“Worry about the dollars and the pennies take care of themselves.” — anonymous
It’s worthwhile to keep that adage above in mind when you are being pitched to buy a franchise business.
One of the most costly mistakes veterans can make is paying too much upfront for a franchise that you can’t sell for the same price the next day. It’s the venture equivalent of buying a used Chevy for the price of new BMW.
I hate it when I receive letters from veterans who “want out” of a franchise they just bought. They feel snookered, trapped, and annoyed at themselves for not looking at the details before signing on the dotted line.
The best way to avoid buyer’s remorse is to become a smart shopper of franchise opportunities. Here are five tips to help you assess if you are more likely to make money or lose money in the franchise world.
1. Set higher standards
If your objective is to merely “go into business for yourself” or “own a franchise” then your aspirations are not high enough to be a successful business owner. After all, you will achieve your goal of business ownership the day you sign the franchise contract! Then what?
A more purposeful objective is to own a franchise that will make money for you. When you set high standards for your financial return on your invested time and savings your tire-kicking “due diligence” questions become more precise and purposeful.
2. Understand sales rep motivations
When you start to explore different franchise opportunities, you will come in contact with franchisor representatives and business brokers who have just one purpose—to sell you a franchise as fast as possible. These individuals are not your trusted friends or unbiased financial advisors. Certainly don’t sign any franchise agreement without prior review from an experienced corporate attorney who understands franchise valuations and royalty obligations.
3. Add up cost of acquisition
Sneaky franchise brokers are adept at hiding the true investment cost of a franchise purchase. If you sign up to buy a franchise, your cost of acquisition is more than the down payment. Include the amount you have to borrow to acquire the franchise plus other savings you may have to apply to the business until it achieves at least cash flow breakeven. (when net sales revenues exceed expenses every month) This is the total amount you will have at risk in your new business. How comfortable are you with this amount? What would happen if you lost it all?
4. Evaluate owner’s compensation
Another trick of franchise sales reps is to present impressive financial projections of average franchise unit performance. Look closely at these projections. Do they include a budget allocation for the owner’s salary, healthcare, adequate insurance and other real world expenses associated with running a business? If there is no allocation for an owner’s salary and benefits and you intend to work full time in the business, beware!
Remember, year-end profits should be your financial return on your invested capital, not your sole source of compensation for working 40 to 70 hours a week to keep the franchise alive! Of course, the business could fail to generate a profit too which means you as the founder earns nothing for a lot of work.
5. Understand market value
Buy low, then sell high. If you pay $25,000, $50,000, or $100,000 to buy into a franchise, then you should find evidence that other franchises can be sold at least for that much or more. Unfortunately, the opposite is often true.
Research the market for this brand of franchise. What are the average resale purchase prices in your state? Who buys up franchises when the owner wants out? Does the corporate office buy back franchises? What does the franchise agreement call for? Frequently, one regional franchise operator buys distressed properties at deep discounts.
Given all the risks associated with owning a business and personal obligation to repay debt, you should walk away from any franchise that cannot eventually be sold for at least two times your invested capital.
Unfortunately, I get too many letters from franchise buyers who are desperate to get out of a money-losing franchise. They realize they overpaid for a franchise usually within a year of purchase. They didn’t pay attention to the quantitative issues where they could lose hard cash because the sales reps kept their attention on how great it will be to at last be the boss of a money making business. At the end of the day, they didn’t make any money and didn’t have any fun as a business owner.
Now you know better.
Susan Schreter is a devoted Yellow Ribbon Reintegration Program workshop presenter and founder of Start on Purpose, a service organization that empowers business owners anywhere in America to find and manage business funding with confidence. Connect with her at Susan@StartonPurpose.