When You’ve Bought a Franchise, But the Numbers Don’t Add Up – Cliff Ennico

Cliff Ennico “A partner and I invested in a franchise last year.  The franchise offers a variety of healthy foods, but focuses primarily on soups and salads.

We were offered a number of territories, but chose a large downtown area in an upscale Midwestern city.

The problem has been finding the right location for the first restaurant.  We have found a potential site, but the rent is extremely high and the landlord won’t budge.  We have ‘run the numbers’ and the bottom line is that we will have to sell about 250 soups and salads every day just to cover the rent.  My partner and I are not comfortable we will be able to achieve that sales volume anytime soon, especially in the current down economy.

The franchise really likes this location and is pushing us to start building our territory since we’ve had it for a year now.  But we do not want to ‘throw good money after bad’ building a location that won’t ever be profitable.  How can we handle this situation in a ‘win win’ way?”

Generally, the time to figure out whether a franchise is going to work is BEFORE you buy the franchise, not after.  One of the key issues you want to raise with any franchise, before you buy, is their “average breakeven”:  how long does it take the typical franchisee to generate enough operating revenue to cover its monthly operating expenses and start paying back their initial investment?  If the franchise won’t disclose this information, you should call lots of their franchisees and ask them point-blank how long it took them to “break even”.

Another key issue is “geographic distribution.”   The perfect franchise is one that has franchisees in all 50 states and in every conceivable demographic area:  high income, low income, urban (high population density), rural (low population density), and so forth.  A franchise that is very successful in rural America may experience difficulty when it opens outlets in large cities where real estate, labor and, well, everything else is a whole lot more expensive.  Item 20 of the franchise’s Franchise Disclosure Statement (FDD) will provide this information.

Since you have already bought the franchise and selected your territory, it is too late to do this type of homework.  Here are some ways you might – might – be able to move forward with this franchise.

Show Them the Numbers.  It won’t be enough to call the franchise and say that you and your partner are getting “cold feet.”  The franchise won’t like that, and may be tempted to terminate your franchise agreement (the default section of the agreement usually allows them to do that).

You will need to make a detailed presentation – in spreadsheet format – showing them clearly that the numbers at this location aren’t likely to work.  Show them exactly how many daily, weekly and monthly sales you will need to generate at the franchise’s current price level to meet your monthly expenses at this location, and ask bluntly if any of their other franchisees has succeeded in achieving that sales level within a reasonable time after opening.

Spell Out Your Breakeven Expectations.  Now it’s time for some hardball.  You will need to state clearly that you and your partner do not want to build a location “unless there’s a better than average chance we will break even within X to Y months; if it takes much longer than that we will be looking for the exits and cut our losses.”  Ask to see the “average breakeven” figures for other franchisees, especially those in high-rent areas similar to your territory.

Renegotiate Royalties.  If the franchise is really eager for you to build a location at this site, they may be willing to temporarily waive or reduce their royalty rates and other regular monthly fees.

Renegotiate Prices.  Many franchises base their product and service prices on nationwide average price data, disregarding the fact that it costs more to operate in certain areas of the country than others.  If you are the first franchisee to operate in a high-rent urban area, you may be able to persuade the franchise to raise their price levels just in your territory.

Keep in mind, though, that you may be raising your prices so high that you discourage business.  Nobody I know, even in New York City, will pay $50 or more for a basic soup-and-salad combination (unless it’s being offered by a celebrity chef at a four-star restaurant).

Renegotiate the Territory.  If some of the franchise’s other franchisees are “breaking even” quickly in territories that don’t look like yours, you may be able to exchange your territory for another one where you will be likelier to succeed.

Exit the Franchise.  If push comes to shove, you may have to “throw in the towel” and exit the franchise empty-handed.  It will be painful, but at least you will know you have “cut your losses”.  Better luck with the next franchise.

Cliff Ennico (www.succeedinginyourbusiness.com), a leading expert on small business law and taxes, is the author of “Small Business Survival Guide,” “The eBay Seller’s Tax and Legal Answer Book” and 15 other books.

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