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The Pitfalls of Franchising

Know the challenges — or your dream business could become a nightmare

Accept that you don't call the shots

It's important to realize that regardless of the sales pitch, you're not really your own boss. If that's what you want, franchising may not be for you, as Sheerer found out. You must follow the formula. There's little wiggle room for innovation. Franchises depend on the by-the-book execution of a business plan.

In general, you have to be willing to do what you're told. "If you aren't comfortable following a system, you have no business being in franchising," Bailey says.

Do your due diligence

What happens if there's a problem at the corporate parent of your franchise? For example, Denver-based submarine sandwich maker Quiznos recently filed to reorganize under Chapter 11 of the U.S. Bankruptcy Code. And the franchise operator also has been sued by disgruntled franchisees who cited a number of grievances. This includes being required to buy reportedly overpriced food from vendors approved by the franchisor, which the plaintiffs claim has affected their profits.

After the bankruptcy filing, Quiznos CEO Stuart Mathis addressed franchisee concerns in a statement: "We look forward to continuing to work with and support our global network of franchise owners, who are the backbone of our business. Our business plan includes several key elements aimed at supporting our franchisees, including reducing food costs, implementing a franchise owner rebate program, in certain circumstances making loans available to franchisees for restaurant improvements, investing in advertising to improve location awareness, and providing new incentives for prospective franchisees."

"All specific buying agreements are clearly spelled out in the franchisor's disclosure document," says FranNet's Bailey. "Using a good franchise attorney to review the license agreement is a must. The franchise attorney can explain exactly what the franchisor can require in the future."

All but seven of Quiznos' nearly 2,100 restaurants are independently owned and operated by franchisees in the U.S. and 30 other countries around the world. As separate businesses, these restaurants are not a part of the Chapter 11 proceedings and are open and operating as usual.

Be a detective

The franchise industry is regulated by the Federal Trade Commission, which offers a consumer guide to buying a franchise and resources to help you avoid common scams.

Step one is to request a franchisor's disclosure document. It provides contact information for previous purchasers in your region, audited financial statements, a breakdown of start-up and ongoing costs, and an outline of your responsibilities and the franchiser's obligations.

Pay close attention to the pages in the document showing franchisee turnover. Names and phone numbers of former and current franchisees in your area should be listed.

Contacting former franchisees may take some legwork, but the key is to find out why they're no longer in business. It might be, for instance, that the promised training didn't materialize for them or the robust marketing support that was touted upfront never materialized.

Talk to franchisees at all levels of the business — from those who are wildly successful, to those in the middle of the pack and those who are struggling, Bailey says. About 20 percent knock it out of the park, 60 percent make a good living, and 20 percent are less successful, she adds.

It's best to interview franchisees in person. Chances are that they will be more forthcoming in a face-to-face meeting. Be aware that some may have signed confidentiality agreements that prevent them from talking to you.

Be sure you have enough money

One of the biggest mistakes people make is to jump in undercapitalized, according to Bailey. "Talk to other franchisees to get a feel for a realistic reserve that you should have on hand. Always err on the side of being conservative and put more back, rather than less."

Have a savings cushion

How much can you afford to lose? Do you have a financial cushion to cover your living expenses for a year or more? If not, pump the brakes. It's essential to create a budget and figure out how much you will need to live on while your start-up gains traction.

While some franchises do break even quickly, most take 12 months or longer before a newcomer can draw a salary. While the initial fee for a franchise is clearly stated in the disclosure documents, newcomers often underestimate operating costs, Bailey says.

Next page: Contemplate a loan and be ready to get your hands dirty. »

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