10 questions to ask before buying a franchise

If you’re looking to start your own business, buying a franchise can be an attractive alternative to starting a venture from scratch. For many, buying a franchise means investing in a concept that is already successful and that has a proven track record.

However, there’s no guarantee that you’ll actually wind up with the franchise that you want. In fact, the most popular franchisors have more inquiries from interested franchisees than they have franchise opportunities. For example, you can figure on having a lot of hoops to jump through if you want to open an outlet of what Entrepreneur Magazine identified as its top five franchise opportunities in 2008: 7-Eleven, Subway, Dunkin’ Donuts, Pizza Hut, and McDonald’s.

Regardless of whether you are interested in one of the most popular worldwide franchises or a little-known chain in your area, here are some common questions that you’ll want to resolve before taking the franchise leap.

1. How profitable have the company’s other franchises been?   We're not talking projections here, but real numbers. A successful franchisor should be able to put you in touch with its franchisees who can talk with you about their experiences, and how their bottom line has compared with their initial projections.
2. How reputable is the franchisor?   There’s not a single magic bullet for information on a franchisor. You will have to research the market, talk with competitors as well as other franchisees, and seek out information from trade organizations and other sources.

   Your local Better Business Bureau might have information on whether there are any complaints on file for the franchisor. In addition, the Federal Trade Commission keeps track of consumer complaints that it receives. However, in order to get these records, you’ll likely have to file a Freedom of Information Act request, and it can take several months to get a response to those requests.

3. What will the franchisor do to help me succeed?   The best franchisors have high success rates for their franchisees and provide ongoing support. Generally, they help the business owner monitor the franchise and improve his or her overall systems and operations. Keep in mind that some franchisors simply collect their fees and leave you to your own devices.
4. Is my franchisor going to create competition for me?   Everyone has to worry about competition, but should you have to worry about the franchisor selling franchises that compete directly in your market? Your franchise agreement should state whether the franchisor can set up other outlets in your market area. You’ll probably be happier and more profitable if you don’t have franchise "siblings" competing with you.
5. Should I find my own space, or rent from the franchisor?   Some franchisors make substantial profit owning business locations and leasing them to franchisees. You’ll want to confirm that the lease terms and rates are competitive with other businesses in your market. Talk with local commercial real-estate agents, if possible, to determine whether your lease is competitive.
6. What's my up-front cost going to be?   Most franchisors charge an up-front fee. Find out what this business is going to cost you from the start. Some franchisors may allow you to pay the franchise fee on some sort of installment basis, but remember that you can wind up paying interest charges and other fees as well.
7. What is my ongoing obligation to the franchisor?   As a franchisee, you typically will be buying products and/or services from the franchisor. You may be required to purchase a certain amount of product monthly. Although you might want to shop around for outside consulting services or ancillary supplies and products, the franchisor may require that you obtain those items from them instead. Be sure you understand how much flexibility you’ll have in purchasing and contracting decisions.
8. What's my exit strategy if I succeed?   You might be able to sell your franchise at a nice profit someday if you can show a record of increasing sales and profits. On the other hand, with one success, you could expand and put what you’ve learned to work among several franchise operations. Either way, you’ll want to determine how you can capitalize on your success.
9. What's my exit strategy if I fail?   In many respects, your franchise commitment only begins with your purchase agreement. You may have such obligations as a long-term location lease, equipment rental contracts, inventory and supply purchase agreements, and other outlays. Determine ahead of time whether the franchisor will buy back or release you from a franchise (and on what terms), and what it will do to assist a failing operation.
10. Where can I get legal help?  Franchise agreements and contracts can be complicated. The Federal Trade Commission’s Franchise Rule requires that you have at least 10 days to review any franchise agreement or offering circular before signing any contracts.

    If you don’t already have an attorney, talk with other small-business owners or franchisees to get referrals or recommendations. Your state bar association may have referrals to lawyers specializing in contract or business law issues.

About the author   Joseph Anthony is a business-finance writer who has a tax practice in Portland, Ore., specializing in tax preparation and planning for individuals and small businesses. As an Enrolled Agent, he also represents taxpayers in their dealings with the Internal Revenue Service, and regularly speaks on current tax topics and controversies.