EVALUATING A FRANCHISE OPPORTUNITY

A franchise typically requires investing between several thousand and several million dollars, and also obligates the franchisee to pay royalties and other fees. Obviously, it pays to evaluate the investment carefully. But unlike a real-estate purchase, in which tests for structural defects and termites are inexpensive and well known, a franchise’s soundness is complex and must be evaluated in many different ways.

Here are some of the factors that attorney Katz considers, and the methods he uses, to help his clients decide whether to invest in a franchise:

 
1. Regulatory Review

You can learn about the franchisor, including past or pending complaints against it, from the Federal Trade Commission in Washington and the regulatory board of the state in which it is located.

 
2. Business Plan Review

The client may want to have a business-school professor or other expert evaluate the franchisor’s business plan. Attorney Katz receives no money for this service from either his client or the expert, but he believes that this can be money well spent if the expert is astute and is not too expensive.

 
3. Contract Review

Attorney Katz will evaluate the contract that the franchisor wants the franchisee to sign, and negotiate changes in terms that are onerous to his client. Under what circumstances can the franchisor terminate the franchise? What state’s law will govern if a franchisor–franchisee dispute arises? Is the franchisor free to sell franchise products nearby, for example, in supermarkets, and to compete with the franchisee’s sales? Etc. The contract must be scrutinized to protect the franchisee.

 
4. Uniform Franchise Offering Circular Review

The UFOC is a form that the franchisor is required by law to fill out, and it discloses a lot of important information about the franchisor and its business. Katz will review it and point out the strengths and weaknesses of the investment.

 
5. Contacting Present and Former Franchisees

This is a good way to find out the truth about the franchise. Has the investment worked out well for the franchisees? What do they like about the purchase? What don’t they like? Etc.

 
6. Why Does the Client Want to Buy a Franchise?

Has she retired? Been laid off? Does she wants to quit a salaried position and be her own boss?

How much does she need to earn? How much does the franchisor promise that its franchisees will earn?

What terms govern these important facets of a franchise:

• Reselling the franchise?
  
• Obtaining a refund of the fees and payments that were made in acquiring the franchise?
  
• Releasing debts for leased equipment and equipment purchased after the franchise is terminated?
  
• The franchisee’s participating in other business activities while running the franchise?

 
7. Other Available Investments

Has the client investigated other franchises? What was his basis for choosing the one he did?

Has he investigated non-franchise investments, such as distributorships, dealerships,or start-ups?

 
8. Funding

What sources of capital will the franchisee use? A bank loan? Loans from friends or family? Savings? Refinancing of the franchisee's home? Selling shares to investors?

What will the cost of capital be (which involves, but is not the same as, the interest rate that the franchisee will pay)?

 
9. The Franchisee’s Anticipated Income

• What will the client’s income be if the franchisor’s representations turn out to be true?
  
• What is the client’s risk of loss if the franchise isn’t profitable within the first six months?
  
• Is the client allowed to sell the franchise?

 
10. The Franchise’s Total Cost

• Required cash payments to franchisor and any other parties?
  
• All finance charges, interest charges, and other charges?
  
• Construction costs?
  
• Cost of upgrading franchise during term or at renewal?
  
• Professional services such as lawyer and accountant?
  
• Other costs?

 
11. The Prospective Franchisee’s Skills

• Educational background
  
• Ability to manage money (earnings history, savings history, debt history)
  
• Business experience
  
• Employment history

 
12. Risk-Benefit Analysis

The franchisee’s accountant should prepare a pro-forma income-and-expense statement about the proposed franchise, using all available data.

This has been a partial list of the factors that attorney Stephen A. Katz considers when he evaluates a franchise purchase with a client.

  For people who are considering buying a franchise, attorney Katz is happy to provide general franchise information, apart from legal information.  How long do franchise terms usually last?  Is 10% a high franchisor's royalty, or just average?  Has Katz heard complaints about a particular franchise recently?  This type of franchise information is needed by investors to make informed choices, and Katz is available to provide it whenever possible.

An Explanation of Attorney Katz’s Legal Fees

In evaluating a franchise opportunity, the preliminary consideration of many franchise offers should be kept as inexpensive as possible for the client. But at the point where the client has decided to purchase a franchise but wants his attorney to evaluate the deal, Katz will do an evaluation for a flat fee of $1,000. That sum purchases Katz's compiling all the information described above, and also purchases his evaluating the Uniform Franchise Offering Circular. Those two services should protect the client, and allow him to decide, based on substantial information, whether he wants to go ahead with purchasing the franchise.

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