Top 4 Mistakes When Franchising Your Business

A lawyer whose life work consists of giving advice to potential franchisors shares his insight.
February 01, 2012

Michael S. Rosenthal has childhood issues relating to franchising. No, he isn’t damaged by a bad experience; he’s regretful of what could have been. Back in 1957, the same year as his birth, his father Harvey opened a hot dog joint on the north side of Chicago. One day, a man came in and asked Harvey to go into business with him, offering a restaurant concept at $5,000 per store that, the man said, would blanket the nation and make Harvey very rich.

“My Dad told him to get the hell out of his store, that there was no way he would pony up $5,000—that was a lot of money back then,” says Rosenthal. “That man was Ray Kroc, the founder of McDonalds. If only he had said yes, I wouldn’t be working right now.”

Perhaps due to this story, Rosenthal has made it his life’s work to save wannabe franchisors from bad decisions. Today he heads the franchise law practice at Wagner, Johnston & Rosenthal in Atlanta, Georgia, and shares the top four biggest mistakes he sees every day.

Mistake No. 1: Underestimating costs

While franchising can make your company (and you) wildly successful, it can also sink you in a massive hole if you don’t have enough money on the outset. Most startup costs go to legal representation and the drafting of regulatory documents, says Rosenthal. And regardless if your franchise is doing well or not, the Federal Trade Commission mandates you update them once per year.

On the legal side, Rosenthal says costs can range from the “low teens to the mid-20s.” From there, you must file with your state’s attorney general, which could cost you another $1,000 to $2,000. Then there are the accountant fees (franchised businesses must be audited once per year, even if you don’t sell any units), which could ring you anywhere from $7,500 to $15,000. Gulp.

How much are we talking here?

“I’d say you should have somewhere in the high five figures,” says Rosenthal. “I’ve had clients start with less, but it is rare. You really need to set aside legal and marketing money because things add up quicker than you think.”

Greg Archer learned this the hard way. As co-founder of Age Advantage, a San Diego, California-based company that provides in-home care to senior citizens, he and his wife began offering franchises in 2006, but stopped about 18 months later largely because of under capitalization. He says you need even more than five figures starting out.

“Being undercapitalized really inhibits growth; I recommend starting with a minimum of $300,000 to $500,000,” he says. “As a new franchisor, there is no cash flow. You really don’t make money on the sale of a franchise, you make your money on ongoing royalties.”

In addition to legal and regulatory fees, the Archers were strapped with sales and marketing costs, all which proved to be too much. In 2008, they reevaluated their business. Two years later another company bought out their original location, which freed them up to focus on franchising alone.

Today, they are going to tradeshows and actively advertising. According to Archer, the company is on par to close about 15 more locations (they already have six) this year.

Mistake No. 2: Confusing the roles of franchisor and business owner

Rosenthal uses a barbecue restaurant as an example. As the business owner, it is your job to deliver mouth watering pulled pork; you do a great job and have legions of loyal customers. Pretty soon a potential business partner offers to open a franchise and you jump at the opportunity. It’s an ace in the hole, right? Not exactly.

“You need to recognize that being a franchisor and a business owner are two different skill sets,” says Rosenthal. “You may be a great chef, but that doesn’t mean you will be a great franchisor.”

Franchisors must be focused on finding and recruiting franchisees, says Rosenthal. Processes need to be put into place, manuals need to be written and franchisors need to invest time into training franchisees and lower level employees. These duties can take away from those related to owning your primary business.

Also consider bringing in a franchise consultant to help you with the process. (Note: to find a consultant, check out the International Franchise Association.)

Mistake No. 3: Lack of planning

Planning is key to a successful franchised business. Before even considering the business model, make sure you have a detailed operations manual for your business that goes step by step through every process in your company and you’ve talked to an attorney or franchise consultant, recommends Rosenthal.

“Don’t just think that you can do it on the cheap and see how it goes,” he says. “Franchises take a lot of pre-planning.”

Mistake No. 4: Franchising too soon

Just because your five-month-old Mexican restaurant is selling out every night doesn’t mean it’s time to think about franchising. Rosenthal suggests waiting three years before considering the business model.

“You need to have everything figured out,” he says. “No one is going to want to buy your franchise if you haven’t worked the kinks out yet.”