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IN THIS CHAPTER

❯❯ Understanding the different kinds of franchised businesses

❯❯ Exploring franchising arrangements

There are a wide variety of franchise opportunities and levels of investment available today. The choice of products and services offered by franchised businesses is limited only by the imagination and skills of the men and women who create them.

More than 120 distinct lines of business use franchising, including hotels, home healthcare, agriculture, car rentals, payroll services, hair care, lawn care, mosquito control, mold detection, restaurants, fitness centers, and everything in between. Because of franchising, national and local brands have leaped into our national consciousness and improved our quality of life.

As you begin to explore franchising, you need to cast a wide net because a number of industries and companies will likely surprise and interest you and the breadth of what is available is wide and deep. Although running a restaurant may be one of the most popular choices available (close to 20 percent of all franchised businesses fall into the restaurant category), restaurants are not the only – or necessarily the best – way to go. You are just getting started. Take your time and explore, and we promise you will not be disappointed by the variety of the opportunities you will find.

Don’t dive into the pool too quickly because the selection of possible franchise opportunities can be overwhelming. Wade in slowly, get your feet wet, and choose carefully because becoming a franchisee can be life-changing. This chapter simply introduces you to what is available.

Getting Started with a Single Franchise

Many people naturally begin their exploration of franchising by first looking at the restaurant and food-related franchises because they seem to be on every corner. Without a doubt, food franchises have made many franchisees happy and wealthy (they were probably already wise, so franchising cannot take credit for that). But don’t be too surprised when we tell you that many non-restaurant opportunities not only do better financially than some of the better-known restaurant concepts, but they also may offer a more stable investment and might even be easier to operate.

Where to start: It’s two in the morning and you can’t sleep

We have all been there. The career we trained for in school and the job we thought was the one we would have until we retired are under challenge because of the economy and/or technology. Maybe your company is moving out of state, or you’re simply bored and it’s just time to change direction. Beginning to work for yourself and achieve what some call, the Great American Dream of independent business ownership might be something to consider.

Going it alone and opening your own business from scratch are very good options. Many people do, and it can be highly successful. If you are a true entrepreneur, it may be your best choice. But if going it “alone” includes being part of a branded system, franchising is a path to consider.

A good place to begin exploring franchising is on the Internet, and the good news is that at 2 a.m., it’s open. At this stage of your investigation all you want to do is begin to narrow your search to industries and companies that are attractive to you.

Every franchise opportunity has a website touting why it’s the perfect investment opportunity. Each will have multiple competitors including many you have never have heard of. You are also going to find industries using franchising today that you didn’t know even existed. To begin to understand the breadth of the opportunities, you need a guide. Thankfully, there are numerous compendiums of franchise opportunities, and the best ones are online.

We admit that we are partial to the online Franchise Opportunities Guide published by the International Franchise Association (IFA) at www.franchise.org/franchise-opportunities. It may seem disloyal if we were not, since both of your authors have held leadership positions in the IFA for quite some time. But there are also other outstanding web portals you should consider, including the following three:

❯❯ Franchising.com published by Franchise Update Media (www.franchising.com)

❯❯ Franchise Times (www.franchise.org/franchise-opportunities)

❯❯ Entrepreneur magazine (www.entrepreneur.com/franchise500)

Both Franchise Update Media and Franchise Times are franchising giants that are read and relied upon by the professionals in franchising. As with the IFA, each publication also contains resources including articles written by professionals, educational tools, conference information, and contact information for professionals in franchising. Entrepreneur includes a ranking of the franchise opportunities they list.

We may take some heat for saying this, but based on our experience we recommend that you never choose a franchise system to invest in because of any third-party ranking. Chapter 4 explains why.

Sifting through the options

As we mentioned, over 120 industries use franchising, but to make your review a bit easier, here are the broad lines of business categories:

❯❯ Automotive

❯❯ Business services

❯❯ Commercial and residential services

❯❯ Lodging

❯❯ Personal services

❯❯ Quick service restaurants

❯❯ Real estate

❯❯ Retail food

❯❯ Retail products and services

❯❯ Table/full-service restaurants

As you begin your exploration you will find within each line of business a long list of franchise opportunities in a variety of industries. Unfortunately, there is no universally adopted classification system in franchising, and each source guide will use different industry and business classifications. That can make things confusing, because you may think that companies within a given category are similar, but that’s not always true.

For example, take something as simple as pizza. Some pizza franchisors provide a system in which pizza is delivered to customers’ houses, whereas others don’t provide home delivery. Some may only have eat-in facilities, others offer both eat-in and home delivery, and for others, the customer must pick up the pie. Some have pies priced for feeding a little league team, and others are gourmet offerings. There are companies like Papa Murphy’s where you can customize your pie at the store and then take it home and bake it yourself at 425 degrees. (Your family might even think you know how to cook if you hide the box from them). All these businesses are pizza franchises and may show up in some source guides under the same category. But their varying features make them significantly different types of franchise and investment opportunities.

The investment required will also vary widely, as will the types and number of employees you will need, types of real estate you can use, equipment requirements, amount of money you can earn, the markets they have available for you to invest in, and maybe even the number of locations the franchisor will allow you to open. In some systems you may only be able to open in mature markets, and in others you may have the opportunity to build the brand in new markets, which opens up for you some interesting possibilities.

Let’s move on to hair salons. Some franchised salon chains are geared to cutting only men’s hair while others focus on women. Some are full service and provide waxing, coloring, manicures, and perms, while others are limited service opportunities like Great Clips targeting their customers based on their low price for a haircut and how quickly you can get in and out. There are even those that specialize in haircuts for children, and concepts like Sport Clips that are based on a sports theme with TV screens tuned to sporting events. All hair salons may work on hair, but how they segment the market and approach their customers differ widely from company to company.

“Great Clips has as its core service, haircuts, and our price for services has barely changed over 35 years,” says Steve Hockett, president of Great Clips, Inc. “Our goal has always been to provide a great experience for customers with short waits, moderate pricing, convenient locations and hours – for men, women, seniors and kids. We have never wanted to be all things to all people, which is why, for example, we have never provided coloring services. We have a simple business, with a consistent focus, and it has served Great Clips franchisees well, with over 4,100 salons open in 175 TV markets across the U.S. and Canada.”

In a similar fashion, franchises within the fitness and gym industry range from traditional gyms to specialty fitness centers with a focus on a specific type of workout (such as Pilates, Zumba, barre, cycling, or boxing) and some are open 24 hours a day. There are concepts that offer memberships only to women and there are still others that offer ancillary services, such as nutrition consulting, massage, or tanning services.

There is so much information about franchise opportunities available today that you can easily get overwhelmed. The vast investment differences between franchise opportunities listed under the same broad industry heading is one of the reasons why we recommend you ignore the ratings given by some of the publications. Two companies may both sell pizza, but from an investor point of view, they are in very different industries.

The easiest way to conduct your research is to select one great source of information that is clearly written, understandable, and available in a style you understand (sort of like this book). Put the other sources aside and do all your research using that one guide. Only after you get your list of possible industries and companies down to a reasonable few should you also explore those opportunities by name in the other listings. Working this way is much easier, and usually you will not miss much of the information that you will need at this early stage of your investigation. Using the IFA, Franchise Update, Franchise Times or Entrepreneur listings are good ways to begin.

Paying attention to what’s hot

So which franchises are hot?

That is always the first question asked of us by reporters and every prospective franchisee we meet. We will give you the same answer we give to them: It depends. With all the industries that use franchising and all of the companies offering opportunities in those industries, it is hard to give a meaningful answer. What is hot this year may not be next year. And most importantly, what we may consider hot may not be something that fits what you are looking for. Becoming a franchisee and choosing the right opportunity is a very personal decision – one that you must ultimately make yourself.

Start by looking for the trends and see who is capitalizing on them:

❯❯ If health and wellness is what attracts you, and fresher, locally grown, upscale, and grown-up food are what you’re looking for, then maybe one of the brands populating the fast casual segment, like Blaze Pizza, may be the right choice for you. If food is not something that excites you, then possibly a fitness concept like Kaia Fit or a nutraceutical concept is where you should look.

❯❯ If you think that having Mom and Dad working longer hours outside of the home has created an opportunity for helping families save time and parents better bond with and care for their children or parents, take a look at franchise systems that provide children’s education and entertainment or home healthcare like the Goddard School, School of Rock, or Bright Star.

❯❯ Paul McCartney wrote “When I’m 64” when he was 24, and in 2006, when he reached that magic number, he was glad to learn that today’s 64 is yesterday’s 44. Servicing the senior citizen who is living longer and healthier may be your magic ticket as demographic and sociographic trends support those industries’ growth. Fitness concepts like Blink or Orangetheory or maybe a golf business like GolfTEC may be attractive to you.

Every year, new trends even in legacy industries unfold. Consider that quick service and fast casual restaurants are going through rapid changes to their labor models as apps replace waitstaff and robots begin to replace back-of-house staff. Similarly, hotels are lowering their operating costs by using online reservation systems, even providing guests with room keys before they arrive. Many are changing their décor and services to attract millennial travelers, like Marriott’s Moxy or Hilton’s Tru.

Because of changes in demographics, consumer trends, technology, the economy, and geopolitical events, existing franchises will change, and exciting new opportunities will continue to emerge. Follow the trends, look through the fads, and somewhere on the other side you will find a company that has started a franchise system designed to capitalize on the opportunity interesting to you or an older brand like Popeye’s Louisiana Kitchen remaking itself for the same reasons.

If you choose to invest in a franchise in one of the popular industries, you might consider a newer or smaller franchise system. Emerging franchisors are often more flexible with respect to development, training, and fee structures than the larger, more established ones. Alternatively, you may want to go down the less-worn path and look closely at opportunities in less-popular industries that you believe, based on your research, are just now starting to become popular.

Keep in mind, though, that the smaller systems, while possibly more flexible in working with you, may not offer all the benefits and services of the larger, better-established franchisors. A strong legacy system – one that can provide you with the operational support and efficient supply chain you need – can be a very attractive investment. Although you may need to invest more in marketing your location, becoming established in a new market can have some terrific benefits as well.

Adding Franchises, One at a Time

The number of franchisors, the variety of industries represented in franchising, and the range of investments available create opportunities for the smallest single-unit mom-and-pop operator to a large multimillion-dollar investor group or established businesses that are looking to add a franchise investment to its portfolio.

Flying solo: Single-unit franchises

A single-unit or direct-unit franchise is just what it says it is: As a franchisee, you obtain the right to own and operate one franchised business from a franchisor.

Over the years, most franchise systems have grown one franchise at a time. It is the classic method and, until the past few decades, was the most common type of relationship in franchising. As people looked for a way to get to their dream of independence through business ownership, franchising became their chosen vehicle. In a single-unit franchise, the franchisee (often along with family members) generally manages and supervises the business on a day-to-day basis. It is how their family makes a living.

Although a single-unit franchise is the classic method for franchise system growth, it does have some weaknesses for franchisors:

❯❯ Franchisors generally experience slower growth with a single-unit strategy than with a multi-unit approach, and the growth can be more costly on a unit basis because franchisors have to locate a new franchisee for each location.

❯❯ The franchisor has many franchisees to work with, and those franchisees may be less sophisticated and less interested in taking business risks than larger, multi-unit franchisees.

❯❯ Because each location is individually owned and operated, single-unit franchises tend to be more expensive to support than when one franchisee owns and operates multiple locations.

❯❯ In some markets that may be attractive to a multi-unit franchisee, the presence of single-unit franchisees in the market may make the opportunity less attractive to multi-unit operators who don’t want to compete for customers or locations.

Although there may be some disadvantages to franchisors, there are more single-unit franchisees looking for opportunities than there are multi-unit investors. Also, because the locations are managed directly by the franchisee and generally are a significant part of the franchisee’s family income, single-unit operators tend to be better focused on operating their locations to brand standards and contributing to the neighborhoods in which their businesses are located. That’s because they usually live in the community, their children go to the same schools, they attend the same churches, and their customers are their neighbors.

Figure 2-1 displays the single-unit franchise relationship tree.

© John Wiley & Sons, Inc.

FIGURE 2-1: The single-unit franchisee family tree.

Growing a family one franchise at a time

As single-unit franchisees prosper (see the preceding section), eventually they will want to acquire another franchise from the same franchisor. After all, they have an understanding of the business, have a relationship with the franchisor, can project the return that an additional unit can generate, and know the types of locations that work best. Initial training likely won’t be needed, and some of the key employees they already have may be perfect managers in their second and third locations.

As they add additional locations, their little chain now can leverage off of the prior locations by sharing staff, inventory, storage, and back-of-house resources like bookkeeping and payroll processing. Investing in additional franchises is a terrific way to grow, because with experience their risk is generally lower than when they made their initial franchise decision, and even though they have more franchises, the relationship between the franchisor and franchisee is substantially the same.

However, growing one location at a time is different from agreeing to operate multiple locations from the beginning, because you don’t usually obtain a reduction in initial or continuing fees and you’ll continue to share the market with other franchisees. But with more units and more money invested, you will tend to be noticed more often by the franchisor and its staff because they are hoping you will continue to grow and grow and grow.

It’s important to understand that franchisors will periodically update their franchise agreements, and franchisees who acquire additional franchises are likely to find variations between their original contract with the franchisor and the new franchise agreement for later units. Your franchisor may also include cross defaults in the agreements, meaning that if you can be terminated at one location, the franchisor reserves the right to terminate all of your franchises at the same time – even if every other location is operating perfectly.

As with all franchise agreements, you should have a qualified franchise attorney work with you. They may be able to also help you negotiate some changes to your agreements including personal guarantees, cross defaults, and changes in fees that other franchisees may be required to pay.

Developing a Territory on Your Own

Instead of growing one location at a time, many franchisees instead choose to become multi-unit franchisees right from the start. By entering into a multi-unit development agreement, a developer obtains the right and the obligation to open a specific number of locations during a defined period of time and usually within a specified contiguous geographic area.

For example, say you want to open ten hair salons in your town. You can go to the franchisor and buy one franchise at a time (see the preceding section), but you have certain risks:

❯❯ You may have to share the market with other franchisees from the system. And by the time you’re ready to grow, the best locations for your brand may have been taken by other franchisees, or worse, the franchisor may have achieved critical mass in your market and is no longer offering additional opportunities where you want to grow.

❯❯ Even if the franchisor is offering a better “deal” to multi-unit developers, it may not be offering that same deal to single-unit franchisees, and you likely won’t have the necessary leverage you need to negotiate the changes you want.

To avoid these risks, you can enter into a multi-unit development agreement and agree to open and operate your multiple locations, say over the next several years, and the franchisor will grant you an exclusive market to develop your little chain.

If possible, you want your multi-unit development agreement to include market exclusivity, ensuring that you are the only franchisee operating in your area. Frequently, though, there may already be locations up and running in the area you want, and you’ll need to decide whether market exclusivity is important to you prior to making your investment decision.

A multi-unit developer will typically pay the franchisor a fee for the right to enter into a multi-unit development agreement. As you sign a franchise agreement for each new location, generally a portion of the multi-unit development fee is credited by the franchisor against your initial franchise fee. (More on this shortly.)

Expect that your development obligations will be specific. For example, instead of simply agreeing to ten units over five years, your agreement will usually have precise dates that you must meet, such as requiring that you have your locations open and operating on January 1, July 1, and so on during the term. These opening dates are important to the franchisor, so if you think the time provided for development is too restrictive or ambitious, this is something you and your attorney should discuss with the franchisor before you sign the development agreement.

Don’t expect the franchisor to allow you to slip on your opening dates later on – missing those dates might trigger certain terminations and cross default rights by the franchisor, including the loss of your development rights and the fee you have paid.

Frequently, the initial franchise fee for locations developed after the initial franchise in a development agreement will be reduced from the franchisor’s standard initial fee. However, how the franchisor applies your development fee to the initial franchise fees you will owe varies from company to company.

In most franchise systems, as the franchisee signs a new single-unit franchise agreement and pays the initial fee, a pro-rata portion of the development fee paid will be applied to the initial franchise fee due. In other situations, you will receive no credit and you may pay the full initial franchise fee for each location.

You can expect that the development agreement may modify some portions of your franchise agreements. In addition to changing the initial franchise fees you may be charged, the franchisor may offer a reduced royalty after a certain number of locations have been developed, and changes in training, site selection, and development are common. You can also expect your franchisor to require you to have a general manager overseeing your units, and they may require you to have someone on staff to conduct the training of your staff.

A multi-unit development relationship can have significant advantages for both the franchisor and the multi-unit franchisee.

For the franchisor:

❯❯ Each multi-unit franchisee will be opening more than one location. That means the cost of acquiring a franchise on a per-unit basis will be lower than had the franchisor needed to find separate franchisees for each location.

❯❯ Fewer franchisees owning multiple locations means that the cost of supporting each location may be lower because the franchisor will be working with the franchisee’s general manager for all the locations and may not work with separate unit managers for each location.

❯❯ Having controlled growth leads to better planning for advertising and better leveraging when negotiating with suppliers and other vendors.

❯❯ With fewer franchisees in a market, it is easier to coordinate local advertising and promotions.

For the multi-unit developer:

❯❯ You gain the ability to shift personnel from one location to another depending on where the staff is needed.

❯❯ You may be able to establish a commissary or kitchen and combine the preparation of products for all the locations or save on freight and other costs by buying in greater quantities at a lower cost and storing inventory in a centralized warehouse, allowing for smaller retail locations and lower real estate costs.

❯❯ General managers overseeing multiple locations may reduce management costs at each location. Franchisees may only need an assistant manager, and with consolidated back-of-house support staff, including a trainer, internal costs on a unit basis can be reduced.

Figure 2-2 depicts the multi-unit franchisee-franchisor relationship.

© John Wiley & Sons, Inc.

FIGURE 2-2: The multi-unit franchisee family tree.

Why are two agreements needed? Because the multi-unit development agreement and the franchise agreement serve different purposes. The multi-unit development agreement lays out the rights and obligations being granted to open the locations, and the franchise agreement governs how each location, as part of the franchise system, will operate.

Make certain that the market you select can handle the number of locations you’ve committed to open, that you have the financial backing to live up to your development obligations, if the first location gets off to a slower start than anticipated, and most certainly, that you are ready and able to operate each location per the terms of the individual franchise agreement.

Becoming a Master Franchisee

When you become a master franchisee, you become a franchisor in an area and are authorized to offer subfranchises through your master franchise license. As with any franchisor, your master franchisor will prepare and provide to prospective franchisees its own FDD and agreements that will contain information about you and your services.

In most master franchise relationships, the first thing you will likely be required to do is open and operate a few locations of your own. Once that has been accomplished, you will then be allowed to offer franchise rights to other franchisees (called subfranchises) to open and operate franchises in your market.

You will sign a master franchise agreement with the franchisor and usually pay a master franchise fee. Because your subfranchisees pay you their initial franchise fees and continuing royalty, typically you share a portion with your franchisor. The percentage split will vary widely depending on the franchise system. There is no standard master franchise relationship:

❯❯ The subfranchisee may execute a franchise agreement directly with the franchisor or with the master franchisee.

❯❯ The franchisor may or may not have the right to approve the new subfranchisee.

❯❯ The subfranchisee may receive training and continuing support from the franchisor, the master franchisee, or both.

❯❯ The subfranchisee may pay fees directly to the master franchisee, to the franchisor, or a combination of both.

Of all the types of franchising relationships, the master franchise or subfranchise relationship is the most complex.

Figure 2-3 shows the master franchise relationship.

© John Wiley & Sons

FIGURE 2-3: The master franchisee family tree.

With the exception of foreign franchisors entering into the United States, don’t expect a lot of U.S. – based franchisors to offer a master franchise relationship today. Although it is still used to some extent by U.S. franchisors internationally – and the trend is shifting away from master franchising to multi-unit development relationships, as technology and other advancements have made it possible to better directly support franchisees internationally – its popularity is waning.

If you are a franchisor looking at developing internationally, and that includes foreign franchisors entering the United States, we recommend that you first consider going direct and offering a multi-unit development agreement and not use a master franchise relationship. By franchising directly to multi-unit franchisees, you avoid the need to share the fees and other revenue in a market and retain most of the benefits of master franchising. Technology has reduced the need for master franchising to a very great extent, and with a well-structured multi-unit development growth strategy, much of the expected benefits of master franchising are no longer as significant.

There are occasions where master franchising still makes sense, and in those circumstances both of your authors still use it with our clients. But rarely today is it our first choice, and we generally explore other approaches first.

The Area Rep: Master Franchise Lite

Both an area representative and a master franchisee acquire a territory in which to solicit and support franchisees, and both share in the initial and continuing fees collected from franchisees with the franchisor. The difference is that the area representative is not a franchisor, does not deliver their own FDD, and doesn’t execute any agreements with the franchisees. In essence, an area rep is a commissioned sales and field support person for the franchisor.

As in a master franchise relationship, the area representative pays the franchisor a market development fee for the opportunity to develop and provide services to a specific minimum number of units, during a specified time period in a defined area. Once recruited, the franchisees sign their single-unit and multi-unit development agreements with their franchisor.

For many of the same reasons discussed earlier related to master franchising, the use of area representatives is on the decline. An area rep can recruit franchisees quickly. But because they share in the franchisor’s fees, rather than earn their income as an employee, there is a strong argument that they tend to depress the exit or enterprise value of the franchisor despite their potential advantage in recruitment. When the franchise system is sold, the buyer of the system will value the continuing revenue stream available, and sharing of royalties with an area representative will reduce the value of the system to the buyer.

Area reps also are focused more on expansion and less on supporting the franchisees. Should that occur, the franchised businesses in their area – if not in the entire franchise system – suffer, and there is the potential for a higher level of closures and litigation.

There are ways to address some of the downsides of an area representative relationship by structuring the rep’s role and modifying their fee arrangement to be based on the performance of the locations in their area. Still given the downside risks and the availability of alternative growth strategies, we would expect the use of area representatives to continue to decline.

Figure 2-4 displays the typical area representative relationship.

© John Wiley & Sons, Inc.

FIGURE 2-4: The area representative family tree.

Sharing Risks and Rewards in a Joint Venture

Think of a joint venture as a form of partnership between a franchisor and a franchisee. Different from a standard franchisor-franchisee relationship, generally each party contributes assets to the joint venture, and each shares in the profits and losses of the entity they form. What each party contributes will vary greatly from one joint-venture relationship to another.

In a simple joint-venture relationship found in franchising, the franchisor identifies a strong operator as its joint-venture partner. The franchisee and the franchisor (the franchisor usually establishes a subsidiary or separate entity for this purpose) form a joint-venture entity, and that entity signs a franchise agreement with the franchisor. The franchisee participant operates the franchise for the joint venture and earns a separate fee for doing so. The franchise agreement is a standard agreement, and generally the fees and obligations are the same as with any other franchisee.

The joint-venture agreement will also define the rights and obligations of each party as you would find in any partnership agreement. Common elements would include limitations or restrictions on the franchisee joint-venture partner to dispose of certain assets, acquire debt, or take other specified actions. Formulas or methods are also included to allow for cross defaults and, most importantly, how to unravel the relationship, should that be required.

Several franchisors have used joint-venture relationships both in the United States and as part of their international expansion, but it is not a common structure because it is complicated, somewhat difficult to manage, and creates difficulties should the relationship need to be terminated and unwound.

Councils, Associations, Cooperatives, and Buying Groups

Most modern franchise systems will establish at some point a franchisee advisory council (FAC). Whether elected by the franchisees in the system or appointed by the franchisor, the purpose of the FAC is to be a sounding board for the franchisor. Although the FAC doesn’t have any decision-making powers, it’s an important part of most franchisors’ processes for evaluating changes to the system, recommending improvements to the system, and testing new ideas by obtaining the input of operating franchisees.

Associations, cooperatives, and buying groups are different. These groups are generally formed either independently by franchisees or in conjunction with the franchisor and may be separate legal entities.

Historically, franchisee associations were created when some event occurred that put the franchisees and the franchisor at odds with each other. In most instances the franchisees would join the association and pay dues. Generally, the first hire of the franchisee association would be an attorney to represent the association in discussions or litigation with the franchisor. Franchisee associations were therefore not looked upon fondly by franchisors – were seen as sort of a franchisee union – and the nature of the relationship was often contentious. As franchising has matured, many franchisors have established beneficial relationships with franchisee associations, although most franchisors still prefer to work through their FAC and not through a franchisee association.

A buying group or cooperative is established to provide cost savings opportunities for participating franchisees by fully exploiting the buying power of the many franchisees operating in a franchise system. Typically, the buying group or purchasing cooperative negotiates supplier arrangements and facilitates its members’ purchases on uniform pricing and delivery terms.

Reliance on buying groups and cooperatives is especially common in the food sector, but they exist across all industries. A well-managed buying entity will ordinarily generate significant cost savings, and for that reason franchise systems that embrace these groups often enjoy a competitive advantage.

It is important to understand that franchisees who participate in these groups are still required to follow the franchisor’s brand standards and specifications. For this reason, franchisors often exercise significant influence over quality and other standards applicable to selection of products and the suppliers themselves. Some franchisors even participate directly in the groups, to better service the franchisor’s corporate (non-franchised) locations. For more on buying groups and cooperatives, see Chapter 9.

Buying Franchisor-Owned Locations

On occasion, franchisors make company-owned locations available for sale to franchisees. This is called either retrofranchising (locations that have never been franchised) or refranchising (locations that once were franchised but were acquired and operated by the franchisor). For all practical purposes, for franchisees looking to invest in established businesses, they are the same.

Franchisors have many reasons for wanting to sell company-owned locations:

❯❯ They may no longer fit the franchisor’s strategic plan.

❯❯ The franchisor may want to consolidate the number of markets or number of locations it directly operates.

❯❯ The franchisor wants to stimulate the development of additional units in a market, and providing franchisees with cash flow from established units is part of that strategy.

❯❯ The franchisor may simply need the proceeds from the sale.

In some situations, franchisees are just better at operating locations than the franchisor, and the franchisor is selling locations simply because it believes the locations work better under the control of a franchisee than under the franchisor’s own personnel.

Acquiring an existing location from another franchisee or from the franchisor has many advantages:

❯❯ It shortens the time to get the business up and running because you don’t have to find the location or work through constructing and equipping the business – and it already may have a trained staff and management team.

❯❯ Bank financing may be easier because the business exists.

❯❯ The seller may offer seller financing, and a motivated seller might be willing to cut you a good deal.

❯❯ You are buying a business that currently is operating, has existing customers and an established cash flow, and you know the performance of the operating business. Your investment decision is based on current operations and not on projections.

❯❯ If the location is being sold by the franchisor, it can share with you the financials for the location, even if it doesn’t include an Item 19 Financial Performance Representation in the FDD (see Chapter 6).

As with any purchase, you should take your time to evaluate the business. Sometimes you will find franchisors that are churning locations. Churning occurs when a franchisor is selling a company-owned location that it may have taken back from a franchisee because the unit is failing or has failed. If the unit wasn’t viable before, there is a good chance it won’t be viable under new ownership either and likely should have been closed. Churning frequently happens in some systems where the franchisor is trying to avoid disclosing in the FDD a unit failure and instead buys a failing location before it closes.

Always get a history of ownership of any business you are looking to purchase. Don’t assume that you are a smarter or better operator than the last guy. A franchisor that has a high percentage of churning may offer little chance for success to any type of franchisee and so may not be a sound franchise investment – even for franchisees not buying one of these recycled locations. Thankfully, not many franchisors churn their locations, but you still have to be alert to the possibility.

CONVERSION AND NONTRADITIONAL FRANCHISES

A less common alternative to the traditional franchise relationship is a conversion franchise, in which an independent operator, in the same business as the franchise system, converts its operation substantially to the franchise system. For example, an operator of a local pizza restaurant completes remodeling and modification of its menu to operate as a Pie Five Pizza under a franchise agreement. In a conversion franchise, the new franchisee may execute a franchise agreement that has some material differences from the franchisor’s standard agreement, including fees and a transition plan to convert their existing business over to the franchise system’s retail offering.

Other variations of the standard franchise fall into a broad category usually referred to as nontraditional locations, including mass-gathering locations – airports, train stations, hospitals, college campuses, sports stadiums, ballparks, food courts, portable kiosks in parks and amusement parks, military bases, and so forth – where traffic to your business is generated by someone else’s customers. Also included in this area are locations found in host locations, such as convenience stores, big-box retailers, and so on. These types of locations are generally not available to the average franchisee, and it is common for a franchisor, even when it is giving the franchisee some territorial rights to carve out these locations from the franchisee’s protected territory.