The Hardest Job in Franchising: Turning Down the Check

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 run them.

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 own businesses.

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.