Beware of Paying Too Much for a Franchise

Easy, sensible ways for entrepreneurs to evaluate franchise opportunities like a pro

Q.  I want to start a daycare franchise but I don't know where to start to find financing. I plan to use the equity in my house as the down-payment and borrow the rest from the SBA. Most notable day care franchises want up to $250,000 in startup fees. I need some direction in this matter.

A.  Here's a sweet thought to consider. Wouldn't it be great if every time we managed to make it into any competitive game, a victory was guaranteed? But as we all know, just showing up is never enough. Winning requires hard work, talent and strategy.

The franchise venture game works the same way too. No matter what aggressive franchise business sellers say, putting together the money to buy into a franchise doesn't guarantee the individual franchise operation will succeed.

So, what is a worthwhile franchise opportunity? Is it a business that pays you a steady salary plus generates a healthy annual profit? Or is it, a business that grows in value so that one day you can cash out with a big check in hand? Both answers are correct.

But since you want to finance just about 100% of the franchise startup fees, the franchise also has to produce enough cash to pay the monthly principal and interest payments on your personal debt. This perhaps is your best test if a franchise business is right for you.

Here's another consideration. Unlike other businesses that you may buy or start on your own, in a franchise operation you don't really "own" all of the company's operating decisions and income.

Franchisors make their money from the initial franchise sales fee, which you already know can be quite high. Plus franchisors make money from ongoing royalty fees on your daycare center's gross sales, advertising fees, and sale of operating supplies. Some franchisors also make money from renting property or providing other services to its franchise network. That's a lot of your money going back to the franchise headquarters. Is it worth it?

The only way to find out is by asking questions and reviewing the franchise operating results in detail. Here are some starting points:

• What is the financial position of the franchisor today? Ask for current financial statements and share this information with your accountant and lawyer. Avoid franchisors with high debt levels and skimpy net worths. Also determine if the franchisor is surviving on upfront franchise fees or from ongoing franchise operations. If franchise owners are not making money, eventually the franchisor will fail.
• Will the franchisor allow you to open a day care facility wherever you want? Many fast-growth franchisors sell large territory rights to "sub franchisors" forcing new single owners to develop less desirable locations.
• How long has the franchise network been in business successfully? Stay clear of franchisors that don't have actual 24 month results for individual franchise locations. If the average franchise operation doesn't generate enough cash to pay the principal and interest on your debt, then you "win" by staying away from a bad business deal.

While many entrepreneurs hate going over financial details, I think numbers are wonderful fortune and misfortune tellers. Take the time to understand their meaning to you.

I predict that at the end of this exercise you will know quite a bit about daycare operations. Actually you may determine that you can start and manage your own daycare operation all by yourself without paying hefty franchise fees.

Good luck and let me know what you decide.

Take Command Action Step

One of the most important documents for prospective franchise buyers to review (with qualified legal counsel) is the franchise agreement. This document outlines the relationship between the franchise company or "franchisor" and you as the potential franchise buyer. Pay extra attention to the terms in which you can transfer or sell your franchise business. If you don't like the daycare business, can you get out of the deal with reasonable ease? Find out before you sign. Talk to former franchise owners for insight too. You can do it!

Do you need time-saving tips to help fund and grow your business? Ask Susan How! Write to small business funding expert Susan Schreter at susan@takecommand.org