BY BILL BRADLEY | January 11, 2013
Have you weighed the benefits of buying a franchise vs. buying an independent business? If you’re unfortunate enough to have read a Department of Commerce study published in the mid 1980’s, you may be under the false impression that 94% of franchise businesses were open after 2 years and 93% after 3 years. This franchise survival statistic is flat out bogus. Do not be misled. Many franchises fail for a variety of reasons. Today’s post focuses on avoiding the mistakes that contribute to franchise failure.
Early Stage Financial Mistakes
Do not try and do this yourself. Once you’ve narrowed your choices and enter into the due diligence process, it is vital that you get the advice of legal and financial advisers who have experience in franchising. Failure to understand the legal obligations and the financial obligations can come back to haunt you.
If you don’t understand the financial obligations and the earnings claim statements, it is virtually impossible to determine the initial fees, operating costs and the amount of working capital you will need.
Leasehold Improvements
Many new franchise owners underestimate the cost of leasehold improvements. Before you sign on the dotted line, be abundantly clear about the build-out costs, inventory, security deposits, costs associated with employee training, grand opening expenses, and advertising. Add an additional 10% to your estimates.
Working Capital
Estimating the amount of working capital you will need is very hard to do. You need to include the monies you will need to support your family in this figure as well. You cannot assume revenues in the market sector will remain stable. The recession is a testament to the possibility of an unstable economy.
Devote a great deal of time talking to current franchisees. Go overboard with this. Talk to as many franchisees as possible to learn their break-even point in months. Is their demographic similar to what yours would be? Are there seasonal factors to consider? What kind of financial cushion did they allocate both personal and business?
Be very cautious here. You need to expect the worst and set aside at least one year of cash flow. If business in the sector is trending lower year to year per the franchisees you talked with, set aside two years of cash flow.
Dangers of Overleveraging
Borrowing money is expensive. More important, borrowing too much money places your business at risk from the very beginning. If you borrow 90% of the funds to buy your franchise business and things don’t go well you are in trouble. If you didn’t set aside enough working capital and you’re unable to borrow any more money, you’re in serious trouble. Bottom line, if you can’t put at least 30% and more favorably 50% equity into your business, you may want to rethink your investment.
Know your Expectations
If you buy a franchise you are personally guaranteeing any obligations you may have. If you have a 10-year lease, you are personally obligated to make the payments or pay the full amount of the lease. If you take out a bank loan it is your responsibility to pay it back. If you get an SBA loan, you can be assured your real estate will be securing the SBA loan. If you default on the SBA loan, they will likely attach your real estate.
Exit Strategy
When you buy a franchise, you are making a 10 to 20 year commitment to build the business. The last thing you want to do is to think you can build the business in 5 years and turn around and sell it for a profit. Franchises are not that liquid. You need to expect to be in the business for the full term.
Finding the Right Franchise for You
Remember you’re committing to this franchise business for 10 to 20 years. You better be sure it’s a good fit for you. If you’re not comfortable in sales, you should not entertain buying a sales oriented business. If you love being outside and networking with the public, you don’t want to buy a retail franchise. Waiting for people to come to you will drive you crazy. If you don’t have patience being around children, steer clear of a children’s franchise. Find a good match for your personality as well as your skill sets.
Management Skills
If there is one skill set that is a requirement when owning a franchise, its managing people. The best entrepreneurs manage people well. For the most part this is a learned skill. The more you do it, the better you get. You’ll need to be good at delegating responsibilities. You’ll need to do it in a fashion that doesn’t offend your employees. You’ll need to build solid working relationships. You’ll need to hire and fire people. You’ll need to be able to recognize employees that will fit into your business and get along with other employees. There is no short-cut here. If you’re not a natural leader and you struggle with managing people, you will not succeed as a franchisee.
Do You Have the Ability to Follow the Franchise System?
The point to buying a franchise is that they have a proven system. The system has been tried and tested and adjusted over time until it becomes proven. They’ve made mistakes along the way but overcome them. They’ve learned to be efficient the hard way. So, buy a franchise with a proven system and follow it. There are a whole lot of other variables that could come into play that will have an impact on your success. Nevertheless, if you don’t follow the prototype you bought into, you cannot be successful. What would be the point?
Know your expectations. What will the franchisor do for you and what is expected of you to make this relationship a success? Avoid the mistakes we’ve outlined above and you’ll have a better chance at success in franchising.
