Know the risks and rewards

…franchise relationships too often sour and end in lawsuits, says Mr. Stewart. He wants an independent national agency that would monitor and enforce franchise law.

The Ottawa Citizen
October 19, 2004

Know the risks and rewards
Before you invest, investigate franchising thoroughly
Andrew Mayeda

Hal Hashem needs help running his business and he knows it. That's why he's glad to be running a franchise, not his own small business.

He and his partner, Tony Abou-Hammad, could probably have started their own kitchen remodelling shop. With Abou-Hammad's more than 20 years of experience as a general contractor and Hashem's sales finesse, they make a natural team.

But then they would have had to hire more staff and negotiate with suppliers from scratch, not to mention design a business model and build a brand.

As it is, their Kitchen Solvers franchise has virtually no overhead, except for phone bills and other minor expenses. "It's just me and my partner. If we make a sale, we make money," said Mr. Hashem. "If we're not producing, we're not losing money, at least."

And when they want advice on how to market their services or handle customer complaints, they can call the company's headquarters in Wisconsin. Kitchen Solvers has 131 franchises in the United States and eight in Canada that offer cabinet refacing, kitchen design and other services.

"They have always been there if we have any problems, any questions. The support for me is very important."

Owning a franchise has worked out well for Mr. Hashem and Mr. Abou-Hammad. Sales grew about 30 per cent last year, the business is profitable and they are debt-free. But not every franchise story has a happy ending.

It's not uncommon for franchisors and franchisees to lock horns. In a 1998 white paper, Ontario's Ministry of Consumer and Business Services estimated there were 5,000 civil franchise cases filed every year in Ontario alone. That rate has likely increased, says Les Stewart, president of the Canadian Alliance of Franchise Operators, which represents the interests of franchisees.

When someone buys a franchise, they are typically granted the right to sell products under the franchisor's trademark in a set geographic area or territory. Franchisees usually pay an up-front fee of as much as $100,000, with the average being between $20,000 and $50,000, according to Ontario franchise law firm Siskinds.

Franchisors also receive sales royalties and advertising fees, which together amount to between six and 12 per cent of gross sales, on average.

Mr. Hashem and Mr. Abou-Hammad got a good deal on the Kitchen Solvers franchise, buying it for $19,000 several years ago from the previous Ottawa franchisee, a discount from the standard startup fee. They pay five per cent in royalties, but don't have to pay the usual one per cent in advertising fees, since the company doesn't promote itself much in Canada.

Like any business model, however, there are risks and rewards to franchising. It's a good idea to consider them before investing your time and money.

Start with the rewards. Unlike an independent business, a franchise usually comes with its own ready-made brand, promotional materials, supplier network and in some cases, store front. Those are the most obvious benefits of buying into a franchise, says Richard Cunningham, president of the Canadian Franchise Association, which represents more than 350 franchise firms in Canada.

"With a franchise, you have some sort of immediate identity," said Mr. Cunningham.

Other benefits include the ability to seek advice from head-office staff and other franchisees in the network.

"If you're in business by yourself, you don't really have anybody unless you pay a consultant or have a family member who knows the business."

Also, securing financing for an independent business can be more difficult than raising funds for franchises, which are usually backed by large corporations.

For all these reasons, franchises are less likely to fail than independent businesses, according to the association.

So what about the risks? First, franchisees have to understand they don't own the business, says Mr. Cunningham. Though they may own assets such as inventory and equipment, they are merely granted the right to run the business for a period of time.

As a result, a franchise might not be the best match for entrepreneurial types who want to control the business. It's also important to realize not all franchises are the same and they can have vastly different conditions

Mr. Cunningham estimates there are between 800 to 900 franchise companies in Canada, with 80,000 to 90,000 outlets and $90 billion in sales. These range from big fast-food names such as McDonald's and Tim Hortons to hotel chains, car-rental services and mobile operations such as interior decorating businesses.

Therefore, it's essential for franchisees to know what they own and what they can sell. Canadian Tire stores, for example, are listed as franchises by the association. But franchisees only assume ownership of the inventory and other fixed assets, not the store building itself, and there are restrictions on what they can sell and where they can source it, says Mr. Cunningham.

Mr. Hashem knows how much the experience depends on the franchising model.

Before he took over Kitchen Solvers' Ottawa franchise a few years ago, he ran a Golden Griddle restaurant for a decade. Business was good until rivals such as Denny's turned up the heat. To compete, Mr. Hashem's restaurant, which has since closed, switched to a 24-hour format. He had to hire and train more staff, and his overhead costs ballooned.

"It became demanding for me. I wasn't ready for the hours," says Mr. Hashem, 48.

Kitchen Solvers is a better fit. His work day rarely starts before 10 a.m. and he works fewer weekends, giving him more time to spend time with his wife and keep an eye on his three teenage daughters.

"You make your own schedule."

Ultimately, the issue boils down to control — of assets, inventory, cash flow and so forth. Franchisees have to be careful how much they cede, because the greatest risk is franchisor opportunism, says Mr. Stewart, who knows how ugly the owner-franchisee relationship can get.

A former franchisee himself, he was successfully sued by the lawn-care company he worked under, which drove him into bankruptcy. He now advises franchisees in distress.

Recently, he has taken up the cause of five former distributors of Tupperware Canada Inc. who are being sued by the company for debts it says they owe. Some have countersued, claiming Tupperware misrepresented the earnings potential of the business.

Mr. Stewart cites a list of potential franchising pitfalls.

Under many agreements, franchisees must buy certain goods and services from the franchisor, who often claims this lowers procurement costs. But in many cases franchisees get gouged on prices, says Mr. Stewart.

Mr. Stewart also warns prospective franchisees to think twice before giving a franchisor direct access to their bank account. He also recommends talking to former franchisees, not just current ones, who may not be able to speak freely.

For franchisees who feel taken advantage of, the law offers some protection. Ontario and Alberta have passed franchise legislation that forces franchisors to disclose financial statements and any material facts that affect the decision to buy a franchise. Franchisees can sue for damages against owners who misrepresent these facts. The laws also compel both sides to demonstrate "fair dealing" and behave in a commercially responsible way.

Sections of the federal Competition Act also provide protection. It is illegal, for example, for suppliers to "attempt to upwardly influence" prices.

The Canadian Franchise Association requires members to abide by an ethics code. Among other things, the code advises franchisors to try to resolve disputes without going to court and provide "reasonable guidance, training, support and supervision."

The association has also posted questions on its website — www.cfa.ca — that prospective franchisees should try to answer before taking the plunge.

Despite such support channels, franchise relationships too often sour and end in lawsuits, says Mr. Stewart. He wants an independent national agency that would monitor and enforce franchise law.

Both Cunningham and Stewart recommend doing as much homework as possible before buying a franchise.

In addition to current and former franchisees, people should consult franchise lawyers and even bank officials in charge of franchise lending, who may be able to comment on a franchisor's track record, said Mr. Cunningham.

"You're committing your life savings and your family's financial health for the next 15 to 20 years. That's something to take very, very seriously," says Mr. Stewart.

© The Ottawa Citizen 2004


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