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Before Starting A Franchise, Entrepreneurs Should Stay Informed

February 3, 2011

small business owner with open signThe stiff competition of today's job market is encouraging more people to test out their entrepreneurial skills by opening up small businesses. Franchises are particularly attractive options for many aspiring entrepreneurs because of the instant brand recognition the company creates and the proven business model it offers.

However, officials at the Washington State Department of Financial Institutions advise prospective franchise owners to thoroughly research contractual agreements before investing in new business ventures, particularly franchises, The Seattle Post-Intelligencer reported.

"The first step before investing your money in any security or business venture is to do your homework," said Bill Beatty, the department's director of securities. "For franchise investors, this means, at a minimum, reviewing the franchise disclosure document and getting in touch with current and former franchisees. You should be very skeptical if earnings for existing franchises are not disclosed and if experienced franchisees are unhappy or unreachable."

In addition, the department encourages franchise investors to recruit legal counsel to help them understand the terms and conditions of their franchise agreement, which is typically drafted by the franchisor's attorney who almost always gives the franchisor the advantage.

Potential pitfalls for investors include no automatic right to renew the franchise after an initial term, liability for future royalties if the investor ends the agreement early and requirements that disputes be resolved in the state where the franchisor is located, which may be inconvenient and expensive.

"If the franchisor makes any verbal promises or guarantees, make sure you get those in writing, too," said Beatty. "Even if you have researched the franchisor and spoken with a number of successful franchisees, you need to protect yourself should your venture not take off as planned."

According to Forbes, picking the right franchise company is crucial to opening a profitable business. With nearly 3,500 franchises to choose from, each governed by a Franchise Disclosure Document that is about 400 pages long, this task may prove daunting to many entrepreneurs.

Robert Bond, publisher of Bond's Franchising guides and chief executive of the World Franchising Network, a franchise database, says that investors often pick franchises for their brand name.

"One of the reasons people buy a franchise is they have instant credibility," Bond said. "If you are a lesser known franchise, it takes years to get that national recognition."

Bond admits that big name companies demand higher startup fees, but the long term investment is often worth it.

"Because they are big, they are not lusting after franchise fees and royalties," said Bond. "The best ones take care of their franchisees. A lot of franchisors don't provide value to the franchisee. Unless they do that on a long-term basis, the system is not going to work."

Alternatively, entrepreneurs who start their own business can opt to open a franchise, Small Business Trends noted. However, this endeavor is no small feat; it requires careful planning, capital and profitability to ensure success. Christian Faulconer, chief executive officer of Franchise Foundry, discourages business owners from founding their own franchises because of the difficulty of managing multiple enterprises. If a business venture is extremely successful, however, an entrepreneur can hire someone else to run the franchise.


Compiled by Alexander Gong

Sources:

"Getting information is key before signing a franchise agreement," blog.seattlepi.com, January 31, 2011, Rita R. Robison

"The Top Franchises For The Money," forbes.com, January 18, 2011, Levi Davis and Maureen Farrell

"Want to Franchise a Business? 5 Sacred Rules to Become the Next Great Franchise," smallbiztrends.com, January 20, 2011, Todd Taskey

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