Is franchising for you?

Posted by on September 1, 2009 in entrepreneur

Franchising is often seen as a good balance between being an employee and being self-employed. Ideally, a franchise provides its franchisees a turn key operation for a branded business while providing more freedom than typical employment. However, a 1995 study by Wayne State University found that 62% of franchises were operating after 4 years, compared to 68% of independent businesses. Furthermore, the same study found that independent businesses were more profitable during this period of time.

How do we reconcile what should be a business model designed to mitigate against business failure with a relatively lower success rate?

I used to represent franchisee and franchisor alike as a lawyer. It would be easy to say that the business model is fundamentally flawed but it is not. Like all things, it is how it is executed and there are always a few things to consider if you are thinking of buying a franchise.

You bought yourself a job

At the very worst, entering into a franchise agreement is like buying yourself a job. Franchises are about branding and operational consistency. You must follow the operational manual to the letter and franchises are constantly audited. In many respects, you continue to have a boss. This can be both a good and bad thing. For those who want to work hard but have a hard time maintaining discipline, a franchise may be an ideal structure since you are mandated to do certain things at certain times week after week, month after month, year after year.

In this sense, buying yourself a job is not necessarily a bad thing since a successful franchise owner can make well in excess of six figures annually if you like hard work and don’t mind following instructions. However…

The flip side of the equation, and a constant sore point for franchisors, is some franchisees do not like following instructions and like to experiment and get off play-book. For some of the more established and successful franchises, there is a reason why there is an operational manual. The process works. Getting off play-book means you are moving from something that works to something that may not and the negative consequences which may follow. In this sense, you have bought yourself a job where you never listen to the boss and you know what happens when you don’t listen to the boss…

Franchises can be drains on cash flow

Most established franchises require a rather large infusion of capital. To maintain priorities in the event of default, most franchisees also cannot obtain bank financing to purchase or operate the franchise. The result is that some franchises can make a franchisee short of working capital since most of it is used to obtain the franchise. Meanwhile, franchise license and marketing fees (in the aggregate, being in the range of 5-8% of gross revenue) eats up profit. The result can be the franchise is constantly in a cash flow squeeze and tend not to have much cushion if things are slow.

To avoid this issue, some franchises, especially service based franchises (personal care, baby-salsa, day-care), tend to avoid stacking the franchisee with upfront fees. The morale of the story is always keep a lot of operating capital on hand (good advice for all entrepreneurs) and research carefully.

Some franchises are simply bad

Unfortunately, some franchises are simply bad for their owners and it has nothing to do with the goods or services being sold. Franchises can simply not be marketing aggressively, not supporting the franchise owners, squeezing too many franchises in an area or simply not providing value for the fees paid.

The key here is to conduct careful due diligence. Typically, I use to advise my clients to call as many other franchisees as possible for reference checks, calling franchisees who have left (certain jurisdictions mandate by law listing who have left and why), touring headquarters to get a sense of staff (at some point, a franchise with many owners and few staff means bad support), visiting franchise chat forums to assess reputation (certain individuals are known to set up bad franchises, disappear for a few years and then set up another franchise), become a customer if you already have not and ask as many questions as you can before you hand over your money.

The key, as usual, is to conduct the proper due diligence before investing your hard earned dollars. Good luck.

4 Comments on Is franchising for you?

By Sara on September 1, 2009 at 1:27 pm

Franchising can be good and bad. It all depends on which one you chose and if it is the right choice for you.

Franchising is like buying into your own job. If you are creative and hate having to follow rules though, it isn’t for you.

If you like having a parent figure over you deciding how things are done, then you would like being involved with a franchise.

By Mr. Cheap on September 1, 2009 at 4:17 pm

Great post! I was looking into buying a Subway franchise years ago, but the idea of going in every day to slap together subs got me down…

By admin on September 2, 2009 at 9:46 am

Mr. Cheap- There are many allegations that Subway does not treat their franchisees.

By This and That: Home Renovation Tax Credit and more… | Canadian Capitalist on September 3, 2009 at 11:55 pm

[...] Thicken My Wallet has some tips for investors thinking of buying a franchise. [...]

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