Franchises – The Lure

Franchises are an attractive way for small business owners to have an immediate regional or national brand, take advantage of group purchasing power and utilize a business model that has worked for other small business owners. There are hundreds of franchising opportunities in the market today, all promising to give the owner the satisfaction of self employment. Franchise purchase prices run from $10,000 to over $150,000 plus facility construction and equipment costs and the franchise sales process is very creative.

The Reality

A franchisee purchases a franchise that gives them permission to use the brand, within strict limits, and gives them the privilege of paying the franchisor 2% to 7% of gross receipts in royalty fees for the life of the franchise.   In addition, some franchise agreements call for a periodic renewal fee that can be thousands of dollars. Many franchisees are under capitalized having raised the money to go into business by borrowing from relatives or a bank, or worse, cashing in their retirement accounts, and using their house for collaterol for all the debt. The royalty fee is often equial to or greater than the profit margin, particular in the early months and years of a business. That means the franchisor gets paid, but the franchisee often doesn’t.  In addition, the franchisee must usually sign a personal guarantee for business debts and accounts and any smart vendor will limit credit and immediately discontinue deliveries when a payment is late.

If the business fails, the franchisee loses the business and their house and is immediately responsible for all business debts, some of which may be to relatives. All of this often leads to a personal bankruptcy filing. It’s an ugly end to a rosey beginning. Franchises are designed to make money for the franchisor, not the franchisee, the person that took the risk. Your best defense is critical thinking and analysis of what you’re being told compared to what your research tells you.

What Works

Are there successful franchisees? Of course. Each of us does business with franchises everyday and many of those are successful.  It didn’t happen overnight, it’s not magic and there is no Easter bunny. The economics of franchises is complex. Except for the best known franchises, the successful franchisees often own several franchises or locations.  Location, how well the business is run, the business experience and expertise of the owner, the quality of products and many other factors spell success or failure of a franchise owner. Step 1 is always a business plan, often provided by the franchisor. How convenient! Step 2 is a critical review of the business plan with a heavy dose of skepticism. Do your  homework, make the right deal and you have a chance to make it.

What To Do

Read the franchise agreement carefully. It’s a binding agreement written to the franchisor’s advantage and it can be very expensive to get out of. Write your own business plan. Talk to current franchisees, not just the ones the franchisor wants you to talk to, but the ones he doesn’t mention. Business planning is accounting and art. Research, research, research. I can help you review a franchise plan so that you go in with your eyes wide open. You’ll know the economics and the weaknesses of the plan before you plunk down your money instead of afterward.