Five Questions to Ask Prospective Franchisors

Thinking of buying a franchise? Before you sign any papers, you need to be very thorough in your research about your prospect. Buying a franchise is a serious investment. When you sit down to talk to a potential franchisor, treat it like a job interview and have a series of questions prepared for them to answer.

Here’s a list of five of the most important things you should ask.

Franchise questions

What will my startup investment need to be?

Items 5 through 7 of the Franchise Disclosure Document (FDD) will highlight the initial fees, and offer a range that your total investment will fall between. Sit down with the franchisor and review these items in detail. Learn more about the investment range for specific items such as build out. What have others done to come in on the lower end of this range? What expenses that aren’t listed could possibly arise?

How much money will I need to have on hand until the franchise turns a profit?

After you determine how much of an investment the franchise will require to open your doors, you also need to calculate how much liquid capital is required until your franchise starts to make a profit. A detailed business plan, complete with a P&L, will help you determine whether you are financially capable of keeping the business afloat until it is self sustaining.

Seek the opinion of both the franchisor and franchisees when trying to determine the amount of working capital needed.

The UPS Store
photo credit: Thomas Hawk / Flickr

Will the franchisor assist with any of the startup costs?

Most franchisees will acquire a loan of some sort to assist with the startup costs of their franchise and in many cases franchisors will assist with these costs. If equipment is involved, franchisors may offer financing options. If this is the case, you should compare their terms with those of other lending institutions. It could be extremely beneficial if your lender is also your business partner should tough times be encountered.

If the franchisor doesn’t offer financing, ask them what banks or other lenders they have relationships with. Lenders are focused on minimizing risk, and if they have already vetted a concept thoroughly they will be more apt to offering financing, and at a competitive rate.

How financially stable is the franchisor?

Finding a franchise concept that fits your skill set will mean nothing if the franchise company you are considering isn’t properly poised for growth, and the FDD is ripe with insight. Item 20 will detail the number of outlets opened at the beginning of each year over a three-year period. It will highlight locations opened, as well as those closed due to contract termination, nonrenewal, or taken over by the franchisor. If any of the figures don’t sit well with you, approach the franchisor. Ask them why franchisees are leaving the system, and whether they are growing at a pace they expect.

Item 21 of the FDD provides the most recent financial statements for the franchisor which will give you an indication of the franchise system’s financial picture. Pay close attention to what percentage of income comes from franchise sales vs royalties. Royalties represent a steady and predictable stream of income. Red flags should go up if a franchise is generating the bulk of their revenue from franchise sales, coupled with an unusually large percentage of franchisees leaving the system.

Finally, comb through Item 19 of the FDD, which offers financial representation. Franchisors do not have to offer any detail in this section, however, these days the majority do. If the company you are exploring chooses not to, or you find the information lacking detail, approach the franchisor for an explanation.

One final note – newer concepts may be able to check these boxes for you, and that’s OK. You will undoubtedly have to take a leap of faith when exploring an emerging brand. Make sure to take a closer look at the financials for the corporate locations.

McD, NYC – photo credit: Melfoody / Flickr

What support does the franchisor offer franchisees after the initial training?

The great thing about being a franchise owner is being in business for yourself, but not by yourself. That is why it is important to determine if your prospective franchisor is truly there with you for the long haul. Is there a support staff you can access on a day-to-day basis? Are there ongoing training opportunities? Is on-site assistance available?

During the exploration process, ask to speak with the operations manager. Those in the field supporting the franchisees will be a great resource to determine just how much assistance is provided.