U.S. Small Business Administration MP-26


 EVALUATING FRANCHISE OPPORTUNITIES

 Management and Planning Series

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While we consider the contents of this publication to be of
general merit, its sponsorship by the U.S. Small Business
Administration does not necessarily constitute an endorsement of
the views and opinions of the authors or the products and
services of the companies with which they are affiliated.

All of SBA's programs are extended to the public on a
nondiscriminatory basis.

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 TABLE OF CONTENTS

INTRODUCTION

WHAT IS FRANCHISING?

BENEFITS OF A FRANCHISE

INVESTIGATE YOUR OPTIONS
 What is the Business?
 Who is the Franchiser?
 What is the Franchise Package?
 The Disclosure Document

PERSONAL ASSESSMENT

OBTAINING PROFESSIONAL ADVICE

APPENDIX: INFORMATION RESOURCES
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INTRODUCTION

The success rate for franchise-owned businesses is very high.
According to studies conducted by the U.S. Department of Commerce
from 1971 to 1987, less than 5 percent of franchised businesses
failed or were discontinued in each of those years. However,
success is not guaranteed. One of the biggest mistakes that you
can make is to be in a hurry to get into business. If you take
shortcuts on your evaluation of a potential business, you might
neglect to consider other franchises that are more suitable for
you. Don't be pressured into a franchise that is not right for
you. Although most franchise operations are managed by reputable
individuals, as in all industries, some are not. Also, some
franchised businesses are poorly managed and financially weak.
Resist pressure to purchase before you complete a thorough
investigation.

This publication is designed to assist you in investigating your
options. It includes the questions you should ask to adequately
evaluate the business, the franchiser, the franchise package and
yourself as a franchise owner.
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WHAT IS FRANCHISING?

A franchise is a legal and commercial relationship between the
owner of a trademark, service mark, trade name or advertising
symbol and an individual or group seeking the right to use that
identification in a business. The franchise agreement governs the
method for conducting business between the two parties. Although
forms of franchising have been in use since the Civil War,
enormous growth has occurred more recently. By the end of 1990,
more than 500,000 franchised establishments in 60 industries
achieved gross sales of over $700 billion dollars and employed
7 million full- and part-time workers. Industries that rely on
franchised businesses to distribute their products and services
touch every aspect of life, from automobile sales and real estate
to fast foods and tax preparation.

In its simplest form, a franchiser owns the right to a name or
trademark and sells that right to a franchisee. This is known as
product/trade name franchising. In the more complex form, known
as business format franchising, a broader and ongoing
relationship exists between the two parties. Business format
franchises often provide a full range of services, including

 * Site selection.

 * Training.

 * Product supply.

 * Marketing plans.

 * Financing.

Generally, a franchisee sells goods or services that are supplied
by the franchiser or that meet the franchiser's quality
standards.
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BENEFITS OF A FRANCHISE

There are a number of aspects to the franchising method that
appeal to prospective business owners. For example, easy access
to an established product and a proven method of operating a
business reduces the many risks of opening a business. In fact,
U.S. Small Business Administration and U.S. Department of
Commerce statistics show a significantly lower failure rate for
franchised businesses than for other business start-ups. The
franchisee purchases not only a trademark, but also the
experience and expertise of the franchiser's organization.
However, a franchise does not ensure easy success. If you are not
prepared for the total commitment of time, energy and financial
resources that any business requires, you should stop and
reconsider your decision to enter the franchise business.
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INVESTIGATE YOUR OPTIONS

As in all major business decisions, nothing substitutes for
thorough investigation, planning and analysis of your options.
This publication is designed to help you systematically review
the possibilities and pitfalls of the franchised business you are
considering. Use the questions below to guide your research and
cover all the bases. Read the entire publication before you begin
to gather information.

What Is the Business?

Determine whether the business opportunity would be a successful
venture on its own, apart from the benefits offered by the
franchiser.

 * Is the product or service being offered new or established?
 Does the business require special skills or aptitudes that
 you may lack? Do you feel strong motivation for producing
 the product or providing the service?

 * Does the product meet a local demand? Is there a proven
 market?

 * Who is the competition?

 * If the product requires servicing, who bears the
 responsibilities covered by warranties and guarantees? The
 franchisee? The franchiser? If neither, are service options
 available?

 * What kind of reputation does the product or service enjoy?

 * Are suppliers available? What reputation do they enjoy?

Who Is the Franchiser?

Visit at least one of the firm's franchises. Ask for a list of
all of the firm's current franchises and make sure that you
select the one to visit. Avoid calling those names recommended by
the franchiser. At the very least, the franchiser must provide
you with the names of 10 franchises in your prospective market
area.

When you meet with the franchisees, observe their operation,
discuss expenses and ask how well the franchiser supports the
franchise units. Does the franchiser actively promote and market
the products or services of the franchise? You should determine
the reputation, stability and financial strength of the
franchiser.

 * How long has the franchiser been in the industry? How long
 has the firm granted franchises?

 * How many franchises are there? How many in your area?

 * Examine the attitude of the franchiser toward you. Is the
 firm concerned about your qualifications? Are you being
 rushed to sign the agreement? Does the firm seem interested
 in a long-term relationship, or does that interest end with
 the initial fee?

 * What is the current financial condition of the franchiser?
 Check the franchiser's financial statements in the
 disclosure document (see page 3). If the franchisees are
 paying their upfront fees but not their royalties, this may
 indicate that franchise units are being sold to investors
 but that they fail to open or perform too poorly to pay
 royalties.

 * Who are the principal officers, owners and management
 staff? What is each person's background? How much
 experience in franchising do they have?

 * Compare sales promises with existing documentation. Be
 certain that the sales presentation is realistic and that
 major promises are clearly written into the contract. Be
 alert for exaggerated claims and pressure tactics.

 * For newly established franchises, make sure the franchiser
 has registered the company's trademark. If not, the
 company's name and logo may have to be altered, forcing you
 to change your market identity after you have established
 yourself.

 * Verify earnings claims and compare them with other business
 opportunities. Investigate all earnings claims carefully.
 Earnings claims must (1) be in writing; (2) describe the
 basis and assumptions for the claim; (3) state the number
 and percentage of other units whose actual experience
 equals or exceeds the claim; (4) be accompanied by an offer
 to show substantiating material for the claim; and (5)
 include certain cautionary language. Treat this opportunity
 like any other investment. Does the franchise offer the
 return you require? If not, you may want to look at a
 different business.

 * What is the legal history of the franchiser? Have any of
 the executives been involved in criminal or civil actions?
 Is any litigation pending, particularly involving any
 restrictions on trade that may affect the franchise?

 * Is the franchise a member of the International Franchise
 Association (IFA)? If not, why not? The IFA has a strict
 code of ethics that must be met before a company can become
 a member.

What Is the Franchise Package?

Bring all your information and resources together as you examine
the contract. Think carefully about the level of independence you
will maintain as a franchisee. How comprehensive are the
operating controls? Be very clear about the full costs of
purchasing the franchise. Involve your attorney, accountant
and/or business advisor as you examine these questions.

 * What is the full initial cost? What does it cover?

 -- Licensing fee?

 -- Land purchase or lease?

 -- Building construction or renovation?

 -- Equipment?

 -- Training?

 -- Starting inventory?

 -- Promotional fees?

 -- Use of operations manuals?

 * What ongoing costs are paid to the franchiser?

 -- Royalties?

 -- Ongoing training?

 -- Cooperative advertising fees?

 -- Insurance?

 -- Interest or financing?

 * Are you required to purchase supplies from the franchiser
 or a designated supplier? Are the prices competitive with
 other suppliers?

 
 * What, if any, restrictions apply to competition with other
 franchises?

 * What are the terms covering renewal rights? Reselling the
 franchise?

The Disclosure Document

The Federal Trade Commission (FTC) requires sellers of franchises
and other business opportunity ventures to provide prospective
investors with the information they need to make an informed
investment decision. It also requires that all earnings claims be
documented, that the information investors receive be complete
and accurate and that investors have adequate time to consider
and evaluate the disclosures before making any final purchase
commitment. All required information is given to prospective
investors in the form of a franchise disclosure document, which
must be furnished at least 10 business days before any purchase
may occur. This document includes 20 important items of
information, such as

 * Names, addresses and telephone numbers of other
 franchisees.

 * A fully audited financial statement of the seller.

 * The cost required to start and maintain the business.

 * The responsibilities you and the seller will share once you
 buy a franchise.

 * Litigation involving the company or its officers, if any.

Again, use your professional support to examine all of these
issues. Some of the contract terms may be negotiable. Find out
before you sign; otherwise, it will be too late.
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PERSONAL ASSESSMENT

Perhaps your most important step in evaluating a franchise
opportunity is examining your own skills, abilities and
experience. The ideal franchisee is a creative, outgoing person
who is eager to succeed, but not so independent that he or she
resents other people's advice. You must be able to balance your
entrepreneurial initiative with a willingness to comply with the
business formulas used by the franchiser. Remember, a successful
partnership between a franchisee and franchiser involves a mutual
understanding of each other's values and achievements.

Determine exactly what you want out of life and what you are
willing to sacrifice to achieve your goals. Be honest, rigorous
and specific. Ask yourself: Am I qualified for this field

 * Physically?

 * By experience?

 * By education?

 * By learning capacity?

 * Financially?

Ask yourself how this decision will affect your family. Do they
understand the risks and sacrifices required, and will they
support your efforts? Beginning a franchise business is a major
decision that does not ensure easy success. However, an informed
commitment of time, energy and money by you and your family can
lead to an exciting and profitable venture.
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OBTAINING PROFESSIONAL ADVICE

You should consult a franchise attorney, an accountant and/or a
business advisor to counsel you and go over the disclosure
document and proposed contract. Their advice will help you make a
realistic and sound decision. Remember, the money and time you
spend may save you from a major loss on a bad investment. Also,
see the information resources in the appendix.
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APPENDIX: INFORMATION RESOURCES

U.S. Small Business Administration (SBA)

The SBA offers an extensive selection of information on most
business management topics, from how to start a business to
exporting your products.

SBA has offices throughout the country. Consult the U.S. 
Government section in your telephone directory for the office
nearest you. SBA offers a number of programs and services,
including training and educational programs, counseling services,
financial programs and contract assistance. Ask about

 * SCORE: Counselors to Americas Small Business, a 
 national organization sponsored by SBA of over 11,000
 volunteer business executives who provide free
 counseling, workshops and seminars to prospective and
 existing small business people. Free online counseling
 and training at www.score.org. 

 * Small Business Development Centers (SBDCs), sponsored
 by the SBA in partnership with state governments, the
 educational community and the private sector. They
 provide assistance, counseling and training to 
 prospective and existing business people.

 * Womens Business Centers (WBCs), sponsored by the SBA 
 in partnership with local non-government organizations
 across the nation. Centers are geared specifically to 
 provide training for women in finance, management,
 marketing, procurement and the Internet.

For more information about SBA business development programs and
services call the SBA Small Business Answer Desk at 1-800-U-ASK-
SBA (827-5722) or visit our website, www.sba.gov. 

Other U.S. Government Resources

Many publications on business management and other related topics
are available from the Government Printing Office (GPO). GPO
bookstores are located in 24 major cities and are listed in the
Yellow Pages under the bookstore heading. Find a Catalog of
Government Publications at http://catalog.gpo.gov/F 

Many federal agencies offer Websites and publications of interest 
to small businesses. There is a nominal fee for some, but most 
are free. Below is a selected list of government agencies that 
provide publications and other services targeted to small 
businesses. To get their publications, contact the regional 
offices listed in the telephone directory or write to the 
addresses below:

Federal Citizen Information Center (FCIC)
Http://www.pueblo.gsa.gov 
1-800-333-4636
The CIO offers a consumer information catalog of federal
publications.

Consumer Product Safety Commission (CPSC)
Publications Request
Washington, DC 20207
http://www.cpsc.gov/cpscpub/pubs/pub_idx.html 
The CPSC offers guidelines for product safety requirements.

U.S. Department of Agriculture (USDA)
12th Street and Independence Avenue, SW
Washington, DC 20250
http://www.usda.gov 
The USDA offers publications on selling to the USDA. Publications
and programs on entrepreneurship are also available through 
county extension offices nationwide.

U.S. Department of Commerce (DOC)
Office of Business Liaison
14th Street and Constitution Avenue, NW
Washington, DC 20230
http://www.osec.doc.gov/obl/ 
DOC's Business Liaison Center provides listings of business
opportunities available in the federal government. This service
also will refer businesses to different programs and services in
the DOC and other federal agencies.

U.S. Department of Health and Human Services (HHS)
Substance Abuse and Mental Health Services Administration
1 Choke Cherry Road
Rockville, MD 20857
http://www.workplace.samhsa.gov 
Helpline: 1-800-workplace. Provides information on Employee
Assistance Programs Drug, Alcohol and other Substance Abuse.

U.S. Department of Labor (DOL)
Employment Standards Administration
200 Constitution Avenue, NW
Washington, DC 20210
The DOL offers publications on compliance with labor laws.

U.S. Department of Treasury
Internal Revenue Service (IRS)
1500 Pennsylvania Avenue NW
Washington DC 20230
http://www.irs.gov/business/index.html 
The IRS offers information on tax requirements for small
businesses.

U.S. Environmental Protection Agency (EPA)
Small Business Ombudsman
1200 Pennsylvania Avenue NW
Washington, DC 20480
http://epa.gov/sbo
Hotline: 1-800-368-5888
The EPA offers more than 100 publications designed to help small
businesses understand how they can comply with EPA regulations.

U.S. Food and Drug Administration (FDA)
5600 Fishers Lane
Rockville MD 20857-0001
http://www.fda.gov
Hotline: 1-888-463-6332
The FDA offers information on packaging and labeling requirements
for food and food-related products.

For More Information

A librarian can help you locate the specific information you need
in reference books. Most libraries have a variety of directories,
indexes and encyclopedias that cover many business topics. They
also have other resources, such as

 * Trade association information
 Ask the librarian to show you a directory of trade
 associations. Associations provide a valuable network
 of resources to their members through publications 
 and services such as newsletters, conferences and
 seminars.

 * Books
 Many guidebooks, textbooks and manuals on small
 business are published annually. To find the names of
 books not in your local library check Books In Print,
 a directory of books currently available from
 publishers.

 * Magazine and newspaper articles
 Business and professional magazines provide 
 information that is more current than that found in
 books and textbooks. There are a number of indexes to
 help you find specific articles in periodicals.

 * Internet Search Engines

In addition to books and magazines, many libraries offer free
workshops, free access to computers and the Internet, lend 
skill-building tapes and have catalogues and brochures 
describing continuing education opportunities.
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