When Buying a Franchise Your "Investment" Involves Much More than Franchise Fees and Start-Up Expenses
If you are considering the purchase of a franchise it is critical to recognize that your "investment" goes beyond - well beyond - initial franchise fees and startup expenses. While franchise fees and start-up expenses (such as equipment purchases and "build-out") are critical expenses that must be evaluated, they only tell half the story. That is, when signing a franchise agreement you will be committing yourself to a serious of legal obligations that will involve the commitment of your time, future financial resources and legal obligations for many years to come.
So when evaluating the "cost" of a franchise, in addition to franchise fees and initial start-up costs, give some serious consideration to:
(a) Reserve Capital. Additional funds that you may be required to invest in your business/franchise during periods of unprofitability and negative cash flow. As with any business you may very well encounter periods of unprofitability and losses. When faced with losses and cash flow shortages you will be required to invest additional assets and resources to sustain the operations of your franchise;
(b) Your Time. The extensive time that your will be devoting to operating and managing your new franchise. Your time is valuable and when operating your franchise you will be foregoing income and opportunities from other sources of employment. Although obvious, this expense / opportunity cost is commonly overlooked. If your franchised business does not work out remember that your losses include missed opportunity costs and income that you would have otherwise earned.
(c) Post-Termination Restrictive Covenants and Fees. As a franchisee in most instances you will be committing yourself to long-term obligations and restrictive covenants. These covenants and obligations have a cost, especially when they restrict what you can and cannot do if you elect to shut down your franchise. This is of special concern to current business owners with established reputations within a community who - for legitimate reasons - decide to become a franchisee of a national company.
For Example - If you are a carpenter with a long established reputation within a community and you elect to purchase and become a franchisee of a national "repair" or "handyman" franchise what happens if your franchise relationship does not work out and you cancel your franchise agreement? Will you be precluded from operating your own repair business - a business that you operated many years before becoming a franchisee? The answer is that it all depends on the restrictive covenants contained in your franchise agreement - covenants and obligations that you should review and discuss in detail with your franchise lawyer "before" signing a franchise agreement.
So when considering the "cost" of your franchise investment you must go beyond "out of pocket" expenses and fees and evaluate the substantive impact of the long-term legal obligations that you will be committing to.
Excellent points.
Many people are completely unaware that the 3 months of working capital estimates a) have no basis in reality, and b) are used simply to avoid an illegal item 19 claim.
Excellent points that are generally never taken into account by the prospective franchisees whose "high hopes" blind them to realities.
Unfortunately, the startup costs and the time frames the franchisors provide do act as implied "earnings claims" that don't require any substantiation in the form of facts that have to be disclosed to prospective buyers of franchisees before purchase, under the FTC Rule.
Apparently, all the presale puffery and implied earnings claims made outside of the FDD and the actual franchise agreement are moot once the contract is signed.
Franchisees don't understand that optional Item 19 provides the opportunity for the franchisor to avoid putting anything in writing in terms of facts within the FDD or the actual franchise agreement.
Only a very small percentage of franchisors make written earnings claims in Item 19 because, of course, the franchisors can sell the franchises without making these claims in writing, based on the implied earnings claim; i.e. the startup costs. If a franchisor makes an Item 19 earnings claim, he has to prove it with facts.
The lack of any disclosure to new buyers of franchises of "facts" (concerning failure/success/profitability of units within the system) acts to protect the franchisor from fraudulent inducement claims in arbitration and the courts.
It is truly dangerous to invest in a franchise with the view that regulation and disclosure will protect you. Prospective franchisees need honest attorneys and CPA's to help them VET a franchise purchase. Item 19 and Item 20 are just an artifice, in my opinion, to protect the franchisor from fraudulent inducement/concealment claims in arbitration and the courts in the sale of the franchise.