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How to Evaluate a Franchise: Top 3 Tips

By Stephanie Rabiner, Esq. | Last updated on

Deciding whether or not to invest in a franchise is a big decision that requires a lot of leg work. Franchise business plans are designed to lure you in and sell the virtues of the company, painting a picture of longevity and high revenues.

But just because it looks good on the surface, doesn't mean an investment will net you enough income to pay you and the franchisor.

It is thus important to make a thorough franchise evaluation that looks in between the lines. The following are the top 3 things you should consider when it's time to evaluate a franchise.

1. "Hidden" Costs. The biggest mistake people make when they evaluate a franchise is not considering all the costs associated with starting a franchise. In addition to the initial franchise fee, new franchisees may also need to pay rent, outfit a place of business, purchase initial inventory, and acquire licenses and insurance. Franchisees may also have to pay the franchisor a special fee to promote the new location.

A proper franchise evaluation also takes into consideration the startup lag. It often takes businesses a few months to a year to get a foothold in the community and start making money. One must be prepared to finance payroll and inventory during a potentially low-profit time.

2. Markets and Marketing. When you sit down to evaluate a franchise, pay special attention to how the company's business plan discusses marketing costs and the breakdown of competition. While some companies are able to rely primarily on reputation--always a good thing for franchisees, by the way--others need to heavily market their product or service. Who is responsible for this marketing? And how will it work?

Connected to the marketing are markets. Who is your competition? If you open up a franchise in a certain area, will you be competing with numerous businesses that offer the same service? Will you be competing with other locations of the same franchise, diluting your customer base? An analysis of local competition is essential to any franchise evaluation.

3. Finances. As important as it is to know the future finances of any franchise, it's more important to know the franchisor's financial history. Take a good look at the financial disclosure documents (and if you don't know how to properly assess one, hire a lawyer to do it for you) and determine whether or not the franchisor is a risky investment. Focus on growth patterns--whether it has been steady and whether there is a plan to continue that growth. Evaluate how the franchisor makes its money--from royalties or the sale of franchises.

Knowledge is power, so make sure you have yours before you make such a big investment.

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