Franchises Among Top Seven Overrated Investments

Posted by: Nick Leiber on September 04, 2009

This is a post by guest blogger Don Sniegowski, the founding editor of the daily franchise news site BlueMauMau.

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Fall is when many franchising firms crank up the volume to get the attention of prospective franchise buyers. This time around, as the economy bottoms out, there are a lot of people out of work who are hungry for opportunities to start a business. Raining on the franchising parade are veteran small business editors Kelly Spors and Kevin Salwen, who are sounding the unusual warning that buying a franchise is one of the seven most overrated business investments. Here are a few crucial paragraphs to consider from their article:

The idea of being handed a proven business plan without the uncertainties and headaches that come with building a business from scratch is understandably alluring. But too many people don’t understand the risks associated with franchising and sign restrictive franchise agreements without thoroughly researching their franchisor and their contractual obligations, says SCORE’s [Ken] Yancey.

Some franchisors, for instance, allow franchisees to open stores too close together, over saturating the market. Or they simply require their franchisees pay so much in royalties and fees or other operational costs that it’s very difficult to be profitable. Beyond that, when a franchisee fails, a franchisor may make it extremely difficult and costly to get out of its contract.

It’s a myth that franchises are far more successful than independent businesses. A 1995 study by a researcher [Professor Tim Bates, urban economist] at Wayne State University found that 62% of franchises were open for business after four years, compared with 68% of independent businesses. And franchises were also found to be less profitable in those early years.”

The last paragraph is particularly of interest. Besides professor Timothy Bates’ study, the Small Business Administration, which oversees its government-backed loan program for small businesses, has also been warning the nation’s bankers and franchise buyers that its experiences show that generic franchises fail more often than independent small businesses. “Despite the popular view that franchisees are much more successful than non-franchisees, SBA’s experience with defaulted loans does not support this,” the Administration’s Office of Inspector General reported.

There are some good choices out there, but just because a business is a franchise doesn’t mean that you’re ahead of the game.

Don Sniegowski is the founder and editor of Blue MauMau, a daily business news site for franchise buyers and owner-operators. Previously, he led global field operations and franchise development for a quick-print franchising firm. Sniegowski also helped lead global publishing efforts for trade publisher Global Sources Media and led Asia-Pacific retail and operations for Franklin Covey.

Reader Comments

Arnie Duncan

September 4, 2009 12:28 PM

Don Sniegowski is a waste of air, time to close your mouth and try to produce something of value. His site is a complete joke and everything he says is a waste of time. I'd feel more educated reading the cartoons out of the paper than anything this clown has written.

Carol Cross

September 4, 2009 01:05 PM

It is good that those who review the business community and investments are starting to tell the truth about the "risk" of franchising for franchisees.

Congratulations to Kelly Spors and Kevin Salwen for their strong warning that "buying a franchise is one of the seven most overrated investments." It would be interesting to know the criteria for placement of a franchise purchase as the seventh most overrated investment.

Speaking about "seven" it is interesting to read on Donald Trump's Website that there are "Seven Disastrous Reasons Not to Buy a Franchise." The Donald has never been bashful about telling the truth, as he sees it!

Franchisees, unfortunately, very often invest with no idea of the great risk they are taking because of ineffective regulation that permits franchisors to sell their franchises without disclosing unit financial performance statistics, in their possession, to the new buyers.

Thanks to Don Siegnowski for the information about the additional warning in the form of the SBA notice to bankiers, lenders, and franchisees that "generic franchises fail more often than independent small businesses."

Domenick Celentano

September 5, 2009 10:56 AM

Franchises come in so many forms... the average person only knows a few of the banners, McDonalds being the most known.

My view of franchising is this... the very nature of it attracts a segment of those who are not true Entrepreneurs.

One of my courses in the Entrepreneurship Department at Fairleigh Dickinson is Mangement of Small Business.

I stress that an Entrepreneur takes an idea, determines if there is a true maket gap and determines if the idea is a true opportunity. There is then the issue of proof of concept, leading to proving the business can replicate the product or service consistently. Finally can the business scale.

Franchises for the most part address some or all of the above. Many however don't apply any rigor to the extent of the market gap.

They present a business in a box... and this appeals the the person who has the employee mentality. It appears that "someone else" has taken care of the details and I can step in like an employee and run this business.

Of course not all franchisees fall into this category...

Given the high levels of unemployment, it will be interesting to see if franchise interest increases as those unemployed explore this as one option to financial independence.

Carol Cross

September 5, 2009 01:18 PM

Poster above hits the nail on the head!

Franchisors do present the franchise in a "box" and prospective franchisees, in recessions, do look to self-employment, and have the money to invest in themselves. They generally pay the franchisor, who is the entrepreneur, an additional fee to be trained to operate the branded business and invest several hundred thousand dollars to build and start up a physical unit upon which to hang the brand name and provide gross sales for the franchisor and for themselves.

The trouble is that, under the law, the franchisor appears not to have to disclose to the buyer of the franchise the risk of what is in the box in terms of the historical financial performance of the units within the franchise system. The prospective franchise buyer thinks they are buying a "proven" business that will be profitable and provide a job as well as profits.

The box, then, when opened, turns out often to contain a surprise that makes them sick at heart when they lose their entire investments because they unknowingly have invested hundreds of thousands of dollars in unviable and unprofitable franchises with high failure rates of "founding" franchisees. These failed units are then churned in fire sales to second-generation franchisees and remain in the service of the entrepreneur franchisors

Franchises are sold as if there is very little risk and it is implied that franchises are much more successful than independent startups, which, of course, isn't true. Professor Scot Shane, in Small Business Trends, Statup Failure Rates, provided a graph that indicated that 50% of startups of small businesses fail by the end of the fifth year. (The malice of personally guaranteed but unbargained 10-year franchise agreements and binding leases that are personally guaranteed becomes obvious, doesn't it?)

The Entrepreneur Franchisor, under contract, has all of the rights of an employer, but none of the obligations or the expenses of being an employer --OR a small business owner.

As indicated by Don Sniegowski in this Post, the SBA is apparently surprised to discover that there are so many losers on the SBA Franchise Registry, eligible for 90% guaranteed loans, and are warning the banks.

Maybe this time and in this recession, things will be different and franchising won't grow disproportionately in our economy.

Leo

September 6, 2009 08:51 AM

I agree.

After falling into the franchise notion that a franchise is a safer investment, and listening to them - sell - to me, I lost, in a big way.

If I were going to do it again - I would do it a whole lot differently.

The franchise DOES give you some support, and for someone just starting out, it is helpful.

But, the franchisor - is definately out there to make a buck - at your expense.

I would strongly caution anyone going into business to think again, before buying into a franchise. Someone can do it on their own, without the franchise, with lower risk, and with less "conditions".

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About

What's it like to run your own company today? Entrepreneurs face multiple hurdles new and old, from raising capital and managing employees to keeping up with technology and competing in a global marketplace. In this blog, the Small Business channel's John Tozzi and Nick Leiber discuss the news, trends, and ideas that matter to small business owners. Follow them on Twitter @newentrepreneur.

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