How to Evaluate a Franchising Opportunity (AllBusiness.com's Chris Bjorklund interviews Nick Bibby, one of the country's top franchising experts.)

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Chris Bjorklund: So you want to own a business and think that buying a franchise is the way to go, my guest today Nick Bibby will help you evaluate a franchising opportunity. His consulting firm specializes in developing new and existing franchises and helping clients check things out before buying a franchise. Nick teaches at Louisiana State University and has immersed himself in all aspects of franchising for more than 25 years. So Nick, just how big is the franchising industry in the United States nowadays?

Nick Bibby: Well, no one really knows the true answer to that question because certain states require registration of a franchise, others do not and by the way, I think there are 17 registration states but other than that, if you want to franchise, you meet the requirements of the Federal Trade Commission and go about franchising. However, best guess would tell us that there may be in the vicinity of 3000 active franchising companies and they in total would have, in terms of total single unit operation somewhere in the vicinity of a half a million to three-quarters of a million street units.

Bjorklund: And what about gross sales, is there any estimate of that?

Bibby: That's an interesting question, and of course, because franchising is all over the board today representing over 100 industry segments, printing, pizza, dry cleaning, for example, each being a segment. Each business would have its own numbers or expected average sales, so you really can't pin a number on that. In addition, we now have home-based businesses which I think are traditionally lower-gross sales businesses than the big bucks concepts.

Bjorklund: Well, you've been in the industry for more than 20 years and you've probably seen a lot of changes. What are some of them?

Bibby: I think the biggest change occurred in 1979 when the Federal Trade Commission implemented its disclosure regulation, those being most commonly known as the Uniform Franchise Offering Circular or UFOC. Prior to that time, this was really a wild west industry and it was really every man for himself.

Bjorklund: Lots of scams and fraud?

Bibby: Yeah, land of the blue suede shoes and so much of that has changed and disclosure has been more and more intense. As a matter of fact, the UFOC will be going away beginning the end of July 2007 this summer and be completely done away with as of end of July 2008 and it's being replaced with an FDD (Franchise Disclosure Document). So with each passing year, and with more government regulation, more disclosure is required. Now, I'm certainly not a big government man; however, prior to disclosure documents or the UFOC in 1979, the buyer was truly at a disadvantage because they had very little facts to go on with regards to their due diligence and their research before investing in a franchise. Sadly, though, on the other hand, most franchisees never read the disclosure document but you could lead a horse to water, so to speak.

Bjorklund: Right, we can talk about that a little later in the show, what are some of the things that are included in such a disclosure document and why it's important to read it but before we do that, I'm wondering if you can describe, just generally, how a traditional franchise might work?

Bibby: Sure. Let's look at it from 2 different perspectives. One, it works for the franchisor because it's one of the easiest paths to follow in expanding a business concept. You're not only working with OPM (other people's money) because they invest in the concept but you're dealing with other people's management time and skills. So for a slice of the income known as royalties and for an upfront training fee and other elements contained within the franchise fee, the franchisor is allowed to expand its system and not really outlay any money. As a matter of fact, each sale should be a profit for the franchisor. So that's from the franchisor's perspective. From the franchisee's perspective, if you look across the wide screen of executive America , let's just term it like that, most executives are really good at attending a meeting and scheduling things but they don't really have a marketable skill or trade to take to the market place if they weren't working under the broad umbrella of the corporation. So, the franchise system teaches in a very short period of time, a particular business skill and business system that the investor or franchisee can take back to the market place. So, I think those are the key advantages. The franchisor gets to spread its concept far beyond what it could ever do on its own and the franchisee receives a system and an operations plan. So, virtually the only decision that a franchisee really has to make when you get down to brass tacks of it is do I want to buy this or not. Everything from color scheme and logos to when to lock the door at night is taken care of.

Bjorklund: With regard to the franchisee, are there any specific disadvantages to becoming a franchisee?

Bibby: Yeah, and the most obvious one really is that if you're not willing to follow the franchisor's system, you probably will be very unhappy. Because, outside of and a great example, by the way is the franchisee in McDonald's who came up with the, oh gosh, what's the sandwich with extra bacon and lettuce, whatever.

Bjorklund: Well.

Bibby: I can't think of that particular sandwich.

Bjorklund: Okay.

Bibby: But a franchisee came up with that recipe and of course, offered it to McDonald's headquarters and they accepted it and so, there was some latitude. But for the most part, if you're the type of personality who, that needs to tinker with the world and create, you'll probably not going to be very happy in the long term.

Bjorklund: What you might be happy about though is the success rates of franchises. They seem to be very high.

Bibby: Well, there are some very high numbers quoted. In all fairness, I don't know how true they are. And franchisors can play a very cute game with numbers in this respect. If they have a failure, they may well take the unit back and nurse it along until they can resell it. So, I believe that it's true that franchise businesses are generally more successful than independent businesses and I think the SPA tells us that somewhere in the vicinity of 75 percent of all new businesses fail within the first three years. I certainly think that franchises do better, way better than that. But I don't really believe that the success rate is anything close to 90 percent. In addition, and I think this is a very important point if you're considering to buy a franchise, there's a term used in the UFOC called an earnings claim. Now, an earnings claim is a formulated description of what X number of franchisees within a given system earn. Now that could be expressed in terms of gross sales, gross profit, unit sales, could be expressed in different ways. However, what I find most intriguing is the fact that only around 25 percent of all franchisors use an earnings claim in their disclosure document. So what does that tell you?

Bjorklund: Well, okay, I think it says a lot.

Bibby: It tells a ton. And this is why I am loathe to make sweeping statements about the franchise industry because over the approximately 3,000 franchise offerings and the half to three-quarters of a million units and the hundred business segments they all represent, I don't think you can make one sweeping statement.

Bjorklund: Of course not. But can you give us some examples of successful franchise operations and some that have not been so successful?

Bibby: Well we all know the big ones and very few of us know the bad ones so I'm not here to name names. The reason that the good ones exist is that they always have had and always will have the very best systems. Now, I will tell you that I have seen companies in near bankruptcy who are chosen by a very popular magazine to be among the best featured franchises or offerings available. So not until, and again I go back to my prior statement that you cannot make real sweeping statements about the industry. I think everything is on a case-to-case basis and that is why due diligence on the part of the buyer is so critical, but as thoroughly, as I said, very few people take advantage of the opportunity to research and investigate.

Bjorklund: I was going to ask you for a friend of mine, who had been thinking about buying a franchise for a women's exercise fitness thing. She was also thinking about a wine bar, wine store and I mean, she's just exploring now, visiting other franchisees, sort of seeing the setup, trying to figure out how many are going to be in the system and so on. It's not something she's franchising. It's something she's going to buy into perhaps.

Bibby: Right, right.

Bjorklund: Where, what would be her first step? Where would she begin? I know you're supposed to read the agreement but let's say, even prior to that, when you're still in the exploratory phase, where might she begin?

Bibby: That's a great question and I might surprise you with the first part of the answer. Your friend should begin with herself. Over the years, and this is getting away from franchising a little bit but it's dead center on the issue. Over the years, and you know, in my prior life, I was an adult counselor and oddly enough, my practice grew more and more toward the field of entrepreneurship, working with people who owned businesses and people who thought they wanted to be self-employed. And eventually, I wrote a program which I teach at LSU in Shreveport, and also have online, if you don't mind me saying it, emerging-entrepreneurs.com and the program is called the Focus Program for Emerging Entrepreneurs and what it consists of is several weeks of insight work, homework deciding on who you might be as an entrepreneur and specifically what type of business you might consider as an entrepreneur. And without the concept, or without good fit, let me use the word good fit, there is almost no sense going into a business whether it is franchised or independent, because without loving the business, the road to success in small business is so narrow, that whether you're franchised or not, you probably won't have the staying capacity to see it through.

Bjorklund: Can you give me a couple of examples of questions you might ask yourself to find out if you're really suited, let's say, to be a franchisee?

Bibby: Do you remember the book What Color is My Parachute?

Bjorklund: A classic. A classic?

Bibby: A classic. And really, the Focus Program runs down kind of the same road but with a bent toward entrepreneurship. So, of course, a critical question is where do I want to live and what do I want to do when I get there? Or, I'm happiest when blank, you know? I mean, skills, hobbies, if a person is a busy executive and is just getting bored with corporate life, and one of their things is going home and cooking for relief and having dinner parties, then obviously, they're looking, you know, at the food or entertainment business. But in the case of your friend, perhaps she is a connoisseur of fine wine and perhaps she loves to go to her aerobics and Pilates five times a week. So, it's possible that someone could have an interest in both interests. But the key is, observing the business, whether you observe an independent or go to franchised units and spend an afternoon and look at it and say, would I like to do this particular task or not?

Bjorklund: I would think imagination is really not a strength for some people so they have to physically go experience that?

Bibby: I think so and how foolish are you to throw a hundred thousand dollars plus at a potential venture and you haven't tried it out?

Bjorklund: That's crazy!

Bibby: Not so crazy that many of them don't do it and that is going way back to one of your first questions and that is why I don't put a lot of faith in the statement that most franchises succeed because lots of people buy them and I've met these lots of people who are just brutally unhappy with what they purchased.

Bjorklund: Let's say you've done that navel gazing that's required to see if you think that a franchise is the way you want to go. Obviously, you've got to look at the investment itself. Are there other things? Now, I know the disclosure, we started touching on the UFOC, the Uniform Franchise Offering Circular, does that have to cover things like how many locations of how many that would be within such and such a geographic area? Is that something important to consider?

Bibby: Are you asking me, how many units might be in the area that you intend to work in?

Bjorklund: Yes.

Bibby: Well, yeah, I think that's really important because one key to franchise success in terms of the overall network is the question of what is the brand recognition where you are? I mean, if your franchisor is on the west coast and that's the focus of their business, and you're in Maine, and you open a unit up and you don't have any, you know, name support, you might as well just show up the business system, you might as well just opened your own. And also with that is something that a franchisee, especially new franchisees, tend to shoot themselves in the foot with is the issue of extra territory. Franchisees always want an extra helping of territory but rarely if the franchisor has done good profiling on what a territory looks like, rarely is that a good idea for the franchisee. Does that make sense?

Bjorklund: It does, it does. It means that they've pretty much studied the market and figured out, you know, how many units should be in a particular area, how many pretzels or oil changes or whatever it is might be consumed by that number of people? It might be looking at population?

Bibby: I--that is, you--just nailed it.

Bjorklund: I did? Oh good.

Bibby: You nailed it for this reason. Surprisingly enough, most franchisors, outside of the great ones and some of the real smart new ones, never considered the word profile. Now, we know profiling is a word with our FBI investigations and so on. But I coined profiling, gosh; back in the early 80s with regard to franchising because I saw at the time that a company I was working with was spraying the world with advertising. And I said, wait a minute, wouldn't it be a lot better if we simply knew what we were trying to attract and went to where those people lived? And also, once those people came into the system, wouldn't it be wise if we knew exactly what the demographics of a quality territory would look like? So profiling and knowing what the dynamics of a good territory, exclusive territory would be, I think are critical issues.

Bjorklund: What can I expect from my franchisor? What's realistic to expect, at least the core things?

Bibby: Draw a line right down the middle of the paper. On the one side, you've got franchise fee and on the other side, you've got royalty fee. Now the franchise fee is, of course, your opening salvo. That's your first investment into the mind and training offered by the franchisor. Some of the things that you would be getting on that one side might be name, federally trademarked branding, meaning the logo, the mark, the upfront training, how do I run this business, help in setting up the business, the training manuals, perhaps an exclusive territory, those kinds of things that go into setting the business up. Then on the other side of the ledger, you've got royalty fees. And royalty fees are about ongoing support. At minimum, the franchisor should be able to demonstrate that you are receiving at least an equal amount of support and help back that you're paying. The best franchisors offer not only a dollar-for-dollar exchange or even better than that, but they also offer a psychic value because you know they're there and you're part of a community.

Bjorklund: Does it make sense when checking out a franchising opportunity, to talk to other franchisees to see how they're doing, to see how happy they are? I've read that you shouldn't necessarily follow up only on the referrals given to you by the franchisor.

Bibby: Well technically, a franchisor cannot direct you. I mean that would be, that's verboten, but many of them call, you know, talk to what they call singers who will sing their praises and probably get a healthy referral fee as a result of talking to a prospect. But it's an interesting question because, here's the truth of it. Franchisees and by the way, the UFOC is to provide a list of both current franchisees and past franchisees. So, with current franchisees, you have people who have learned the system. They're the cadre within the network. And they feel, and perhaps rightfully so in many cases, feel that they know what they're doing and really don't want to pay royalties anymore because they are satisfied that they don't need the franchisor. The other part of the party is the ex-franchisee and for the most part, these are your failures, these are the people who couldn't get along with the franchisor, found that it wasn't worth it and they're going to stab it as deeply as they can. So, is speaking to franchisees and ex-franchisees important? Yeah, it's an important part of your due diligence. But you have to take the comments with a grain of salt, and you know, if you have selective thinking or selective hearing, because you're in love with the concept, you'll probably going to just remember the people who told you how great it was.

Bjorklund: Exactly. Do I need to talk to an attorney or a CPA at some point in the process?

Bibby: My answer, of course, is yes because unless you're astute in reading the disclosure documents and the franchise agreement, you're going to miss a lot. And as I tell franchise or clients of mine, you should encourage people to read all of your documents not because you want people to come back and ask for changes but because you want them to understand what they're signing. So the answer is yes and of course, not too many people would or could buy a house without a realtor and a transactional attorney.

Bjorklund: Well, this is like a prenuptial sort of thing, isn't it? I mean...

Bibby: Yeah.

Bjorklund: I mean, it's like a prenup, we have to work things out.

Bibby: I think that's a great way at looking at it. I never thought of it in that way but that's true.

Bjorklund: Before we're out of time, I'm hoping you can identify a number of big red flags for people when they're investigating a franchise opportunity?

Bibby: I think that the biggest and this is not easy to look at and investigate. Well, let me back up. The first question is do I like the people I'm dealing with? Not in a salesy way, not the salesman's good, but when I visited the franchise company, did I feel clean and healthy after my visit or did I feel that I was there just to sign a check? So gut feeling is critically important with regard to the people. If you didn't feel comfortable with that franchisor, run to your next appointment.

Bjorklund: Trust the gut. Trust the gut.

Bibby: That's right. And next, if you're astute enough and this is the hard thing that I was going to mention a second ago, realize that most franchises; this is something rarely said, but realize that most franchises have a hole in them some place. If they were perfect systems that have sold ten thousand of them over and over again, whether it's marketing, whether it's support, whether it's technology, look for the complete picture. Can you justify to yourself that all of your issues will be fully and rightfully handled by the franchisor?

Bjorklund: So in closing, I just want to know besides advising people to take their time, and read these agreements, maybe consult with an expert, do your navel gazing, I forgot to mention that first; is there any place else you might send them to learn more general, get some general guidelines about the franchise industry and begin to understand some of the risks and benefits of owning a franchise?

Bibby: Yeah. Well, first of all, at the risk of really poor self-promotion, bibbygroup.com has one of the most intense sites in terms of page after page, well over a hundred pages of what about and how to's and this due diligence is really the key. Now, franchise.org which is the International Franchise Association, publishes really good information but don't forget they're pulling for their membership which is franchise orgs and also some franchisees. The good news is that the internet provides such incredible information. You could Google in XYZ franchise negative and find out all the problems or XYZ positive and find out the good stuff. So, if a person fails at their due diligence today, it's their problem. It's not because the issues weren't open to them.

Bjorklund: Well, thank you so much for joining me today. I really enjoyed learning all about this from you. Thank you again.

Bibby: Take care. Thank you very much.

Bjorklund: You've been listening to one of the top experts in the franchise industry, Nick Bibby. If you would like to give us feed back on this show or want to recommend a guest for a future podcast, send your emails to podcasts@AllBusiness.com. I'm Chris Bjorklund and thanks for listening.