Buy A Franchise, But Read The Fine Print

2009 September 2

by Kyle

Last week, I wrote that buying a franchise is an oft-overlooked short-cut to becoming an entrepreneur (read How To Buy A Franchise for more on what to look for). Let’s face it, starting a small business is scary. When you buy a franchise, you are also buying a variety of advantages over starting an independent small business. Not surprisingly, these advantages show up in the success rate statistics: franchised businesses are, on the whole, significantly more successful and enjoy a longer average shelf-life than independent businesses. That’s not to say you can’t succeed by going it alone (the potential rewards are probably much higher), just that you might have to work harder and take on more risk.

That said, buying a franchise isn’t an easy path to entrepreneurial riches. Not all franchises opportunities are created equal (in fact, most aren’t all that great), and it’s easy to throw your time and money away. Some franchise agreements demand exorbitant licensing fees while others don’t provide much in the way of advice or support. So go ahead, buy a franchise, but don’t forget to read the fine print.

Buy A Franchise Going In With Your Eyes Open

Fact is, many if not most franchise opportunities simply aren’t worth it. For every Subway franchise out there are five sub-par franchise license agreements. A few of the gotchas include:

Poor Operational Support – A franchise agreement might give you the right to conduct business a certain way under a certain brand, but that doesn’t mean you’ll get any actual support. Some franchise contracts, such as Subway for example, give owner access to collective, centralized bargaining for supplies with top-notch, name-brand suppliers, giving these owners a huge advantage sourcing their products for the lowest possible price. Who do you think will be able to purchase sandwich items cheaper, the Subway operator or the small, independent sandwich shop? My bet is on Subway. The independent sandwich shop might have a superior product, but product quality is only one of many determinants of success. It certainly won’t guarantee it.
Poor Strategic Support – Good franchisers will give individual operators a geographic monopoly. The territory will be large enough to support a franchiser’s business but not so large as to leave untapped potential. It’s a delicate balancing act to be sure, but many franchisers do nothing to help owners in this regard. The worst will allow you to open far more branches than a given territory can support, leading to over-saturation and poor returns. A good franchise opportunity will assist you in deciding where and how many branches to open.
Franchises Are Less Profitable In The Early Years – It’s a fact of life that franchises tend to be less profitable in their early years as compared to surviving independent businesses. This is mostly due to licensing fees and upfront costs putting a squeeze on margins early on while the business is still small. On the other hand, franchising often offers a degree of business process automation that just isn’t possible for many kinds of independent businesses. Regardless, tighter margins are something you’ll have to cope with.
Excessive Fees – Unfortunately, many franchisers are more interested in squeezing owners with fees than helping them grow their businesses. Choose wisely, because the fees are something you’ll have to live with as long as you own your business. If you buy a franchise with excessive licensing fees, it could be difficult to ever turn much of a profit.

Large, Established Brands May Work Best

This is just a guess, but it seems likely that large, established franchise brands probably offer the best risk/reward potential. You probably won’t get rich running a Subway franchise (unless you are running multiple units), but you’re also less likely to go broke. People who like Subway, and there are plenty of those people, are just as likely to eat at your Subway than any other if it’s closer to where they live or work.

Additionally, it’s less likely large, nationally-recognized brands could get away with outright cheating their owners. A public lawsuit would be enough to cause serious long-term damage to a national brand’s bottom line. A small operator, on the other hand, would find it much easier to simply close shop and move on to something else, and there’s not much legal recourse you would have in that situation.