Pick A Winner: Find Out How Much Money You'll Make-before You Buy

THE FIRST TIME HE BOUGHT A FRANCHISE, John Munson got burned. It was in the early 1980's, after the former industrial salesman had built a small fortune in the commodities and oil-drilling business.

In 1984, he and three partners made an ill-fated leap into franchising. Munson quickly lost $250,000 on an investment in the transmission repair and quick tune-up business.

"We thought we had done our homework and found a diamond in the rough," says Munson. "We talked to the company's franchisees and discovered they were happy and making money. We reviewed the franchise documentation and liked what we saw. We met with the franchisor and developed a pro forma that looked great." Munson and his partners chipped in $150,000 apiece to buy the franchise rights from Illinois-based Mr. Transmission for four transmission shops and four Tune-O-Mize quick tune and lube locations. Their dream was taking shape.

Munson soon hit the hard wall of reality. "All of the Mr. Transmission franchisees we met were single-unit owners," says Munson. "They didn't have any of the hassles or costs of managing multiple locations. And the Tune-O-Mize franchisees were new to the concept, so they hadn't yet passed the test of time." Munson discovered that the transmission business needed a tremendous amount of attention. It was impossible to divide his time effectively among four locations and still make a profit. And the Tune-O-Mize concept was so undeveloped and risky that the partners scrapped the idea before opening even a single unit.

They sold their Mr. Transmission franchises to owner/operators. Munson has offset some of the losses by collecting rent.

Still, Munson believes in franchising. He says the marketing support and security it provides are unique. "In my mind, it's still the safest way for people to get into business, sort of a halfway house for those who want to own business but not completely on their own." Three years ago, when Munson again searched for a new franchise to buy, he performed a deeper investigation, one that would give him a better read on the return from his franchise investment. Munson is in the process of investing $10 million in as many as 50 Candy Express franchises in the southeastern United States.

The Secret Is Legwork Munson and others like him are a new breed of franchisee-investors who are unwilling simply to take the word of franchisors or operating franchisees when the time comes to lay money on the line. Instead, they are launching their own comprehensive reviews of franchises to uncover just how much they can make owning a franchise.

That's never an easy task. The cruel irony of franchising is that most franchisors withhold earnings claims to prospective franchisees in order to avoid liability should projections fall short.

So it's up to you- the prospective franchisee- to do your own digging. To help you, we went out and found some of the best tips and tricks to help focus the crystal ball. Here's what we uncovered: "We learned from our Mr. Transmission experience that the problem with simply talking to the company's franchisees is that most franchisees don't know how much money they are making," Munson says. So his investigation started not with franchisees but with a set of criteria he and his partners invented to evaluate franchisors.

First, a franchisor would have to have a core of at least 25 operating units. Fewer than that indicated the firm might not have enough experience.

Second, the franchise had to have company-operated stores at which they trained franchisees, tested new ideas, or just made money. "We wanted to know that franchisors thought enough about their own concept to own some locations themselves," Munson says.

Third, the franchise had to be growing regionally instead of shotgunning locations across the country. Munson believes franchising is marketing game. There has to be a concentration of units to build market share and sales.

Fourth, Munson says, "We wanted our franchisor to treat us as working partners, not like children or simply customers." The partners scoured franchise listings to find companies that met the criteria. Two hundred and fifty franchises made the initial cut.

Munson and his partners collected and read the disclosure documents from each one to determine whether they fit the bill. If the answer wasn't readily apparent, they called the franchisor's sales staff.

"We learned a lot of critical information just talking with the sales agents," says Munson. "For instance, a lot of franchises have company-owned units in name but not practice. When you investigate, you realize that the franchisor might have re-acquired them from struggling franchisees and is stuck with them. Ask a salesperson if these so-called company-owned stores are for sale. You'll learn real fast whether the franchise has legitimate company-owned locations." Munson had a second reason for wanting to know about company-owned locations. Since most franchisors are concerned about legal liability, they won't make earnings claims. Consequently, the only way to dissect the company financially is to look at actual operating figures from the company-owned stores. By finding those franchises with legitimate company-owned locations. Munson knew he had uncovered vital data he would later plug into his search formula.

After six months of Munson's telephone calls, only 20 franchise companies remained (Munson won't tell which ones, but he claims that 11 of his finalists appeared on SUCCESS's 1992 Gold 100 franchise ranking).

From there, Munson stepped away from franchising and talked with investment bankers and business brokers to determine the rates of return they demand when investing or buying businesses. Time and again, the figure came back at 35 percent.

"We used that as our benchmark," says Munson, "and concentrated only on those franchises that could return 35 percent of our initial investment every year over the life of the franchise agreement." The challenge then was to find out exactly which of the 20 franchise companies could deliver the 35-percent return.

Munson returned to the franchise's company-owned units. He studied closely their financials, as revealed in the disclosure documents. He used them to identify ranges of operating costs for everything from rent to labor.

The ranges served as litmus tests by which he compared the profitability of operating franchisees.

"We used the ranges as a framework for determining the real performance of franchisees," says Munson. "For instance, if we knew that labor in a franchised unit should run at about 35 percent of total costs and a franchisee wasn't showing a profit but was paying 50 percent for labor, we could guess that either the owner wasn't managing personnel effectively or he was taking an inordinate salary." This framework stripped away anomalies, providing clear insights into a franchise's profitability.

After applying the formula to the finalists, Munson was left with a half-dozen franchises. Yet none was the winner.

"We never intended for the analysis to take precedence over common sense," says Munson. "We wanted it to serve as a way to confirm our decision and to find the franchise with the greatest possibility of delivering a 35-percent return. If a franchise appeared that met all the criteria except one or two, and the deficiencies could be explained, then we wanted to take a look at it." That franchise was Candy Express Inc., of Columbia, Md. Although the firm ranked number four on The SUCCESS 1992 Gold 100 survey, Munson had dismissed it early on because it had only 18units opened.

But Munson discovered that Candy Express's merchandise and supply costs ran 35 percent of gross sales, net operating income was about 16 to 22 percent.

Munson then turned to Candy Express franchisees and determined that the average store was annually grossing about $425,000. When he applied his cost ranges to their operations, he was left with a net return of about $68,000 per store. Based on an initial investment of $200,00, Munson's ROI fell at just about 35 percent.

That gave him the go-ahead to invest. So far, Munson and his partners have opened 12 stores in five southeastern states. All are performing according to projection.

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