Secrets And Snags To Franchising Success

When Ricki Wilson and her husband, Matt, decided to open a Butterfly Life health club franchise in 2006, they thought they were on the road to financial fitness. "We attended a seminar in Atlanta, and it looked pretty good," says Matt, 40. "They seemed like they had everything all together. The numbers looked very attractive in the sales pitch."

It sounds nice: Pay what seems a reasonable fee for a prefabricated business, and watch the cash come rolling in. But when it comes to running your own franchise, pumping up profits isn't nearly as easy as pumping iron.

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"The greatest pitfall is [falling] in love with a particular business model or brand," says Bob Snelling, president and founder of Honor Capital Group, a Plano, Texas-based lender to franchisees. "[Prospective buyers] say, 'That's for me,' without looking at the negatives." And there are plenty of those, say the Wilsons, if you know where to look.

Founded in 2003, San Ramon, Calif.-based Butterfly Life targets women aged 35 to 60 who are looking to lose weight and gain self-confidence. According to Matt Wilson, Butterfly representatives initially told him that he would have to shell out about $70,000 to get a club up and running. Yet a glance at Butterfly's 2006 Uniform Franchise Offering Circular--the hefty, federally mandated document that lays out the terms of the franchise relationship--reveals that the estimated initial investment for a single location ranged from "approximately $89,566 to $138,658."

As with most franchises, a chunk of that start-up bill--in the Wilson's case, $29,500 in cash--covers a one-time, non-refundable fee to the franchiser for the right to use its brand name. Not included, among other items: equipment (with sales tax, shipping and installation to an approved Butterfly vendor); a point-of-sale computer system and accounting software; advertising expenses; land lease and improvements (to a landlord); and miscellaneous "non-fitness" equipment.

Then there are the ongoing fees, in the form of monthly royalty payments to the franchiser. Finally, there are contract-renewal fees and so-called liquidation damages--in the event struggling franchisees want to break their contracts, which often extend for multiple years. And don't forget the lawyers' fees, of course.

Clipped Wings
After trying to digest Butterfly's couple-hundred page UFOC, the Wilsons figured they would give it a go. Soon they had blown through their nest egg and maxed out two credit cards. Sadly, new club members were hard to come by while costs ballooned. Advertising alone ate up $1,500 per month.

"Once we got our doors open, Butterfly stopped targeting the Atlanta market," says Matt. "[The company] stopped advertising in the area."

The new club survived just 10 months before the Wilsons shut the doors last October. Luckily Matt kept his full-time job as a compliance manager in the outdoor power-equipment industry, though he admits that the couple is struggling to make ends meet. A big hurdle: getting out of their club's five-year property lease. If they can't find a new tenant, Matt says, they will probably have to declare bankruptcy.

The Wilsons aren't the only ones nursing clipped wings after signing up with Butterfly Life, now with 100 franchises across the U.S., up from just three in 2004. Last Thursday, 10 Butterfly franchisees, most in California, filed a class action against Butterfly, alleging that the company made "illegal earnings claims" and failed to make clear disclosures in its UFOC. (Butterfly's 2006 UFOC states that the company does not furnish any oral or written information concerning the profitability of individual health centers.)

"Most of the time when a franchisee doesn't make it, [franchisees] don't blame themselves, but the franchiser," says company Chief Executive Mark Golob. "Our mission is to help women all over the country, and we have helped thousands and thousands of women." Of the class action, he adds: "We are vigorously fighting this lawsuit. We believe that we will win." The claim is now pending with the American Arbitration Association.

Tough Choice
These dust-ups are fairly common in the franchise realm. One reason, perhaps: thin regulation. The Federal Trade Commission isn't required to review UFOC documents, and most states don't have franchisee-protection laws on the books.

And while many of those UFOCs are packed with information, they are by no means complete. According to the International Franchise Association (IFA), just 18% of franchisers provide details on a new location's expected performance. Full pro-forma income statements are almost unheard of.

From hotel chains to sub shops, there are some 3,000 franchise systems in the U.S. By no means are they all created equal. How to choose? For starters, look for the following four hallmarks:

Quality control. There's a reason McDonald's French fries taste the same no matter where you are. While it may seem a nuisance to adhere to a slew of strict requirements, that extreme level of quality control keeps customers coming back.

Training. Pick a franchiser with a thorough, established training program. Chances are the head office knows how to run its operation better than you do.

Marketing. How many small business owners can afford a Super Bowl commercial? Franchisers usually ask franchisees to kick in a fraction of sales for regional and national ad campaigns. Make sure the franchiser is doing a good job helping you get the word out.

Fit. Just because you like coffee doesn't mean that you should open a Dunkin' Donuts store. If possible, choose a franchise that aligns with your personality and area of expertise.

Ticking Time Bombs
Once you think you've found the right outfit, keep digging. There are plenty of time bombs lurking in franchise contracts, but with plenty of foresight, due diligence and the aid of a decent lawyer, aspiring franchisees can defuse them before they blow.

If a vast majority of a franchiser's revenues comes from upfront fees, run. In this case, the franchiser has already gotten his money and may not be exactly supportive when things start going bad for you. A franchiser's financials--including income statement, balance sheet and statement of cash flows--are available in its UFOC.

Make sure the royalty payments are reasonable. Franchisees kick back an average 6.7% of their gross sales in monthly royalty fees, according to the IFA. The cut varies by industry--from 4.6% for hotel franchises, up to 12.5% for personnel-service shops. Check out the average for your industry at www.franchise.org.

Also check out the size of your territory. If your region is too small, nearby locations may cannibalize your business; too large, and you won't be able to afford the marketing costs. Also, choose a region where the brand is already recognized--or at least where the franchiser has demonstrated a serious commitment.

Finally, look for tripwires in the termination clauses. Franchise agreements can last for 10 years, and many franchisers make it difficult for franchisees to cut and run. Breach your contract and you'll pay "liquidation damages." Every UFOC contains (or should contain) a section devoted to rules governing termination, renewal and transfer of contracts. Read it--and every other section of the UFOC--very closely.

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