Common Pitfalls of Start-up Franchising and How to Avoid Them
by John Sotos
This article originally appeared in Canadian Opportunities Magazine
Start-up franchising ought not be a shot in the dark. After all, one of the biggest selling propositions of franchising over starting up an independent business is that with franchising, the franchisor has invested the time, money and sweat equity to work out all of the major impediments to operating a unit of the business so that the franchise concept may then be used by a prospective business operator or franchisee. As a result, the franchisee gets a head start in exchange for the initial and on-going fees that it undertakes to pay. Unfortunately, not every start-up franchisor follows good franchising practices often resulting in poor outcomes for everyone involved. What follows is a discussion of some of the common - and easily preventable - difficulties faced by the start-up franchisor.
1. Idea vs. Successful Business Concept.
A good idea for a business does not mean that it is ready for presentation on a franchise show trade floor. Although virtually anything and everything is franchisable, converting a good idea into a great concept is neither simple nor straight forward. Even a wildly successful business unit does not equate with success when multiplied. While many franchises originate from a single successful operation, the successful start-up franchisors go through a process of replication, refinement and evidence of profitability in different locations and under different management. A franchise concept needs to exist and improve under a variety of conditions before franchising is undertaken. This trial period is necessary to validate that success is not location dependent (the proverbial seafood restaurant on the Vancouver waterfront) and that there is a viable market beyond the direct management of a charismatic founder.
The failure to understand and invest in the systematic process of franchising often consigns fledgling franchise concepts to the dustbin of history. Those that manage to survive generally do so after the founders have been forced to sell the concept to more experienced and better capitalized investors who understand franchising as a process. The start-up franchisor who invests in doing it right after going through the crucible of franchisee dissent and litigation can also experience great long-term success. As I always counsel my clients, you either make the investment upfront or you will make a much larger investment later. There is no escaping the cost of proofing the concept.
2. Unprotected trade name.
The first discussion between the prospective franchisor and his or her lawyer should end with instructions to secure trade mark protection for the distinctive trade name and identity of the prospective franchisor. Without a secure trademark and related intellectual property, it becomes extremely difficult to franchise. Yet, without fail, year after year, start-up franchise companies receive a nasty letter from a law firm advising them that the trade name they are doing business under and have licensed others to do the same is the protected property of their client and that the franchisor must cease and desist from further use and pay unspecified damages. While any problem can be resolved with enough time and money, the expense of re-identification or buying-out the interest of the rightful trademark owner is going to be far more expensive than the modest cost of investigating and securing or selecting an alternative trade name from the outset.
3. No Manuals.
I have yet to see a franchise agreement, however badly written, that does not contain a provision requiring franchisees to observe the franchisor's proven methods of operation and management techniques as described in more detail in one or more manuals. Yet many a start-up franchisor will grant franchises without a manual, or worse, by producing one that is a copy of somebody else's system, replete with references and processes or equipment unknown to this franchise system. While the franchise agreement defines the nature of the legal relationship between franchisor and franchisee, the manual is the heart of every system. The failure of the franchisor to prepare a manual or manuals that describe the details of how its particular business is run always demonstrates premature franchising. While corporate consultants can be hired to assist with the preparation of manuals, this exercise requires extensive input and time commitment from the principals of the franchisor, which explains, in part, why manuals get neglected.
4. Training.
Prospective franchisees will often lack experience with the franchisor's business, industry or concept. Even with manuals in place, the absence of adequate initial training sufficient to impart all of the basic components of operating and managing the proposed franchise business will hamstring the franchisee from day one. Failure to train franchisees from the get-go results in their perpetuating and training on their own mistakes, an outcome which the purchase of a franchise is intended to prevent in the first place More importantly, failure to properly train franchisees impedes execution at store level thereby sapping the concept of its early growth potential. Every franchise has to budget and develop a training programme at the inception of the system complete with a training manual and a competent trainer to deliver it. A charismatic chef who communicates by throwing kitchen utensils around should not qualify as a competent trainer.
5. Site Selection or Real Estate.
Control over one's real estate is a tremendous advantage to any franchisor whose business relies on customer visits. One of the best ways to exercise that control is for the franchisor to take a head lease of its locations and then to sublease them to its franchisees.
However, the indiscriminate or inconsistent selection of sites, particularly during economic downturns, has been a significant source of start-up franchisor failures. The burden of even a few uneconomic locations, when added to previously marginal locations failing more or less at the same time, can bring the average start-up crashing down. While there are numerous planning devices to protect against such outcomes, this planning has to anticipate the problem. Experienced franchise counsel can assist in structuring the appropriate real estate and leasing vehicles for a particular system.
6. The Accidental Franchisor / Ignorance of the Law.
Since the enactment of franchise-specific laws in various provinces, a fair number of legal relationships, commonly referred to as dealerships, are now considered to be franchises by the relevant franchise statutes. In many provinces, franchisors must provide a disclosure document prior to the grant or renewal of a franchise. Failing to do so allows a franchisee (in most cases) to claim, pursuant to franchise legislation, both the return of their initial investment paid to the franchisor as well as all losses accumulated in connection with the business for a two year period from the date of the franchise grant. If, for example, one's business network consists of the sale or distribution of goods and services using the owner's trademarks, and the owner makes a profit by selling goods, then experienced legal advice should be obtained, despite the fact that in other jurisdictions, such business structures might not be considered to be examples of franchising.
7. Running Afoul of Legal Requirements.
Since the enactment of franchise legislation, franchisors in the affected jurisdictions are required to produce a disclosure document in relation to the business opportunity being offered, which is similar to a securities-type prospectus. Franchisors doing business in provinces with franchise legislation often fail to appreciate the risk of inadequate disclosure. In the interests of false costs savings, these franchisors attempt to prepare a disclosure document internally, or based on price rather than professional expertise. As with the accidental franchisor, the consequences can be devastating if the system has a couple of hiccups in its early stages of growth.
Risk Avoidance Tips.
While no business can avoid all risk, minimizing foreseeable risk is possible. Retaining experienced consultants to help develop a successful franchise system, together with the engagement of experienced legal counsel to advise on legal structures and prepare documentation catered to a particular franchise concept, are measures that will go a long way towards reducing the foreseeable risk and personal liability that otherwise attaches to those who ignore the law.