Congratulations! You are confident that your concept is franchise worthy! Or, if it isn’t but you are still reading on, it’s never too late to retool your model—to invest the time and financial resources to improve your system. In fact, we all have to keep our concepts fresh, because customers’ demands change and your competitors won’t sit still.
In this chapter you will learn the fundamentals of how to prepare yourself and your organization for franchising. Great resources are available to help you navigate the learning curve at the beginning of this journey as well as to keep you applying best practices for continual improvement as a franchisor.
Once we have you steeped in learning and the available resources that can enable you to be a world-class franchisor, we will explore the capital needed to launch a franchise system. With further knowledge and capital in place, it is time to look at how you will prepare your own franchise disclosure statement (FDD) for the launch of your franchise system.
Become a Student of Franchising
If you intend to go into the business of franchising, you must learn and understand what it means to be a good franchisor. The founder must be “all in” as a leader, a franchisor, a brand champion, a transparent communicator with integrity, and a relationship builder. You can be excellent at delivering your product or service and be an unskilled franchisor; in this case, everyone loses—you and the franchisees that want to join and follow you. I don’t believe franchising is merely a distribution model or solely an expansion strategy. It’s a business unto itself. When you understand that, then you recognize that franchising is also an industry unto itself. For example, BrightStar operates in two industries—healthcare and franchising.
Furthering your education about franchising encompasses three equally important areas: associations, mentors, and your franchise communication network. First, you need to join associations and attend as many franchise-focused events as possible. Second, you’ll want to find someone who can mentor you during the first months you are franchising your business. And third, you’ll want to keep your franchisees informed about franchise trends to ensure the greatest success for everyone.
Active Participation in the Franchise Industry
If you are new to franchising, the good news is that lots of resources are available to you as a student. Primary among them is the International Franchise Association (IFA), an association dedicated to helping franchisors and franchisees learn and constantly improve their knowledge and understanding of franchising. You will soon get to the point where you know the basics and have built a few key relationships with other franchisors and needed suppliers. Within one year of becoming active in IFA, for example, I obtained my designation as a Certified Franchise Executive (CFE), had an array of mentors available to me, and had formed a board of advisors made up of accomplished franchise leaders and suppliers. I was learning about franchising while I was also building my franchise. Often, the best learning happens when you can ask specific questions and apply the teaching to real-life situations.
BRIGHT IDEA:
Begin your discovery and become a student of franchising while you are following the path to launching and growing your franchise system.
Attend two or three events per year to learn and network. The more events you attend, the more people you meet. Someone will always welcome you and take you under his wing. I highly recommend attending the IFA’s Annual Convention and Franchise Update Media Group’s annual Franchise Leadership & Development Conference. A third great event for new franchisors is the Emerging Franchisor Conference sponsored by Nova Southeastern University each November in Fort Lauderdale. If you have been in franchising but just haven’t been able to get the value you need thus far, make a commitment for a year to attend these great educational and networking events.
International Franchise Association
The International Franchise Association is the oldest and largest organization representing franchising worldwide. IFA’s mission is to protect, enhance, and promote franchising through government relations, media relations, and professional development programs. IFA offers the following development opportunities:
- a remarkable low-cost/high-value introductory two-year membership;
- a Certified Franchise Executive program to enhance the professionalism of franchising by certifying the highest standards of quality training and education and by helping franchisors gain the knowledge they need to lead a world-class franchise organization;
- the FranShip program, through which you can access a mentor; and
- the FranGuard program, held throughout the year, where you can learn about the legal and business aspects of compliance in the franchise sales process.
Plan ahead and prepare for IFA’s annual convention by selecting the educational and roundtable session topics that are the most critical to you at the time. Make note of the speakers and table hosts for the sessions you attend and try to meet them. My strategy is to identify one or two areas in which I need to learn multiple best practices. For example, in 2006 and 2007, I focused on how to plan my first franchisee conference, which we held in June 2007. In 2007 and 2008, I focused on establishing our Franchise Advisory Council. In 2009 and 2010, I focused on international expansion—where to go and not to go first, how to support, how to structure, etc. In each case I learned what to avoid and took the business card of a few experts to contact after I got home. When I was able to execute on what I learned, it was evident that the time and money invested in attending the conference had paid huge dividends. Bear in mind that these conventions are large and can be a bit overwhelming. Each year, focus on and prioritize a topic or two, getting to know three to five new people really well (rather than getting the business cards of 200 people and remembering none of them), and getting to know and evaluate two or three potential new suppliers.
Another way the IFA can help you is through the FranPAC, a political action committee. FranPAC represents the industry and our very livelihood against proposed onerous legislation and regulation that could negatively impact the cost of doing business. Your contributions will support pro-business candidates for federal office who understand the benefits of a climate favorable to franchising. Anyone who benefits from franchising should contribute to the FranPAC—$1 a day would get you their “365” pin to wear proudly. Once you have supported the FranPAC, subscribe to the briefs on the key issues to watch, contact your representatives (the IFA provides the tools on the website to do that quickly and easily), and attend the annual Public Affairs Conference, where more than 500 franchisors and franchisees meet with their representatives to educate them on proposed legislation that we need them to support or oppose.
AVOID THIS PITFALL:
Meeting those who are well respected within IFA circles would have saved me $75,000 in legal fees paid to a big national law firm and $25,000 paid to a big national public relations firm that didn’t understand franchising.
As you begin to get your sea legs, get more involved by joining IFA committees—which is another great way to meet people in smaller groups and begin giving back to the association that will give you so much.
When I think about $2,200 for a two-year membership in the IFA and a conference registration, plus travel costs to the conferences, it is small change compared to the cost of picking the wrong lawyer and the wrong PR firm.
Franchise Update Media Group’s Leadership & Development Conference
This annual event for franchisors only focuses on two key areas: growing the number of new franchisees and leadership. New franchisors can gain insight from peers who are leaders in the franchise industry into what lead-generation tools and technology are working the best. Franchise Update’s mission, as they see it, is as follows: “Increase Leads. Boost Sales. Grow Your Brand.”
The conference offers 25 educational sessions focused on franchise sales, marketing, and development; five in-depth pre-conference power sessions; and revealing research, such as their “Annual Franchise Development Report.”
In addition, there is an all-day Franchise CEO Summit exclusively for CEOs and presidents that provides a private, interactive environment in which franchise CEOs can solve tough issues, exchange ideas, develop best practices, and discover how to respond to make-or-break decisions through strategic business conversations that typically wouldn’t, or simply couldn’t, take place anywhere else. The CEO Summit is designed to help you achieve your goal of building a truly great company.
The access to information and benchmarking data and the ability to develop relationships with industry leaders make this a “must attend” event for me every year. It is the only venue with a solid focus on growth in the number of franchisees and how to achieve that singular goal.
Executive Leadership Conference
A third conference for the leaders of franchise companies is my favorite of the year. It is the IFA’s Executive Leadership Conference (ELC), where you have the rare opportunity to interact in an intimate setting with business leaders, futurists, economists, and notable professors. In your first couple of years, you will want to strongly consider attending Nova’s Emerging Franchisor Conference and then, as you move beyond the launch stage of your franchise system, the ELC will provide the networking and ideas to help evolve your system to the next level.
Find a Mentor
Franchising is unique. In no other industry will you find so many who are willing to share so much and where networking turns into deep friendships. I encourage you to seek out well-known experts in the industry as
mentors at particular points in time to help you with your most important objectives. You can identify the experts by attending educational sessions at conferences and selecting those speakers who have a compelling message and style from which you could benefit. I have gone to experts for advice and then, as I implemented the techniques they suggested, they’ve helped me with challenges or questions I had along the way. Experts are busy, so I work around their schedules and I try to honor a start and a stop date so they know my request for their mentorship is not indefinite.
I met my first mentor, Kurt Landwehr, in Atlanta at the Franchise Update Media Group’s Franchise Leadership & Development Conference in September 2006. I attended an all-day session conducted by Kurt, Tom Wood, and Brian Schnell, and though I learned a lot about franchise sales, I realized I needed to learn a lot more. I tracked Kurt down and asked if he would mentor me to help me build our sales process. He said he had limited time during the day but would spend his Thursday evenings and Saturday mornings for a few months with me. I meticulously took notes on everything he said during each phone conversation we had. We would not have sold fifteen units in the first year without him. He and I have continued as friends over the years, and Kurt even ran our sales department for a year until we filled the role on-site. Having a mentor to go to for advice and coaching really accelerates the learning curve. While the scheduled time may subside as your knowledge in an area increases, that mentor is always there to go back to when you need a sounding board. I find my mentors to be a safety net as I need a breakthrough in a particular area or function within our organization.
Your Franchisees Need to Be Educated Too
The more you learn about franchising as your system grows, the more important it will be to educate your franchisees. Franchisees always benefit from being informed. One way to provide them with information is to register your entire system to receive communications from the IFA, particularly the legislative briefs. Beginning in late 2008, I began bringing my top-performing multi-unit franchisee to the Public Affairs Conference to see his representatives and participate in the IFA Franchisee Forum (yes, I paid for his travel). In 2010, I also began paying for him to attend the IFA Annual Convention. I think active participation by franchisees—not just ours, but those of all systems—is their responsibility. It is our collective system, and many great ideas come from franchisees and corporate working together to accomplish more.
Another benefit of keeping franchisees informed is that they will be able to compare the range of support across the franchising industry. What better way is there for them to really appreciate how well their system works or how strong or lacking their support level is? I like the perspective my corporate team and my franchisees gain annually: It is one thing for me to say how strong our support is, and another to actually show doubters how rare it is to have a franchisor invest in a support infrastructure like BrightStar’s.
Secure Capital
As is true for franchisees, the number one failure for franchisors is under-capitalization. This section will help you get past that danger point.
It is very important to ensure you have enough capital to launch and enough capital to invest in support until recurring revenues of royalties can cover your overhead. Many franchisors make a big mistake in calculating only the amount they need to launch, wrongly assuming that the amount they collect from selling franchises in initial franchise fees will cover overhead. New franchisors often assume that they can grow their company using other people’s money, but often the franchise fee revenues do not fund the necessary infrastructure, leaving the emerging franchisor scrambling. If you are not sitting on a cash war chest of $500,000, you may run out of cash before you achieve the point of royalty self-sufficiency. (In chapter 8, I discuss royalty self-sufficiency—the point at which royalties paid by franchisees cover the overhead costs of the franchisor—in much more detail.)
BRIGHT IDEA:
You need to understand how to assess the initial capital needed to launch the franchise and to sustain it to the point of royalty self-sufficiency.
Once you have estimated the amount of money needed, you need to prepare the information required in order for you to access financing through your bank. Let’s walk through both of these key aspects of securing capital in greater detail.
Assess Capital Requirements
Remember, you must consider not only the amount of financing needed to launch the franchise system, but also the cumulative amount you will need until the franchise becomes royalty self-sufficient. You will learn as you go through these chapters about all the areas to consider in terms of the personnel to hire and when to hire them, as well as the opportunities to use suppliers for certain projects to delay the hiring of personnel. The good news is that by reading this book and following the steps included, you can understand how to avoid some of the pitfalls we encountered.
We estimated we needed to invest $300,000 to launch the franchise and sustain it until the point of royalty self-sufficiency. I contributed $100,000 of our own money and accessed $200,000 in debt financing. We were about 18 months in when the cash began to get painfully tight.
We actually needed $500,000, so we thought we had underestimated. It turned out, however, that we had a cash drain problem.
We had overspent during those 18 months on unnecessary or ill-advised hiring: at least $100,000 on legal and public relations firms not active in IFA; $50,000 for salaried employees to do work that contracted consultants could have done, particularly franchise training; and $50,000 to $75,000 for outside help in the first year to handle franchise sales when that role really belonged to a founder or key executive. (Ultimately, we had to involve either my husband or me in every franchise sale, so hiring personnel for this position was unnecessary.) Add up those overages and you see that our initial estimate of $300,000 would have been adequate if we had known then what we know now. You may avoid our pitfalls by reading this book, but you should still plan on $100,000 to $200,000 in additional cash reserves—over and above what your financial model shows you need to fund your franchise through the point of royalty self-sufficiency—as you find new pitfalls that might put you in the position to fumble on the five-yard line.
Access Capital
Among the sources of capital you’ll want to consider when setting up your franchise are these: investing the profits from your company-owned units in the new entity that will franchise; borrowing from a bank; borrowing money through a government program in your state; or borrowing money from friends and/or family. The following section will walk you through how to pursue capital from these sources.
Borrowing from Banks
You will always need more capital than you think. Although the lessons I share in this book could save you many thousands of dollars, you may have to learn new lessons on your own that will result in unexpected costs and the need to borrow. The capital markets have gotten tighter, but there is still money available.
Banks review lots of requests, and they are going to be more inclined to loan to those who make their job easier by anticipating their questions and concerns as to how their loan will be repaid. In our first business plan for franchising, we intended to sell 10 franchises in the first year, another 25 in the second year, 40 in the third year, and about 50 each year in the fourth and fifth years. Naturally, the bank questioned how we would sell 10 franchises in a year without any experience. As I discussed in chapter 1, we had thoroughly researched our competitors and we were prepared to convince the bank that we would be able to meet our goal.
You will need to have great market research on your industry sector and performance compared to your peers; you will need to exert strong confidence in your abilities to achieve the results in your business plan and to repay the loan; and you will need to have skin in the game. Expect to give a personal guaranty for the loan, including securing the franchising entity loan with the assets of the company-owned entity. Also, see how much of the profit of the company-owned entity can be distributed or loaned (consult your legal and tax advisors for advice) to the franchising entity without weakening the former in the effort to help the latter launch and grow.
You will want to be thoroughly prepared before you meet with the bank. The key items to include in your package are these: a full business plan; financial statements for the first five years, including a statement of cash flow; and the competitive analysis on your industry to show that your assumptions for unit sales by year, royalty revenues per year and per unit, and earnings as a percentage of revenue are within the ranges of what has occurred historically in the industry.
Borrowing Through a Government Program
I scoured all the possible government programs, concentrating on ones that were available to women-owned businesses, and sure enough, in Illinois I found a program that would loan up to $200,000. I had to put in $100,000, which I had planned to do anyway, and I had to create 20 jobs during the five-year loan term ($10,000 per job). You’ll be amazed by the number of resources that may be available within your state, especially if your company-owned units are performing well.
I met with the bankers who would underwrite the state program. I prepared binders with a presentation and tabs for five-year projections of income statements, balance sheets, and, most important, cash flows. I rehearsed the presentation over and over and then, on the big day, went through it from memory. I was nervous, but just like the deodorant commercial, I didn’t let them see me sweat. I got the loan. Although the lending climate is different as of this writing, I could get funded again if I spent the same time on market research and preparation. I might need to pitch 10 banks before finding a lender, but I would get one. And so can you.
Other Sources of Capital
Remember how I underestimated the money we needed by $200,000? That was a hard moment, but I knew we would ultimately make it. We had to access more capital and really build, or entrench and stall growth. Knowing that the 12 franchisees were with us because of their belief in the vision of our future—which meant growing, not going home defeated—we tabled our pride and asked my husband’s parents for a loan of $200,000. It was a big chunk, and I was so ashamed to ask them that I requested J.D. to ask his mom and dad without me being by his side for support.
They agreed to help us. My pride had me structuring the one-year loan with 14 percent interest (to match their returns in the market, since they had to pull out the money to loan to us). We were able to pay it back in 11 months, using franchising and the company-owned operations to do it. We will always be grateful that they stood by us. Receiving financial help from family members is humbling and is something that stays with you, grounds you, and drives you to never have to repeat the experience.
This experience encouraged us over the years to empathize with franchisees that were struggling with proper capitalization. In a few instances, we cosigned loans for four franchisees and loaned money outright to three. You won’t be able to help out everyone in need, of course. If you reach a point where you can help out franchisees, be sure to limit assistance to those who are absolutely following the model and just need a temporary helping hand. Our experience is more typical than many may realize—the first 12 to 18 months in any business is when “cash is king” and things are tight. Everything is on the line financially, and you must match it with a positive, high-energy attitude. You need to “be in it for the right reasons, use all of the available tools, and be in it to win it,” to borrow a line from our president of BrightStar Care.
Making it to the third year in business is reaching the “sweet spot,” that is, the point where, if you have been diligent in building your system and doing the right thing during your first two years, you should know from your strong indicators that you can make it. Generally the indicators fall into two areas and are true for both franchisors and franchisees:
(1) Average unit sales are on par with your peers; and (2) your franchisees are satisfied (measured by two-thirds franchisee satisfaction, per a survey administered by a third party that we will discuss more in chapter 10) and/or your customers are satisfied (measured by a net promoter score that we will discuss more in chapter 12).
Prepare Your Franchise Disclosure Document
Now, with a solid business model, market opportunity, secured intellectual property, and capital in place, it is time for you to invest in a great franchise attorney and prepare your franchise disclosure document (FDD) so that you can begin screening potential franchisees to join your system. The work up until now has prepared you for the launch. It is time to begin growing your franchise system, and the FDD is one of the first steps in the official launching process.
As you build your franchise program, you will learn that franchising is regulated in different respects at both the federal and the state levels. One aspect of the regulatory environment for franchisors is the presale requirements that apply to the offer and sale of franchises. The FDD is the disclosure document that is required by the Federal Trade Commission and those states that regulate the offer and sale of franchises. The FDD serves a critical purpose in the franchise sales process, as it is intended to provide a prospective franchisee with the essential information that will allow the prospect to make an informed decision about the franchise opportunity and business. Beyond the disclosures required by franchise laws, the FDD includes a copy of the franchise agreement and all exhibits that a prospective franchisee must sign as part of joining the franchise system. In addition to the FDD requirements, you will need to understand many other legal aspects that apply to franchising. As you can imagine, your decision on whom to use as franchise counsel is an important one.
At the IFA convention you will find representatives from many great law firms that have been active with the IFA for years. There is no harm in interviewing a few law firms and negotiating for a flat fee to prepare the FDD. You may get a recommendation from those you meet at franchising events or from a board member. That’s how I found our second lawyer, Lane Fisher of Fisher & Zucker, LLC, who helped us improve on our first franchise disclosure document.
BRIGHT IDEA:
When you begin researching a law firm, leverage the most powerful resources in franchising—the IFA and its members and connections.
As we continued to grow, and as healthcare disclosure items and healthcare state and federal regulations began changing rapidly, we needed a larger law firm that handled franchising and trademarks andthat had a dedicated healthcare practice. I prefer working with well-connected, smaller firms, because I want strong relationships with those with whom I do business (I’m a hugger!), but in a regulated industry like healthcare, it’s often necessary to go with a larger firm.
Once you have selected an attorney to prepare the franchise disclosure document—ideally on a fixed-fee arrangement, with separate rates for the initial FDD and for renewals—it is time to get ready to prepare your FDD. Some of the work can be done on your own, prior to selecting the attorney. But as you begin working with your franchise lawyer, you will be provided a set of questions to consider in determining what you want in your FDD. As a place to start preparing and to help you with any insomnia, gather your competitors’ FDDs and read through them. Mark the sections you like from each, and then look for areas of difference among the FDDs. Use this research to come up with topics and questions for your attorney and for your advisors to help you discover the pros and cons of each. Researching beforehand will save your attorney time so she can spend the hours allotted to the assignment, thinking through some of the deal points rather than walking you through each of the items in the FDD.
BRIGHT IDEA:
I prefer a fixed-fee arrangement: The attorney should invest time learning your business, understanding your competitors, and determining your preferences in structuring your FDD.
Initial Franchise Disclosure Document
So how do you simplify the process? What steps can you take early to prepare for a smooth initial FDD? Here are my recommendations:
- Pull the five-year model that you prepared from chapter 1 to assist with the FDD Item 6 and Item 7 inputs.
- Gather as much information as you have on company-owned operations to populate Item 19, including a full earnings statement and any key statistical information. Some franchisors provide some form of financial performance information to prospects; other franchisors do not. You must decide what is appropriate for you and then work with your franchise attorney and franchise sales team accordingly. For example, for our business, we include in our Item 19 the number of sales calls per period and/or number of customers, dollars per transaction (average ticket), and/or the average length of service per client. I believe a thorough Item 19 is key to an effective sales process because it allows you to share information with prospects and then to ensure that your sales process covers only this information, to avoid any illegal financial performance representations. An illegal financial performance representation can occur if you share financial information about your unit or system performance and that information is not included in Item 19; you can talk only about what is disclosed. For those reasons, you will want to make absolutely certain that you and your team understand the rules (the legal dos and don’ts) regarding the sharing of financial performance information with prospective franchisees.
- Gather competitor FDDs and mark the sections in each where you like the language and/or terms.
- Note the sections in the competitor FDDs that vary from one another and what the options are to consider. Discuss with advisors first and make a list of these areas to discuss with your franchise attorney.
- Review your company-owned market profile to understand the population areas that clients come from (if retail), where sales calls are made (if service), or for the number of cars driving by (via a traffic study for hospitality) to assist with defining territory size.
Decision Points
What are some of the areas—the decision points—for you to consider long and hard? The following list describes how we evolved our FDD once we learned more in the process. This list also shows how we might do things differently in our future FDD and for future concepts. Each situation will be unique, and what is appropriate for you is something you will discuss with your franchise attorney and other advisors. What follows is merely a list to educate you on the decision points to consider and the areas—along with your specific industry considerations—for you to review concerning what your competitors have chosen (and to assess the strengths and weaknesses in the results of their choices).
1. What type of franchising—single unit, multi-unit, area representation, or area developer—is appropriate for you? We chose to be the direct franchisor here in the United States but have chosen to select master franchisees outside the United States that can provide key support for their sub-franchisees because they understand local customs and laws. In the United States, we also chose to sell single units and/or multi-units on a development schedule. We were one of the few in our industry selling multi-unit agreements, but we knew that, with a higher investment range, we would attract a buyer who would need this opportunity. (Chapter 7 gives more details on attracting the right buyer to your concept.) I would offer multi-unit agreements again, but likely with smaller territories in certain situations (as discussed in Item 5 below).
BRIGHT IDEA:
In most instances, limit the number of territories per person to two until they have proven themselves with opening the first territory and being at or better than the system average at six months.
Some franchisors have expanded through an area developer or area representation model, whereby the franchisor establishes a three-party franchise model rather than a direct franchisor–franchisee relationship. In this three-party system, the franchise agreement typically is a contract between the franchisee and franchisor, but the area developer/area representative is a third party who also is under contract with the franchisor and performs many of the franchisor’s obligations in a specific geographic territory, including franchise sales recruitment, in-store training, and ongoing operational support. Subway and UPS stores are examples of this three-party franchise model.
2. Where will you open and why? Will you take a geographical approach (those with the best demographics concentrated in a few states at the beginning and/or states close to the company-owned locations so that it’s easier and less costly to support) or a prospect approach (anywhere that offers a great prospect)? The geography approach makes a lot more sense and costs less to execute, due to lower travel costs, if you rely on location density. Food concepts all have distribution and supply chain issues, so concentric growth through this geographical approach typically is a best practice. Further, with retail concepts, you want to make customers aware of your brand through visibility of multiple locations. For BrightStar, because we are in a service industry and no one sees our non-retail office space, geography didn’t matter to the same degree.
We chose a prospect approach, and even though we did spend the money to pre-map the United States to identify the territories we could develop, in hindsight we could have used the information to potentially delay from the very first stage of development a state in which there were not at least 10 available territories to sell.
AVOID THIS PITFALL:
We could have held off for at least a year in a handful of states and saved money on FDD filing fees and legal complexity, as well as on marketing the franchise opportunity.
Although smaller states may have strong territories and there is no legal reason not to offer and sell in all states right from the beginning, the costs of registering and complying with state franchise laws require certain economies of scale in the first few years of franchising when you are watching every penny.
3. When will you launch the national ad fund (NAF)? You need to decide whether to begin taking contributions from franchisees at inception or at the time of critical mass measured by the number of open units or system-wide sales. We wrote our initial FDD to launch the NAF after we had opened 25 locations, to avoid upsetting franchisees who might resist paying into it before that critical mass had been reached. Our NAF is set with a floor of $500, or 1 percent of prior month sales, whichever is greater. I would have started it much sooner if I were to do it again because, with search engine optimization and search engine marketing, it is easy to spend the money in markets or ways that will benefit the franchisees.
AVOID THIS PITFALL:
Launching the NAF sooner would have allowed me to hire marketing personnel sooner, which I waited way too long to do. As a result, I paid far more for outside suppliers to do the work.
4. Do you offer protected territories or not? You should evaluate what is in the combined best interests of the franchisees and you as the franchisor. You want to ensure that your choice in defining territories enables the growth in brand awareness and gives end customers access to the goods or services you offer. If your competitors are selling protected territories, it will be nearly impossible for you not to. Protected territories are more common in service industries. I caution you against referring to territories as “exclusive” and to use “protected” instead. “Exclusive” implies to a franchisee that no one will do anything in his territory—regardless of new expansions you have, their inability to perform part of the business model due to licensure, or their compliance with brand standards.
5. What size should your territories be and how are the territories defined—by zip code, by households, by city, or otherwise? I recommend erring on the smaller side of the range of your competitors and then potentially negotiating on the first few if needed and as permitted by franchise laws. Territories should be defined by where 80–90 percent of the customers will be coming from and the size of that area, its demographics, and/or the traffic patterns in the territory of your successful company-owned units. I recommend defining territory sizes with only one factor, not multiple ones. All of our first franchise agreements specified a per-territory minimum population of 200,000; however, because most of our initial franchisees’ business was senior care, our secondary territory criterion was a minimum of 30,000 over the age of 65 (2 to 4 times the number designated by most competitors). As we invested in our model to expand into disabled adult care—including the care of veterans, child care, and staffing—that minimum no longer made sense. In some areas of the country there were large territories in which franchisees were not penetrating the sales opportunity.
We studied correlations of territory size to franchisee performance, and found that there was no material correlation in the initial stage of a franchise location (unless a franchisee is willing to invest in multiple salespeople) because a salesperson can realistically cover only 175,000 in average population. With this careful review, we changed territory size definitions to remove the second criterion of 30,000 over 65—the age limitation—and did not see a material change in average unit performances in new territory definitions.
Our decision to change territory size definitions underscores a key point that all franchisors address at different times in their evolution. You will make decisions early on as you launch your franchise program. You then should constantly review some decisions and approaches as you evolve and your business or system changes. Here again, your franchise attorney can help provide you with the necessary flexibility in your franchise documents to enable you to do what is in the best interests of you and the system.
The territory decisions you will consider and the decisions you make are also dependent on your industry. Different industries have unique ways to define territories. Many retail and brick-and-mortar service brands define protected territory according to geography in miles between locations.
6. Are there minimum performance requirements? Are there minimum levels of sales that franchisees must achieve? And if they don’t achieve the minimum level, how will they make up for it, or “cure”? You must be able to demonstrate that it is possible to achieve these minimums through company-owned results and, once you have franchisees, that it is possible for the majority of franchisees who are following the model to achieve them. (We will discuss in chapter 10 the importance to the culture of flexibility in applying performance requirements when temporary external factors affect franchisees’ ability to achieve them.)
7. What is your philosophy on vendor rebates (needed for the FDD Item 8)? It is more common for franchisors in the food service industry to keep rebates because they do a lot of work on supply chain management. Our philosophy is that we should make our earnings on royalties, so we specifically state in Item 8 that we will not derive any financial benefit from vendor rebates. Although it is legal to receive vendor rebates as long as everything is properly disclosed in your FDD, often there is a cost. Certain franchisees may look at rebates as hidden royalty. The products or services that franchisees buy through franchisor-approved or -required vendors should be available for purchase at terms equal to or better than those offered elsewhere for the same quality and under the same circumstances, or the franchisees may revolt when and if sales flatten.
We do, however, disclose in Item 8 that we will accept monies from suppliers in the following ways to benefit franchisees: (1) as sponsorships for conferences to ensure high-quality programs with reasonable franchisee registration fees; (2) as additional funds to be applied to the NAF; and/or (3) as funds to enable the addition of technology features without adding costs to franchisees. None of these three sources are applied to the revenues or income statement of the franchisor. All three reduce the amounts franchisees would otherwise have to spend on attending conferences, generating marketing leads, and/or implementing new technology features.
Closing Thoughts
In closing, I want to share a few additional FDD decision points for you to consider. We had a couple of terms in our franchise agreement that were included for the right reasons but were administratively burdensome, and I would avoid them in the future.
One example: To encourage franchisees to increase their businesses—a benefit to them and us—we included declining royalty rate schedules above $2 million in annual sales. The challenge lies in realizing when they reach this level and changing the royalty rate accordingly. We hope to fully automate this process in the near future. I don’t know that franchisees were necessarily looking for this benefit, and most of our competitors don’t include it, so it was probably not a necessary component to our offering.
The second problematic term removed individual territory minimum performance requirements under our area development agreement as long as the aggregate revenues of all territories equaled 110 percent of the required individual minimum performance levels. Since territories may have varying successes, I didn’t want to penalize owners who showed they could perform in one territory even though another territory fell a little short. With different opening dates of each territory, this has become difficult to administer, and we will remove it from future agreements. (As you will see in chapter 10, our voluntary removal of performance requirements prior to 2010 on second and subsequent territories removed the complexity of this issue. The value to franchisees of the delay in assessing performance requirements was far greater than the benefit of this clause.)
In another variation on the standard agreement, you should look for opportunities to negotiate national contracts for your franchisees to sell their services and/or products. Why? Typically, the sales function is owned by the franchisee, and executing it is her part in following the model. But if I, as the franchisor, am able to negotiate contracts for franchisees, then I should. Yet, because this isn’t part of my core function, I want to be able to cover the costs of adding a dedicated position to work on this opportunity. This is a win-win for the franchisor and the franchisee.
BRIGHT IDEA:
We included a higher royalty on national account revenue sources in our FDD (1 percent higher) to offset the cost of the national account leadership position.
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In the next section, we address the concept of leadership and what the focus of the founder/CEO should be over time. We will discuss how, by understanding the keys to leadership, you can build your internal and external teams to support your vision and align employees, franchisees, and suppliers/consultants to enable you to win.
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