Franchise Seekers Should Go into the Discovery Process With Eyes Wide Open
Every industry has its black sheep story or warts. Franchising is no exception. There may even be more disdain for franchising due to stories about people who had terrible experiences as franchise owners. But these black eyes tend to be rare occurrences. Just like negative Amazon or Yelp reviews, it is far more interesting to yell from the rooftops when unhappy with something. But it is essential to understand the downsides of franchising and discuss reasons why a franchise can go down in flames.
1. Franchisee Success is not Written in Stone
Owning a franchise is risky business. There are grim statistics about the failure rate of entrepreneur businesses making it through the first year. How do franchises stack up against that? Item 20 of the Franchise Disclosure Document (FDD) will list all franchise owners. It’s important to note how many have ceased operating or were terminated. With an older franchise, you could have a high rate of owners who retired after renewing their agreement two or even three times, and now they are done. That is quite different from someone who bought into the system and never got up and running. If you are working with a young franchise with very few owners, that adds to the risk of that franchise since there is limited proven history.
2. A Non-Disparagement Clause Could Hide Facts
Buried in the franchise agreement along with a non-compete could be a non-disparagement clause. This states that you will not say anything negative about the company, their service, etc. This is a problem since one of the most important steps in franchising is the validation process. During validation, you can speak to franchise owners past and present to discuss their experience with that franchise. If you reach out to a franchise owner who signed a non-disparagement clause, he may not return your call or your conversation might be quite benign without the insight you deserve.
3. There’s a Lack of Control
As a franchise business owner, there are areas out of your control that can impact your business. Management changes, acquisitions, supply chain issues, marketing strategy tactics, consumer habits, and of course, labor market concerns are just a few examples that can keep you awake at night. Unlike independent business owners, franchise owners have no authority over unforeseen changes or how the franchisor runs the system.
4. It’s Time Consuming
Franchising is an awards process. It is not a selling situation. Be mindful that it is still critical to the franchisor to keep the puzzle pieces moving to grow and scale the overall company. Once you commit yourself to digging into a few concepts, be mindful of deadlines. Concept review is a timely process, especially if you are working full-time. You will have calls that can last up to an hour, videos to watch, and owners to speak to when it comes time for validation.
As it becomes clear that you are getting more serious about a brand, enlist a franchise attorney to review the FDD and Franchise Agreement so you can move through that process appropriately. Check the wording, and see if there is an expiration to that offer. That is not a heavy-handed sales trick. If you do not decide within that timeframe, then the franchisor has the right to award your territory to someone else.
Franchising is not all doom and gloom, but investors should be armed with knowledge and understand the downsides.
5. You Will be Accountable
Following is text from a Franchise Agreement:
“WE REQUIRE THE FRANCHISEE AND THEIR SPOUSE TO EXECUTE A PERSONAL GUARANTY MAKING SUCH SPOUSE JOINTLY AND SEVERALLY LIABLE FOR ALL OBLIGATIONS OF THE FRANCHISEE UNDER THE FRANCHISE AGREEMENT, WHETHER OR NOT SUCH SPOUSE IS INVOLVED IN THE OPERATION OF THE FRANCHISE BUSINESS. THIS PLACES THE PERSONAL ASSETS OF THE FRANCHISE OWNER AND THEIR SPOUSE AT RISK.”
This text is in caps to denote the seriousness of the statement and the contract that you are about to sign. It should not be taken lightly, and an attorney should review this document thoroughly. This is not a boilerplate statement. This is easily enforceable and can cause devastation in the form of bankruptcy or worse, such as losing your home.
It does not matter if you create an LLC, S-Corp, or C-Corp. This is a personal guarantee that if you do not meet the financial obligations stated in the agreement, the franchisor can take your franchise away, put a lien on your home and garnish the wages of your spouse. You are thinking…why would anyone sign this? Because it is not something that a franchisor wants to enforce. If they do, then it must be disclosed in Item 3 of the FDD.
In your franchise discovery process, look for warning signs. For example, if the franchisor has several lawsuits against franchisees for lack of royalty payments or failure to open territories in the agreed timeframe, it’s worrisome. A laundry list of lawsuits shows that there is a problem within the system itself and the franchisor isn’t skilled at handling disputes.
Franchising is not all doom and gloom, but investors should be armed with knowledge and understand the downsides. There are more than 650,000 franchise owners in the United States, and it continues to be an incredible source of income and stability to our economic growth.
Go into the franchise discovery process with your eyes wide open. Be sure to have a reputable franchise attorney by your side, guidance from a knowledgeable franchise consultant, and a CPA who can help you strategize for success.
“The truth hurts. And much more than love, kindness, or any of these warm feelings you’re so fond of, truth is beauty, and the thing that will set you free.” ― A.D. Aliwat