How to Choose a Franchise ?

1) What is Franchising ?

• Franchising is an arrangement in which a party (the franchisor) has developed a way of running a business successfully, licenses the rights to operate that business format, under its trademark or name, to another party (the franchisee). The business arrangement involves a formal legal contract between the franchisor and franchisee and continual assistance to the franchisee to run the business on a predetermined basis.
  
  
• At least 2 levels are involved in the franchise system.
  1. The franchisor, who lends the trademark and the business system to;
  2. The franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor's name and system.
     
     
• Beyond contractual arrangement and agreements, successful franchising also involves building and maintaining a strong foundation of relationship and understanding between franchisor and it's franchisee.

2) In assessing a franchise opportunity, some other factors to consider of prime importance:

• The franchisor's financial position (adequately capitalised and financed to run the business;
  
  
• How thoroughly has the business been market tested;
  
  
• Assess how well the system works in practice. Are existing franchisees pleased with their business?
  
  
• Does the business have staying power, or is it based on something which is temporarily fashionable;
  
  
• Ask a solicitor to check the franchise agreement. Control in franchise agreements is needed to ensure uniformity of the system and the quality of its product or services. Agreement should be fair to you and the franchisor.

3) What is involved In Franchising ?

• Tenure or period of contract
  This is the period of validity of the legal contract between the franchisor and franchisee. It is usually set by the franchisor. The legal contract can be as short as 3 years to as long as 10 years or more. Usually, the condition to renew the contract is stated. Franchisors may allow for a renewal of the contract for the same period again at no additional cost or ask for payment of an additional fee to renew the contract. It is therefore important to find out exactly how long the validity period of the contract is for the sum of money paid to join the franchise.
  
  
• Initial fee
  The initial fee is the upfront payment that the franchisee must make to the franchisor to obtain the rights to the business format and trade or service mark(s) or trade name(s) for a specified period. In return for this fee, most franchisors provide services like shop opening assistance, design and layout of the premises to facilitate an early conversion to a franchise outlet. It is good to find out exactly what services and/or goods will be provided for the amount paid.
  
  
• Royalty/management fee
  This is an on-going payment, usually made monthly, by the franchisee to the franchisor. The fee is usually based on a percentage of the gross monthly sales. However, it could also be a fixed fee or a variation of one or both. In return for this fee, the franchisor usually provides management services including joint advertising and promotions, updating of the procedures, continuous new product development and so on. It is good to work out the monthly amount to be paid by the franchisee based on certain projected sales.
  
  
• Renovation cost
  The renovation cost refers to the cost that will be incurred by the franchisee to convert the premises to the image and layout specified by the franchisor. This cost has to be borne at the beginning of the franchise relationship. Hence, franchisees will need to have sufficient capital to pay for this amount upfront even before customers start coming in.
  
  
• Franchise agreement
  The franchise agreement is a legal contract between the franchisor and the franchisee spelling out the rights and obligations of both parties, terms and conditions including that for termination, and the validity period. This agreement is drawn up by the franchisor's lawyer. A potential franchisee should consult people who are knowledgeable on such agreements to go through the details before signing it.
  
  
• Working capital
  Franchisees must set aside sufficient funds as working capital to pay for normal business overheads e.g. utility bills, salaries, purchases of goods and services. Although most franchisors do provide credit terms for the goods and services provided, this only defers the payment. When the time arrives, franchisees will still need to pay up.
  
  
• Payment terms
  Good and services provided by the franchisor to the franchisee have to be paid for. The period by which franchisees are given to pay up is specified by the franchisor under payment terms.
  
  
• Territory
  Franchisors usually undertake not to set up another franchise outlet within the territory specified under the franchise agreement. The size of the territory can vary greatly depending on the nature of the business and the contract. If a franchise can support a large number of franchisees throughout Singapore, the territory given may be small.
  
  
• Compliance with contract
  Franchisees are required to comply with the terms and conditions of the franchise agreement. This is to ensure that franchisees do not conduct themselves in a manner that affects the image and business of other franchisees. Franchisors have the right to terminate the franchise agreement in the case of franchisees who, after repeated warnings, fail to comply. On the other hand, if the franchisor does not abide with the terms spelt out in the franchise agreement, the franchisee can also seek legal redress.
  
  
• Terms for termination
  There are 3 ways in which the franchise arrangement can be terminated. The first is when the contract expires. The second is termination by the franchisor under a breach of a term(s) in the franchise agreement. This can happen before expiry of the agreement. However such forced termination is not common unless there are frequent breaches of the contract by the franchisee. The third is when the franchisee opts to withdraw from the franchise before expiry of the franchise contract.
  
  

4) How to Assess The Franchise ?

• Assess the reputation and reliability of the franchisor
  Based on the track records of the franchisor and observation made when visiting the current and past franchisees, establish whether the franchisor is reputable and reliable. You can also seek other references to assess the credit standing of the franchisor.
  
  
• Find out the demand for products/services offered in the franchise
  This is an important consideration. Find out the sales potential of the products/services from the franchisees. Check published information on whether the product/service has potential to grow further. Find out about the competitors to see if there is still room to make a profit. If the franchisor claims that the product is patented, ask for proof. Assess also whether the product/service is suited to the location you have in mind.
  
  
• Do sales projection
  Based on the demand projected for a respective potential franchisee, do a sales projection under the best, expected and worst scenario. The expected scenario can be drawn from the average sales of franchisees. The franchisor should be able to help you do a projection based on the performances of other franchisees.
  
  
• Find out from other franchisees the support services provided
  Make sure that the franchisor provides adequate support services to the franchisees. Listen to what the franchisees have to say. Verify that with what the franchisor promises.
  
  
• Work out the amount of capital need upfront
  Calculate exactly why capital is needed at the start of joining the franchise. This includes the franchise fee, renovation fee, cost of equipment, rental deposit if the premises are leased, banker's guarantee (if any), working capital for staff salaries and utilities, etc. Check the amount of capital required with franchisees and the franchisor. Compare the amount of capital required among different franchises. Seek help to work this out if you are unable to do it yourself.
  
  
• Work out the amount of cash required under worst case scenario
  Many small businesses go bankrupt because of problems with cash flow. You have to add up the cash inflow and deduct all the cash outflow to come up with the amount of cash required. Make sure that in addition to the upfront capital, you have sufficient cash to tide over the business especially in the first two years. Again, approach someone who can do this for you if you have difficulties.
  
  
• Go through a contract thoroughly with a lawyer
  Seek legal advice regarding the franchise agreement. You are strongly advised to read through the fine prints of the agreement. Particular advice should be sought on the following:
  • termination by either party;
  • obligations of the franchisor;
  • restrictions on reassignments of the franchise;
  • restriction of businesses entered into after termination of franchise;
  • territory rights of the franchisee;
  • resolution of conflicts; and
  • rights of the franchisee.