8 Questions to Ask and Answer Before Buying a Franchise

8 Questions to Ask and Answer Before Buying a FranchiseFor many people, buying a franchise provides a way to fulfill their lifelong dreams of achieving and exceeding their financial and lifestyle goals.. Truthfully, owning a franchise can totally change your life and provide you with the dream life you’ve always wanted, provided you find the right franchise that leverages your skills, abilities and interests.

There are numerous stories of people who started with a franchise and built them into multi-million dollar businesses, and unfortunately there are also a lot of stories of people who have lost their life savings. Because franchising does not automatically guarantee success, before buying any franchise, you need to consider some highly important questions. And until you have successfully answered most or all of these questions in the affirmative, we strongly suggest that you slow down and reassess the opportunity, even if the franchisor is one of the best Canadian franchises.

1) Is There Any Demand for the Product or Service?

The very first thing you need to do is get a solid understanding of  how strong the current AND future demand for the product or service is for the franchise you intend to buy. It’s not just enough to get a franchise. There has to be sustainable demand for the product or service. While some businesses like automotive, food and hair care are very recession-resistant and often called “evergreen”, sub-trends within evergreen businesses can change over time.

You’ll also want to check if there’s a lot of competition for your products and services. We view competition as healthy because this means there’s strong demand for the product or service. Even in markets with fierce competition, franchises thrive because the franchisor has figured out ways to outperform their franchised and less sophisticated non-franchised competitors. The alternative is a market with little to no competition now, but there may be possibility of more competition in the future.  These should be considered when buying a franchise in Canada.

2) How strong is the franchisor’s Track Record of Success?

Find out what the story is behind the franchisor’s success. What kind of reputation do they have in the marketplace? Are they respected and trusted or do they have some questionable history? What is their litigation history with their franchisees?

How well have they been able to assist franchisees to successfully launch in other markets? How migrate-able is the concept from one geographic market to another?

Contact their current franchises and get first hand information from them regarding their own franchise and their relationship with the franchisor.

3) How Financially Stable is Your Franchisor?

It is important to get a sense of how strong your franchisor is financially, because you’ll be relying on them for long-term support. Most jurisdictions have franchise legislation that requires disclosure of current financial statements, so take this to your accountant and get them to review it and offer comments/observations.

4) What’s Their Payment Structure?

Find out what their fee structure is.  What is their initial franchise fee? You really want to understand the complete picture about the value you’re getting for it! What is their royalty structure – a percentage of sales, or a flat monthly fee? Again, you really want to understand the complete picture about the value you’re getting for it so you’ll want to talk to enough existing franchisees (we recommend at least 8 to 12) and get their impressions of the initial and ongoing value they’ve been experiencing. If you are considering some of the best franchises in Canada, or considering buying a franchise in Canada, compare this information with other concepts in the same market.

5) How’s Your Franchisor Making Money?

Is the franchisor relying on the sale of franchises to fund the system, or can they rely on the revenue stream that is being generated by the existing franchisees? (FAR safer scenario)  It is important for you to understand and be comfortable with how your franchisor is deriving their revenue – the more mature the franchise system, the more revenue that should be generated from royalties.  This will allow the Franchisor to invest in new products, better service providers, frequent management training and growth strategies.

6) What Are Their Expansion Plans?

Do they intend to expand provincially, nationwide, or possibly even internationally? Whatever their plans, it’s important for the franchisor to ensure that the rate they build their franchisee base is matched by the rate they grow their franchisee support staff – surprisingly, too many franchise systems have failed and closed because they grew more rapidly than they could support the growth!

Expansion plans are often linked to the maturity of the franchise system. Emerging systems (franchising for 4 years or less) often want to grow rapidly, but if their franchisee recruitment process isn’t thought through then they might be willing to settle on awarding franchises to people who simply have enough money, but who aren’t a good fit for the day-to-day running of the business – this creates significant long-term risk for both the franchisor and its franchisees. Mezzanine systems (franchising for 5 -12 years) enjoy the benefit of a moderately to strongly proven system and thus are often growing both strategically and aggressively, usually into additional geographic markets; while they don’t yet enjoy brand potency, many concepts in this maturity range offer the best balance between price and mitigated risk. Mature systems (those franchising for 13 years or longer) typically enjoy brand potency; they are well-distributed across many jurisdictions. Growth is often focused on filling in “holes” in existing markets or expanding into emerging/secondary markets.

Whatever the expansion strategy, you want to ensure that their franchisee selection strategy is robust enough that they can tell you in some detail why they feel you’re a solid fit for their franchise model; what you want to avoid at all costs is the ‘pulse-check franchisee recruiting strategy’ – if you have a pulse and can write a big enough cheque, come on in! We’ll figure out everything as we go!

Other considerations regarding understanding the franchisor’s expansion strategy includes: Is there a chance that you might have to compete against them for the same market share one day? Will you have exclusive rights to their products and services within your territory? If they’ll be selling more franchises, how many will they be selling within your city, province or geographical territory?

And how will you fare against that kind of competition? Will there be enough demand to go around? These are important questions you need to ask so you don’t get surprised if you find there’s another franchise setting up close to you.

7) What’s the Success Rate of Other Franchises They Sold?

This is perhaps the most crucial factor. Every franchise system has a performance bell curve; what you want to understand is what percentage of the curve are meeting or exceeding your financial and lifestyle goals. If enough of the existing franchises are performing well enough (ideally 30% or greater), and if you have similar skill sets and interests as those franchisees, then it’s reasonable to conclude that you have a strong likelihood of achieving similar results.. The higher the number of franchisees achieving your desired lifestyle, the greater your odds are for success.

8) What’s My Exit Strategy?

You should never go into business without and end game or exit strategy in mind, because some businesses simply do not provide a robust exit opportunity. We typically see three primary exit strategies:

  1. Build for a certain period of time (usually 7 to 10 years) and then sell for a significant amount (2.5x to 3.5x annual profitability is a reasonable guideline)
  2. Build for a certain period of time (usually 5 – 7 years) then hire a full-time manager to run the day-to-day business while you manage the manager and oversee the business on a part-time basis (+/- 20 hours/week)
  3. Build for a certain amount of time then get your kids involved and pass the business on to them

Some businesses create tremendous income generation opportunity while the business is up and running, but have little to no exit value that can be realized. Some businesses have transferability restrictions, and some businesses require your full time and attention throughout the entire term of the franchise relationship. Given all of this, it’s important for you to understand what exit strategy limitations might exist, before you buy your franchise.

These are some of the critical questions you need to ask before buying a franchise; there are simply far too many questions to list so we guide our clients through a range of questions based on the stage of research they are at.  If you have questions about buying a franchise in Canada, give us a call.  We would be happy to discuss it with you.

About Gary Prenevost

Gary PrenevostGary Prenevost is one of North America’s leading franchise matchmaking experts. He has been a licensor, a master franchisor, a franchise consultant and a franchisee. As a Senior Advisor with iFranchise Group, Gary also works with companies to franchise their businesses; he also helps existing franchise systems improve their systems and processes. Prior to becoming an entrepreneur, Gary was a banker for over seven years, so with over 20 years of experience “on all sides of the franchise table”, Gary truly brings a 360° perspective to helping his clients find and buy the optimum franchise for them. Please visit www.CanadaFranchiseExpert.ca for more information about Gary and his no-cost franchise matchmaking services.

May 5, 2014