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Buying a Franchise - Mr. Franchise (and Mrs. Franchise) Buy Their First Franchise

For the last twenty-eight years, as a franchise attorney, author, instructor and recognized franchise expert, I’ve helped firms enter and prosper in the franchise industry – each hoping to become the next “McDonalds” of their respective industries. Along the way, I've met and worked with an interesting group of entrepreneurial founders. From apparel to water treatment, the franchised concepts were also incredibly diverse. Some of them interested me to the point where I considered buying a franchise myself. In two or three cases, talks were initiated to discuss the possibility, but never moved forward. I just couldn’t find the precise set of criteria to satisfy my exacting requirements. After all, I had advised hundreds of prospective franchise buyers, and developed sophisticated radar for detecting the good, the bad and the ugly in franchise investments.

In May of 2002, my life changed dramatically as I took the plunge and became a first-time franchise owner. I'd just completed a franchise development project for a San Francisco Peninsula company poised to enter franchising. They operated a very successful home improvement business that specialized in a unique niche. Targeting homes constructed in the 1960’s to the 1980’s having old, flat, ugly interior doors, this company replaced all interior doors in a home with new, freshly-painted raised panel designer doors, locksets and hinges. Their advertising mantra was “Replacing America’s 1.16 Billion Interior Doors.”

After interviewing a couple interested franchise candidates who didn’t sign up, the company became concerned about selling its first franchise. Selling the first one is usually the most challenging task facing any new franchise company. There are no other franchise owners a prospective buyer can talk to about financial performance, training, ongoing support and other franchise relationship issues. Because of this void, selling the first one is difficult. After I was repeatedly asked when they could expect to sell their first franchise, my hand finally jumped up and I volunteered for the assignment. After discussing the venture with my wife Linh Luu-Murphy, who agreed to take a hiatus from her successful Napa Valley foot reflexology massage business to help me, our franchise agreement was signed May 22, 2002.

Let’s consider the major assumptions and factors I evaluated in making my buying a franchise investment decision, and see how things worked out.

INDUSTRY TREND
As stated in the previous franchise article, a major issue is finding a franchise in a cutting-edge industry that is doing well currently and is projected to do well in the future despite any economic slowdown. From my experience in evaluating hundreds of franchises, I observed the home-improvement industry was a stable segment. People are always looking for ways to improve the appearance and value of their homes.

Unlike other home improvement companies that concentrate on a single, high ticket improvement (a kitchen remodel, for example, that can cost $50,000 and more), for a couple thousand dollars ($2,000 to $5,000), a homeowner can give every room in their entire home a major face lift by replacing their old, flat doors with new raised panel, designer doors. In the aftermath of the 9-11 attacks, and the country’s high security anxiety, I felt more people than ever would be nesting at home. A home typically represents the most valuable asset in a family’s portfolio. If the homeowner can be educated and motivated to improve the appearance and value of this asset, by making a reasonable investment, sales are easy.

Major home improvement chains, like Home Depot, realized this and were aggressively promoting interior door replacement. However, they were not organized to meet the needs of the target market in a cost-effective manner. The franchise company had discovered and perfected the “do-it-right” approach for this market, and actually welcomed competitive bids from the Home Depot and other large home improvement chains. In my estimation, all of this bode well for home improvements in general, and this franchise company in particular.

TOTAL INITIAL FRANCHISE INVESTMENT
The franchise company estimated initial franchise investment between $127,00 and $180,000 in its Franchise Offering Circular. Turned out, we came in below the low end of the range. Including the $20,000 in franchise fees and the $78,000 I used against a home equity line of credit, our total investment was just under $100,000. Incredibly, this was enough to get the business operational AND reach the critical break-even point where cash flow paid all the bills. As discussed in the other franchise article, reaching the break-even point in many businesses can take a year, two years or more.

Getting operational happened fairly quickly. From the time my wife Linh and I signed the franchise agreement at the end of May, 2002, secured the real estate in mid-July, 2002, completed improvements then training in August, 2002, and began operations like a rocket in the first week of September, 2002, about four months elapsed. We hit the break-even point in mid-October, 2002, just six weeks after operations started, and began to accumulate an ever-increasing balance in the business savings account.

When we sold our franchise in September of 2003, our interior door replacement business was rocking and rolling. Residential home owners negotiated for position on our six to eight week waiting list to get their old, ugly, flat interior doors replaced with new raised-panel, designer interior doors and shinny lock sets. The new owner paid $236,000 for our franchise, and we received $235,000 after escrow fees. Subtracting our $100,000 investment left a tidy $135,000 profit. Not bad for operating the business exactly one year, and this didn’t include operating monthly income before the business was sold.

REAL BUSINESS
We operated a retail business with a storefront, as opposed to a "work out of your home" operation.

FRANCHISE MANAGEMENT EXPERTISE
The management team of the franchisor had no past achievement and experience in operating a franchise company. They had just started the franchise company and were learning on the fly. That was definitely a major risk. However, I’d given them detailed seminars on how to operate a franchise company and manage franchise relationships based on my twenty-plus years of franchise industry expertise, and had every reason to believe they’d follow my advice. And, because I was their very first franchise, I also believed they would do everything it took to make us a success. My goal was to develop the first franchise from scratch, build it up, then either develop other franchises for them, or sell out – depending on what happened in the franchise relationship. We opted to sell out.

NORMAL WORKING HOURS AND DAYS; SUFFICIENT INCOME LEVEL - FRANCHISE PROFITS AND FRANCHISE PROFITABILITY
The nature of this business was a normal five-day, forty-hour workweek. Our business hours were 9A to 5P, Monday through Friday initially. After talking with the owner of the second franchise in early 2003, I discovered and copied his idea of a forty-hour work week spread over four, instead of five days.

Although this meant our employees needed to work four ten-hour days, they were very receptive to the idea. By starting on Monday and getting all door orders for the week installed by Thursday, everyone had a three day weekend every week, not just on an occasional holiday. Of course, I didn’t have to work ten hours a day. I arrived by 10 a.m. and usually finished by 4 p.m. - Monday through Thursday. Supervising four employees, working 24 hours a week and having 3-day weekends off every week – try finding that in another franchise!

What about the financial picture? Let’s take June of 2003, our tenth month of operations when we started interviewing a number of interested buyers. Sales were $47,000 less expenses of $35,500, left an income that month of $11,500. Of course other months varied, and the business was still in the start-up development stage operating with only a single crew of four employees - but you get the idea. Using the results for June and multiplying by twelve for an annual result, we'd entered financial performance territory only enjoyed by a select group in the entire franchise industry.

MINIMUM NUMBER OF EMPLOYEES
Remember my key question here: can you operate the business with six or fewer employees? When we started business operations in September, 2002, we had two employees. A month later, we added another. When the business sold a year later, our crew consisted of one part-time and three full-time employees, plus me and my super-energetic wife, Linh Luu-Murphy.

LEASING AND LOCATION
Our interior door replacement business operated from a low rent commercial business zone, so high square foot rent and triple net leases were never a concern. The 7,200 square foot warehouse and retail showroom we settled on in San Carlos, CA, with rent starting at $0.65 per foot the first year, seemed almost too big (and expensive) initially. Cutting a rental check to the landlord for about $5,000 every month, by far our biggest initial operating expense, made my heart race while I thought "is this whole thing going to work and how long will it take to reach the break-even point?" But, as things turned out, our location was perfect, sales were never an issue, and we hit break-even just six weeks after operations started.

Due to the size of our facility and nature of the interior door replacement business, three crews were possible and bringing them online, one crew at a time, would double then ultimately triple sales. Also, because we were the first to enter the franchise system, we selected the very lucrative, exclusive territory that stretched from Palo Alto, CA all the way up to San Francisco, CA. Although we never expanded the business beyond a single crew, these "next steps" in the evolution of the business in such a prime territory were strong selling points. The new owner of our franchise ultimately took the next steps and with three crews enjoys weekly sales of $30K to $35K - which is over $1.5 million per year.

IMAGE AND LIFESTYLE
I didn’t need to flip burgers, scoop ice cream or clean restrooms. As a franchise co-owner, my principal job was creating and maintaining client relations. I placed ads designed by the franchise company, responded to customer phone calls, set up appointments, did estimates and sent out contracts. A lot of my working time was spent driving to customer’s homes, meeting with them over coffee, taking measurements of all their interior doors, going over the options and explaining our one week production cycle – picking up their old doors on a Monday and installing the new doors by Thursday.

Back at the office, I’d enter the estimate information in our computer and generate a contract proposal. Then I’d email or fax the contract to the customer and wait for their deposit. About 70% of the proposals turned into jobs. Customers called back, gave me their credit card billing information, faxed in the signed contract and I scheduled their production week. By the time we sold the business in September of 2003, residential homeowners negotiated for position on our six to eight week waiting list to get their interior doors replaced.

I also ordered the new doors, lock sets, hinges, paint and accessories. Finally, I paid the bills. It was a very efficient business, great cash flow, no billing and no waiting for payment. As I look back, I saw some very nice homes and met some very interesting people. The pickup, production, painting and installation process was handled directly by our employees under the supervision of our contractor, so I wasn’t involved in this aspect – although I did go out with our crew for about three months picking up and installing doors. That way, I understood the process firsthand, and this helped considerably in knowing how to bid jobs and cover contingencies in the contract.

TRUE FRANCHISE VALUE
My wife and I knew going in this franchise investment was not with an established ‘blue chip’ franchise company. After all, we’d purchased their very first franchise, becoming the ground breakers, the pioneers – willing to accept a much greater degree of risk than other franchise buyers. In return, we expected an adequate level of support from the franchise company. Virtually every new franchise company gives not only adequate, but extra support to its first franchise to compensate for that franchisee’s help in pioneering the new franchise system and the additional risk they’ve assumed. There’s also a self-interest in providing extra support – the future growth of the franchise network hinges on the success of the first franchise.

The ultimate test of franchise value came in November of 2002. I was en-route, driving our box van, jamb-packed with doors, power tools, lock sets, hinges, etc., headed to our biggest installation job yet, with our contractor, Scotty, who supervised our team and was our franchisor-approved manager. Everyone else was back at the shop, frantically cutting, sanding and painting the rest of the 100-plus doors scheduled for other jobs that week.

Knowing we had taken on the busiest week of our fledgling business, contractor Scotty complained all week about his wages, saying he wasn’t being paid enough. I’d explained, numerous times, our cash flow wouldn’t support any pay increases at the moment, that he’d only been working for us a little over two months, and his pay was exactly what he requested when we hired him. Scotty wasn't listening and his complaints continued during our drive along El Camino Real to the client’s house. We were stopped at a red light, waiting to make a turn when Scotty abruptly announced “I’m out of here, I quit.” Opening the passenger door, he jumped out, and walked quickly down the sidewalk of El Camino Real, leaving me stranded in a van that’s a bit larger than a UPS delivery truck. Scotty believed he was indispensable and his theatrics were nothing but a hardball, power play for money.

Looking back at all those freshly painted doors in the van, I knew there was no way one person could install them. I completed my turn, pulled over, and called our shop with my cell phone. Our main door cutter and best employee, Brian, confirmed what I already knew. He could leave and meet me for the install, but that would throw off our entire schedule for the week.

Then, I remembered something important. “That’s why I bought a franchise,” I thought to myself, "we’re in business for ourselves, but not by ourselves." Surely the franchise company would know exactly what to do, and help us, their very first franchise, deal with a problem that could cripple or kill our new business. They were just a short twenty-minute drive away, had multiple crews, etc. I called the founder, Mr. Interior Door himself.

The first thing Mike said, after I’d related my predicament was: “Do you think Scott will start a competing business?” I assured him that wasn’t even remotely possible. Starting a door business usually cost upwards of $350,000, requires a sizeable warehouse-showroom, power tools, delivery van and other things. Scotty, besides his tools, had no assets. He'd even moved into our warehouse from day one so he didn't have to pay rent and lived paycheck to paycheck.

I quickly redirected Mike to the purpose of my call and asked for his advice and H-E-L-P. Perhaps a couple of his door installers for the rest of the week, at my expense? Answer - no. What about one person for the rest of the day? Answer - no. What about one person for just a couple hours? Same answer - no. Incredibly, Mr. Interior Door said he couldn’t spare even a single person (including himself) for a couple hours to help us out.

So, no help - but what about advice? Mike's only advice: call all our customers, including the one I was en-route to, tell them we couldn't make it this week and re-schedule all jobs forward a week. Since we’d already booked other jobs over the next two weeks, this would have been a disaster, not only to our cash flow (payroll, rent and supplier bills were due that week) but also for our customers who'd already scheduled time off work to be at their homes on the scheduled dates.

That’s when I realized we were in business for ourselves . . . and by ourselves. After thinking things over in the silent van, I called the shop and told Brian to meet me at the customer's home for the installation. I figured at least we'd collect $4,000 doing this job and just have to see about the rest of the week. By the time Brian and I finished, the day was over. We arrived back at the shop at 4 p.m. – quitting time for our construction workers. Our door jobs for the next day were not even close to being finished. The crisis was finally upon us - should I follow Mike's advice, call all our customers and try to reschedule for the following week?

Linh and I decided on a different approach. We held a little meeting, explained the situation, and asked our employees if they’d be willing to work overtime, so our new business wouldn’t go out of business. We also fully realized our employee's concerns. They'd been working very hard that week to help us achieve our ambitious goal. Our team leader, Scotty, was history, and they all had families and responsibilities at home. Under normal circumstances we'd be up the proverbial creek without a paddle.

LINH LUU'S MANAGEMENT STYLE TO THE RESCUE
Fortunately, my wife’s management style was about to pay off. Born and raised in Vietnam, and used to working in a number of family-owned Asian businesses, Linh convinced me from the very beginning to treat our employees in Asian tradition, like members of our family. It was a very extended version of theory "Y" management style I'd studied in my graduate business classes. Everyday, we bought lunch for all employees and ate together, discussing what was new in their lives as well as exchanging door stories. We also provided soft drinks, coffee and snacks throughout the day at the shop. On birthdays, we’d take the person out to a movie of their choice and dinner afterwards.

Luckily, we didn’t have that many employees, but every month saw an ever-increasing total for these benefits on our profit and loss statement. I questioned Linh about it, reminding her Mr. Interior Door only provided employee meals once every couple months for a special occasion. Linh always had the same reply – “don’t worry, it’s the right thing to do and if we ever need them, they’ll be there for us.” As part of her management style, Linh also accompanied our crew on door installation days and hung doors right along side them. It was amazing to see this little Asian-American woman carry solid core doors that weighed as much as she did into the customer's home, and install them right with our team - a definite morale booster. Linh told our crew "This boss likes to get involved."

Linh’s management style kept our business in business and on track that November. All employees immediately agreed to work overtime. I ordered pizzas for everyone for dinner and they worked from 5 p.m. until 1 a.m. the next morning. This dedication repeated itself over the next two days, which is nothing short of incredible, given they all had to report back to work at 7 a.m. each morning. We completed all jobs scheduled for that week, collected our money and all customers were very satisfied. By the next week, the business was on track, humming along, and strengthened by overcoming the adversity.

SUMMARY
Looking back, we happened to be in the right place at the right time, and were willing to take a calculated risk. We didn’t rush in, took a lot of time evaluating many factors, and kept emotions out of the franchise investment decision - thus avoiding the three mistakes made by most franchise buyers.

It was definitely an effort getting the business established, finding the right location, the right workers, and navigating a new business on our own. But the challenges were a learning experience, and overcoming them was very rewarding. Although I’ve advised hundreds of individuals and firms about the in’s and out’s of franchising, the insights gained and lessons learned in operating my own franchise and interacting with the franchise company retooled my knowledge of franchise relationships.

© 2003-2008, Kevin B. Murphy, B.S., M.B.A., J.D. - all rights reserved

For more information, visit the Franchise Foundations website

About the Author

Known in the industry as Mr. Franchise, Mr. Murphy is an internationally-known franchise expert, MBA franchise attorney, author, and instructor. He holds degrees in Business Administration (B.S.B.A.) and Law (J.D.) from the University of San Francisco and a Master's degree in Business Administration (M.B.A.) from San Francisco State University.

For the past twenty-eight years he has specialized exclusively in the franchise industry as a San Francisco franchise attorney and owned a very successful franchise in the home improvement field. He has written over 30 publications, including four books on franchising and one book on trade secrets.

Mr. Franchise instructs franchise company personnel in best franchise practices and teaches franchise, licensing and intellectual property courses to attorneys. He has drafted, reviewed and negotiated over 500 franchise disclosure documents.

Mr. Franchise is a franchise attorney and Director of Operations for Franchise Foundations a San Francisco-based professional law corporation.

How to calculate NPV breakeven point?

The question

cost is at 12,000,000

sales is at 7,500,000 less 5,500,000 annual costs, net cash flows are at 2,000,000 per year

assuming the cash flows are after tax, and discount rate is compounded on a per annum basis

simply multiply 2 million on the NPV per year for the next 12 years, add them up and you will get 12,289,134.21

NPV of compunded cashflow after 12 years is actually 289,134.21

NPV breakeven point is at less than 12yrs but more than 11 years.

actually on the 12th year you would only need about 1,250,000 net cash flow to break even

if this is not clear send me a ym, ill send you the excel file

id dangerously_inluv

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