What To Be Aware Of When Buying a

Franchise in Canada
When buying a franchise in Canada, it is important to conduct thorough due diligence, to the
point where you can complete a detailed a cost-benefit analysis of the franchise opportunity (to
determine to what degree it can enable you to satisfy your financial and lifestyle goals.
Before you even begin to consider franchising, is important to understand what a franchise is. A
franchise is the legal agreement between a franchisor and franchisee, where the franchisee
is granted license rights to use the franchisors name and/or trademarks to sell/distribute
products and/or services for a specific period of time, usually five or 10 year terms; most
franchise agreements also have the opportunity to renew for additional terms. Under the license,
the franchisee also agrees to utilize and adhere to the franchisors business systems and processes
and for good reason too! For good franchise systems, these systems and processes have been
developed over years of accumulated experience (both positive and negative) of the franchisees
within the system. This consolidated learning enables new franchisees to launch their business
with greater efficiency, while avoiding costly mistakes, and thus forms part of the value
equation.
The franchise license is granted in exchange for an initial franchise fees and ongoing royalties;
franchisors should be able to clearly define and justify the value they are providing for the
fees they are asking. There is no set rate for initial franchise fees; the majority of franchisors
fees are between $25,000 and $45,000 but it is not uncommon to find fees as high as $75,000,
especially for service-based businesses. There is also no set rate for royalties; royalties are
calculated prior to any profits and are typically structured in one of two formats:
1. a percentage of gross sales (the most common format):4% to 6.5% is quite common for
retail and food concepts; 7% to 10% is quite common for service-based businesses.
2. a monthly flat fee: this type of royalty structure can range from $400/month to as much as
$2000 per month; the advantage of this type of royalty is that the more business you do,
the more you get to keep. The disadvantage though is that even if youre not doing well,
you still have to pay the monthly fee
Most franchisors also charge a marketing fee; this is often misunderstood by prospective
franchisees. In most jurisdictions, marketing fees collected essentially belong to the base of
franchisees; the franchisor administers this fund, often with input from their franchisee base.
They are not allowed to use these funds for general business purposes.
Fees to buying a franchise in Canada are not always apparent. The Canadian Franchise
Association (CFA) offers a list of fees and guidelines of financial terms and conditions to
franchise agreements. Most franchise licensing contracts include an upfront franchise fee due at
time of signatory on agreement.
Here is a list of some common benefits to buying a GOOD franchise in Canada, please keep in
mind though that not all franchisors have everything on this list:
Benefits:
initial and ongoing Training from head office;,
Proven product and service offerings
proven marketing and business generation methodologies,
proven operating systems
coaching, Supervision , mentoring and consulting
Collective buying power,
Financing,
Continuous research and development
Tremendous knowledge and experience resource base of other franchisees to draw upon.
These benefits combine into a very strong offering that often enables franchisees to get a much
faster start in business and achieve higher levels of success than the non-franchised independent
business owners in the same industry.
Here are some common drawbacks of franchise ownership:
You have to pay initial franchise fees: We like to think of it this way though: If youre
going to go into business, you are going to have to pay a tutelage fee when you buy a
franchise, the initial fee should reflect reasonable value for the kind of benefits mentioned
above. For business owners who start a business from scratch, there will also be a
tutelage fee while these entrepreneurs dont have to pay the initial franchise fees, their
tutelage fees often come in the form of unforeseen business expenses, costly mistakes,
missed opportunities, etc. The trouble is that its incredibly difficult to determine how
costly these can be, but since weve been involved in franchised businesses as well as
started businesses from scratch, it is our clear belief that the tutelage costs associated
with independent businesses are much higher than initial franchise fees!
In most cases you have to pay ongoing royalties: after 22 years in this business, weve yet
to meet a franchisee who likes writing royalty cheques. However, the simple fact of the
matter is in good franchise systems, there is tremendous ongoing value derived from
being part of a growing franchise system. In order to square off with this drawback, you
should talk to enough existing franchisees within the system youre considering and
asked them this critical question: On a scale of 1 to 10, how much value are you getting
for your ongoing royalty dollar? Listen very closely to the answers you hear!
Most franchise systems have some form of territorial restrictions
Loss of independence: when you join a franchise system, you are definitely going to give
up some measure of control over how to execute the business, but this is often much less
of a factor than most people initially perceive. In highly structured bricks and mortar-type
of businesses (like fast food restaurants), then the owner is definitely managing the
business to a very tight and predetermined set of standards and processes; it is these types
of businesses where the most independence is sacrificed. In a lot of business-to-business
and business-to- consumer service-based franchises, the franchisee has much wider
operational latitude these types of businesses often appeal to mid and senior executives
from corporate Canada.
Brand problems are shared:
Limited expansion possibilities
Part of finding the right franchise means determining the right balance between benefits and
drawbacks.
The big 5 Franchise Buying Risks
1. Mismatch is likely the biggest cause of underperformance and failure in franchising
today!
In spite of the wide perception that of franchises being low risk investments, the fact is
that the sustainability of a franchised business will largely depend on the effectiveness
and efficiency of each individual franchisees operations. It doesnt matter how good the
franchise business model is, if the franchisee is not following the established processes,
guidelines and rules, the business is still likely to fail. It is for this reason that it is critical
that the prospect of buyer thoroughly understand the critical roles and activities required
to drive success on a day in, day out basis, so that they can identify to what degree they
will be able to perform those tasks.
2. Undercapitalization is another one of the biggest contributors to failure the trouble is
that too many people who buy franchises use the vast majority of their available savings
and borrowing power to buy the franchise, with the expectation that they will be able to
achieve breakeven within a short period of time. Unfortunately, far too many businesses
take longer than people expect to achieve breakeven and positive cash flow; if there are
insufficient capital reserves to inject into the business, then there is a high risk of the
franchise will fail because bankers are highly unlikely to lend additional funds until the
business can demonstrate strong performance. To plan safely and avoid this high risk
factor, you should have at least six months more and ideally 12 months more working
capital available as a safety buffer (i.e. if you are planning for the business to take six
months to achieve breakeven, then you should have 12 to 18 months of working capital
available)
3. Not all franchise systems are created equal just because something is franchised, it
doesnt mean its good, it just means that its been duplicated. The younger the franchise
system, the higher the risk that the systems and processes have not been fully developed,
and the higher the risk that the demand for the product or service is not fully proven. It
should also be noted that some franchisors who have been around for many years do not
bring enough innovation to their business; the brand risks becoming tired, their systems
and processes become obsolete, or both! Someone can bring tremendous intellectual
capability and transferable skills to a franchise opportunity, but if the opportunity is not
supported by key trends, or if the franchisors business model is weak, this individual
also faces a high likelihood of failure.
4. Market Saturation unfortunately, too many people get excited about a specific industry
where there is lots of initial growth, but there is no predictable path for long-term
sustainability. Numerous competing franchise brands pop up and lots of people buy into
the concept, only to find 3 to 5 years later that the demand has significantly waned and
thus their business fails. An example of this was the bagel business in the early 90s
within a four-year period, hundreds of franchises were awarded, but within five years the
vast majority of them had closed. Part of the problem was that several late entry
franchisors created a me too strategy to capitalize on the interest, but they did not have
sustainable market differentiation.We see a current flurry of activity in several subsectors
in the food industry that demonstrated similar pattern: poutine, burgers and frozen yogurt
in each of these cases there are dominant strong players, but caution should be
exercised when considering late entry upstarts that dont offer sustainable differentiation.
5. Lack of optimum location availability the three rules of a retail business are location,
location and location! The less sophisticated the franchisors franchise location strategy
and practices, the higher risk for the franchisee. There should be a minimum of key
selection criteria that the franchisor governs location approval with; it is important to ask
existing franchisees how much support they got in location selection and how good that
support was. The flurry of activity noted in the market saturation point above has put
tremendous pressure on location availability so you want to be very careful; you should
not settle on an inferior location.


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