Should You Franchise Your Business?

If you want to expand, but lack the money, the people and the time, it may be time to think about franchising.
By Mark C. Siebert

Have a better mousetrap but scared to death that the world is actually beating a path to your door? Trouble sleeping at night wondering who will knock off your operation first? Certain that yours is the next Ray Kroc story, if only you could get the capital? Tired of reading about companies and thinking, "I have a better franchise concept than that company"?

Maybe you, too, should consider franchising.

Why Franchise?

In general, companies decide to begin franchising for one of three reasons: lack of money, people or time.

The primary barrier to expansion that today's entrepreneur faces is lack of capital. And franchising allows companies to expand without the risk of debt or the cost of equity. Since franchisees provide the initial investment at the unit level, franchising allows for expansion with minimal capital investment on the part of the franchisor. In addition, since it's the franchisee, and not the franchisor, who signs the lease and commits to various service contracts, franchising allows for expansion with virtually no contingent liability, thus greatly reducing a franchisor's risk.

The second barrier to expansion is finding and retaining good unit managers. All too often, a business owner spends months looking for and training a new manager only to see that manager leave-or worse yet, get hired away by a competitor.

Franchising allows entrepreneurs to overcome many of these problems by substituting a motivated franchisee for a unit manager. Interestingly enough, since the franchisee has both an investment in the unit and a stake in the profits, unit performance will often improve. And since a franchisor's income is based on the franchisee's gross sales-and not profitability-monitoring unit-level expenses becomes significantly less cumbersome.

Finally, opening another location takes time. Hunt for sites. Negotiate leases. Arrange for design and build-out. Secure financing. Hire and train staff. Purchase equipment and inventory. The end result is that the number of units you can open in any given period of time is limited by the amount of time it takes to do it properly.

For companies with too little time (or too little staff), franchising is often the fastest way to grow. That's because it's the franchisee who performs most of these growth tasks. The franchisor provides the guidance, of course, but the franchisee does the legwork. Thus franchising not only allows the franchisor financial leverage, but it allows him to leverage his resources as well.

Is Your Business "Franchisable"?
Franchising is a relatively flexible format, and just about any type of business can be franchised, provided it meets some basic characteristics:

• It needs to be credible. Does your company have experienced management? A track-record over time? Is the concept proven? Have you achieved good local press or public acclaim?
• It needs to be unique. Is your business adequately differentiated from its competitors? Is it marketable as a business opportunity? Does it have a sustainable competitive advantage?
• It needs to be teachable. Are the systems in place? Are operating procedures documented? Could someone learn to operate your business in three months or less?
• It needs to provide an adequate return. I don't mean just profitability. If a business can't generate a 15 to 20 percent return on investment after deducting a royalty (typically between 4 and 8 percent), it's going to have difficulty keeping franchisees happy.

If your business meets these criteria, then it may be a good candidate for franchising.
When a company makes a decision to franchise, it must first develop a sound plan for expansion. This plan must take into consideration the numerous issues confronting a new franchisor: speed of growth, territorial development, support services, staffing and fee structure, to name just a few of the most important issues. Larger companies need to address more complex issues such as channel conflict, anti-trust issues, and resource allocation. And obviously, your entire plan needs to be subjected to rigorous financial analysis and scrutiny to fine-tune your strategy for growth.

Once your plan is in place, you'll need the proper legal documentation. At a minimum, you'll need a franchise contract, an offering circular (as required under FTC Rule 436), and, depending on where franchises are being sold, state registrations. There are literally hundreds of different business issues that must be addressed in a good franchise agreement, and the decisions made regarding these issues will ultimately dictate your success as a franchisee.

Quality control for a new franchisor involves the development of highly developed systems. Generally, this translates into the development of an operations manual that must contain not only the systems used by the business, but also the checklists, policies, procedures and tactics that will allow these systems to be uniformly enforced. Moreover, operations manuals must be careful to avoid the creation of an agency and must also address issues that could create claims of negligence if you're to maintain an effective shield against consumer liability.

Finally, as a new franchisor, you must develop the ability to market and sell franchises. That requires knowledge of how to attract prospective buyers and the necessary materials (brochures, mini-brochures, videotapes, DVDs, and so on) that will help make the sale. Moreover, since the franchise sales process is highly regulated, you'll need to be educated in proper sales, disclosure and compliance techniques.

Every new franchisor quickly learns that when they turn to franchising, they've entered a completely different business. Regardless of how you make money as a franchisor, you'll have two roles: selling franchises and servicing franchisees. And of the two, ensuring the success of your franchisees is the most important.

Properly structured, franchising can allow small companies to more effectively compete with much larger competitors. It can also allow larger companies to gain the advantages of highly motivated unit management while reducing overhead. As such, franchising is an option that more and more companies should explore.

The key to success in franchising is successful franchisees. Without successful franchisees, no franchise system will last. But if you can put the interests of your franchisee first, those same franchisees might help you become the next McDonald's.