Software Club 210: Light Red/Club_Software_210_Light_Red_Micro_Star_1997.iso/sba/f425.sbe

Text File | 1997-01-27 | 12.9 KB | 329 lines

           ┌─────────────────────────────────────────┐
           │  INVESTIGATION OF FRANCHISE OFFERINGS:  │
           │  THE FRANCHISOR'S DISCLOSURE DOCUMENT   │
           └─────────────────────────────────────────┘

Before you invest in any franchise system, be sure to get
a copy of the franchisor's disclosure document, sometimes
called a Franchise Offering Circular.  Under the Federal
Trade Commission's (FTC) Franchise Rule, you must receive
this document at least 10 business days before you are
asked to sign any contract or pay any money to the
franchisor.  Take your time and read the entire disclosure
document.

The following outline should help you to understand the key
portions of typical franchise disclosure documents.  It
should also help you to be able to ask important questions
about the disclosures.  Because much of the disclosure
document may be written in legalese that you will not fully
understand, take it to your lawyer or other trusted advisor
if you are unclear as to what any part of it means.

Don't invest until you get a clarification or answer to your
concerns!

BUSINESS BACKGROUND.  This part of the disclosure document
identifies the executives of the franchisor and describes
their prior business experience.  Pay attention to whether
they have experience in managing a franchise system, not
just whether they possess a general business background.
You will also want to know how long they have been with the
company, since you may be more at risk investing with an
inexperienced franchisor than one with a long, successful
track record in the franchising business.

LITIGATION.  The document must also disclose any prior
litigation involving the franchisor or its executives,
relating to franchise relationships.  In addition, it
tells you if the franchisor, or any of its executive
officers, have been convicted of felonies involving, for
example, fraud, violations of franchise laws, or any
unfair or deceptive practices law.  It also must tell you
if they are subject to any state or federal injunctions
involving similar misconduct.  If the company or executives
have had a significant number of litigation claims against
them, it may indicate that they have frequently not
performed according to their agreements, or, at a minimum,
that the franchisees have been very disappointed with
their performance.

BANKRUPTCY.  The disclosures must tell you if the
franchisor or any of its executives have recently been
involved in a bankruptcy.  If they have, be wary, as they
may not be financially stable, and may thus be unable to
deliver on their promises to you.

COSTS.  The document must tell you about the various costs
you will incur to start one of the company's franchises.
Be sure the disclosure mentions all the following items,
or, if leaves out any of them, you may want to inquire as
to whether you will be incurring such costs and, if not,
a satisfactory explanation as to why not.

  . Initial deposit or franchise fee (which may or may
    not be refundable);

  . Continuing royalty payments to the franchisor;

  . Costs for initial inventory, signs, equipment,
    leases, or rentals;

  . Advertising payments, to both local and national
    advertising funds, if applicable;

  . Grand opening or other such initial promotional
    expenses;

  . Product or service supply costs;

  . Business or operating licenses;

  . Discretionary equipment, such as computer network
    or burglar alarm system;

  . Training costs;

  . Legal, financial and accounting fees;

  . Insurance;

  . Costs of compliance with local ordinances, such as for
    waste removal, or zoning, fire and safety codes;

  . Employee salaries and fringe benefits, and related
    payroll taxes;

  . Employee salaries and benefits; and

  . Rent for business premises, and occupancy costs such
    as utilities, property taxes, maintenance, and
    janitorial costs.

Your accountant may be able to help you evaluate this
information and whether the disclosures appear to be
reasonable and realistic.

OPERATING RESTRICTIONS.  The franchisor may restrict how
you operate your business, in a number of ways.  The
disclosure document will tell you if the franchisor limits
the supplier of goods from whom you may purchase; the
goods or services you may offer for sale; which customers
you can offer goods or services to; or the territory in
which you may sell.  Be sure you understand any such
limitations or restrictions, and think through how they
will affect your ability to operate the franchise outlet
profitably.

TERMINATION.  The document must tell you the conditions
under which the franchisor may terminate your franchise,
and your obligations after such a termination.  It will
also tell you the conditions under which you will be
allowed to renew your franchise, or to sell or assign the
franchise to other parties.

TRAINING AND OTHER HELP FROM THE FRANCHISOR.  The document
will explain the training and assistance program, if any,
offered by the franchisor.  Questions you may want to
have answered would include the following:

  . What kind of ongoing training will the franchisor
    offer, and what will it cost you?

  . Who will teach the training courses, and what
    qualifications and experience do they have?

  . How many employees are eligible for training?

  . Can new employees also receive training, and,
    if so, at what additional cost, if any?

  . How long do training sessions last?

  . Will someone be able to come to your place of
    business to provide more individualized, hands-on
    assistance?

  . How many support personnel are assigned to your
    area by the franchisor?

  . To whom can you speak if problems arise?

If the franchisor's disclosures or responses to the above
questions leave you with doubts that the training will be
sufficient to handle day-to-day business operations, you
probably should consider a different franchise opportunity
more suited to your background, or one offered by a company
with a better training and support program.

ADVERTISING.  Often, franchisees are required under a
franchise agreement to contribute a percentage of their
business income to an advertising fund.  Generally, you
will have little, if any, control over how this money is
spent, and you may feel that it is not being spent in a
way that benefits your franchise.  Often, franchisors
use such funds to advance their own agenda, or look upon
it as another way to extract more funds from their
franchisees, in addition to royalty fees.  Questions to
ask in this regard should include the following:

  . How much of the advertising fund is spent on
    administrative costs?

  . What other expenses, if any, are paid from the
    advertising fund?

  . Will you have any control over how the money is
    spent on advertising?

  . What kind of advertising has the company done
    in the past, and what is planned in the near
    future?

  . What part of the fund is spent on national
    advertising, and how much is spent in your
    market area?

  . What part of the fund goes to promote sales of
    more franchises?

  . Do all franchisees contribute equally to the fund?

  . Will you need the consent of the franchisor to
    conduct your own advertising?

  . Does the franchisor receive commissions or rebates
    when it places advertisements?  If so, do franchisees
    benefit from such commissions or rebates, or does the
    franchisor retain them for itself?

CURRENT AND FORMER FRANCHISEES.  It can be very informative
to know if there has been a lot of turnover (or very little
turnover) in the number of franchisees, due to terminations,
bankruptcies, or non-renewals.  Also, you will be keenly
interested in how many franchisees there are, or how many
will be allowed, in your area, as there may be more
competition than you would like.  Note that some franchisors
may attempt to conceal the number of failed franchises by
repurchasing them and running them as company-owned outlets.

The disclosure document will give the names and addresses of
current franchisees and those who have left the system within
the last year.  Speaking with a fair number of current and
former franchisees about their experience with the franchisor
will often tell you more about the merits of the franchise
opportunity than any number of disclosure documents, so be
sure to contact a number of them and find out how they are
doing, or why they ceased to be franchisees, in the case of
former franchisees.

EARNINGS POTENTIAL.  Franchisors are not required to make
any claims about what you are likely to earn.  However, if
they do, the FTC rules require them to have a reasonable
basis for any such claims, and to give you a document that
substantiates their claims.  Make sure, if you have been
told how much money you will make, that you get any such
claims IN WRITING.  Also, find out how many franchisees
earned as much as or more than the "average" earnings the
franchisor discloses.  If there are a relatively small
number of franchisees, and a few are making huge profits,
this can mask the fact that most franchisees are making
little, if any money, if a "mean average" amount is given.
A "median" earnings number would be more representative
of the typical results of franchisees in the system,
rather than a "mean average" number that can be distorted
by a few very successful franchise outlets.  A "median"
figure of $60,000 means, in effect, that half of all
franchisees made more than $60,000, and half made less,
and is thus not distorted by a few unusually high
earners.

Disclosures usually will not mention net profits, only
gross sales.  Thus, it is very important that you have a
good understanding of what your operating costs will be,
since it may take a large amount of gross sales to
generate a decent profit, if profit margins are very
low in the type of business in question.  Also, if the
document does disclose net profit figures, ask if they
include the results from company-owned outlets.  If so,
the figures may be misleading, since the company-owned
outlets may be much more profitable than the franchised
outlets for a variety of reasons, such as ownership of
their property, which would mean they would not have
rental expenses; or, they may be renting their premises
at bargain rates from the parent company.

Your job is to unpaint the carefully painted picture, and
find out what other franchisees like you are actually
making, as net profits.

FINANCIAL HISTORY.  The disclosure documents will provide
you with important information about the company's financial
situation, including audited financial statements.  Unless
you are a financial professional, these statements probably
will not tell you very much, so it is a good idea to have
your accountant review them and give you his or her opinion
as to the financial status and prospects for the franchisor
company.

For further information on analyzing franchise opportunities,
write to:

        International Franchise Association, Inc.
        1350 New York Avenue, Suite 900
        Washington, D.C. 20005.
        Telephone: [phone]

Or, request the booklet entitled "A CONSUMER GUIDE TO
BUYING A FRANCHISE," published by the Federal Trade
Commission.  You can obtain a copy from the Regional
Office of the FTC in a number of major cities, or write
to FTC headquarters, at:

        Federal Trade Commission
        6th & Pennsylvania Avenue, N.W.
        Washington, DC 20580
        [phone]
        TDD [phone]

Also, the "FRANCHISE OPPORTUNITIES HANDBOOK" is available
for purchase from the U.S. Government Printing Office,
Washington, D.C. 20402.  This useful publication offers
descriptions of hundreds of different franchises listed
by category, and provides a checklist for evaluating a
franchise.

FINAL PRECAUTIONS:  Here are general basic precautions
you should take before investing in a franchise:

  . Study the required disclosure statement and proposed
    contracts carefully.

  . Consult with an attorney and other professional
    advisors, as necessary, before you make any binding
    commitment.

  . Be sure that all promises made by the seller are
    clearly written into the contract.

  . Be wary of all earnings claims, and investigate them
    carefully.

  . Resist pressure from the franchisor to close the deal
    before you have had a full opportunity to examine all
    the facts and consider reasonable alternatives.

  . Be sure you buy exclusive rights, and that the product
    or service in question sells elsewhere under similar
    circumstances.

  . Finally, comparison-shop for other franchises in the
    field, and for similar opportunities not franchised.

When making any major business decision, and especially
when entering into a franchise agreement, it's good to
keep in mind an old Arab proverb:  "Trust in Allah.  But
always tie your camel."