who has seen many different franchise concepts work with many different franchise companies and so that they know their problems, they know the pros and cons of franchising and they can give you answers without having to back and research to find out what the answers are.

Bjorklund: Nick, how important is it to define territories in the beginning and territorial rights?

Bibby: I’m a huge proponent of exclusive territory and I’ve been a proponent of exclusive territories for years and now it’s a very popular means of marketing. But unfortunately it’s a popular means of marketing. Now what do I mean by that? Franchisees always want an extra helping of territory. So if I’m looking to locate my franchise in the city of Dallas, Texas, and for ego reasons or for whatever reason I ask the franchisor to give me all of Dallas, I’m shooting my business in its feet and the franchisor would be a fool to give that to me. So what is going on is that like every other part of franchising, be it fees or territory, this is an individual analysis and discussion which should result in a proper sizing of a territory so that it is close to being perfect between the location and the market served as possible. Does that make sense?

Bjorklund: Uh-huh.

Bibby: OK.

Bjorklund: What about marketing the franchise? Is that something you need to give advance thought to?

Bibby: Well yes, and I think that the most critical issue up front is where are you going to sell the franchise? If you have a jambalaya specialty in south Louisiana, you probably are not looking at selling too many in Minneapolis. All right? So you need to know up front what the logical marketing plan is and part of franchise development is market planning as is strategic planning as is fees planning as is territorial planning. So we’ll get back to this whole issue of do it yourself versus professional. If you will not hire a Warren Lewis or a Nick Bibby type and a good CPA who understands what’s required, you should not do it.

Bjorklund: Right.

Bibby: Because I really think you’re throwing time and money away.

Bjorklund: Warren, what are the most important legal priorities for a business considering franchising?

Lewis: What a business considering franchising really should look at four basic priorities. One would be trademarks, the other would be the corporation of a franchise company, then the franchise disclosure document and then appropriate registrations. Now in terms of your trademark, when you use a name, a logo, a design at your business, you are using a trademark and you get a certain amount of local protection but if you’re going into franchising, you need to get federal protection. And that means registering with the U.S. Patent and Trademark Office. So that you should do well before you even go into franchising. Then when it’s time to go into franchising, you need to create a franchise disclosure document, which is required by federal and state law and that includes 23 items of disclosure. And then some states require you to have that disclosure document reviewed by the state. There are 11 states that actually look at the disclosure document and approve it before you can use it. So you need to know which states you need to get approval from before you either offer or sell any franchise in that state. And then the other priority is generally you’re going to want to start a new corporation, either a corporation or an LLC to franchise because when you franchise, you have to audit your books and most people do not want to go back three years and try to audit the books of their base business that they’ve been operating. So it’s much better and generally the case that you would then form a fresh company and you would then audit that company and then going forward, you would audit that company.

Bjorklund: In closing, Nick and Warren, I want to give you both a shot at this. What is your biggest takeaway for someone listening to this program who’s thinking, “Should I franchise my business?” Nick, we’ll start with you.

Bibby: Sure. One, do not assume that your success as an entrepreneur in your particular core business will translate in any way, shape or form to franchise success. Franchising is an industry unique unto itself with pitfalls that are unforeseen and unforetold until you fall into those pits. So be sure that your study is complete and listen to reality. Do not listen to the song of the franchise sirens and I’ve written two articles just on that subject and I’m talking not about sirens of the fire truck, I’m talking to the Greek sirens who beckon to the mariners. Most people who choose to franchise a business have been lulled into or convinced by family, friends, clientele, customers that they have a wonderful franchise concept and oftentimes, they will forego true feasibility and analysis in deference to those who have convinced them that franchising is the next logical step.

Bjorklund: Warren, your shot.

Lewis: Going into franchising can be a very exciting opportunity for a business person who has a new concept, a fresh concept, a profitable concept. The key, and Nick has pointed to this several times, the key is not to be sold on the idea of franchising. It’s just another way of expanding your business. So you need to do due diligence. Check with other franchisors. Check with consultants. Use the internet. Use books to know what you’re getting into because you don’t want someone just to tell you to go into franchising and then invest the money and find out later it’s not for you. The other thing is you need to be properly capitalized. If you don’t have $100,000 or $200,000 that you can use or have access to the franchise, that may be a very difficult barrier to go over. And third, don’t go into franchising without really checking all of your legal obligations because I have seen in many times, people will inadvertently go into franchising by letting other people use their trademarks or their systems and they get into trouble with the states or they get sued by the people that they permitted to use their trademark and system because the people say they didn’t comply with the law. So don’t start off getting into trouble under the law. Make sure that you have an appropriate disclosure document and comply with the law so that you can build a solid base for the new business that you’re going to start which is your franchise business.

Bjorklund: Warren Lewis and Nick Bibby, thanks so much for talking to us today.

Bibby: Thank you Chris.

Lewis: Thank you Chris.

Bjorklund: Thanks to Nick Bibby from the Bibby Group and Warren Lewis, an attorney with the law firm Williams Moen, for talking to us about franchising your business on this AllBusiness podcast. Check out our podcast library for other shows about the different aspects of franchising and send your feedback and suggestions for future guests to podcasts@allbusiness.com. I’m Chris Bjorklund, thank you for joining us.