This is the continuation of the Security Franchise Series. Please jump to the first post through the link below or continue on…
- What do I really want?
- What am I prepared to give?
- What am I really getting? coming soon
- Will I have real ownership? coming soon
- Do we share a common vision? coming soon
How much thinking have you put into what your life will look like after you sign the dotted line? Are you treating franchising like a new puppy? When you ‘new-puppy’ something, you think about the cute and the cuddly and all the good and fantastic times you’re going to have once you have that something, sometimes neglecting the cost of ownership. If you’re caught up in that, take some time to think about the responsibilities. How about not getting to leave the house for more than 3 hours at a time, spending a ton of money on dog food, grooming, required vaccinations, licensing, and visits to the vet? Did you consider those things? Think about cleaning up vomit and/or explosive diarrhea from the floor, carpets, and/or furniture every time a thunderstorm rolls in (yeah, I’m not bitter). Imagine losing valuable items (shoes, decorative items, and artwork) to puppy teething. Consider sitting out in the rain, sleet, and snow just waiting for the lil thing to learn where it’s appropriate to do its duty. What about liability once/if it’s big enough to be dangerous? Think about those things and allow them to temper the envisioned good times with a dose of reality and responsibility. Doing so doesn’t have to ruin the experience, and it’s not just fruitless negativity. Far from it, you should be realistic with your expectations. So what should you consider when it comes to buying a security franchise? What are you prepared to give?
What Are the Soft Costs?
Think about some of the intangible things that you’ll be giving. Think about the time required. What’s the real cost of that time? How much of your time is required as part of your franchise agreement? Is that articulated? Then think of the opportunity cost of your time spent. In other words, what opportunities might you be giving up to make a commitment to a new security franchise? What else might you do with that time for fun or profit? How much of that time could you otherwise spend with family or friends? To be sure, sacrifices have to be made in order to achieve success and the transformation required to build something lasting and worthwhile. Have you thought of how much you’ll need to sacrifice? How clear is the franchisor on that point? Have you tried to validate or verify any claims by the franchise salesperson?
What about your well-being? Are you prepared to give more of your mental capacity, emotional stability, and… availability. Security is a margins game that comes down to mere pennies. Between an initial fee to purchase your territory and the right to franchise, startup costs that are going to be required (regardless of whether you’re starting an independent business or a franchise), and an ongoing monthly royalty, you may be operating in the red for longer than expected. Are you prepared for that? Have you put contingency plans in place? What will that do to you? What will that do to your relationships; especially close ones? Are you prepared to starve before you can begin to recover and thrive?
Think clearly about what the business will require of you. How long until you’re able to afford your first employee? Running a successful private contract security business requires that you go where your customers need you to go when they need you to go there. Security coverage is something that’s generally in more demand on the nights and the weekends, times that most people like to relax and wind down (or get rowdy and drunk, hence the need for security). If you’re contemplating a security franchise, it’s likely that you already know that, but it’s worth mentioning and considering when talking about what you’re prepared to give. Even if you’re prepared to give your nights and weekends until you can hire others to make that sacrifice, will your friends, family, and extended network be negatively impacted by the kind of hours that you need to put in? Have you talked about that with them? Again, granted, sacrifices are required to get ahead. You may argue that if your friends, family, and network really support you, they’ll understand the sacrifice and what it will eventually mean down the road when you’re reaping the benefits. That’s great, just be sure you’re clear about what it will take and how much you’re really giving and getting there (more on what you’re getting in our next installment in this series). Is it worth it, or are their alternative approaches that can yield better outcomes for your hard work and sacrifice?
There’s nothing wrong with getting excited as you think about the fun, as you envision the profit, being your own boss, or whatever that prize may be, but think about what’s required to get there. Talk it over with your loved ones, and consider the impact it’s going to have if your investment goes sideways. After that exercise, if you still want to move forward, really consider the hard costs.
What Are the Hard Costs?
How much of your franchise profits can you bring to the bank? This is another way of asking how much you’re paying for the right to be in business as a security franchise. What’s the royalty? Any service fees? Are those services required as part of your agreement, or to purchase the franchise? Can you find more fixed ways of paying for the services offered without taking a percentage of your revenue? For example, you may be able to find a bookkeeping service that has a more fixed cost. Tying that to a percentage of the business you do could mean drastically overpaying for that service as your business and revenue grows. What’s the combined royalty and service percentage that you can expect to pay each month? Find that number, confirm it, and then look at the average profit margin for your industry, particularly in your territory. Will the territory you’re considering buck or generally follow industry trends? How much will the royalty and additional fees cut into your profits? In an industry that bases contract buying decisions on lowest price while simultaneously expecting greater value, will that cut make you less competitive than your independently owned competition?
Robert H. Perry & Associates, an international broker that represents sellers of contract security businesses, puts out a periodic white paper on the state of the physical contract security guard industry, and the trends that might affect the sale of a security company. The 2015 White Paper on the U.S. Contract Security Industry, puts the growth rate of the four top market leaders at 7%, and the overall industry growth rate at about 4%. These figures are similarly mirrored by a hardcopy publication titled The United States Security Industry: Size and Scope, Insights, Trends, and Data 2014-2017 by ASIS International and the Institute of Finance & Management (IOFM). Furthermore, as mentioned in the white paper, margins have been on a 5 year decline, and have recently bottomed out between 2014 and 2015 due to “competitive pressures and increased direct costs.” Two examples of direct costs are rising minimum wages, and costs associated with The Affordable Care Act. Profit margins are under pressure for nearly all contract security businesses. That should worry any prospective new franchisee already considering a 4%+ royalty and service fee while facing competitors in their market that aren’t similarly burdened. You should take a good hard look at the value of the security franchise royalty and service fees, and ask yourself if paying for them will provide enough value advantage to overcome the overhead advantage available to your competition.
How Else Do You Give Your Pound of Flesh?
What are your royalties and fees based on? When are they due? If they’re due on your billables instead of your receivables, will you have enough to pay them while waiting on cashflow? What will happen if you’re forced to make a decision between paying royalties and fees… or your payrolls? How will you respond? Be wary if your franchisor offers to finance the gap, and what that would mean to your continued profitability and success. Add that finance interest rate percentage to the royalty and fees you’re already paying. Ask yourself this, if your franchisor is willing to become essentially a bank to help float your debts to them, how many other franchisees are similarly dependent? What are the legal implications of such a business model? How sustainable is it?
How much more on top of your royalty, mandatory service fees, and interest owed will you be expected to pay for advertising? Many franchise models requires some contribution to marketing and advertising, but make no guarantees that such revenue will actually be used to benefit the franchises paying the fees. Definitely follow up with your franchise sales point of contact and clarify with them exactly what your fees are, and how they’ll be used to benefit you.
Speaking of territory… when you buy a franchise, you’re agreeing to buy a chunk of something in which you can operate. How much territory will you be buying? What is the criteria for the purchase? It’s typical to see the territory valued by the population density. This makes sense given that you’re opportunity for business will be somewhat proportionate to that population density. A larger market doesn’t necessarily reflect a larger opportunity. Even if it does, consider what the costs will be for travel within your territory. If you’re basing the majority of your business, or at least the profitability of your business, on a patrol model, think about how navigation within your territory will affect costs.
Think also about how your competition affects the market opportunity in your territory. What players will you be going up against, and is there any available information that can help you establish their bidding range? The size of the company you’re competing against will give some indication as to their margins. The larger the security company or conglomerate, the lower their margins can be due to their volume. Large players have more market advantages in terms of benefits, wages, recruiting, exposure, reach, and volume. All of this can determine the price at which they can profitably supply security services. Is their price point within range of yours? Can your security franchise boast the same, keeping in mind royalties, fees, and other costs?
Ok, so territory may not seem to be an issue starting out, maybe you’re super happy with the territory you’re contemplating, but what kind of trends and other developments might drive business in that territory (or out of it) down the road? Location, location, location is a thing for a reason, and that shouldn’t be discounted when considering buying a security franchise. You might argue that such a thing is true for any business, regardless of franchising. Ah, but therein lies the rub. Independent businesses are able to pick up and expand or move when the market dictates they should. Franchising may not be so easy. You may spend a lot more selling, buying, or moving territories right when you need the money the most. Consider this as you evaluate your territory.
There’s another side of location to consider, as well. When you buy a franchise, you’re buying that franchise’s business plan, branding, image, marketing, and many other strategic and tactical standards. How critical is compliance? If it’s a well-known, national brand, and the franchise cares about that brand, then they’ll act decisively to protect that from possibly lax, weak, or bad players (perceived or otherwise). That’s actually a good thing, if you think about it. The strength of the brand is one of the stronger benefits to franchising. It basically comes down to the entire system’s reputation. Research that reputation. If that reputation isn’t worth buying into as a customer, then it’s definitely not worth buying into as a franchise. But think about the flexibility you might require to really gain a toehold in the marketplace as you build your business. If you can’t respond to market demands because of the rigidity of your franchise agreement and their business plan, then your territory may not be as valuable as it could otherwise be. A good example of this is a business model that relies on one type of security offering in favor of another. Think dedicated security vs roving vehicle patrols vs executive protection vs event security. Some territories may rely more on one or the other or different mixes. Make sure there’s alignment there in your business plan.
Lastly, if a territory is not defined and protected, this should give you major cause for concern. You don’t want to do the hard work of tending fields that others in your own franchise network eventually come along and sow. Think about how much you could be giving if you’re providing security services in a territory where you have no explicit rights. Is your prospective franchisor encouraging this? Can you do some homework and ask around? You may not get far with the franchise corporate office, but ask what percentage of service is being provided in territory vs out of territory on average. If you can’t get a straight answer from the franchisor, this should be a worrying sign. Calling around to existing franchisees may help you paint a clearer picture. If that number is more than 10%, the franchisor better have a really good reason as to why, and they should be able to follow that up with how they’re protecting the interests of any franchisees operating out of their territory. If more than 50% of services are being conducted out-of-territory, run for the hills! The franchisor clearly doesn’t have your best interests in mind, and only wants to use such out-of-territory franchises as surrogates to sweeten the deal for more franchise territory sales. Think about the incentives there for the franchisor to sell that premium territory right out from under you for a nice markup. Oh, sure, they may give you first right of refusal, including the markup. But do you really want to pay a premium for market penetration that you already paid the price to attain? Can you afford it? If you’re already in hock on royalties or service fees owed, or are approaching the end of a renewal period, the franchisor may already know the answer to that question, or may leverage renewal to their benefit. It would take only the highest degree and standard of integrity to avoid capitalizing on such compelling and profitable encroachment on out-of-territory services. Would you want that to happen at your expense? Does the executive team at the franchise you’re considering have such a moral compass? What are they driven by? Ask what their guiding light really is, not just what their corporate mission statement says. You don’t have to wonder, and… you shouldn’t. You can ask around. Find franchisees that are no longer a part of the system, especially award-recipients or top performers of years past that have since left the system. Find out who they are and call them, ask them why they left. Ask them how they were treated.
Merchandise, Branding, & Supplies
This is another critical area to evaluate in terms of your costs. Who will be your suppliers and service providers? Who will be the vendors that help you run your security franchise? How much control do you have over those decisions? Are you required to go through “preferred” channels to get your uniforms, branding, technology, and other services? How much of a premium will you be paying through those channels? Are those channels being treated as a profit-center by your prospective franchisor? Is that franchisor receiving some sort of a volume discount, and are they passing on the savings to you? Most importantly, will mandatory participation with preferred providers and vendors eliminate your ability to shop around for a better deal?
Contract & Legal
Your contract terms will define your experience as a security franchise. Franchisors spend a ton of money on getting their contracts and disclosures put together, and with good reason. They want to protect themselves and mitigate risk while increasing the chance for profitability. The language of your contract will reflect this. How you negotiate the legal terms of your contract is a big deal, and one that you may not have as much control over as you’d like. Be prepared to give a lot, here, because franchisors often want all the leverage they can get. That’s in general terms and in the event of disputes (or avoiding them). Franchisors will want the legal advantage in most cases, and most of them get it. There are a number of things to look out for, here, that can make it difficult for you to achieve the success you envision and work for, or defend yourself or seek remedies if you’re wronged. An FDD, or franchise disclosure document should contain contract details. Read them, or have a trusted advisor help you translate the legalese if necessary. You’ll want to know what you’re getting yourself into. Be on the look out for the following:
- Territory definition: As mentioned above. This is the number one thing to get right when it comes to negotiating your security franchise contract.
- Restricted covenants: Pay particular attention to what you can and cannot do during and after your relationship with the franchise. Do your covenants require a specified amount of your time? It may be acceptable that they do, but you’ll want to know ahead of time so you can prepare to satisfy your obligations. Many people also don’t think about what will happen after they’re no longer a franchise, but there is very often a “cooling-off” period following the sale of a franchise or termination of a franchise agreement. If you spend half a decade or longer in the business, and you want to sell that business and go into a related field afterward, make sure you have the ability to do so. Imagine not being able to continue work in the industry that best suits your experience and skill set. Non-competition clauses that survive long past the end of your contract may make it difficult to parlay your franchise experience into further career advancement in the same or similar field. Do yourself and your family a favor and consider all the responsibilities and potential consequences of restricted covenants.
- Gag clauses: Publicity clauses are a great way for a franchisor to shut you up in the event you’re mistreated. Imagine signing away your rights to talk about being abused. That means that even if you wanted to warn a potential franchisee, you may be opening yourself up to legal scrutiny as a result. Be sure that you can talk about your legal arrangements between you and your franchisor. Question heavily if they want to shut you and others up. What are they hiding? Publicity clauses aren’t all bad, however, and sometimes they can be used to outline how your name and image as part of the system are used. Evaluate the publicity clause in your potential contract, and determine how much you’re willing to give. This clause isn’t to be confused with confidentiality terms. To be sure, some information such as “trade secrets” and other business-critical approaches and “formulas” should be protected as best possible from the prying eyes of your competition. No, the publicity clause specifically calls out portions of your contract that you’ll need permission from the franchisor to discuss with third-parties. Think about how this might be an inhibiting factor going forward.
- Arbitration: You may be signing away your legal rights by agreeing to arbitrate disputes. This may not be a show stopper, but it’s useful to know that arbitration can be binding. Look at the arbitration contract language. If you get a bum deal through that process, and it is binding, you waive your right to an appeal. That can have unexpected and troubling consequences that can cut both ways, both for and/or against you. Arbitration can also, in some circumstances, be more costly than a typical court battle, although situations where arbitration is binding are designed to reduce the cost and headache of ongoing appeals. Be sure to check the rules and see who pays and who doesn’t, and in what circumstances. Clarify as well whether arbitration is mandatory or voluntary. The franchisor may have the financial wherewithal to arbitrate at your expense. Even if you’re not footing the bill, can you afford to foot the hidden costs (time, attention, energy, focus) of mandatory arbitration? That financial and/or resource disparity favors the party with the deeper pockets. Also know that an arbitration award is not the same as judgement. An award won, judgement entered, and order rendered is not the same thing as money in the bank. Your franchisor may have the financial stamina to draw things out long past your ability to financially defend yourself. That may be exactly the position they want to be in. Do you?
- Governing Law: There will almost certainly be a clause that states which country and state law governs your contract. This may not immediately appear to be a problem, but consider mandatory arbitration that requires you to drop everything and fly to another state… or even another country. How will that affect your business, life, family, or finances? Who pays for travel expenses? Something to keep in mind as you consider the legal side of your contract.
These may belong above in “Contract & Legal,” but I wanted to call special attention to the terms of your contract that might affect your valuation once you decide to sell your franchise. It’s critically important to know these details going into a transaction, especially given that you’re probably not focusing on an exit right up front. You’re likely to be busy focusing on the challenges of the startup process, and may be choosing to make your stand around those contract details at the expense of terms governing your exit. An unscrupulous franchise could use this to their advantage. Don’t let them:
- Renewal rights: Your right to renew your franchise will govern how much control you have over your exit. It will also determine how much leverage the franchisor has over a sale of your franchise, and the potential value. You’ll ideally want the right to renew forever. If this isn’t clearly defined, or you’re getting hard pushback on this point… consider your alternatives. You don’t want to wake up after years of building a franchise to find that you have no control over the sale… or valuation… of your business.
- Right to acquire “units:” Franchise agreements will often come with some right on behalf of the franchisor to purchase your franchise at the end of your agreement. This isn’t unreasonable, but be sure to focus specifically on the terms of that sale. You’ll want a fair price. If the valuation is based on fair-market value, then you may get a fair shake. Be wary, however, of valuations determined by “depreciated value.” This clause can be used to put the franchisor in the so-called “catbird seat.” The franchisor may use this clause to their advantage and scoop up your business for a song, using the end of your agreement as leverage. Your franchise would then become a corporate owned unit, which can be resold for a premium to the highest bidder. You get stuck holding the bag. “Hey, you’ll be lucky to get what we give you outta the deal. Because if you don’t sell to me now, you’ll walk away with nothing by the end of the year.” It happens more than you might realize. Ignore this at your own peril. Another thing to consider here is if this clause exempts internal transactions. That is to say, does the franchisor have the right to acquire your franchise in the event you’re trying to sell it to another franchise owner?
- Franchisor right of first refusal: Franchisors will often argue for the right to purchase your franchise, should you put it up for sale. This is also a reasonable thing to expect, and it’s understandable why a franchisor would want to control to an extent the buying and purchasing of their franchises. But this can limit your ability in some cases to shop around for a best purchase price for your business. Third-parties will be less inclined to go through the work to make you an offer if they know the franchisor can just turn around and take advantage of the deal. Be careful the effect this can have on the process, and on your opportunity to find qualified buyers. As you look at negotiating your contract terms, really think about fighting the Right of First Refusal (ROFR) clause and aim to have it replaced with a Right of First Offer (ROFO). The critical distinction here is in who initiates things. With an ROFR, it will put the power in the hands of the franchisor if they want to take advantage of a qualified or bonafide offer from a third-party to buy your business. An ROFO, on the other hand, puts the power more in your hands. You can decide the timing of when you put your franchise up for sale. You’ll want to make sure there is language around this detailing how long your franchisor has to respond to your offer before you can begin approaching third-parties. Your franchisor will want some protections around the valuation or pricing of the offer. This is so you can’t navigate around them by simply setting the price at an unreasonable level and riding out the grace period. To that end, you should expect some qualifying language around the offer. This will similarly prevent you from asking for an unreasonable price, and then adjusting that price when positioning yourself to outside buyers. Fair-market value NOT depreciated value is the thing to aim for, here.
Guarantees & Performance/Compliance
Guarantees are additional contract terms that may be defined too broadly by the franchisor. These can involve franchise costs and fees, and the schedule for payment. They can also include business costs, liability terms, and other expenses that the franchisor may reasonably expect the franchisee to cover in the course of conducting business. But there are some guarantees that may not be so reasonable. Overly broad guarantees will seek to place business risks and damages on the shoulders of you, the franchise owner. Make sure this is equitable. It’s not unreasonable that the franchisor assume some of that risk as well. The best advice here is to have some good legal help when negotiating your terms. You don’t want to be stuck with the full weight of damages in the event of a corporate lawsuit.
Other considerations as you contemplate a franchise contract are related to ongoing performance, startup schedule, and compliance. The franchise as a whole will want to protect their brand and reputation, so expect terms that allow them to hold you accountable as a security franchise owner. Imagine if McDonalds suddenly let their franchises just decide to call all the branding, service, and pricing shots. There’s a reason you can expect and predict the kind of experience you’re going to have when you go to buy a Big Mac anywhere in the country. That reason is due to corporate governance, performance, and compliance.
While some of what you’re giving in exchange for the ability to own and operate a security franchise is expected and reasonable, be sure that you’re clear on what’s at stake. Consider the soft and hard costs of franchise ownership, and don’t skip out on negotiating the best deal for yourself when it comes time to sign the dotted line. You can be absolutely sure the franchisor has already negotiated their best deal when they approach you with a contract, so be prepared to level that playing field. Negotiation takes a lot of work, but there’s a reason to engage in it. You’ll want to make sure that you’re fully aware of what you’re walking into, and what you’re prepared to give.