How to Research New Franchise
Protect yourself by learning what a new franchise business opportunity really is, how
the government regulates new franchise businesses including retail franchises, and the
proven business ownership steps required to ensure successful new
ownership. Find new franchise, review available franchise opportunities
and get started in owning a new franchise business.
Just what is a
new franchise business
opportunity? That question has plagued a great
many people trying to decide whether to buy a current independent
business, a franchise, or what we'll refer to in this text as a new
To allay the confusion, we offer a simple analogy. Think back
to elementary school when your teacher was explaining the difference
between a rectangle and a square. A square is also a rectangle, but a
rectangle isn't necessarily a square. The same relationship exists between
business opportunities, independent businesses for sale and franchises.
All franchises and independent businesses for sale are business
opportunities, but not all business opportunities meet the requirement of
being a franchise nor are they in the strictest sense of the word
independent businesses for sale.
Making matters even more confusing is the fact that 26 states have
passed laws defining business opportunities and regulating their sales.
Often these statutes are drafted so comprehensively that they include
franchises as well.
Not every state with a new franchise
business opportunity law defines the term in the
same manner. However, most of them use the following general criteria to
1. A new franchise business opportunity involves the sale or lease of any product,
service, equipment, etc. that will enable the purchaser-licensee to
begin a business.
2. The licensor or seller of a new
franchise business opportunity declares that it
will secure or assist the buyer in finding a suitable location or
provide the product to the purchaser-licensee.
3. The licensor-seller guarantees an income greater than or equal to
the price the licensee-buyer pays for the product when it's resold and
that there is a market present for the product or service.
4. The initial fee paid to the seller in order to start the
new franchise business opportunity must range between $400 and $1,000.
5. The licensor-seller promises to buy back any product purchased by
the licensee-buyer in the event it cannot be sold to the prospective
customers of the business.
6. Any products or services developed by the seller-licensor will be
purchased by the licensee-buyer.
7. The licensor-seller of the new
franchise business opportunity will supply a
sales or marketing program for the licensee-buyer that many times will
include the use of a trade name or trademark.
The laws covering new
new franchise business
opportunity ventures usually exclude the
sale of an independent business by its owner. Rather, they are meant to
cover the multiple sales of distributorships or new businesses that do not
meet the requirements of a franchise under the Federal Trade Commission (FTC) rule passed in 1979. This act defines new business offerings in three
formats: new package franchises, new product franchises and new new
learn more about the
rules and regulations
for franchise and new
according to the federal
trade commission, visit
the Federal Trade
In order to be a new new franchise business
opportunity venture under the FTC rule, four
elements must be present:
1. The individual who buys a new franchise business opportunity, often referred to as
a licensee or franchisee, must distribute or sell goods or services
supplied by the licenser or franchisor.
2. The licensor or franchisor must help secure a retail outlet or
accounts for the goods and services the licensee is distributing or
3. There must be a cash transaction between the two parties of at
least $500 prior to or within six months after the licensee or
franchisee starts the business venture.
4. All terms and conditions of the relationship between the licensor
and the licensee must be stated in writing.
You can readily see that the sale of business opportunities as defined
by the FTC rule is quite different from the sale of an independent
business. When you're dealing with the sale of an independent business,
the buyer has no obligations to the seller. Once the sales transaction is
completed, the buyer can subscribe to any business operations system he or
she prefers. There is no continued relationship required by the seller.
new franchise business opportunity ventures, like franchises, are businesses in which
the seller makes a commitment of continuing involvement with the buyer.
The FTC describes the most common types of
new franchise business opportunity
ventures as follows:
Distributorship. Refers to an independent agent that has
entered into an agreement to offer and sell the product of another but
is not entitled to use the manufacturer's trade name as part of its
trade name. Depending on the agreement, the distributor may be limited
to selling only that company's goods or it may have the freedom to
market several different product lines or services from various firms.
Rack jobber. Involves the selling of another company's
products through a distribution system of racks in a variety of stores
that are serviced by the rack jobber. Typically, the agent or buyer
enters into an agreement with the parent company to market their goods
to various stores by means of strategically located store racks. The
parent company obtains a number of locations in which the racks are
placed on a consignment basis. It's up to the agent to maintain the
inventory, move the merchandise around to attract the customer, and do
the bookkeeping. The agent presents the store manager with a copy of
the inventory control sheet which indicates how much merchandise was
sold, and then the distributor is paid by the store or location which
has the rack-less the store's commission.
Vending machine routes. Very similar to rack jobbing. The
investment is usually greater for this type of new franchise business
venture since the businessperson must buy the machines as well as the
merchandise being vended, but here the situation is reversed in terms
of the pay procedure. The vending machine operator must pay the
location owner a percentage based on sales. The big secret to any
route deal is to get locations in high-foot-traffic areas, and of
course, as close to one another as possible. If your locations are
spread far apart, you waste time and traveling expenses servicing
In addition to the three types of business opportunities listed above,
there are four other categories you should be aware of:
Dealer. Similar to a distributor but while a distributor may
sell to a number of dealers, a dealer will usually sell only to a
retailer or the consumer.
Trademark/product licenses. Under this type of arrangement,
the licensee obtains the right to use the seller's trade name as well
as specific methods, equipment, technology or products. Use of the
trade name is purely optional.
Network marketing. This is a generic term that covers the
realm of direct sales and multilevel marketing. As a network marketing
agent, you would sell products through your own network of friends,
neighbors, co-workers and so on. In some instances, you may gain
additional commissions by recruiting other agents.
Cooperatives. This business is similar to a licensee
arrangement in which an existing business, such as a hotel or hardware
store, can affiliate with a larger network of similar businesses,
often for the sole purpose of advertising and promoting through a
The FTC Rule, which has been in effect since the latter part of 1979,
has had a broad-ranging impact on the franchise and new franchise business
industry and would-be franchisees and licensees. The rule is designed to
assure all prospective buyers, of either a franchise or new franchise
business opportunity, that they'll receive a full disclosure containing the type of
background information needed to make an informed investment decision.
In spite of the FTC's rule and aggressive action at the state level,
there are sellers who seek every possible means to escape regulation.
Neither the FTC rule nor state regulations can guarantee freedom from
fraud. That's why you should pay especially close attention to the FTC
disclosure statement that is presented to you.
Every prospective buyer of a new franchise
business opportunity must receive the FTC
disclosure statement at least 10 business days before signing a binding
contract or paying money (or other consideration) to the seller. The
10-business day requirement is minimal. If you meet face-to-face with the
licensor or a representative to discuss a proposed sale or purchase of the
new franchise business opportunity, and if the conversation results in a serous sales
presentation, the licensor must provide you with a disclosure document at
If you haven't received an FTC disclosure document, don't sign anything
or pay out any money, even if claims are made that it is
If the seller doesn't give you a disclosure document, they're violating
federal law and may also be violating state law. If the salesperson claims
his or her offering is exempt from the FTC requirements, demand to see an
opinion letter from counsel before dealing with them any further. Also ask
the salesperson for the phone number of the local state agency or FTC
office that has advised them they are exempt. Very few new franchise
business opportunity offerings are exempt. The only major exceptions are those
where the total initial payment within the first six months is less than
$500, or where payment is made only for initial inventory sold at bona
fide wholesale price.
As a rule of thumb, a franchisee receives more support from the parent
company, gets to use the trademarked name, and is more stringently
controlled by the franchisee. New franchise business opportunities, on the other hand,
don't receive as much support from the parent company, generally aren't
offered the use of a trademarked name, and are independent of the parent
company's operational guidelines.
As we've previously noted, there are numerous forms of
new franchise business opportunity ventures. Some are even turnkey operations similar to a lot of
package-format franchises. These business opportunities provide everything
you could possibly need to start a business. They help you select a
location, they provide training, they offer support for the licensee's
marketing efforts, and they supply a complete start-up inventory.
Unlike a package-format franchise, however, these types of
new franchise business opportunity ventures aren't trademarked outlets for the parent company.
The company's name, logo and how it's legally operated are left solely to
the licensee. Many times the only binding requirement between the seller
and the buyer is that inventory be purchased solely through the parent
company. Of course, all these stipulations are outlined in the disclosure
statement and contract.
Requires a lower initial fee than a franchise. Although the
number of low-investment franchises has increased, the fee to get into
a new franchise business opportunity is still considerably lower. The FTC requires a
$500 minimum investment for an opportunity to be considered a new
franchise business opportunity, but there are many that fall under this set fee, although
most average around $2,000 to $3,000.
A proven system of operation or product. Existing systems
serve to maximize efficiency and returns and minimize problems. It's
simply a matter of passing on experience, still the best teacher.
Whether they admit it or not, most people like having their hands held
once in a while. During crises, the parent company is there to help
the licensee over the bumps. Many people like this idea of safety in
Intensive training programs. In any new business, a lot of
time and money are consumed during the learning period. A good new
franchise business opportunity venture can eliminate the majority of ineffective
moves through an intensive training program.
Better financing options. Because of its financial size,
credit line and contractual agreements, the parent company offering
the new franchise business opportunity can often arrange better financing than an
individual could obtain. Financial leverage is an important
consideration in any investment situation.
Professional advertising and promotion. Most small
businesspeople don't spend sufficient money on advertising. When they
do, their efforts are often poorly conceived and inconsistent. Many
new franchise business opportunity ventures supply the buyer with print advertising
slicks, radio ads, TV storyboards, etc., in order to provide a better
marketing effort. Some new franchise business opportunity ventures will even have a
cooperative advertising agreement under which they will split the cost
of print, radio or TV ads. This type of marketing help is especially
beneficial in large metropolitan areas where the cost of media is
prohibitive to the one-shop owner.
Ongoing counseling. Most new
franchise business opportunity ventures offer
support not only through training but also through counseling from a
staff of experts who offer assistance that no independent could
afford. Legal advice is available to a certain degree. The most
efficient accounting systems—perfect for that particular
business—have been designed by experts in the field. Some licensors
offer free computer analysis of records, and through comparison with
other units can pinpoint areas of inefficiency or loss as well as
profitable aspects of the business that are being neglected.
Franchise Site selection assistance. Experts in site selection and
marketing choose locations using all the scientific tools available.
Professional negotiators arrange leases and contracts to the best
advantage, using the power of a large organization to influence
landlords and other important figures.
Franchise Business Purchasing power. Many times, the parent company's tremendous
buying power and special buying techniques can bring products,
equipment and outside services to the licensee at a much lower cost
than an independent could ever get.
No ongoing Franchise royalties. In a
new franchise business opportunity, unlike in a
franchise, there are no ongoing royalties to pay to the seller. The
profits are all yours.
Under ideal conditions, business opportunities are a good,
low-investment way to get into business with minimum risk and a good
chance for success. But nothing in this world is perfect, so here are some
problems that can be expected:
Poor Franchise site selection. The majority of business opportunities
are consumer-oriented retail operations which rely on good location,
visibility and easy access to the establishment. Most buyers of
business opportunities casually accept the locations chosen for them.
DON'T! Look it over thoroughly yourself. You might even hire an
outside marketing consultant to evaluate and possibly argue with the
parent company's choice. Having a better locations could literally
mean millions of dollars in profit over the course of 20 years.
Lack of ongoing Franchisee support. There is usually no requirement for
the new franchise business opportunity seller to offer ongoing support of any kind.
If the seller decides not to supply information or guidelines that
could help you once you're in operation, you may not have much
recourse available to you.
Franchise Exclusivity clauses. Are you restricted to selling only the
manufacturer's merchandise? If this is the case and you deviate for
any reason whatsoever, you run the risk of the licensor canceling the
agreement. If you do buy from other sources, it will be very hard to
hide—most parent companies will require you to open your books for
examination at pre-designated periods of time. Any irregularities will
be spotted at these times. Most smart buyers of business opportunities
will negotiate the point in the agreement stipulating sources of
supply in case product quality is inconsistent.
Franchise Parent-company bankruptcy. Another pitfall is the
possibility of the parent company overextending itself and going
bankrupt. While this is not as serious in a new franchise business
opportunity as it
would be in a franchise, you still run the risk of losing the business
because your property contracts may have been financed through the
You should carefully investigate any new
franchise business opportunity you're
considering. Get a list of operators from the parent company and call
them. Have a lawyer look over any agreement drafted by the parent company.
Make sure you receive a disclosure statement. Then carefully evaluate the
licensor. Don't let anyone hurry you. Make sure a responsible company
backs the new franchise business opportunity.
First make sure your new franchise business
opportunity of choice complies with all
new franchise business opportunity statutes--which vary from state to state--and is
registered in states where required. Next, find out if the new franchise
business opportunity you're interested in provides an offering prospectus to
buyers. If it's a new franchise business opportunity that falls under the FTC rule, then
it's required to disclose specific information to you.
When choosing a new franchise business
opportunity, keep in mind that if you buy an
opportunity from a company with a sizable number of outlets that's been in
business for at least three years, you'll pay more for this established
concept that you would for a newer one. If you're considering a more
recently established new franchise business opportunity, you should check out the parent
company's history to evaluate its success and longevity in its particular
field of operation.
If you were to ask a business consultant how to evaluate the
"right" new franchise business opportunity for you, you would probably receive
1. Make an honest evaluation of yourself and your franchise ownership
you've been behind a desk for many years, will you be happy calling on
businesspeople and selling them an intangible service? If you've been a
field salesperson for years, will you be satisfied selling snack foods
behind a counter?
2. You must run your new franchise business enthusiastically. Will you be
happy introducing a new product or an unusual service that the public
knows nothing about? Can you generate excitement for an item not
3. You must have complete knowledge of the
franchise product or franchise service with
which you are involved. If the parent company gives you little or no
training in technical or management know-how, be wary of the new
franchise business opportunity. If the licensor-seller has organized all the operating
knowledge into a standard operating manual, look with favor upon this
new franchise business opportunity.
4. Make a market evaluation of the
franchise product or franchise service to be
offered. Is the time right to introduce it to the public? Is there a
need for this type of item, and what is its potential in relation to
5. Find out how many buyers have been in the
franchise business successfully
for a respectable period of time. A legitimate new franchise
will even provide you with phone numbers of other buyers, so you can
verify that they're generally satisfied with the opportunity and that
the seller is capable of fulfilling his or her promises.
6. Check the new franchisee training and
franchise ownership experience required to run the business
properly. Is there a suitable curriculum of training? What is the
scope of training? Does your background fit its requirements?
7. What is the parent company's profit ratio to sales; to time and
service requirements; and to the financial leverage requirements? Can
you make more in another type of franchise business from Franchise Giant
8. Do you have to work more hours as a
franchise owner to make the same amount you do
now? Can you invest the same amount in the new franchise business
operate a larger operation and get a better return on investment?
9. Check with current franchise operators to see how they're making out.
Are they happy with their franchise businesses? What problems do they have, if
any, that are common to all franchise units sold?
10. Research parent company's history. Is it a new firm with little
expertise and experience? Is it an older firm whose regular franchise products
have satisfied customers for years? Are the business opportunities all
offshoots of their regular franchise business?
11. Is there financial strength and strong credit behind the
new franchise business opportunity? Can the licensor-seller give you an escrow
agreement to deliver a building, equipment, leasehold improvements,
inventory, etc., as the franchise unit is made ready for your use? Check out the
bank references given by the licensor-seller; discuss the company's
financial strength with the appropriate franchise managers.
12. Evaluate the franchise policies and plans of the company with the
associations and business groups in which the parent company or
13. The Better
Business Bureau will give you a report if others have lodged
previous franchise complaints against the company.
14. Having an attorney, accountant or
franchise business consultant conduct
an in-depth study of the franchise company may be an excellent idea.
15. Visit the headquarters of the licensor-seller. Talk to the
personnel and the franchise training director. Visit the original prototype of the
franchise business being sold. Evaluate other franchise outlets. Expose yourself to the
other franchise outlets' products and franchise services to determine the quality dispensed.
In the preceding section, we outlined numerous things you should do to
ensure that you're choosing a franchise venture that will be appropriate for you
personally, and will represent a sound business ownership investment. It's important that you
cover all your bases before signing a new business franchise contract with the seller. The
following are some strategies you should use to protect yourself as a
Have legal representation. Your attorney should be present
when you're negotiating the franchise purchase with the licensor-seller. At the very least,
your attorney should go over the franchise contract to purchase the
new franchise business opportunity and advise you as to whether or not you should sign it in
its present condition. He or she should explain what each aspect of
the franchise contract means so that you understand what you're signing.
Have financial representation. Your accountant should look
over the financial statements of the licensor-seller. In addition, he
or she should be able to check out the financial strength of the
parent company and determine whether the franchise business is a viable financial
investment for you.
Make your own independent survey of other
franchise owners of new business franchise opportunities sold by the parent company. Are
the franchisees happy with the
company? Did the company do everything it promised? Is the company
good to work with? Does it give its franchise distributors help? Does it send
out franchise advertising materials? What do they feel are the strengths of the
franchise opportunity? If they had to do it over again, would these licensees
buy another franchise unit? Would they advise you to buy a another
Contact franchise competitors. This will verify the status of the
franchise company in the industry. A competing franchise company will tell you in a hurry
what the company's weaknesses are. You'll also get an opportunity to
see whether or not the new franchise business opportunity compares favorably in
terms of pricing and so on.
Check the credit of the franchise seller. Your accountant or the person
auditing the new franchise business opportunity can help you with this.
Be sure you understand everything you're signing. Read the
franchise purchase agreement disclosure statement, the franchise purchase agreement and
all of the franchise advertising
Check the credibility of the parent company. The parent
company doesn't have to be big in terms of dollars to be credible. Use
your common sense and advice from people you trust to determine
whether or not a franchise company seems credible. In many cases, small
franchise companies are a great investment for a franchise buyer because you generally
deal with the president or the top people in the company. They are
going to be franchise training you and working with you. This is a tremendous
advantage, as opposed to working with somebody five or six rungs down
the ladder who may be just doing a job. Are the franchise seller's people truly
interested in you? Do they seem to be sincere? Did they check you out
thoroughly? Are they concerned with the kind of franchise buyer that will be
carrying their banner? This is very important. If they're just
interested in taking your money, you're in trouble.
Check the performance of the parent company. Are the
claims backed by performance? Do the claims that the franchise seller make when
advertising their product, for example, stand up at the franchise store level?
Do the current franchise operators you've talked to confirm the profit claims
that the franchise seller makes?
Check the franchise company's management. It's not enough that they've
got a good idea. Do they have the franchise management strength to be able to
train you, help you and keep the franchise company running for another 20 years?
Know all the franchise costs and obligations, both yours and the
What franchise costs are you going to have to incur? What are your franchise obligations
on an ongoing basis?
Is the franchise company going to train you? Is
franchise training at your own
expense? In most cases, you have to pay your own franchise expenses to the
training site. How long will the franchise training last? Do you have enough
money to sustain yourself while you're in franchise training and before your
business starts earning money? What kind of ongoing franchise supervision will
the franchise company give you?
Determine what type of franchise advertising program is available from the
licensor. Will that franchise advertising program work for you? Check your
local market. For instance, if you're buying a new franchise business in
which you'll be selling bathtub liners, will franchise advertising in trade
magazines really help? Also, what are their ads like? Is the copy
good? What about visual art? Don't negate the possibility that their franchise
advertising program will hurt you more than it will help. Just because
you're dealing with a franchise company that has experience in the field, their
marketing campaigns aren't necessarily going to be successful.
Are you getting value for your initial
franchise purchase price? Examine
the list of equipment, fixtures, inventory, operating supplies, etc.
and call a few franchise suppliers dealing in these items. Compare the prices
those franchise suppliers quote you against the new franchise business
You may be able to purchase everything, including the inventory, for
less money yourself than you could by affiliating with the franchise licensor.
A franchise disclosure statement is a document that contains everything there is
to know about the new franchise business opportunity and the franchise seller's company. It
includes the franchise promoter's financial strength, how many franchise operating units there
are, and exactly what you're going to be required to pay in total so there
are no hidden franchise fees. The purpose of the franchise disclosure statement is to protect
the franchise licensee as well as the franchise licensor and to eliminate some unscrupulous
As already mentioned, some 26 states have legal requirements for
disclosure statements and registration. In addition, there are also
federal laws regarding franchise business opportunities. The most significant is the
FTC rule requiring full disclosure of the new franchise business
opportunity on a
national level. The rule doesn't require a franchise registration, but it does
require a franchise disclosure that follows a specific format.
Most states that have franchise disclosure requirements parallel the federal
standards of information that must be supplied to the franchise buyer. In addition,
state-required disclosure statements often include information stating
that the franchise buyer has three to seven days referred to as a "cooling
off" period so the franchise purchaser/investor can reconsider the subject
after being bombarded by franchise sales pitches from slick salespeople.
When reviewing a franchise disclosure statement, be aware of the following items:
The licensor. The history of the
franchise parent company needs to be
detailed. It should include the identity and business experience of
any persons affiliated with the franchise licensor, whether the company has been
involved in any litigation, whether it or any of the officials in the franchise
company have ever declared bankruptcy, any other initial payment or
any payment in total, and any other fees.
Obligations of the franchise licensee. If there are any
arrangements, they have to be stated. If you are going to be required
to buy from any franchise supplier, that should be stated up front. The
disclosure statement also states what the franchise parent company will have to
provide in terms of equipment, franchise training, ongoing services and a
What the franchise licensor promises to deliver. This should include
whether you're getting an exclusive area or franchise territory as a licensee.
Any trademarks, service marks, trade names, logo types and commercial
symbols as well as any patents or copyrights which you're going to be
able to use as a franchise licensee need to be identified in here.
Obligation of the franchise licensee. This is how you will participate
in the actual operation of the new franchise business opportunity. If this is an
absentee franchise business, it must be stated. If the franchise licensor indicates that
you must personally operate the franchise business, that should also be stated.
Restrictions on goods and services offered by the franchise licensee are
covered. It has some provisions for renewal and termination,
repurchase and modification. It also has to list the current franchise licensees
and their addresses so you have the franchise opportunity to contact these
Public-figure relationships. If this is a
new franchise business opportunity that is identified with a given public figure like a
celebrity or athlete, it should indicate what arrangements have been
made with that person. Is that person active in the franchise business or
receiving a royalty out of the proceeds?
Financial statements of the company. This is required in
almost every state. It is an audited financial statement prepared by a
CPA. There is usually a letter from the accountant indicating that the
books have been audited and are available for people to study. Any
estimates or projections of earnings would have to be part of the franchise
Franchise profit and loss statements are part of the financing process. In
business offerings, these are usually statements audited by a CPA. When
you look at a franchise licensor, you'll want to see an audited statement of the
company's earnings. You'll know you're getting a legitimate financial
statement because CPAs will not stamp a statement that hasn't been
properly audited and certified.
You should have an accountant look at the franchise financial statement and
interpret exactly what the franchise statement represents for you. You should
compare franchise statements from at least two years to see the direction in which
the company is moving: Is it on an upswing or a downswing? Is it becoming
more profitable and more efficient? The balance sheet, which shows the franchise
company's assets and liabilities, is another yardstick with which to
determine the strength of a franchise company. The franchise profit-and-loss statement tells
you how much money the franchise company is making or losing. The franchise balance sheet
tells you what the franchise company is worth in terms of assessing a company's
Franchise companies may give you pro forma projections to show what you can
expect to earn in this particular new franchise business opportunity. A pro forma is a
projected franchise financial statement. It is developed by taking the typical costs
for a franchise unit doing $200,000, $300,000 or $400,000 a year and showing you
approximately what you can expect to earn at each of those sales levels.
Some states have outlawed the use of pro-forma franchise statements except in the
case of current operating franchise units. In terms of their reliability, they do
not always accurately reflect franchise earning potential.
We recommend examining actual audited franchise operating statements to get a
good feel for what this company is doing. Larger companies will be able to
provide you with these. Smaller companies usually can't, and that's where
a gamble is involved. This is where you have to use your own personal
accounting and franchise legal assistance in order to thoroughly check out a
Franchise Information Source: The Small Business Encyclopedia
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