Many potential franchisees are lured into franchising opportunities by the often-cited statistic that nine out of 10 franchises succeed while nine out of 10 small businesses fail. That statistic comes from a study done by the Small Business Administration (SBA), according to the Boston Globe, but another study, also done by the SBA, shows that within 12 years, 75 percent of new franchise systems fail.
With such conflicting numbers, it can be difficult for investors interested in owning a business to determine whether purchasing a franchise and becoming a franchisee is a relatively secure investment or whether, since franchising is not in fact the risk-free investment opportunity it is sometimes made out to be, it would be better to start a business of their own.
What it might come down to is the personality of the individual investor. There is going to be risk involved no matter which method investors choose. But the benefit of purchasing a franchise is the proven system and the support offered by the franchisor.
“Franchising offers franchisees the advantage of starting up a new business quickly based on a proven trademark and formula of doing business, as opposed to having to build a new business and brand from scratch (often in the face of aggressive competition from franchise operators),” Dave Meholovitch wrote in an article for BusinessMart.
Franchisees are essentially saved the trouble of going through a potentially costly trial and error process when purchasing a franchise rather than starting their own business. Others have already found out what works and what doesn’t and have come up with a specific system for franchisees to follow.
“A well run franchise would offer a turnkey business: from site selection to lease negotiation, training, mentoring and ongoing support as well as statutory requirements and troubleshooting,” Meholovitch wrote.
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Another benefit of franchising is that, when conducting due diligence, investors “can get an excellent picture of what typical experience is for an owner of [a particular franchise]. They will be receiving names and phones numbers of anyone [who] is doing that kind of business,” Jeff Levy, a franchisee of The Entrepreneur’s Source, said. “If they know what [they] are looking for in terms of their own financial goals as an investor, they should be able to determine by speaking to other people whether those goals are attainable.”
If an investor has chosen to pursue franchising, they then have to consider whether they want to buy an existing franchise location or a new franchise location. Not surprisingly, there are pros and cons to this decision as well. Investors should take their financial goals into account when considering whether to purchase a new or existing franchise location.
“If the [investor] has a significant need for short term cash flow, then looking at existing resale franchises may be the best route for that. If they don’t have any immediate need for cash flow, and they want to build something, then starting [a franchise] from scratch might be the better route,” Levy said.
Time is money, as the saying goes, and franchisees who choose not to buy an existing franchise must take the time to hire and train employees in addition to other basics such as securing a location and purchasing the necessary inventory for the franchise.
“If you purchase an existing franchise, a lot of the unknowns are taken out,” Levy said. “There is a location and it is already there, and the employees are already there, the customers or clients already there. There is cash flow [and] local brand recognition….The down side is [investors] may not have has many choices of businesses if they buy resale, and they will be taking over somebody else’s business momentum and culture.”
For some investors, however, having to follow the path someone else has already forged would feel stifling. Such entrepreneurially-minded investors would probably be better off starting their own business and making their own rules. And, while such a choice would sacrifice the safety net offered by franchisors, the potential success of the small business is not limited by a franchisor, either.
“[Franchising] is not right for everybody, and those who would tell you that it is may be more concerned with their own welfare than yours,” Meholovitch wrote.
Franchisees are often investors who “have a lower risk tolerance,” Levy said. “In my world, the difference between [a franchisee and] a business owner will be how involved they want to be, but the true risk investor is probably not going to be looking at franchises.”
Opening a small business is typically more difficult than opening a franchise because of financing. Investors who purchase franchises can often obtain an SBA loan based on the past performance of other similar franchise locations. In addition, many franchisors offer some degree of financing to their franchisees.
Investors looking to fund a start-up, however, generally have to reach into their own pockets, ask their network of friends and family or seek venture capital or angel financing.
Investors should keep their personalities and passions in mind before deciding to pursue a franchise opportunity or make their own small business opportunity. Franchising is less risky than small business ownership thanks to its regulations and support, but there is an upper limit on the returns available. Not only do franchisees often have to pay royalties to franchisors, franchisees do not own the brand. Thus, if they want to expand, they have to buy more licenses and pay more money to the franchisor. For small business owners, though, it is possible that their business could become the next big thing and provide them with sky-high returns.
