On a regular basis, prospective franchisors ask me about the most
difficult aspect of franchising. "Is it franchise sales?"
"Is it ensuring franchisee success?" "Is
it quality control?"
And my answer never ceases to surprise them. "No, it is turning
down a check for $25,000."
Perhaps the single biggest mistake made by novice franchisors is
to sell franchises to candidates who are not truly qualified to
It is easy to understand why this mistake gets made. A new franchisor,
who has spent perhaps $100,000 preparing to franchise, finally begins
offering franchises. The low close rate typical of franchise sales,
combined with the long sales cycle, makes it feel like that first
franchise sale will never take place. Doubt creeps in. "Will
I ever sell a franchise?" And then, a prospect that the
franchisor knows is marginal indicates they want to sign the franchise
agreement and pay their initial fee.
So what do you do?
Importance of Choosing the Right Franchisee
Before you take that check, the first thing you need to remember
is that you are in this for the long run - you can't be a successful
franchisor unless your franchisees are also successful in their
Underperforming franchisees require much more support than strong
franchisees, and thus they cost you more. At the same time, they
will generate lower revenues and thus pay less in royalties. And,
of course, failed franchisees don't pay royalties at all, and are
much more likely to bring litigation against the franchisor.
You should also remember that every one of your franchisees (and
every one of your lawsuits, should you have any) will be disclosed
in your offering circular. A sharp franchise candidate will always
speak with these franchisees as part of their due diligence process.
Suppose you accept a franchisee that is unqualified, undercapitalized
and lazy. Do you really think he will say,
"Frankly, the reason I am failing is that I am unqualified,
undercapitalized, and lazy. This is a great franchise and the
franchisor is wonderful."?
Not likely. Regardless of whether you were to blame in actuality,
imagine instead that the franchisee you call says,
"Don't do it! It costs a lot more to do this than you
think. And it's a lot harder than the franchisor lets on. You
never get enough support. And now I've lost my life's savings
investing in this. My wife has left me. My kids are gone. And
I may lose my house
Well, I can pretty much guarantee you that anyone who talks to
that franchisee isn't likely to sign a franchise agreement with
you anytime soon.
So what's the trade off? Increased support costs, increased litigation,
reduced royalties, and a reduced ability (or maybe no ability) to
sell franchises on one hand versus a check for $25,000 on the other.
The bottom line: sometimes you have to walk away.
Sorting the Wheat from the Chaff
So how do you identify franchisees that will be successful? Some
criteria are easily identified. For example, there may be specific
skill sets that are necessary for success: mechanical expertise,
foodservice experience, or other related skills.
These "hard skills" questions are among the first the
new franchisor should address. "Are we better off with experienced
prospects or should we look to train our franchisees from scratch?"
Franchisors should ask themselves the following types of questions
in order to answer that question:
- What resources do we have to train and support new franchisees?
- Do we have an adequate value proposition to sell people who
already have experience in our industry?
- How important is prior experience in terms of the franchisee's
ability to become profitable in their first year?
A related question that must be addressed is whether the franchisor
will allow for "passive investors" as opposed to owner-operators
who will work onsite. The trade off here is fairly basic. Owner-operators,
if properly selected, will typically have better unit level performance
(both from a quality and from a financial perspective). Because
they will own the franchise where they work, they will be more attentive
to details and more concerned with quality and customer satisfaction
than most managers. On the other hand, opening the franchise opportunity
to passive investors can mean faster growth and a larger pool of
prospective franchisees from which to draw. One possible solution
to this question is to require investor groups to designate an "operating
partner" who holds some equity in the franchisee's company
and also brings the skills you're seeking to the franchised business.
Perhaps the single biggest criterion in franchising is capitalization.
Inadequate capitalization is the single biggest reason for franchisee
failure, and thus every new franchisor should examine this criterion
closely. The three primary criteria to be examined should be liquid
net worth, net worth, and the candidate's credit score.
Depending on the nature of the business, your franchisee may be
able to finance a portion of their initial investment. The amount
financed will be a function of what is being financed (equipment
is easier to finance than working capital, for example) and the
creditworthiness of the franchisee. That said, a franchisor should
be sure that they take a conservative approach to each franchisee's
ability to service debt - and should walk away from franchisees
who are going to be too highly leveraged. In terms of single unit
operators, most franchisors will look for a minimum of 30% of the
investment in liquid net worth, 100% in net worth, and FICO credit
scores of 700 - 725 or better.
Of course, none of this is carved in stone. Franchisees with a
working spouse may need lower working capital requirements. Alternatively,
franchisors with a longer start-up periods or greater working capital
requirements may want to take a more conservative approach.
As you continue the evaluation process, you will also want to assess
other criteria such as intelligence. While franchisees may be looking
for a "no-brainer" of a business, the truth of the matter
is that most businesses do require intelligence to run. And the
fact of the matter is, "you can't coach "smart."
And since most people will tell you that they are smarter than average,
it is incumbent on you to determine if they are good judges of their
own talent. Short of intelligence tests, measures such as a candidate's
work history, academic achievements, vocabulary and general presence
will help to provide the clues you're looking for.
Likewise, most businesses require hard work, and franchisees expecting
an easy go of things may wash out early. So when measuring work
ethic, look for the way a prospect conducts his life. Ask the prospect
about their "average day" and about their hobbies. If
your prospect sounds like a 40-hour week will wear them out or brags
about their two-handicap on the golf course, you can pretty much
figure that they'll spend too much time away from their franchise
after they join your system.
Soft skills can be equally important to a franchisee's success.
Depending on the franchise, sales and/or management skills may be
a franchisee's most important asset. Relationship factors, such
as honesty, personality, and compatibility, will also play a part
- after all, you will be living with this franchisee for perhaps
the next twenty years.
One of the often-asked questions in the area of franchise qualification
is whether a franchisee should be entrepreneurial. Generally speaking,
we recommend that franchisors avoid highly entrepreneurial candidates.
Entrepreneurs tend to have several definable characteristics. They
tend to have moved from job-to-job and have frequently already started
at least one business of their own. They tend to drive fast cars,
have lots of traffic tickets, and are frequently divorced. True
entrepreneurs tend to be rule breakers - and that is the last thing
that a franchisor should want. In fact, we identify entrepreneurs
by the simple formula that they "Never saw a rule he didn't
want to break."
While you may not want to exclude entrepreneurs outright, franchisors
are better served targeting straight-A students with long-tenure
to their corporate jobs. They tend to drive the family car through
the right lane of life.
In order to assess these soft criteria, franchisors are increasingly
utilizing more sophisticated assessment tools to "benchmark"
the "job" of their franchisees. These tools are then used
by franchisees to determine their compatibility for the role. But
regardless of whether you choose to use these tools or not, assessing
the job of the franchisee - and ultimately doing what you can to
assure the franchisee's success - is the most important and the
most difficult job of every franchisor.
This article first appeared on entrepreneur.com and is reproduced
here with permission.