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Finding Franchise Heaven and Avoiding Franchise Hell

Franchises offer opportunities but also pitfalls, so buyer beware

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“Unfortunately, prospective franchisees don’t really read the (FDD),” says Nathan Natori, owner and attorney at Honolulu-based Natori Law Office LLLC. “Some are over 100 pages long and they may be a little hard to understand and definitely overwhelming, but it’s necessary.”

Egesdal and Natori also stress that prospective franchisees should spend a lot of time contacting current and past franchisees, whose contact information is available in section 20 of the document.

“People are easily sold and franchisors aren’t going to tell you the bad stuff,” says Egesdal. “The only way you’ll find that stuff out is by talking to current or previous franchisees.”

Before he committed to purchasing the Kauai Quiznos, owner David Lehn says, he contacted other Quiznos owners to find out more about the company’s franchise system and whether they thought the price he would be paying was competitive. However, he admits he did not know about the class-action lawsuits against the company when he bought his restaurant and feels he and his wife rushed into their decision to buy.

“In hindsight, we made the decision a little more quickly than we probably should have,” he says. “There was a short timeframe for us to do everything. We had not researched other franchises and I would say I wasn’t completely knowledgeable about what it means to own a franchise.”

Some digging on the Internet can also reveal a lot about different franchisors, especially larger systems with franchises around the country. There are many websites and organizations dedicated to informing current and prospective franchisees about the state of the industry, as well as franchise opportunities and news about specific franchises.

Every year, the federal Small Business Administration releases a list of failure rates for SBA-backed loans to franchisees. From 2001 to 2011, nearly 40 percent of those loans to Quiznos franchisees failed compared to little more than 9 percent of similar loans to franchisees of Subway, the largest quick-service franchise in the world. Though this list does not include private loans without SBA backing, and Subway franchisees are no strangers to grievances either, the SBA’s loan-failure list is an important indicator of the health of a franchise brand.

Due diligence is crucial, says Natori, but so is an exit strategy, in case things don’t pan out as planned.
“I guess (prospective franchisees) are very optimistic and feel really good about entering into their own business,” he says, “but failing to have an exit strategy can really make things difficult. For example, landlords may require personal guarantees for leases, so you cannot just bail out on a lease, even if you sell it to somebody else to take over your business. The same thing goes with lenders.”Hawaii’s Situation

Prospective franchisees should also understand that Hawaii poses unique challenges. Though FDDs provide estimates of your initial investment in a franchise, Egesdal says, those estimates don’t apply here. “Most FDDs are prepared for mainland outlets, so expect costs (in Hawaii) to be quite a bit more.”

Hawaii’s geographic isolation and high cost of living also mean overhead costs are significantly higher than for mainland franchisees.
“Everything we bring in has to be shipped,” says Lehn. “I cringe every time a barrel of oil goes up to $115.”

Not to mention that national marketing and advertising campaigns may not extend to the Islands, and are less effective, maybe even counterproductive when local franchisees are unable to honor promotional pricing and coupons. How many times have you been upset to find that a cheap promotional price you saw on TV or a discount coupon that you downloaded from the Web doesn’t apply to Hawaii?

Despite this, local franchisees are still required to contribute a percentage of their gross weekly sales to a marketing and advertising fund, in addition to the weekly royalties they must pay.

“I’ve put around $1,200 a month on advertising that I believe I get no benefit from,” Lehn says.

Bobby Guied, owner of the Kapolei Quiznos franchise, adds, “Marketing is one of the most important things, but a lot of people didn’t even know what Quiznos was.”

Future with Quiznos

Luckily for Lehn and Guied, Quiznos’ national owners have revved up efforts to improve branding and business for its franchisees since a change in majority ownership and completion of financial restructuring early this year.

In May, the company launched Qrave Quiznos, a new branding campaign; introduced the new “Better Than Ever” menu; and announced its commitment to improving its products and customer service, and providing franchisees with more resources.

“The relationship between the corporation and its local franchisees has improved dramatically since the restructuring,” Lehn says. “There is a lot more communication and, at this point, it is communication, whereas before it was more of a directive.”

Though Quiznos is making a significant effort to rebuild its franchise base and reputation, Lehn is unsure of his future as a Quiznos franchisee. “We’ll keep it open now,” he says, “and then, depending on how the next year or so goes, make a determination whether we should just sell and move on.”

HB intern Michael Hanson contributed to this report.

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