Buying A Business Opportunity or Franchise
Had it with the daily commute? Been downsized? Bored with your present job? Retired, but still too young to just sit on the front porch? Dream of owning your own business? Need extra money? It doesn't matter what the reason is, every day people invest in business opportunities. Whether this investment is a dream come true or a nightmare will depend a great deal on pre-purchase homework.
A business opportunity can include vending machines, distributorships, franchises, multi-level marketing arrangements and others. Before you go out and invest your hard-earned money, investigate! Consider what type of business suits your experience, the amount of money you have to invest, your interests, and your skills.
What is a Business Opportunity?
- A business opportunity is legally defined as the sale or lease of any product, equipment, supply, or service which will enable the purchaser to start a business,
- The seller represents that he or she will provide locations or assist the buyer in finding locations, for the use or operation of vending devices, coin-operated amusement machines, or similar devices (this may include referring the buyer to a professional locating service, often one the seller has an interest in);
- The seller represents that he or she will purchase any product made, produced, fabricated, assembled, modified, grown or bred by the purchaser using, in whole or part, any product, equipment, supply, or service sold or leased to the buyer by the seller;
- The seller guarantees that the purchaser will earn an income greater than or equal to the price paid for the business opportunity;
- The seller says that if the buyer pays a fee exceeding three hundred dollars directly or indirectly for the purpose of the seller providing a sales or marketing program, the seller will provide such a program which will enable the purchaser to derive income from the business opportunity which exceeds the price paid for the business opportunity.
What is a Franchise?
A franchise is a format, product, or system developed by the franchisor. By paying a franchise fee, you receive the right to use the franchisor's name and receive assistance. A franchise may cost from a few thousand dollars to several hundred thousand dollars.
One of the biggest benefits of purchasing a franchise is the name recognition. Consider carefully the following outline of a typical franchise system.
Initial Franchise Fee and Other Expenses
In addition to your franchise fee, which may be non-refundable, you may have to rent, lease, build, advertise, and equip an outlet, including the purchase of inventory. You may have to pay license fees, or a "grand opening" fee to promote your new franchise.
You may be required to pay royalties based on a percentage of your gross income. Royalties are usually paid for the right to use the franchisor's name and may need to be paid even if you haven't earned any income or if the franchisor has failed to provide promised services.
Some franchises require that you pay into an advertising fund. A portion of the advertising fees may be for national advertising, and not to specifically target your franchise area.
Because of the name recognition, franchisors typically control how the individual franchisee runs their business. It insures uniformity but may restrict your ability to exercise your own business judgment.
Franchisors may require pre-approved sites for your franchise. The franchisor may not approve the site you wish.
Design or Appearance Standards
Many franchisors have a certain look that is easily recognizable and will impose that look upon you. You may have to conform to seasonal changes or periodic renovations. One of the biggest reasons for investing in a franchise is that people know what to expect no matter where they are when they come into the outlet.
Restrictions on Goods and Services Offered For Sale
Franchisors may control the goods and services you can provide. A fast food franchise can normally only sell the franchisor's menu, they cannot add or subtract items. As the franchisee of an automobile lube, you may not be able to offer additional service like brake or muffler work.
Restrictions on General Operation
You may be obliged to have your employees wear certain uniforms or to only use company advertising. You may have to run only company wide specials during specific times on specific items. This may hinder you from running your business as you see best. Some franchisors may require you to purchase supplies from approved vendors only. This may impact your profit margin if these vendors are more expensive.
Many franchisors will limit you to a certain territory. This could limit your ability to open more outlets or to move to a more profitable location.
Termination and Renewal
If you fail to comply with the franchise contract, you can lose the right to your franchise. Franchise contracts are for a limited time and there is no guarantee that you will be able to renew your franchise when the time comes.
If your franchise is terminated, you could lose your investment. The franchisor may cancel your contract if you fail to pay royalties, or abide by sales restrictions or performance standards.
A typical franchise agreement will run for 15 to 20 years. There is usually no provision that says that the franchisor must renew the agreement. Another thing to be aware of is that the franchisor doesn't have to renew the agreement under the same conditions as the first agreement. They may impose higher royalty fees, new sales restrictions, or may even reduce the size of your territory.
What is Multi-Level Marketing?
Multi-level marketing programs involve the sales of products or services through various levels of distributors. A distributor, also known as a sponsor, is expected to recruit other distributors. He or she is then responsible for training and motivating the new distributors. In return, he or she receives a percentage of their sales, and may receive bonuses when sales quotas are exceeded. If these distributors recruit their own distributors, the original sponsor also receives a percentage of this new downline's sales.
Multi-level marketing is a way to get in business for a very small amount of capital investment, sometimes less than one hundred dollars. Some people do very well, but the people who are very successful are few and far between. The people who are really successful are usually zealous about their product and company, and they are usually extremely good salespeople. Obviously these are attributes that will make a person successful in most any business.
Know the difference between a multi-level marketing program and a pyramid scheme. Bona fide multi-level marketing programs allow a distributor to sell the product or service if they do not wish to recruit others. Pyramid schemes make their money by recruiting other people to invest. If there is a product or service, it is incidental to the recruiting effort. Pyramid schemes always collapse with only the promoters and/or the very first investors making any money.
Before You Buy
Before you invest, whether it is in a franchise, multi-level marketing program or other business opportunity, there are many things you should consider. The following is a guide to some of the questions you should ask yourself. Go over these questions carefully to help make your decision.
- How much money do you have to invest?
- How much money can you afford to lose?
- Will you operate alone or will you have partners?
- Will you need financing? How will you obtain it?
- Do you have savings or income to live on while you start your new business?
Your Knowledge and Skills
- Are special skills or education required?
- Do you posses these skills or can you easily get them?
- What specialized knowledge or talents do you bring to the business?
- Do you have the necessary skills to manage a business?
- Do you require a specific level of income?
Is this a new field of interest?
- Do you like sales or performing a service?
- How many hours are you willing to spend on your business?
- Do you want the day to day management of the business or are you going to hire a manager?
- Will this be your primary source of income or a supplement to your present income?
- Is this something that you will enjoy doing for the next 20 years?
- Are you interested in staying small or do you want to grow large?
Making Your Selection
Investing in a Business Opportunity is like any other investment, there are risks. As you narrow down your possibilities, carefully consider these factors.
- What is the background of the promoter?
- What is the level of support you will receive?
- Have you talked to other owners?
- Is there a demand for the product or service?
- Is it seasonal?
- Is it a fad?
- Is the product or service a one time shot, or will it generate repeat business?
- Even though it may be the greatest thing in Florida, will it work in Washington?
- Is there competition, not only in your immediate area, but nationally?
- Are there other companies offering the same products or services?
- Will you be competing with well-established businesses with name recognition?
- What will set you apart from them?
Your Ability to Operate a Business
- Will you be able to operate if the promoter or parent company goes out of business?
- Will you be able to purchase supplies?
- Can you run your business alone without extra personnel?
Name Recognition (Franchises or Multi-level Marketing)
The main reason for purchasing a franchise or multi-level marketing program is the right to use the company's name. The more successful the franchisor or multi-level program, the more the name will be recognized.
- How widely recognized is the name?
- Is the name and/or logo a registered trademark?
- How long has the parent company been in business?
- What is the company's reputation for services, products?
- Are there any complaints on file against the company with the Better Business Bureau or a local consumer protection agency?
- Are there any complaints on file with the Department of Financial Institutions Securities Division?
Training and Support Services
- Does the company offer training or ongoing support services?
- How does the training compare with other similar training?
- Will you be competing with others with more training?
- What are the backgrounds of the current franchises or business opportunity owners?
- Do they have prior technical or special training that is enabling them to be successful?
Many franchises and business opportunities have been in business for many years. Many franchisors operate well-established companies with years of either selling goods or services and in managing a franchise system. Some franchises and business opportunities started out operating their own business. Just because a business may be successful doesn't mean that you will be successful. Carefully consider how long the business has been in business. If the promoter seems to have little experience, perhaps their promises of guidance, training, and other support may be unreliable.
A growing franchise or business may increase the name recognition or enable you to attract customers. Growth alone doesn't ensure a successful business. Will the promoter be able to support rapid growth? Do they have sufficient assets and staff? Does your background compare?
Shopping a Franchise/Business Opportunity Show
Attending a Franchise/Business Opportunity Show will offer you an opportunity to see a wide variety of businesses in one place. Remember, however, that the exhibitors are there to sell their product. Their idea of the perfect business for you and your idea may not even be close. Do not let a salesperson tell you what you should be investing in.
How Much Can You Invest?
Have your investment figures firmly in mind because there will be exhibitors that will tell you that you can't afford to pass up this opportunity even if it is much more than you feel you should invest.
Know The Type Of Business That Is Right For You
Only you know what your interests, skills, and desires are. Perhaps the area you are interested in stems from a hobby. Maybe you have lost your job, but due to your years of experience, feel you would like to stay in that field. Only you can make that determination. Don't allow a salesperson to sell you something you are not interested in. Focus on the businesses that are of interest to you.
Walk the floor once to see what is available and what you may be interested in. Listen to several exhibitors as they talk to other interested persons. Get the answers to the following questions:
- How long has the promoter been in business?
- How many business outlets currently exist? Where are they located?
- Can you get references of local owners?
- What are the initial fees?
- Are there continuing royalty payments (franchises)?
- What controls will the promoter impose upon your business?
Exhibitors may offer you prizes, free samples, or free dinners to entice you to attend a promotional meeting later on in the day or sometime during the next week. Don't feel obligated to purchase anything. These meetings should be another way to acquire more information and ask more questions. Walk away if you feel that the product doesn't suit your needs.
Substantiate All Earnings
Some exhibitors may tell you how much you can earn or how much current owners are earning. Be Careful. Any exhibitor that makes such claims must provide you with written substantiation. Ask for and obtain this written substantiation. If the exhibitor cannot or will not provide it to you, consider the claims to be suspect.
Question all charts or claims such as: "You need only make X sales per day with X number of sites to make X amount of money." "Every time you pull this lever, you make $X." Ask what else is involved?
It will be difficult to remember what each exhibitor said. Bring a pad and pen and take notes. Take any promotional literature so that you can review them. Get business cards so you can contact them later with additional questions.
Avoid High Pressure Sales Tactics
The promoter may tell you that the offering is for a limited time only, that only one territory is left, or that the price has been reduced for this show only. Don't allow yourself to be pressured to make a commitment. Legitimate franchisors and business opportunity promoters expect you to comparison shop. If it is a good deal today it should be a good deal tomorrow. It is better to wait and lose a good deal than to jump in and lose everything.
Before You Purchase Checklist
Before you purchase, make sure you thoroughly read the disclosure document and contract. Consult an attorney or accountant, preferably one with experience in this area, before you invest any money or sign any documents. Even the most experienced business people never enter into an important business relationship without consulting a team of professional advisers.
- Check with the Securities Division to see if they are registered. This may save you trouble later on. Contact us at 360-902-8760 or 1-877-RING DFI (1-877-746-4334).
- Financial Statements. Carefully examine the financial statements in the disclosure document. Have an accountant or attorney help you. The financial statements will tell you the promoter's strengths and weaknesses.
- Risk Factors. The disclosure document will outline any factors that may make the business venture risky or speculative. Examples include: no profitable operations within the past 3 years; an erratic financial position; prior business failures; if any of the management team has a criminal history; if the promoter has declared bankruptcy; lack of experience on the part of the promoter's management.
- Seller's Prior Business Track Record. Some of the information the disclosure document will give you is how many businesses have been operating within the preceding calendar year; the names, addresses, and phone numbers of existing purchasers; the number of businesses terminated; the number of businesses reacquired by the seller. Pay particular attention to the number of businesses terminated during the past 3 years. A very high number may be a red flag.
- Litigation History of the Seller and its Partners,
Officers, Directors, Sales Representatives and Affiliates.
The disclosure document will tell you if the seller or any
of its partners, officers, directors, sales representatives
or affiliates have been:
- convicted of a felony involving fraud;
- sued for fraud in an action or the business opportunity relationship;
- subject to an injunction relating to fraudulent dealings
- Insolvency or Bankruptcy of the Seller and its Partners, Officers, Directors, and Affiliates. The disclosure document will also tell you if the seller or any of its partners, officers, directors, or affiliates have filed for bankruptcy, been adjudged bankrupt, or have been reorganized due to insolvency.
- Description of the Business. What specific products and services will the seller provide to you? Is it high quality? Look for details on patents, warranties, frequency of repairs, consumer ratings, and any state or federal restrictions on the use of the product. Is there a market for the product? Ask for a market study. Is special training necessary? Will the seller provide the training? Is the product or service seasonal or cyclical?
- What Will Be Your Total Outlay? How much will the product or franchise cost you? Are there initial fees, deposits, or down payments? Will there be others to whom you will have to make payments? What for? Will you have recurring payments or expenses to the seller such as training, rent, additional equipment or inventory?
- Seller Assisted Financing. If the seller or its affiliate will offer you financing, find out the material terms and conditions. Have an accountant or attorney go over the contract.
- Operational Restrictions. Are you limited in what goods or services you can offer? Are you limited to certain geographical areas? Is your territory protected? Will you be required to be open certain hours and days? Will you need special regulatory permits or licenses? Are there other restrictions such as how many employees you must hire?
- Contract. Can you terminate or modify the contract? What are the conditions? Is renewal automatic? Can you compete with your former business if you terminate or are terminated?
- Site Selection. Will sites be selected based on a market survey? Will the seller help you pick an appropriate site? Will you be able to change sites if the site is not satisfactory? Site selection, especially for a franchise, is very important. If the seller offers little help, think twice about buying.
- High Pressure Sales. If you are pressured to make the decision now, don't.
- Promises of High Profits. Beware of promises of high profits, especially if they are "guaranteed".
- Little or no Risk. If you are told "you can't go wrong" you had better look elsewhere. All businesses involve risk.
- High Start-up Fees. Steer clear of business opportunities that involve high sign-up fees, requirements of large product purchases, expensive product, or have a no product repurchase policy.
- Evasive Answers. If the promoter will not or cannot answer your questions, don't purchase their product.
- Incomplete or Skimpy Contracts. If your contract takes only a couple of minutes to read or seems to be incomplete and the promoter makes promises not covered by the contract, beware. Take the contract to your attorney before you buy so he or she can make sure your rights are protected.
- Irregular Business Practices. You are asked to travel to another state to sign the papers and make payment. The promoter asks you to send your payment by private courier instead of through the mail. The only references are half way across the country or even in another country. The promoter is only willing to give phone numbers of references. The promoter is willing to fly in and meet you at the airport to quickly sign you up.
Any of the above are serious red flags and when they occur, close your checkbook and look elsewhere.
Take your time when investing in a business opportunity. Scams and frauds can be hard to spot, do your homework and investigate thoroughly.
Remember, making money almost always requires hard work, and lots of it.
To check to see if a business opportunity is registered or if any complaints have been filed against it, call or write:
Department of Financial Institutions
PO Box 9033
Olympia WA 98507-9033
1-877-RING DFI (1-877-746-4334)
If you want to come to the office, we are located at:
Department of Financial Institutions
150 Israel Rd. SW
Tumwater, WA 98501
Visit the FTC's Web Site @ www.ftc.gov