Question: My wife and I are interested in purchasing an existing national franchise with two established locations and exclusive rights to operate within a large and fast-growing metropolitan area. What questions should one ask the current owner when considering the purchase of an existing franchise?
-- Pete W., Henderson, Nev.
Answer: Talking extensively with the owners is a good idea when buying any existing business, franchise or not. But be careful putting too much stock in what the seller says, for obvious reason: they want you to buy it.
"Remember, they may be in a bad situation they want to get out of and will paint a rosier picture than is true," says Mario L. Herman, an Adamstown, Md., lawyer who represents franchisees.
More revealing, Mr. Herman says, will be hard data such as the individual franchises' financial and tax records, the franchiser's offering circular, as well as any insights you can gather from the company's other current and former franchisees.
You must determine how profitable the franchise has been, how much you can realistically boost profits and whether the benefits you get from the franchise network are worth all the royalties and fees you'll be providing it. An accountant or franchise specialist could help with this process.
Don't get stuck in the same boat as David House, a Waterford, Wis., man who bought an existing women's gym franchise with his wife in 2004 for about $55,000. Mr. House says they knew the owner was just breaking even on the gym, but the franchiser reassured them that memberships would climb and revenue could reach $40,000 a month if they spent money and energy on marketing.
But even when they reopened the gym, and spent more than $1,000 monthly on advertising, membership numbers stayed flat and they were losing money. They ended up closing the gym in early 2005 and selling the equipment. Part of the problem, Mr. House says, was the franchiser was spearheading the sale instead of the actual owner, and many questions they had for the seller were "deferred to corporate."
Start your inspection by asking the owners for all financial records, accounts receivable, tax returns, and any contracts, including the franchise agreement. Spend ample time with the current owners, talk with employees and some customers and survey the location.
Ask the current owners why they're selling, whether they've been sued, how much debt they have, how long they've owned the business and whether current employees will stay. Get a complete sense of their relationship with the franchiser, such as how involved the franchiser is in the day-to-day operations, how much training and support it has provided and whether it assists with marketing. But again, try to verify these claims through other means.
Keep in mind, you're not only interviewing the owners -- you're interviewing the franchiser, too. "When getting into any franchise, you want to take a look at what kind of services you are going to be provided," in exchange for the royalties and fees you're paying to the franchiser, says Mark Siebert, chief executive of iFranchise Group, in Homewood, Ill. Most royalties are between 4% and 8% of gross revenues, but they can be higher.
Request a copy of the franchiser's offering circular early on. This document has a wealth of useful information, including all the fees you'll owe, financial information for the past three years, legal trouble, the numbers of closures and transfers of franchises and a list of current and former owners with phone numbers.
You won't necessarily get the same franchise agreement and terms as the seller, so ask the franchiser for an advance copy of your agreement terms.
There are some red flags to watch for, says Mr. Herman. If more than 5% of a company's franchises close annually, or more than 10% are transferred to other owners, "your radar should go up," he says. Also be wary if the franchiser is dominating the sale between you and the existing owner. "As a prospective franchisee, you want to have as much communication direct with the seller as you can," he says.