February 28, 2023

How to Select the Right Franchisee for your Restaurant Franchise System

What are the most important factors that determine the success of a restaurant franchisor? From this author’s experience, the answer is threefold:

  1. The consuming public likes the offering;
  2. Optimal locations have been secured; and
  3. The franchisees are the right franchisees for the system.

This article focuses on the last factor.

Typically speaking, restaurant franchisors, like all franchisors, promote their systems to prospective franchisees principally on the basis that their systems are attractive business investments. In so doing, they seek to bring in financially viable prospects to help grow their brand. Likewise, a major factor in any prospective franchisee’s decision to invest in a particular system is the anticipated return on their investment.

While these are important considerations, as a result of this focus, what is sometimes overlooked by both sides during the sales process is whether, apart from meeting the franchisor’s financial requirements, a prospective franchisee has what it takes to be a successful operator in that particular system. This does a disservice both to franchisors and to prospective franchisees.

That is, once the franchise is granted, and assuming a good location is secured, the success or failure of the franchise will generally come down to how the franchisee operates their business. When a good operator is selected, they will generate positive returns for both the franchisee and the franchisor, enhance the brand’s reputation within its community and build cohesiveness within the system. Conversely, when a poor operator joins the system, they will typically be unprofitable, they may test the limits of the system and, through substandard operations, spoil the brand’s reputation amongst consumers and prospective franchisees.

Given this, when evaluating prospective franchisees, franchisors must look to more than just the typical qualification criteria of the prospect’s financial means to purchase a unit, whether the prospect has time to operate the restaurant and whether they can pass the franchisor’s training program.

Consider the following six questions when selecting your next franchisee.

  1. What does it mean to properly qualify a franchisee financially?

Whether a prospective franchisee can purchase a restaurant with a small business loan should not be considered the qualifying financial baseline for purchasing a franchise. Rather, prospective franchisees should have significant available cash capital to sustain losses for at least the initial 12 months, notwithstanding the common provision in franchise agreements that they have resources to cover 3 months of operating costs.

Against that backdrop, it is critical that franchisors appreciate the harm that may be caused to their system when a franchisee struggles to operate financially. First, these operators are the first to cut costs, buy outside of the system, cut staffing levels or hours of operation, complain about profitability, and deflect their attention away from the basics of operating a good restaurant as designed by the system to try to avoid the costs of system compliance.

  1. Is the prospective franchisee customer and employee driven?

Good restaurant franchising assumes the public likes the offering. It is the franchisee’s responsibility to execute the system, which means hiring, training and retaining the best staff, and understanding the best employment practices. Similarly, they need to be customer-friendly and actually enjoy interacting with their customers. Training franchisees in these aspects of the business is no substitute for seeing proof of these characteristics in a prospective franchisee’s application.  Have they successfully hired, trained and managed staff in the past? Have they had experience in sales and customer service?  Do they love these aspects of the business?

  1. Has the prospective franchisee developed an exciting local store marketing plan?

Regardless of a franchisor’s marketing initiatives, most small local businesses thrive when their owners are part of the community they serve and have smart marketing plans to attract that community. A franchisee, and not the franchisor, should be the expert in the local market to be served by the business. Given this, prospective franchisees should be encouraged to develop and present detailed and thoughtful local marketing plans and proposed budgets, together with a demonstration of their personal commitment to the community, during the qualification period.

  1. Does the prospective franchisee possess the same qualities as existing successful franchisees?

Franchisors, with or without the use of available third-party resources, must be able to identify the key qualities of their most successful franchisees and administer testing to prospects to measure how they stack up to the system’s gold standards of franchisee success.  Such testing should be a feature of every franchisor’s qualification process.

For example, one universally valued quality amongst franchisees is ambition. They must be driven to grow their businesses and be driven to invest in more units. Although space limitations prevent a discussion here of the challenges with multi-unit franchising and whether limits should apply to how large a franchisee should be permitted to grow, having successful multi-unit franchisees should be the goal of every system.  It is therefore, critical for a franchisor to know a prospective franchisee’s ambitions for purchasing a franchise and to assess their ability to achieve those goals.  Psychological assessment tools are available to assist with the analysis.

  1. Does the prospective franchisee understand that operating a restaurant is hard?

The qualification process must reveal whether the prospect has a real understanding of what it takes to operate a restaurant and how that can impact their life and the lives of their family members. For example, most franchise agreements require a franchisee to devote their “full time and attention” to the business. In the usual case, that requires both operational management and management oversight on all other aspects of the business. While managers can be trained to perform these functions, franchised restaurant management works best when it is conducted hands-on by the owner. Moreover, given that franchisees incur significant fees that they would not otherwise incur if they were independent (e.g. royalties), these additional costs impact a franchisee’s ability to hire managers. Because of this, franchisees must be personally dedicated to the business and have the support of their families. These qualifications can be assessed in a properly designed and executed interview process.

  1. Does the prospective franchisee understand the respective roles of the franchisor and franchisee?

This is an overlooked aspect of the selection process. Franchisors and franchisees perform different roles in a successful franchise system. Many prospective franchisees do not know, appreciate, and most importantly, accept these differences.

Franchisees’ primary roles are to execute at a high level the franchisor’s system. From time to time, there is a place for franchisors to tap into their franchisees’ experience and obtain the franchisees’ input to help improve the system. Lessons from the trenches can always be learned. On a day-to-day basis, however, it is the franchisee’s responsibility to trust in and execute the system it chose to join to the best of its ability and to work cooperatively with the franchisor in that regard. To that end, lawyers and business advisors who work for prospective franchisees to provide professional advice in the course of the prospect making the decision to invest in a franchise should be providing their clients with this understanding and helping them to assess whether the role of a franchisee is something they are willing and well-suited to perform. Rarely, however, is this done.  Because many restaurant franchise systems provide little room for franchisees to be “entrepreneurial”, it is critical that a franchisor be able to assess accurately whether a prospective franchisee is better suited to own or operate its own business rather than to own and operate a franchised business.

Selecting the wrong franchisee can be seriously detrimental to a franchise system.  Poor franchisees take up a disproportionate amount of management time. They are more likely to try to get out of their agreements or to advance claims against their franchisor. In provinces, like Ontario, where there are franchise disclosure laws, the identity and contact number for each franchisee is listed in the disclosure document. Given this, if other prospects decide to call existing franchisees during the sale process to learn more about the system, they may well get in touch with a poor performing franchisee who might be inclined to speak ill of the franchisor and the brand. Poor franchisees will also generate negative online reviews which have consequences for the entire system. In addition, when an otherwise good location is operated by a poor franchisee, this can lead to the permanent poor performance of the location even when it is subsequently taken over by a new franchisee.

It is hoped that from this discussion, franchisors will look past a prospective franchisee’s mere ability to purchase a unit and do the work necessary to determine if the prospect is a good candidate to be a key piece in the short, medium and long-term success of the franchise system.

Allan Dick, Sotos LLP

At Sotos LLP, we assist restauranteurs in determining whether to franchise their systems and provide aspiring franchisors with the guidance necessary to establish their systems and lead them through their various stages of development and maturity.  We also assist franchisors in every aspect of their sales processes.The author can be reached at adjdick@sotos.ca or 416-805-8989.