How often we read about new franchise programs being launched, with the picture next to the article showing the owners proudly holding up the featured product, and heady numbers thrown around about franchise sales already made or the projected number of new units in the next 12 months. I can tell you that behind the PR curtain there is a scramble underway. The new franchisor is going up against well-established franchise machines and competing for the best-qualified franchise candidates. How can a new franchisor increase its chances of success? There are five critical areas that will make or break a new franchise program.
1. Pick your first franchisees very carefully. There is no greater predictor of the success or failure of a new franchise program than the thoughtful selection of the first franchisees in the program. If they are undercapitalized, inexperienced, or otherwise poorly qualified, their odds of succeeding are low — and they will hurt the franchise program when they fail.
I have seen young franchisors spend substantial sums building their new franchise business and then feel desperate to make franchise sales so they can recoup expenses. They take anyone who comes through the door, and after a few years end up terminating a high percentage of their first franchisees when they fail in the franchised business. This hurts everyone: Investors are disappointed, franchisees lose money (often irreplaceable life savings), the franchise program loses essential cash flow, and the disclosure of the terminations in the FDD discourages future sales.
And it may not end there. Franchisee business failures may also bring serious legal challenges to the franchisor. The franchisee may claim that some aspect of the franchise sale was deceitful or fraudulent or in violation of state or federal law. If you are put inexperienced owners into business, you run a high risk that these unsophisticated investors will make legal claims that they were somehow misled in the course of the franchise sale.
2. Know the rules of franchise sales cold. Selling a franchise has a set of rules and rituals that rival those of a Victorian minuet. Any new franchisor that casually takes on the task of granting a franchise without a thorough understanding of the rules of the dance will get its face slapped, hard. A misstep can lead to a world of legal hurt and possibly even bring down a young franchise program. The most popular targets of franchisee litigation seem to be understating the size of the franchisee’s investment (see Item 7 of the FDD); failure to register a franchise with the proper state franchise or business opportunity authority; disclosure timing; and, of course, that old standby, the financial performance representation (see Item 19 of the FDD). Rookie mistakes in franchise sales can have large consequences.
3. Understand your franchise documents. Far too many franchisors hurry into the sale of their program using lengthy legal documents that they only dimly understand. This is often a shortcoming of the advisors who help create the documents, but it’s a raw fact of franchise life for a new franchisor: It’s complicated. Executives at the helm of a new franchise program need to go to school on the entire field of franchising; there are good materials available, and some solid conferences throughout the year around the country.
4. Know the expenses you’re getting into. It is a rare franchise that is adequately capitalized for the strains of the first couple of years of a new program. The reason is very practical: Not only do you have the high expenses of becoming a franchisor, but the early months of a new franchisee relationship are the most demanding (read: training, more training, hand-holding, and problem solving) on the resources of the franchisor. Like any rocket leaving the grip of earth’s gravity, the greatest expenditure of energy is at launch. For your franchise program to reach escape velocity — especially if you are selective with new franchisees, see #1 above — takes a lot of money and resources, more than most new franchisors anticipate.
5. Protect your legal flanks. Spend the money for a complete professional search of the availability of your trademark for federal registration — one that includes a review of potential conflicting uses in the states — before granting your first franchise. Bumping into a competing trademark owner with superior legal trademark rights is the last surprise you or your franchisees need.
Work closely with legal counsel to complete each set of franchise agreement paperwork correctly. Far too many franchise agreements are incorrectly executed by both franchisors and franchisees who do not understand the legalities of corporate entities and limited liability companies, and their interaction with personal guarantees.
Review your Web site with legal counsel. State franchise regulators are focusing new energy on reviewing statements made on a Web site. California, in particular, is applying its own peculiar advertising standards to franchise Web sites.
Franchising is a tough business at the launch. Of the five steps discussed here, by far the most important is the first one — picking solid franchisees who are well-suited to your business concept. Capitalize adequately so you can be selective, and your new franchise program is already halfway into orbit.
Andrew Caffey is one of the nation’s leading franchise legal specialists and he represents franchisors across the United States. Caffey served as General Counsel of the International Franchise Association, a member of the Governing Committee of the ABA Forum on Franchising, and Chair of the ABA Forum on Franchising. He also is a member of the bar in Maryland and the District of Columbia, and a member of the Panel of Neutrals of the American Arbitration Association. Caffey has appeared on numerous franchise programs and is a frequent speaker and author on subjects of franchise and business opportunity regulation.