Small Business 101

Buying Into a Franchise

If you are thinking about starting your own business, you probably have tons of questions about where to start. Get advice from Small Business 101 to learn more about the basics of entrepreneurship.

Tom Fihe is the lead franchise planner and developer for Ratner Companies. Responsible for launching an area development approach to franchise agreements for Hair Cuttery, he has worked to develop a strategy for executing Hair Cuttery development throughout most of the United States.

His primary duty is promoting the appeal of Hair Cuttery to potential investors. In addition to marketing the concept, Scott is responsible for developing an organizational design and culture that supports franchise potential. This includes providing project management of internal support services including real estate availability, store design and brand consistency.

Tom was online to discuss buying into a franchise.

The transcript follows below.

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washingtonpost.com:

Good afternoon and welcome to this special edition of Live Online. This discussion is a part of our Small Business 101 series, and our guest is Tom Fihe, vice president of franchising for Ratner Companies.

Tom, how did you get into the franchising business?

Tom Fihe: I've been in the franchising business for 12+ years now, working with four different brands. In fact, I've opened hundreds of franchise locations in almost every state except Louisiana, Iowa and Hawaii.

I graduated from Ball State with a degree in business administration and received my MBA from Case Western Reserve. A friend of mine was a franchisee and his franchisor was looking for a field consultant. Sounded like a great opportunity and I jumped on it. Twelve years later, I'm in on the ground floor at Hair Cuttery, a company that's been in business for 30+ years. Together, we launched the company's franchise operations in September 2005 and already we have commitments for 45 locations.

I've been around a lot of different operations and really enjoy the field, especially the entrepreneurs who have the courage and smarts to go out and make it happen.

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New Carrollton, Md.: Hi Tom,

I've had enough of corporate America and want to start my own business. What are some of the pros and cons of owning a franchise, i.e. do I ever own the business?

Tom Fihe: Congratulations on thinking of getting into franchising. I think it's an excellent choice.

PROS: Franchising reduces your risk for failure because best practices of company have been documented. In addition, you are working with an established brand that is providing you with training and support.

CONS: When you're an entrepreneur, you're creating things on your own and it's all about you. When you're part of a franchise system, you don't have all of the freedoms of creating your own brand. The great part is that you are part of a successful brand, but it got to be successful by operating a certain way and you will need to stay within those lines.

As a franchisee, you own the assets of the business so you benefit when you sell the business. Typically, the only thing the franchisor owns is the brand and the franchise agreement.

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Washington, D.C. : Tom,

Could you discuss the pros and cons of buying into an established chain with a well-known brand, versus a newer, fast-growing concept? I'm interested in food services specifically, but would consider other opportunities.

Tom Fihe: You need to look at a company's best practices and business model to fully evaluate the opportunity. Having said that, I can provide you with some guidance on established chains vs. newer concepts.

Newer concepts, like the one I'm managing now for Hair Cuttery, allow you to get in on the ground floor with a wide range of markets available. When you're one of the first, you're going to get a lot of attention from that franchisor because you're one of the first to participate. Unfortunately, you don't have a history -- how the business reacts to different economic conditions, etc.

With an established chain, you have existing franchisees that you can research and speak to about the business. But you may not have as many available territories, as the best markets may be occupied by other territories. You don't have "first-mover" advantage.

Always remember how important the relationship with you and the franchisor is -- do you feel they support you? Do you have a rapport?

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Virginia: Wondering if you all owned the Hair Cuttery or are they all independently owned?

Tom Fihe: Until September of last year, nearly 1,000 Hair Cuttery locations were company-owned. Now, I'm proud to announce that we have agreements for 45 franchised locations in Long Island and Phoenix with more coming soon.

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Virginia: A friend says that Subway requires a $125,000 investment. Is that the normal price?

Tom Fihe: Investments range dramatically from millions to thousands of dollars. It depends on the concept. A Hair Cuttery investment is approximately $150,000 and a popular food service concept could be a couple million dollars.

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Arlington, Va. : What kind of qualifications are franchise companies looking for when evaluating applicants? Is it simply down to money or are they looking for expertise in the industry or in franchising generally?

Tom Fihe: I like this question! When I consider potential franchisee, I look for whether the person has an understanding of franchising. It's not always experience in the industry. Oftentimes, as with Hair Cuttery, the franchisee should have an understanding of how to operate a business (not just the hair business).

I'm also looking to see if you have ample liquidity to invest in the business (the criteria of which are set by the franchisor). And certainly, there has to be a fit/trust between the franchisor and the franchisee.

Make no mistake, though, financial capability is a key to determining the success/failure of any business and it's the same in franchising.

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Chantilly, Va.: A franchisor told me that most franchises make about money enough to just pay the bills. The real profit comes from selling the land that the franchise is on after several years of operation. Your thoughts?

Tom Fihe: Not all franchise opportunities involve the purchase and sale of opportunity. Level of financial success is truly dependent on how you execute the operating system of the franchise. In some case, it is a real estate model, but in most cases, it's based on developing cash flow and getting/keeping customers.

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Alexandria, Va. : What are the fastest-growing franchise chains in the U.S. today?

Tom Fihe: From the March 20, 2005 edition of Franchise Times's "Introducing the Fast 55" article:

1. Dippin'Dots

2. Super Wash

3. Wireless Dimensions

4. Certified Restoration Dry Cleaning

5. RCI Holiday Network

Each of these companies has grown their units by over 1000% in the past five years.

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Reston, Va.: Hello Tom,

I am very interested in environmental issues and recycling. I recently noticed an article about a local franchise business which hauls away clutter, etc., from homes.

Three basic questions.

1. Can you guide me on the best information I would need from the corporation to evaluate a franchise chain which provides a more specialized service? What would be the optimal situation a franchise owner might reasonably expect from the chain corporation?

2. What are the pros and cons of operating a franchise verses doing something on your own?

3. What entrepreneurial and leadership characteristics and timelines are paramount to be successful?

Thank you very much.

Tom Fihe: I'm going to try to be succinct when answering your questions. Here goes.

1. Take a look at three key items when evaluating a franchise. a) Uniform Franchise Offering Circular (UFOC) which all franchisors must provide to you at the first personal meeting b) the company Web site which usually proves a great source of info c) speaking to existing franchisees.

2. The franchisor provides you with the experience and know-how for executing the operating system in return for a fee or royalty. At the same time, the franchisor has a proven business model that you will be expected to follow. In other words, if you'd like to be more creative, starting your own business might be a better option for you.

3. In my mind, the best franchisee have certain characteristics. As a franchisor, I want the risk-taking and confidence of an entrepreneur coupled with the smarts to follow the proven business model. Timelines are fluid -- I'd recommend establishing a timeline based on your own personal needs.

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Reston, Va.: Do you have any books/resources you would recommend for someone interested in franchising or starting their own business?

Tom Fihe: I'd recommend Franchising for Idiots by Michael Seid. Michael is the best consultant in the franchise industry. Also, take a look at the IFA's Web site -- www.ifa.org. They're a tremendous resource on franchise trends and data.

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Brandermill, Va.: How much help on licensing/permitting should a franchisor provide? I'm a business counselor and I'm struck by how little new franchisees know about what licenses they need. I would think the franchisor, having "invented the wheel," would offer that kind of help as part of the fee they charge.

Tom Fihe: Depending upon the business, there may be variations in permits at the state/local level that can be challenging to manage from a franchisor position. In my opinion, permitting at the local level should be the responsibility of the franchisee.

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Washington, D.C.: I wrote a skeletal business plan for a restaurant chain as a lark. How many restaurant franchises fail in a given year would you say? Not individual shops, but entire franchises?

Tom Fihe: Although I do not have the stats on hand to answer your question specifically to the restaurant industry, I can tell you that in general, franchise locations are less likely to fail than businesses that are started up without the support of a franchise. Every franchisor is required to disclose the openings/closings of the franchise within the past three years as part of their UFOC. Keep an eye out for a successful business history when considering a franchise. Ones that have a pattern of success are less likely to fail as an entity.

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Woodbine, Md.: Hello. My question actually has more to do with what would I do to begin researching how to franchise my business? What steps should I begin with? Is there an organization that I can turn to for direction/assistance? Any additional thoughts or suggestions are appreciated. Thanks!

Tom Fihe: The most important first step is to understand how franchising works. Check out the book Franchising for Dummies by Michael Seid, and go to www.franchise.org, which is the Web site for the International Franchise Association (IFA).

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Washington, D.C.: For a small starter company, how does one expect to pay the employees when you're already in the hole to begin with?

Tom Fihe: Starting any type of business is always challenging. Having the necessary capital at start-up is critical for the success of your business. Franchisors will prescribe the ample amount of liquidity and net worth required for the financial start-up and initial operation of your business. Typically, they can also refer you to a reputable lender for additional financing.

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Ashburn, Va.: I noticed in your introduction that it says you are using an area development strategy for Hair Cuttery, how is that different from a standard franchise strategy? What are the benefits to the franchisee?

Tom Fihe: The area developer commits to open a specific number of franchised locations in a specific number of years. The area developer pays the franchisor a fee for the exclusive rights to a defined geographic territory. For example, Hair Cuttery's first franchisee signed an exclusive deal in Nassau and Suffolk Counties (Long Island). The franchisor works very closely with the area developer to maximize market share in the developer territory. By contrast, the single-unit franchise model offers the rights to develop one business unit in one specific location.

Some people are interested in developing one location and then determining if they want to develop more. The area development model is for those individuals who know that they want multiple units in a contiguous geographic area.

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Annandale, Va.: Could you discuss financing for those of us who want to buy into a franchise? I'm interested in entrepreneurship, but I don't know where I would get the resources to be an attractive candidate for a franchisor.

Tom Fihe: Remember, it behooves not just you but also the franchisor for you to have the right financial profile. Talk to the franchisor about the right liquid capital you need to initially start and operate the business. Compare that to your financial capabilities. Then consider a variety of options to attain the proper capital: lenders, partners, investors, etc. Oftentimes, you can benefit from a franchisor's recommendation on a lender.

FYI: You can often find the estimated initial investment on the franchisor's Web site.

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Bethesda, Md. : Tom, thanks for taking questions.

Could you break out the main differences between franchises and "regular" businesses from a financial perspective? Are there substantial built-in differences in profit margins, expenses, etc. between the two, or do the numbers more or less come out in the wash?

Tom Fihe: If I understand your question correctly, I would venture to say that it is slightly less expensive to open a franchise business than starting on your own for two reasons. First, the economies of scale that the franchisor arranges from product purchases, etc., benefit you. Secondly, the expertise that the franchisor offers in the start-up process can improve your efficiencies depending upon your past experience.

One of the only differences in the financial models between a franchised business and an independent small business is that the franchisor is compensated by a royalty. The royalty, typically a percentage of net sales, often ranges from four to seven percent.

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Virginia: My local Subway owner eats free everyday. Do you get free hair cuts?

Tom Fihe: In fact, I pay full price for my shampoo/cut at the Leesburg Hair Cuttery. It's a great value at just $14!

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Arlington, Va.: Tom -- my partner and I were considering investing in a food franchise as silent partners and bringing in an experienced operator. The operator wants a third piece of the pie but wants us to front the capital needed. What would you consider a fair percentage breakout of a partnership like this?

Tom Fihe: I would take a serious look at how much involvement you want in a business and then the complexity of that business. In other words, a very complex business will require a very experienced operator which could correlate with equity/compensation.

I've seen a number of arrangements like the one you've posted. There are thousands of ways to structure ownership arrangements and there a lot of factors to consider. I'd recommend speaking to a trusted business advisor who knows the relevant facts of your situation.

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Tom Fihe: Franchising is a fabulous way to reap the benefits of entrepreneurship while managing the risks of a new business. There are thousands of franchised business strategies to choose from that can meet your needs for investment, return, personality and involvement.

As you're considering franchising, remember that you're not making the decision in a vacuum. Seek out information, whether it be from existing franchisees, competing franchisors or the International Franchise Association (www.franchise.org). Good luck and thanks for chatting.

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Editor's Note: Washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.