How to Evaluate a Great Franchise Opportunity: Lessons from My Journey
Gail Scardapane, CFE
Co-founder Saladworks | Brand Marketing & Franchise Development
Recently, I had the opportunity to work with several experienced business leaders interested in investing in a franchise. They wanted to know which franchises were worth considering in 2024, how I would evaluate them, and what red flags to watch out for.
While I can't provide a comprehensive list of recommended franchise concepts, I can share some key factors I would consider when evaluating a potential franchise opportunity from a franchisor's perspective.
Please note that I'm not a franchise broker but an advisor sharing my years of experience in franchising, marketing, and business development and my 3 "law degrees" (I didn't attend law school but paid at least 3 tuitions). A heartfelt shoutout to all my franchise friends for their support!
The Saladworks Story: My Experience
The Idea was simple: create entrée-sized salads in front of customers, which they could customize with lots of fresh ingredients and a great dressing.
Fast, fresh, and convenient—a healthier alternative to pizza and burgers—the Saladworks idea took off like wildfire. We opened twelve more locations, and everything was buzzing—there was a line at every location every day! Yet, as we set our sights on growing beyond our core market, the skepticism and snarkiness grew stronger; 30 years ago, not many people had faith in a salad concept. We had to listen to comments like these.
"People don't eat salad as a meal, salad is the promise of more food to come." I'll never forget how one leasing agent who worked for one of the largest mall developers in the county, said why are you wasting my time? People in Texas do not eat salad.
Fast-forward to 2001, we started selling Saladworks franchises and expanding from 12 company-owned stores to 150 franchise locations. Lessons were learned, markets tested, and challenges overcome—franchising is never as simple as "build it, and they will come."
It's been an amazing journey so far, aka The American Dream. I'm grateful for everything, even the difficult times because they make the good times that much sweeter.
Let's get into it. How to Evaluate a Franchise Opportunity.
If you're interested in becoming a business owner but need help figuring out where to begin, franchising can be a great option. Franchise brands are supported by proven systems that can lead franchisees toward success and profitability. However, before investing your life savings, it's crucial to research the brand to ensure it's the right fit for you.
Something to remember:
Franchisors earn revenue primarily from ongoing royalties, not just franchise fees. If a franchise company has 100 locations sold but only 3 are open, it's important to investigate why. aka red flag.
Understanding the difference between a franchisor's and a franchisee's responsibilities will help you focus and make it easier to recognize a great franchise opportunity.
Franchisor: The franchisor sells its concept, systems and processes, trademark use, proven vendor network, and design—not how nice it is but how it's built to maximize revenue and speed of service, and perhaps most importantly, the franchise company culture.
Franchisee: This is you—the individual owning and running the franchise location and selling the products or services associated with the franchise concept, such as salads, sneakers, tires, accounting services, etc.
What am I getting at:
Ultimately, focus on the long-term partnership and the value it brings beyond just the initial product or service.
You've Found a Franchise You Love—Now, It's FDD Time
Once you've identified a franchise concept (product or service) that interests you, the next step is to request the Franchise Disclosure Document (FDD) from the franchisor.
The Holy Grail: The Franchise Disclosure Document (FDD)
The FDD is your deep dive into the brand's story. It's a legal document with the whole company story, from soup to nuts; it contains everything you need to know. You'll learn about the company's history, founders, and track record. You'll also see the costs involved, from upfront fees like the franchise fee and building costs to ongoing fees like royalties and marketing.
The FDD will provide information about the current franchisees and their specific locations, how many locations there are, and any legal issues or lawsuits the company has faced. You'll even get an estimate of how long it takes to open a franchise location and other facts about the brand.
Because FDDs can be lengthy and complex, reviewing the document with a lawyer who can help you understand the legal jargon and spot any potential issues is wise.
High fees should be questioned unless they offer unique benefits or exclusivity in their territories.
Key Areas to Examine
Franchise fee
Typically, it ranges from $25,000 to $50,000 and is usually paid upfront when signing the franchise agreement. If a franchise fee exceeds the typical range, it's crucial to understand why.
For example, McDonald's charges a franchise fee of $40,000. If an emerging brand's fee is $50,000+, I would want clarification on why that is the case. Given that everyone is familiar with McDonald's, the value of their name, trademarks, systems, buying power, and training justifies their fee. In contrast, a franchisor that has only been selling franchises for 12 to 18 months may not have the same level of recognition or support. (of course, they don't, no one does this is McDonald's)
Franchise Agreement Term
A typical franchise agreement is a 10-year term.
(Suggestion) I think aligning this term with your retail lease can be beneficial. After ten years, some locations may require remodeling, and landlords may increase rent. Relocating within the territory and renewing may be more cost-effective than paying transfer and renewal fees.
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Startup Costs and Ongoing Fees
Understanding the financial implications of a franchise is crucial. Here's a breakdown of the key costs involved:
Initial Investment
Franchise Fee: This is a one-time payment to the franchisor for the right to use their brand and business model. Typically, this fee ranges from $25,000 to $50,000 as part of the total investment.
Initial Investment: This includes various expenses such as real estate, construction, equipment, inventory, legal fees, and more.
Working Capital: These are funds needed to cover operating costs until the franchise becomes profitable.
Ongoing Fees
Royalty Fees: This is a percentage of your gross sales paid to the franchisor, usually between 4% and 12%.
Advertising Fees: These contributions go toward a fund for national and regional advertising campaigns, typically ranging from 1% to 3% of your gross sales. This is separate from marketing efforts for your specific location.
Technology Fees: These are charges associated with using the franchisor's designated technology systems and often consist of fixed monthly fees.
Knowing the breakeven point is one of the major benefits of buying into a franchise, as it provides a clearer roadmap to profitability compared to going solo.
Understanding Your Break-Even Point in Franchising
The break-even point is when your total revenue equals your total costs. In simpler terms, it's the point where you start making a profit. Understanding this is crucial for any business, especially a franchise. The franchisor can provide valuable insights into your potential break-even point. They may share historical data, sales projections, and best practices to help you achieve profitability sooner.
Key Components to Consider
Fixed Costs: Rent, Salaries and wages, Insurance, Property taxes, Licensing fees, Lease payments (Equipment), Marketing fees (brand fund, etc.), and Administrative costs.
Variable Costs: Royalties (4%-12% of gross sales), Brand fund (1%-3% of gross sales), Cost of goods sold (COGS), Utilities, Credit card fees, Sales commissions, Shipping and handling fees.
Revenue: This is the income generated from sales of products or services.
Seek Insights: Talk to Existing Franchisees
No one can give you a clearer picture of the franchising experience than franchisees already in the game. Be prepared to reach out to several franchisees to get a well-rounded perspective. Talk to successful ones, those who are struggling, and even those who've sold their businesses. Here are some key questions to ask:
The most important non-negotiable part of this decision is the founder's genuine passion for the brand; their authenticity is the heart and soul of the business.
Research the Founders: The Heart Behind the Brand
A franchise's authenticity often stems from its founders. Research the people behind the brand—are they passionate about their product? Do they have a strong industry reputation? A genuine, motivated founder can make all the difference in the brand's success, particularly for emerging brands.
Evaluating Support Systems: What's in It for You?
One of the main advantages of franchising is the built-in support system. Whether you've owned a business or not, you will likely need assistance, pasted the training, especially at the beginning. Franchise support services should be clearly outlined in the Franchise Disclosure Document (FDD).
Think of it like this: the initial franchisee fee ($25,000 - $50,000) is for the concept, and the ongoing fees (4%-12%) are for support.
Make sure to evaluate the extent of the training and the depth of the brand's manuals. In addition to initial training, inquire about what kind of ongoing support you can expect and whether the franchisor delivers on that promise. After all, this is what you're buying.
A reputable franchisor will provide comprehensive support
The Bottom Line: Is Franchising Right for You?
Franchising can be a rewarding way to own a business, but only if you approach it with open eyes and a healthy dose of due diligence. Beyond loving the product or service, make sure you're on board with the business model, the support system, and, most importantly, the people behind the brand. Now, go forth and franchise wisely!