With this being my first article on AllBusiness.com, I want to set the tone for our continuing dialogue. I will be honest with you on what I think is right and what I think is wrong about some of the practices in franchising. You will find that even though my firm earns its living primarily as advisors to both companies looking to become franchisors as well as to many of the leading franchise brands in the U.S. and internationally, we and our clients know well that it is in everyone’s interest that potential franchisees understand what franchising is all about before they make an investment.
Franchising can be somewhat complicated — it’s actually a bit of an art form — and in many ways the culture of the franchisor is as important for success as the particular business being offered through the franchise system. Likewise, it’s important that potential franchisees understand the franchise relationship and not fall into the trap of thinking that all franchise opportunities are the same or equally good investments.
Careful evaluation when selecting an opportunity is critical to anyone wanting to be successful as a franchisee. In future articles, I’ll share my thoughts on how to make a smart franchise selection, as well as advice on a host of issues that often arise within the franchise relationship. In addition, I will discuss how to manage a franchise business for success. My hope is that my articles will become a dialogue among friends, helping you become more profitable — and excited — by your franchise investment.
Franchising Done Badly
Bearing in mind that there can’t be a franchisee until there is a franchisor, let’s begin our dialogue from that vantage point: how to become a franchisor. And to mix things up, let’s look at the negative side of franchising by learning how not to do it, and how easy it is to do badly. If you’re new to franchising, you may be alarmed and possibly even angry. Don’t be. As our dialogue continues over the coming months, I promise that you will begin to understand why franchising works so well in the U.S., and I will provide you with tips to manage and grow a sustainable franchise system and become a great franchisor.
A few months ago, I was reading a franchise blog and noticed that I had been quoted as saying that “anything can be franchised.” What I had actually said was, “anything can legally be franchised.” And the point I was trying to make was that there are no legal standards in the U.S. for who can become a franchisor.
People new to franchising are generally surprised to find that in the U.S., you are not required to have ever operated the business you want to franchise. Your entire franchise offering can be based on a dream you once had, or maybe even a cartoon character you like (don’t laugh — this has happened). It’s not even a legal problem if you have no experience at all in the business you’re hoping to franchise and have not conducted any research into whether anyone is even interested in buying your products or services. You just need an idea and someone willing to invest in becoming your franchisee.
But let’s assume that you do have a business, and today is its first anniversary. Congratulations! Unfortunately, your business did not make a profit last year and you really aren’t sure when it will break even, let alone make money or give you a return on your investment. Can you still franchise it? Sure. Having a profitable business is not a legal requirement for become a franchisor.
But don’t you have to tell prospective franchisees how much money they will make? No. There is no legal obligation to share your sales with prospective franchisees, or whether any of your units made any money at all. The vast majority of franchisors in the U.S. don’t tell their prospects anything about unit economics. And, even without knowing if the business can make money, prospective franchisees make franchise investments every day. Remember, a great franchise salesperson has sold many franchises, and it’s likely that most buyers are making their franchise purchase for the first time. Even Yugo cars found more than a few buyers.
Beware of Sketchy Franchise Practices
No, franchising is not the Wild West, and I don’t want you, despite this negative perspective, to get the sense that I am unenthusiastic about franchising. Franchising is, after all, a very important and successful part of our economy. This is because most franchisors are well structured and have business practices in place to develop and manage great franchise systems. But it is important to understand that the franchise laws in the U.S. mainly focus on presale disclosure obligations, and that not all franchisors are well structured or well managed.
There are quite a few franchisors that most people in franchising wish had never been franchised, because bad franchisors hurt the vast majority that offer great opportunities. To offer a franchise in the U.S., all you legally need to do is prepare some government-mandated paperwork and give it to your prospective franchisees before they sign the franchise agreement.
Legally, companies do not need a lawyer to draw up franchise documents, and they certainly don’t need a franchise advisory firm like mine to design and structure the underlying business and franchise offering. While working with qualified franchise lawyers and franchise consultants is extremely important for your long-term success as a franchisor, you can actually buy a set of fill-in-the-blank documents that are sold in the back of magazines, (generally near the ads that sell flash frozen miniature sea horses that come to life in warm water), or go online and download other companies’ franchise disclosure documents and agreements and modify them for your own purposes.
There are even franchise packaging shops and franchise brokers that will provide you with boilerplate strategies and legal documents, manuals, and marketing materials that they “customize” for you. Be careful, though. These are paths that do not generally lead to success and what you will likely have in a few years is simply a missed opportunity. For the sake of your stakeholders and your future franchisees, take your time, work with professionals, and develop your franchise system with care.
Don’t Rely on Franchise Regulators
You might expect in a regulated environment like franchising that federal and state regulators would sniff out the bad opportunities before they came to market and those franchisors’ documents wouldn’t pass regulatory muster. The first reality is that it’s not the role of any government regulator to decide what is a good franchise investment and what is a bad one. The second reality is that even if a regulator had the talent, or the crystal ball, or the right to pick and choose which franchisors are going to be successful, no one at the federal level, and very few at the state level, will ever see your franchise documents before you give them to a potential franchisee.
The Federal Trade Commission never gets to see your disclosure documents before you use them and most states have no requirement for you to send them disclosure documents. In the U.S. regulatory scheme, only a handful of states require you to submit disclosure documents and receive their permission before you can offer franchises in their states, and some of those states don’t even review them. These filing states are really only looking to collect a filing fee.
As we will discuss in future articles, the rules regarding franchising generally only deal with the required types of disclosures and the process you must follow in making your franchise offering to a prospective franchisor. This may sound like a terrible situation that puts potential franchisees at risk, but in reality, since franchise disclosure laws were enacted, franchising in the United States has been transformed into a legitimate and, arguably, extremely safe form of investment.
But the rules governing franchising do not guarantee that the underlying business is sound, or that the franchisor has the experience, skills, or resources to be effective. All the rules do is ensure that a prospective franchisee have information upon which to investigate a franchise opportunity and to make an informed decision on whether or not to invest in a particular franchise system. In future articles, we will explore what is required to be a great franchisor from a business perspective and how to select the right franchise, among many other issues.
I look forward to our continuing dialogue.
I would like your feedback on my articles as well as your questions. Please email me at firstname.lastname@example.org and I will try to address your questions in future articles.
Michael Seid is the managing director of MSA Worldwide, a domestic and international franchise advisory firm, and the author of Franchising for Dummies. He is past chair of the International Franchise Association’s Supplier Forum, has served on the IFA’s Executive Committee, and was recently re-elected to its board of directors. Seid also serves on the boards of the Health Store Foundation, CFWshops, and the One World Foundation, which have developed more than 90 franchised clinics providing medical services in rural Kenya, Rwanda, and Uganda. As part of its social mission, MSA consults with social franchisors in developing countries to make a world-changing impact on poverty, health, and economic development.