This article was last updated on October 14
A slumping economy and the prospect of prolonged unemployment has led many workers to consider going to business themselves and because of the perceived safety, brand name and established support structures, franchising is often a popular option. In fact rather than use their redundancy payouts to pay off a chunk of the mortgage and other debts or take a holiday people are buying into a franchise and becoming small-business owners. An added bonus is the prospect of being your own boss and the chance to escape the ups and downs on the corporate rat race.
The franchise industry has done an excellent job of selling its strengths. Particularly to those who have little or no experience in running a business. But aspiring franchise owners/investors need to be clear about the risks they are taking when they decide to buy into a system. Here are some of the main ones to watch for:
1. Read the contract and legal jargon. The contract you sign with the franchisor can be quite long and is most likely extremely one-sided – you are buying their business model/brand and they write the contract after all. If anything goes wrong on your side, it is your problem. And if anything goes wrong on their side, they will take their time fixing it. Sure, they want you to succeed – more royalties for them – but you have no leverage over them if the ship starts to sink. So before you jump into any franchise, make sure you read the fine print and it is worth hiring a good lawyer to ensure you have as much coverage (legal recourse) as possible should things get complicated.
2. The Franchisee guidebook is not a recipe to success. Many would be buyers assume that buying a franchise “Turn Key Operation” is going to compensate for their lack of industry experience and management skills. Well, like most things in life, this is a two-edged sword. The franchisor, in fact, will have policies and procedures that are documented to a shocking level of granularity, but these policies also leave very little room to maneuver when the money is NOT rolling in. Specifically, your fixed costs are in fact – fixed. And your variable costs are not as variable as you would think. For instance, with most franchises, you are required to purchase your products from the franchisor, one of its subsidiaries, or a preferred vendor. Therefore, you cannot go shopping around for the best price on the products you sell because the franchisor will not let you. Their argument is always the “quality factor”. How can they guarantee a consistent experience for all customers in all places if the franchisees are buying different products from different vendors? A reasonable assertion, but one that limits your ability to control one of your biggest costs.
Likewise, payroll is a variable cost, but most franchisors require that you have a minimum amount of staff on duty. A franchisee certainly does not want customers sitting in a long line because there is only one individual manning the store, but it is not very cost efficient if you have the same number of people on duty during busy periods as in slow periods (I am sure you have noticed this). Bottom line, “Turn Key” is great when you are making money but gives you very little flexibility when you need it the most, like when you need to cut costs.
For a real-life (and somewhat eye opening) franchisee experience, check out this three part series from a past franchisee
3. Don’t expect to get rich overnight. Most franchisees make between 30K and 70K per year and work long hours. Sure there are a few stores that produce six-figure incomes for the owner, but this is not the norm. After all, if a franchisee is making 200K at his store at the intersection of X and Y, then the franchise company will put another location a few miles away to take advantage of that volume. Franchisors would rather have two stores making 100K each, than one store making 200K. It gives them better control. They don’t like “powerful” franchisees; they are potential threats. The only way to make a lot of money with a franchise is to:
i) Buy a good franchise company – very few will be a runaway success;
ii) Get in early;
iii) Own multiple stores (four or more) in good locations
4. Location, Location, Location. A good business location is probably the most important decision when choosing the franchise – period. And the competition among all types of businesses is fierce for these coveted locations. Most franchisor’s perform traffic/volume analysis on any location before you are allowed to begin negotiating the lease. This is supposedly for your benefit, but in reality, they are just statistics and do not guarantee a profitable volume (in fact they make many assumptions, which you just read as carefully).
5. Franchises can and do fail (so have a Plan B): Despite your best intentions and unwavering effort your small business franchise may fail. The reason the advertised failure rate is so low for most franchisors is because they do not count distressed stores, which are sold at a loss. They only count stores that go completely out of business. So there are many stores that are sold to new owners for free (just take over the lease) and therefore are never reported as a failure. What all this means is that while buying a franchise may be a safer entry into small business than going it alone, it can fail to deliver a suitable return. So always have a Plan B if things go pear shaped. This includes keeping up your existing skills and professional networks, emergency cash reserves and an exit strategy/criteria so you don’t end up bankrupt.
On a final note, the best advice for anyone thinking of buying a franchise is to talk to some of the franchisees already in the system (without the franchisor around if possible) and find out what sort of challenges and business development support the franchisor offers. As with any business investment, there are no guarantees and it pays to be prepare as much as possible before taking the franchising plunge.