Should You Invest in a Franchise?

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Hey, Roland Frazier here. And today I'm going to talk a little bit about investing in franchises. So generally franchises can be wonderful investments. And I've had the chance to interview some pretty significant franchise investors like Emmett Smith and Magic Johnson, people that have basically been successful in one thing and they're looking for a place to invest their money that they've made. But they don't really like the stock market. They don't really want to start a business and they don't necessarily want a job, but they do want to find some way to be in a business. Like that's not just the stock market, not as a retail investor, but something they could actually own and build. And franchises can be really good for that. So the cool thing about franchises is that, that you're not doing a startup right. You're getting a business system and you're getting a brand from somebody who's already done it and has already done it successfully. And so that's a, a really good thing to think about is the franchises can be good. Now here's the thing is a lot of people will say, well, franchises are only good if you want to buy a job, because that's really what a franchise is. It's ideally for somebody that wants to do something like start a restaurant, but maybe they don't have the experience or maybe they just want all the systems and contacts and connections, the marketing, the brand, all that stuff set up so they're not starting from scratch. Because we all know that businesses have about a 90% chance of failure over time for a startup. So franchises, you have a much, much, much better chance of success. But you also very frequently are just buying a job. So you're paying this upfront franchise fee and then you've got ongoing payments as well, and you might even have payments on. I mean, you've got typically a build out kind of investment to make things go. You've got a lot of costs, rent. And typically franchises are in locations that are good for traffic, which means that the rent might be expensive as well if it's a retail franchise. So there's a lot of things to think about when you're getting started with, but they can be good investments. And there are lots of people that I know that I've had as clients that I've had as friends people that I've interviewed who have owned hundreds of franchises. And they're very, very successful and very, very happy at it. So what is a good investment? Like what? What is a good investment amount? Well, really this is just a budget that you're thinking about. So some of the things to think about when you're thinking about a budget is how much can you afford to pay upfront to get started in the franchise. The next thing that you're going to want to think about is what ongoing payments, if any, are there on a minimum basis that are required for you to be able to keep the franchise. Is there some level of income that the franchise has to be generating for you to keep the rights to own the franchise? Because some franchise agreements will have terms like that in them. The other thing you want to think about is are there required commitments to other things that you might have to pay, like a build out? How much does it cost to build out? A McDonald's might cost a million dollars to build out or more. Right. Many franchises cost 100, 300, $500,000 to build out. Do you have that money? And if you don't, or if either way actually can you come up with the money that's necessary to do that or if that has to be financed, have you figured in the amount that you'll have on an ongoing basis to pay the financing of those build outs? Right. You're going to have rental payments, you're going to have a budget for employees. All of these things are going to have to be things that you think about. How long is it going to be before you get customers coming in and how much money will you have to spend on your marketing budget to get those customers to come in? And then how much will it cost to have the people to receive those customers? So is there any additional software that's not included with the franchise agreement? So you need to think about all of those things. And then when you've got an idea of what those are, look at your budget and see if you've got enough money to work with. Because if you don't, then you don't want to start out preparing yourself for failure. Right? You don't want to set yourself up for failure. So the way that I would do this is I would say first think about what is the category of business that you would like to start and then you can do a search. Inc. Magazine has a list of the 500 top franchises. There's all kinds of online resources for just googling and say what category am I interested in and then franchise. That's what I would do is I'd say like, let's say that you want to start a pizza restaurant or you're interested in a pizza restaurant. Then I would put pizza restaurant franchises. Now we know several of those, like Domino's and Pizza Hut and things like that. But, but in addition to that, you're going to want to take a look at what else is out there because there might be some new startups that are cool. You might think about going to a franchise trade show where they have lots and lots of franchisors exhibiting. Franchisors are the people that create the franchise business. And you as a buyer of the franchise are called a franchisee. So all of that is going to help you see, like, what is the universe of options for me to invest in as a franchise. When you do that, then you can kind of take a look and start taking notes and say, well, this is how much it costs to get into a Pizza Hut franchise, and this is how much it costs to get into Papa John's, and this is how much it costs to get into Roland's Crazy Pizza, right? And that upfront payment, then you'll look at the minimum royalties, if there are any, you'll see that there's a percentage typically of sales that has to be paid back to the franchisor. Will you be required to buy product from the franchisor? And, and if so, like McDonald's has Golden State Foods, I think still that's their food company that all their franchisees buy from and they have to buy the product as part of the deal. So is there something like that that's in there? You add up all of those expenses, the rent, the build out, the support, the ongoing labor, the marketing, and then take a look at the different options that you've identified and say, which one of these can I afford? And maybe some of them are super, super affordable because there are franchises that are only 100, 200, 500, $700,000. Right? Maybe that is what you're looking at. And you look and you say, well, I've got $10,000 to work with and the total franchise costs are going to be $3,700. Okay, you're good. But maybe it's that you have $300,000 in your IRA to invest and in your retirement account or something like that, and the franchise costs 600,000. Or maybe the franchise is 150. So you're like, oh, I got it, I got $300,000 in the bank. And it's only 150 for the franchise fee. But then you find out that it's going to cost you 600,000 to build it out and have a three month or six month window of expenses before the thing becomes profitable. Well, it turns out you don't have enough money so maybe you'd have to go borrow some. So those are just a lot of things for you to consider when you are doing your budget. So franchise research. I talked about this a little bit in the budget section where we talked about what, what's the budget that I should have? The bottom line is that you definitely want to do your research first. The research that you're going to do is just what are the options, what are the franchise options for me to invest in within the category that I'm interested in? So if I'm interested in donut shops, then I'm going to Google donut shop franchises. I'm going to look on the trade shows, I'm going to, you know, see what all is out there. Now let's say I've identified 14 of them that are potentially of interest. Then I think it really makes sense for you to do a comprehensive note taking session. Maybe create a Google sheet or something like that, a spreadsheet and say what are all the fees that are associated? What is the performance history of this? This is when we go past just like is it available and what's my budget into? How are these things performing? So there's a document called the fdd, the Franchise Disclosure Document and that FDD in the United States there would likely be similar agreements in other countries, but in the United States we've got this FDD and you want to look at that and see how is the franchisor performing? Like are they profitable or are they losing money? Because if they're losing money, the question is how long can they stay in business and support you? So if to invest a lot of money in a franchise and building one and helping them with their brand, you want to be sure they're going to be around, they're financially strong. The other thing you're going to want to do is see how are the other franchisees performing. Because if those franchisees are not performing well, if they're performing like a network marketing multi level company, you know, where there's only 000-0006% of the people that ever make any money of any significance, the then that's a big red flag, right? So that's something you're gonna wanna look at. You're Gonna look at the franchise disclosure document. You're also going to want to talk to them about the failure rate and in the event of certain levels of non performance, will they buy the franchise back? What's your ability to unwind this deal? That research is going to be important. I'd also talk to at least five franchisees they will recommend. The franchisor will very likely have a few franchisees that they'll make available for you to talk to. Obviously you should talk to them just to be sure that, that their experience is what you think it is. But also I would reach out to two or three franchisees that they do not refer you to. So just say, you know, hey, I'm thinking about getting one of these franchises. How's it going for you? And that will give you a very good indication of management recommended franchisees to talk to and your own. And you'll be able to build a real picture of what is it like to be a franchisee for this franchisor. So those are really good in terms of experientially and then just generally you could run searches to see are there any Better Business Bureau or Federal Trade Commission or other complaints that have been filed against the franchisor, Is there any challenges or any litigation that's going on. Those are kind of red flags for you to take a look at too. And I think if you do those things and then maybe go and do a little bit of research into the trend, like let's say that we're thinking about investing in donuts, a donut shop franchise. And donuts have been super, super hot because all these custom donuts have come out over the past three years and you think this is a good place to be. But you read some trade trend reports and they say that donuts are out, the keto is in again. And so the donut sales are predicted to decline 30% over the next three years. Well, that's going to tell you that maybe you're investing in something that even though the franchise has historical performance that is good, the looking forward performance isn't going to be that great. So I think that's important. As I mentioned, one of the best resources for information is for you just to go and ask other franchisees, other people that have bought the franchise, if you can find anybody who, I mean obviously the current franchisees, the ones that management recommends, the ones that you pick on your own that management didn't recommend, that's, that's important. But if you can also find any franchisees that have sold and talk to them about their experience and ask why did they sell? Did they make money? What was that experience? Like, how friendly was the franchisor to them during the sale process, then that's a lot of great information to always, always, always ask other people that are doing this. Right? Let's see. You might also talk to some competing franchise owners and ask them what's their experience with that franchise. And because they may have looked at the franchise that you're thinking about buying as well and decided that they didn't want to do it, if they, if that's the case, then you want to ask them what were their reasons and why did they ultimately decide to go with the one that they did go with. I think talking to competing franchises and their owners is very, very helpful too. And I would also talk, if you're thinking that you like the XYZ Donuts, Crazy Donuts franchise, talk to a few of the others as well and just see, you know, see how things seem like they're going for those people. The next thing you want to think about is what are the documents and agreements that you're going to have to sign before you invest. I would definitely not get into the franchise game without having an attorney that's got experience reviewing franchise documents to help you. If you're setting up a franchise, for sure, you got to get somebody. There's so many places to make mistakes, right? You create your franchise disclosure document and all the supporting documents. But even when you do all that and even when you have good consultants and good attorneys, there can be challenges, right? So be very, very careful that you've got good, competent help on those documents. Now, on the other side of that, as a franchisee thinking about investing, imagine that you are trying to go and look at these sometimes 60, 80, 100 page documents that are franchise documents and have all this legal mumbo jumbo in them. And then there's an operating agreement, there's a supply agreement, and there's a rental agreement and a site location agreement. All these other things. You are way, way, way outgunned. So don't do that on your own. Don't just think that you're going to just sign it and it's going to be okay because there will be things in there that are important to you that are going to slip under your radar because you don't know what to look for. So I would always recommend that you get both a franchise consultant because they are specifically focused on the franchise. Ideally, they are somebody that does franchise consulting in the specific area or niche that you're looking to have your franchise in and then also get an attorney that has experience with these kinds of deals. And I mean an attorney that actually has experience. If you can get a litigator to look at it, that's one of the best to me in my experience, to have a litigation attorney who's seen the things that go wrong. Review something from a transactional side before you go into the deal. The red flags pop right there. And they're used to seeing them because they've gone through, they've been out on the battlefield going through the challenges and finding out what works and doesn't work. So I think that's a really great resource as you look at these agreements. So whatever the agreements are, you need to get the full list of them, get every single agreement you're going to have to sign, and then get somebody that's a franchise consultant and a franchise attorney, preferably litigator, to review those before you sign. Okay. Last but not least, know when to renew your franchise agreement. So if you're a franchisee, you typically have a term that the franchise lasts and you typically have one or several renewal options that are built in every so often, every so many years. So you want to think about understanding before you even sign the document. You want to think about what does renewal look like? What are my options for renewal and am I exclusive or non exclusive? Is there an ability to, for them to sell more franchises in my territory and I have an exclusive zip code, but a non exclusive in a state or something like that? Like what are the parameters of the rights that I'm actually getting here and are those rights going to continue? And so when renewal comes, do we have to renegotiate the franchise agreement? Is there an opportunity there for me to end up with less than I started with or maybe more than I started with? And what legal renewal rights do I have? What's the term of the renewal? How long will I get this for initially and then how long will I get it for on the renewal? Is renewal automatic or do I have to provide notice that I'm going to renew or not renew? That's really important too, because what if you don't plan to renew and it's a five year term and then you have to, you have to give them notice that you're not going to renew between six months and five months of the renewal date coming, but you forget about it until 30 days before and then you give them notice and they're like, oh, well, sorry, you know, you had the contract says you have to give us notice. And so you're auto renewed and now you're in for five more years. Right. That could be very scary. So the other option would be you think everything's going fine, you're very happy, and you've got a really choice territory and you're making a lot of money and the franchisor is looking at that, saying, boy, that should probably have been two or three or four franchises, not one. We gave this, these people too much territory. Then you forget to give them the notice that you're going to renew. And maybe that's required. That's not an automatic renewal. It terminates unless you give notice 90 days before the 90 days or more before renewal, and it gets to be 60 days before you plan to renew. You're assuming it's all going to happen. And they're like, hey, we're not renewing your franchise because you didn't tell us that you wanted to renew. And they were just sitting there hoping that you wouldn't. And now you're kind of screwed because you've lost the franchise and now you renegotiate and they want to put four franchises in the territory where you only had one before. So there's all of these kinds of things that you want to think about when you're renewing. And again, always, always, always get a franchise consultant, somebody that's been experienced at this to help you with it. Also a franchise attorney, preferably somebody that's done litigation. I love transactional attorneys. I was a transactional attorney when I practiced law. But what I think I have found is that I really like having people who are litigators. They're not like you. Generally, it's good to have both. It's good to have somebody that has litigation experience because they'll know where are the pitfalls and what are the red flags and where do you need to do to protect yourself in the event things don't work out well? Okay. But they don't typically have the great negotiating experience from putting together deals because they're generally just helping clean up the mess of deals that didn't work. So. So it's good to have a good transactional attorney, too. So, like, if it's a lot of money, if you're investing $100,000 or more, I think I would really think about having both the litigator and a transactional franchise attorney take a look at deal. And I also think that the consultants bring invaluable knowledge and experience because they're typically people that have owned and operated and advised hundreds of franchises, right. That between owning and operating a couple and then maybe advising 50, 60, 100 different deals, they'll see enough to really know things that maybe the attorneys who are living in the theoretical world and the defense or litigation world, those people don't know much about the operational world. So the franchise person who's the consultant will be able to help you on the ops side. So those are some things that I think are really, really helpful as you are examining and taking a look at the opportunities that you could have in the franchise world. And I hope that's helpful.

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