Selecting the Right Franchise

This article was written by Betty Otte, SCORE Orange County Management Counselor

(Editor’s Note: This is the second of three articles by Ms. Otte on the subject of franchises. If you missed the first installment, check the April, 2011 edition in the archives)

In Part 1, you checked out your franchise options and decided to purchase a franchise. You have decided which one of the 75 franchising industries is right for you and have narrowed it down to maybe three or four different companies. The big decision now is to select the one franchise that is right for you.

Business demands that we think with our head and our heart, but when doing research the head must take the lead. You are risking your money, your time, and your career, so the choice you make must be congruent with your lifestyle and needs. Researching each option is the key. Here are five simple steps to help you.

1. Contract the franchisor directly and fill out a preliminary application form. This tells the franchisor that you are serious and a viable customer for his franchise. You will likely have a series of interviews with the franchisor.

2. Receive and review the company’s Franchise Disclosure Document (FDD). Once the franchisor believes you are serious, he will send you a copy of the FDD which contains 23 important parts to review. The FDD very clearly defines what the franchisor will do for you and what he expects of you. You will probably want to have an attorney review the FDD; however, it is crucial that you understand every statement in each of the 23 parts. The Federal Trade Commission (FTC) protects franchisee prospects up until the point of sale, but once the franchise is purchased, the FTC looks upon the business as any other start up, so the FDD becomes vitally important.

3. Visit locations and talk to existing franchisees. The vital step will help you to determine the level of satisfaction of other franchisees in the system. You need to know if the franchisor delivers his promises and research is the best possible way to find that out. In addition, it gives you a chance to get an inside look at the business to figure out if you can see yourself in the franchise.

4. Find answers to important questions. What is the initial purchase price? What are the royalty fees? What kind of training and ongoing support is provided? You will most likely be expected to participate in a national marketing budget. What percent of gross is expected? How often do you get new marketing materials? Do you have sufficient funding for ramping g up and maintaining until profits begin?

5. Research the brand and operating system. Will customers gravitate towards your product or service because they know the brand? Has the franchisor provided an operating system which has been proven successful and is easy to learn and use? Will being part of the franchise system help in competing in the market place? Will you be a part of a growth industry?

A good franchise situation is extremely valuable, but you must do a lot of research before you will filter out the good, the bad, and the ugly. The good can be very good and a very wise business decision. Remember that SCORE has over 10,500 volunteers ready to help mentor you, many of whom have franchise experience. Seek help from your nearest SCORE office or online counselor. SCORE counseling is always free and confidential.

Tax Break for Self-Employed Likely to Vanish

The Small Business Jobs Act nixed the tax that self-employed workers pay on health insurance for 2010. Small biz advocates doubt Congress will extend it.

By John Tozzi, reprinted by permission from Businessweek.com

Paula Fleming, a freelance copy editor in Minneapolis, spends $3,600 a year on bare-bones health insurance for herself and her husband. For the 2010 tax year, for the first time, she could deduct that amount from her income when she pays the self-employment tax, the 15 percent levy all freelancers are required to contribute to Social Security and Medicare, saving her $540. Fleming's not counting on the same break for the 2011 tax year, though, because Congress passed it solely for 2010 in last year's Small Business Jobs Act. "When the law no longer applies," she says, "that's more money out the door."

Despite politicians' calls for tax reform and oft-professed devotion to small business, prospects for passing two tax fixes that self-employed business owners like Fleming have sought for years are shrinking, small business advocates say. One bill would make the health insurance tax break permanent, bringing the self-employed in line with payroll workers, whose health insurance is fully deductible. The other would simplify the home office deduction, a proposal that has been around for at least a decade.

"I'm concerned that this is going to fall by the wayside," says Kristie Arslan, executive director of the National Association for the Self-Employed, who has championed both measures. "It's a perfect storm of politics right now. You have a divided house in Congress and you have a Presidential election coming up. The only expectation you can have is gridlock." Arslan plans to urge lawmakers to extend the health insurance deduction when she testifies before the Senate Small Business Committee on May 19. Twenty-two million Americans are self-employed business owners, and more than half work from home, she says.

$1.9 Billion in Tax Savings

The health insurance deduction for 2010 will mean $1.9 billion in tax savings for people who work for themselves, according to an estimate by the Joint Committee on Taxation. It also corrects a quirk in the tax code that leaves this segment—already on the hook for contributions to Social Security and Medicare that are normally split between worker and employer­—as the only businesses whose health-care costs are not fully deductible.

Simplifying the home office deduction would give home-based business owners the option of a standard $1,500 write-off instead of the complicated calculations required to claim the deduction now. In an online survey of 300 members in April, the National Small Business Assn. found that only 47 percent who qualified took the home office deduction. The rest skipped it because they thought it would raise their chances of being audited or because it was too complex.

Both proposals have support from business lobbying groups and have had bipartisan sponsors in several Congresses. That doesn't mean they'll go anywhere. "I think they are likely not to move," says Todd McCracken, president of the NSBA, which supports both measures. He says their best chance to pass is as part of a broader overhaul of the tax code. "The prospects of a larger tax bill get dimmer and dimmer as we move into the summer."

Deficit Concerns

Representative Ron Kind (D-Wis.), who has co-sponsored both bills and introduced similar legislation in previous sessions, says success depends on the cooperation of Republicans in the House, who fought last year's jobs act that included the one-year health insurance deduction. "They may not be that opposed to just letting everything expire," Kind says. Getting the health insurance deduction extended is "a tremendous priority" for California Republican Representative Wally Herger, who introduced the bill in the current session, says spokesman Matt Lavoie.

Washington's heightened sensitivity to increasing the deficit means that lawmakers would have to pay for any bill to extend the deduction with spending cuts or other sources of revenue. "The one challenge that anything faces now is a revenue issue," says Bill Rys, tax counsel at the National Federation of Independent Business, which supports the deduction. He cites the effort to repeal 1099 reporting requirements—seen as a paperwork nightmare for small companies—that both parties and the President supported, which was still delayed for months by squabbles over how to offset the cost. Rys describes both the health insurance deduction and the home office simplification as "common-sense" fixes with bipartisan support. "It really achieves a goal that a lot of people are talking about here in Washington, which is simplifying the tax code."

For Fleming and other self-employed workers, it's a matter of fairness. For one year, she was eligible for the same tax benefits for health insurance costs that other businesses got. It doesn't make sense for them to be rescinded, she says. "I'm an employer. Employers get to deduct the cost of health insurance for their employees."

SO PLEASE HELP ME TO UNDERSTAND . . . . .

This article was written by Barry McKinley, SCORE Orange County Management Counselor

One of the first things I learned in school and later in business was to be prepared. I was never the smartest kid in school and I certainly wasn’t the smartest business person. But I learned the better prepared I was, the more successful I was. I quickly discovered that it was not the smartest business person that succeeded it was the person who knew the most about their competition, their own products and most importantly about their customers. In the past I have written articles about the importance of a good salesperson mastering the art of probing. We learn absolutely, positively nothing when our mouth is moving, but with our ears open we can learn what our customer’s hot buttons are! We learn what stimulates and motivates them into making a buying decision.

So Please Help Me To Understand . . . . .

Why is it when I call a business person leaving a detailed message of my reason for calling and perhaps the information that I require, that over half the time when I get a call back the caller says “Hi I am returning your call” and naturally my response is great, did you review my message. Now comes the part that ‘Blows Me Away’ . . . NO I didn’t have time, I am just calling you back! Well if there was a parade with the Stupid Band of Idiots this person would be the leader! In some cases I have left a very detailed message inquiring about warranties, deliveries, pricing, competition or other facts that help me to make a buying decision. But they are “Too Lazy” to see what my call was about or more importantly get the facts and information I am asking for. In reviewing my message prior to the callback they have an opportunity to prepare their response. As a consumer I can tell you when this happens I have lost all confidence and respect for the person or company I am calling and quickly move on to their competition.

We are all working very hard in this stressed economy to get every customer and follow up on any and all leads. Many companies are spending $100 + for a single lead!

So Please Help Me To Understand . . . . .

Why when leaving a phone message the caller tries to say their call back number in less than two seconds and their name in even less time. Many times I am not even able to call them back because the number is not clear and the number they called from is not the number that they want me to call. Common phone courtesy and good business sense is to slowly say your number INCLUDING area code, your name clearly, and then repeat both.

Another interesting observation I have made in meeting with 1,000’s of business people is their constant addiction to looking at their cell phone. During the meeting they will continually scroll their email and/or checking to see who called.

So Please Help Me To Understand . . . . .

Why do they think they are so important that any phone call or email can’t wait 30 minutes? If for some reason they are expecting an urgent call that can’t wait and may interrupt the meeting, let the people know ahead of time and then ONLY take that call. The most important assignment they have is this meeting. Many times I have witnessed business people who requested an important meeting spend ½ of the meeting time looking at their phone. They need to turn it off and give their entire concentration to the meeting at hand, or they may find that they have plenty of free time and no customers. Focus on the opportunity! Remember the old saying “A bird in the hand is worth two in the bush!”

FINANCIAL PROJECTIONS – UPGRADING YOUR CRYSTAL BALL

This article was written by John Seelinger and Howard Hawkins, SCORE Orange County Management Counselors

Today’s small business owner is often challenged to prepare financial projections either as part of a business plan or at the request of a bank to complete a loan application. The task obviously varies given the history and type of business (product or service), and the financial sophistication of the owner. The projections include the three basic financial statements, and a narrative covering assumptions and external factors that can influence future results. The assumptions support the financial numbers explaining their derivation such as historical trends and could include hypothetical assumptions about future courses of action the business might consider. These assumptions could range from new products or services, personnel changes, or new marketing plans.

The underlying goal of the projections is to convince the reader of two very important details: the business will generate sufficient cash flow to (l) repay debt and (2) provide efficient Return on Investment to insure success for the owner. Before undertaking the task of preparation it is important to confirm the bank’s requirements, especially the number of years to be shown, and whether the periods should be monthly, quarterly, or annual. Banks today generally prefer three years of projections with the first year divided by months or quarters, and the two succeeding years shown on an annual basis.

Given the length of time in business, it is best to show the figures as accurately as possible, and avoid showing numbers in hundreds or thousands. To include a “disclaimer” might be a legal protection, but an experienced lender realizes the numbers are on a best efforts basis, and are subject to change through the normal courses of internal and external factors. Their analysis will result in questions requiring support. The three basic statements are generally accepted and understood throughout the banking industry. The preparation of the statements by a small business can range from CPA prepared to internal methods such as “QuickBooks.” The latter provides a method of providing the statements in an organized and consistent manner, and is most cost beneficial to a small business. The business owner must conform to a consistent pattern of inputting the data in order to prepare a periodic statement to review the progress of the business. Without that, the necessary decisions may be delayed, and a lender is going to look for how often the owner uses the statement information to manage and react to required changes depending on internal and external factors. There are other sources that can be used to prepare the projections and “keep the books”, but the important thing is to do it and be consistent.

The three statements must be consistent with either cash or the accrual method. The doctrine of constructive receipt of income must be consistent. How is income recorded? Upon an order or upon the actual receipt of payment from a customer. The recording of income should be explained with the assumptions, and is certainly a point of certain verification by the lender in his analysis.

The three statements are linked as to their relevance, and some lenders may rely more on the cash flow projections as it is the support of the ability of the business to generate cash to repay any debt. However, their purpose is important in balancing the support necessary for a positive credit analysis. The purpose of the balance sheet is to show the financial position of a business at a particular point in time. The most usual date is at the end of the accounting year. It shows assets (current and fixed/long term), liabilities, and owners net worth/equity. Total assets equal liabilities plus equity. Owners’ equity is the residual interest, or the amount of the assets to which the owners have claim because creditor claims (liabilities) legally have priority. The equity is derived from two sources: (l) paid-in capital which is the contribution of the owners in cash or assets; and (2) retained earnings, which are the accumulated profits (transferred from the income statement) less any losses or withdrawals.

The Income Statement or Profit and Loss shows the revenue, expenses, and net income (or net loss) for a period of time; monthly, quarterly, or annually. The projected income statements support the ability of the business to earn profits.

As stated previously, the Cash Flow Statement will probably bear the most analysis by the lender. Cash flow can come from investments or financing, but it is the operating cash flow (net income plus non-cash depreciation/amortization) that is available for debt service. A bank loan generates cash but is not revenue. Loan payments consume cash, but do not reduce income only liabilities. Most lenders prefer a cash flow presentation showing the addition of debt to support operating expenses, and net income that is available for debt service. The loan payments can be shown and deducted. The margin over the loan payment and the cash available for debt service is the “cushion” the lender will evaluate in their credit analysis.

It might be preferable to show two sets of statement projections. One could be the most reasonable based on historical trends, and the other the most conservative. The latter would reduce the cash flow to show that even in a reduced performance the firm still has the capacity to meet the loan payment required.

Up to this point we have concentrated on internal projections, using the firm as the basis for the forecasts. External data can also be used to support the factors of data specific to the type of firm, including its industry, market, or the general economy. Industry information for external comparisons is readily available through many sources. Public libraries are a treasure of information. The business librarian can assist using zip codes, county, and city information to provide a great variety of comparative data. The 2010 census data is just now becoming available.

Two internet sites: “factfinder.census.gov.” and “censtats.census.gov.” are the sites to be explored for any particular industry data one is interested in. To begin one needs to enter the North American Industry Classification System (NAICS) code for any particular industry. This system, adapted in 1997, supplanted the older Standard Industrial Code (SIC), although the latter is still used by many government agencies.

Industry trade publications coupled with specialized conferences and conventions can provide up to date information. The internet today is a growing source. Link on to “Google”, and almost any question can be answered. Universities offer public access to their specialized research in business topics.

There are two main considerations to keep in mind when doing projections: they must be reasonable and they must be consistent with the narrative in your business plan. If they just show yearly totals of income and expense spread evenly over twelve months, questions arise about the thought put into them, and the credibility of the projection is questioned. Every business has fluctuations and projections should reflect this. Projections should be in line with industry data mentioned above; any variation, positive or negative, should be supported in the narrative. Finally, particularly in the current economic scenario, it is very difficult to increase gross profit margins. Unless there is strong support in the narrative explaining how this can be done, projections showing margin enhancement along with the increasing sales will be subjected to challenges. Sales, income, and profit growth can be achieved with consistent margins that, after all, are a ratio, and not absolute numbers.

Well constructed projections absolutely are great management tools. However, lenders vary as to their requirements. Inquire as to what the lender wants, and in what detail. Loan collateral is often required, and if required may result in more relaxed projections. Some lenders, for lesser loan amounts, perhaps under $100,000, may use credit scoring which could reduce the reliance on projections. If a borrower is seeking credit for an amount in the lower five figures, projections rarely are the critical item in the loan approval process.

Finally, prospective borrowers/business owners must “own” their projections. If the business owner brings an accountant, and defers all questions to this third party, he or she loses credibility and the lender may have doubts about the borrower’s ability to truly understand their business prospects necessary for the proper cash flow to service the debt obligations.