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Buying A Franchise:
A Consumer Guide

... Continued From Previous Page

V. Investigating Before You Invest

The All-Important Disclosure Document

Before you invest in any franchise system, get a copy of the franchisor’s disclosure document. Under the Franchise Rule, which is enforced by the FTC, you must receive the document at least 14 days before you are asked to sign any contract or pay any money to the franchisor or an affiliate of the franchisor. You have the right to ask for—and get—a copy of the disclosure document once the franchisor has received your application and agreed to consider it. Indeed, you may want to get a copy of the franchisor’s disclosure document before incurring any expenses to investigate the franchise offering.

The franchisor may give you a copy of its disclosure document on paper, via email, through a web page, or on a disc. The cover of the disclosure document should have information about its availability in other formats. Make sure you have a copy of the document in a format that is convenient for you, and keep a copy for reference.

Read the entire disclosure document. Don’t be shy about asking for explanations, clarifications, and answers to your questions before you invest. Among the key sections in a complete disclosure document are:

Franchisor’s Background

This section tells how long the franchisor has been in business, likely competition, and any special laws that pertain to the industry, like any license or permit requirements. This will help you understand the costs and risks you are likely to take on if you purchase and operate the franchise.

Read the entire disclosure document. Don’t be shy about asking for explanations, clarifications, and answers to your questions before you invest.

Business Background

This section identifies the executives of the franchise system and describes their experience. Pay attention to their general business backgrounds, their experience in managing a franchise system, and how long they’ve been with the company.

Litigation History

This section discusses prior litigation—whether the franchisor or any of its executive officers have been convicted of felonies involving fraud, violations of franchise law, or unfair or deceptive practices law, or are subject to any state or federal injunctions involving similar misconduct. It also says whether the franchisor or any of its executives have been held liable for—or settled civil actions involving—the franchise relationship. A number of claims against the franchisor may indicate that it has not performed according to its agreements, or, at the very least, that franchisees have been dissatisfied with its performance.

This section also should say whether the franchisor has sued any of its franchisees during the last year, a disclosure that may indicate common types of problems in the franchise system. For example, a franchisor may sue franchisees for failing to pay royalties, which could indicate that franchisees are unsuccessful, and therefore, unable or unwilling to make their royalty payments.

Bankruptcy

This section discloses whether the franchisor or any of its executives have been involved in a recent bankruptcy, information that can help you assess the franchisor’s financial stability and whether the company is capable of delivering the support services it promises.

Initial and Ongoing Costs

This section describes the costs involved in starting and operating a franchise, including deposits or franchise fees that may be non-refundable, and costs for initial inventory, signs, equipment, leases, or rentals. It also explains ongoing costs, like royalties and advertising fees. In addition, ask about:

  • continuing royalty payments

  • advertising payments, both to local
    and national advertising funds

  • grand opening or other initial business promotions

  • business or operating licenses

  • product or service supply costs

  • real estate and leasehold improvements

  • discretionary equipment, such as a computer
    system or a security system

  • training

  • legal fees

  • financial and accounting advice

  • insurance

  • the costs of compliance with local ordinances, such as zoning,
    waste removal, and fire and other safety codes

  • health insurance

  • employee salaries and benefits

Starting your business may take several months. Estimate your operating expenses for the first year and your personal living expenses for up to two years. Compare your estimates with what other franchisees have paid and with competing franchise systems. You may be able to get a better deal with another franchisor.An accountant can help you evaluate this information.

Restrictions

This section tells whether the franchisor limits:

  • suppliers from whom you may purchase goods

  • the goods or services you may offer for sale

  • your customers

  • where you can sell goods or services

  • your use of the Internet to sell goods or services to customers in and out of your territory and the right of the franchisor (or other franchisees) to use the Internet to solicit customers or to sell in your territory

These kinds of restrictions may limit your ability to exercise your own business judgment in operating your outlet. That said, if the franchisor does not limit the territory where each franchisee can sell, the franchisor and other franchisees may compete with you for the same customers, either by establishing their own outlets, or by selling to customers in your area through the Internet, catalogs, telemarketing, and the like.

Terminations

This section spells out the conditions under which the franchisor may end your franchise and your obligations to the franchisor after termination. It also defines the conditions under which you can renew, sell, or assign your franchise to others.

Training

This section explains the franchisor’s training and assistance program. Check for information about:

  • who is eligible for training

  • whether new employees are eligible for training and,
    if so, at what cost. Who pays?

  • how long the training sessions take. How much time is spent on technical training, business management training, and marketing?

  • who conducts the training and their qualifications

  • whether the company offers ongoing training and at what cost

  • support staff available for trouble-shooting: Are they assigned to your area and how many franchisees they are responsible for?

  • whether on-site individual assistance is available
    and at what cost

The training you need will depend on your business experience and your knowledge of the franchisor’s goods and services. If you have doubts about whether the training offered is sufficient to give you the tools you need to handle day-to-day business operations, consider another franchise opportunity.

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