Should you start a franchise?

By Franchise Business Master | Tuesday, May 08, 2018

Should You Open a Franchise Business 101? Thinking about opening a franchise business? You should read this article first.

What are the benefits of opening a franchise business versus creating your own business from scratch? Starting any business can be a very complex and time consuming endeavor. Not only do you have to figure out what product or service you want to sell but you also have to consider a daunting list of other questions, such as the following:
  • Legal concerns
  • Government regulations
  • Logistics for supplies
  • Financing options
  • Design of retail space
  • Construction
  • Finding a good location
  • Creating processes or systems
  • Training employees
  • and much, much more
This is only a small list of questions and issues most business people have to consider. Some of these will vary depending on your type of business, for instance retail vs service business. However, regardless of the type of business, if you're going it alone then you alone will have to figure out the answers to all these questions.

Enter the Franchise based business. With a franchise, someone else has figured out most or all of these questions and has a detailed process for helping their franchisees (possibly you) get the business started and then usually providing ongoing advice and support once you are open for business.
 

Typically, the franchise system will have other franchisees and will be able to show that they have a proven business model with a track record. Although, be aware that this does not mean it's a guaranteed profitable business. You can still lose money and possibly go out of business even with a previously proven business model.
In return for opening a business that's based on the hard work and creation of the Franchisor, you (the Franchisee) will in turn pay the Franchisor an up front Franchise Fee. This Franchise fee can usually anywhere from $5,000 to $50,000 depending on the franchise. You will also generally pay an ongoing Royalty Fee based on sales or some other unit of measurement of your business sales. As well there will often be an ongoing monthly advertising or marketing fee which will usually be a percentage of your sales.

Typically you might expect anywhere from 8% to 15% for monthly/annually Royalty and Marketing fees. You might think that's a lot of money, and it very would could be, but you have to remind yourself that the Franchisor has streamlined a lot of the work for you.

Also, they have likely proven that the business can be profitable (although, again, that doesn't mean it will be profitable). It's possible that the Franchisor has greatly reduced the risk of opening a business vs you trying to come up with a new venture all by yourself.

The common saying about a franchise business is that:  

"You're in business for yourself, but not by yourself"

  This can be a good thing and can help to set your mind at ease that you have people to help guide you along this new journey. However, you also have to remember that they will have rules, processes, procedures that you will have to follow exactly. If you're extremely independent this kind of "nose in your business" could rankle or irritate you over time. So, you should carefully consider if you have the temperament to run your business in conjunction with what amounts to a partner overlord.

There are pluses and minuses to being a franchisee - potentially less risk, with potentially more people involved in telling you how you can and can not run your business. Some business owners will find this to be comforting while others may find it to be annoying.

There are many great franchise concepts and Franchisors and of course there are some that may not be so great to work with. Do your homework and due diligence very thoroughly before you decide to sign on with any Franchisor. Make sure it is going to be a good long term fit since you very well may be running this business for decades to come.

We'll talk about the things you should consider when evaluating potential franchisors in an upcoming post. 

Should You Open a Franchise Business 101?

So, you're thinking about starting your own business? You're tired of working for other people. You do all the work and they make all the money. Maybe you think it's time for you to be the big boss and have other people working to make money and build wealth for you. Or maybe you just want to help create jobs in your community and take control of your own future. Regardless of the reasoning you have decided that you want to start a business. The question is should you start a franchise business? In a previous post "What is a Franchise Business?" we talked about some of the pluses and minuses of a Franchise Business along with what constitutes a Franchise. Why do you want to open a Franchise business? Ask yourself, "Why do I want to open a franchise business"? I ask this question to people a lot. The usual responses that I get tends to include the following:

  • They believe that the concept is a proven business model
  • Quite often they may be a fan of a particular brand and want to become part of that company
  • They think that a franchise provides a level of safety
  • They have no idea how to start a particular business on their own so their looking for the help and guidance of a franchise
  • Tired of their current career and want to be their own boss
These are all reasonable answers. Whenever I talk to a prospective franchisee I want to make sure they are not pursuing a franchise simply as a way to "make more money". Running a business, any business, requires a lot of time, dedication and sacrifice. You really have to be passionate about the business you're running or you will have a much higher chance of burning out before you get to the rewards of owning a business.


Why?
I will also bring a number of questions to the table for prospective franchisees. The first is always "Why?". Why do you want to do this? This will be a huge change of life from whatever you're doing now. So this question is extremely important.
  
The answer to this question is usually something along the line of wanting to be their own boss and building a secure future. Also, building wealth is a common answer. Sometimes people are just passionate about the brand/company. They just want to do that kind of work and they think it's something they would really enjoy.
In my opinion, the people that are passionate about the business they're considering getting into are the ones with the biggest chance for success. Find a business that you're completely obsessed with. You need to love it since you'll be spending so much of your life working in and on this business.


Do I have the money to open a franchise?
 One of the next questions I ask is if the person can afford to open the franchise. Quite often a prospective franchisee has no idea what the actual cost of opening the franchise business will be. Sometimes they see a franchise fee quoted on a companies web site (such as $50,000) and think that is the entire cost to open the business. The reality is that is only a small portion of the cost and the actual cost may well be hundreds of thousands of dollars or more.

Where will you get the money to start the business? Let's say you're opening a business that has a total cost to open of $500,000.

Most people don't have that kind of cash laying around to invest in a new business. So, you will most likely need a small business loan. The typical small business loan tends to be an SBA Loan which is backed to some degree by the U.S. Federal Government. Most lenders will require you to make an equity investment of 20-30% but some may require up to 50% depending on your background, assets and potential risk of the business. Also, the potential franchise has to be an approved franchise by the SBA
.
Let's say you have to come up with 20% of $500,000. That's $100,000 - do you have that available? Is it liquid and accessible to you? Some people will use equity from their house or take 401K loans. This carries a certain amount of risk. The best thing to do is speak with other franchisees of the brand if possible and find out how they financed the business. Then talk to the prospective lenders and find out what their requirements are. Try to do this prior to signing a franchise agreement. However, many Franchisors will ask for financial statements from you prior to offering you a franchise so that they can make sure you will actually be financially qualified for a loan to open the business. We'll talk more in depth about financing in another article but for now these are the basics.
  How safe is it to invest in a franchise?
As with most things in life there is absolutely no guarantee that you will be successful. Some franchise owners are wildly successful, some fail miserably and many do "ok" with their businesses. However, opening a franchise business instead of an independent business can provide some potential margin of safety. The business model has at least been vetted and proven to some degree. I would typically look for a company that has been around for a while rather than a brand new franchise concept. I would also look for a company that shows that they value their franchisees and understand the importance of successful franchisees to the ongoing success of the brand as whole.

It is important to at least consider what would happen to you, your family, your life, your employees if for some reason the business doesn't work out the way you expect. Do you have a "Plan B" or an exit strategy? As tough as it may be to start a franchise business it can be even tougher to get out of the business once you're open. If you try to sell the business the Franchisor will likely have the right to approve anyone that wants to buy your business. Also, you may not be able to sell the business for anything close to what you still owe on the loan.

I say this not to discourage you from pursuing your passion or dream, if that's what you have, but rather to make sure you enter the world of franchise business with your eyes wide open to all potential risks in hopes that you can better avoid those pit falls.
  How soon will I make a profit?
Prospective Franchisees almost invariably ask "How soon will I be able to expect a profit?". The vast majority of Franchisors will not tell you the answer to that question. They are regulated by the FTC (Federal Trade Commission) as to what kind of claims and statements they can make about your potential for making money. This is done for your protection so that shysters don't lure you in with the promise of making millions of dollars. It can be very frustrating for both the Franchisor and the prospective Franchisee since both would probably love to talk openly about the question of profitability.

Some Franchisors may make claims based on a certain segment of their Corporate locations or a particular group of Franchisees. Just be aware  of the specific claims they are making and if it seems to be based on average franchisee performance or a limited group of selected locations.

The FTC does make allowance for some performance claims but there are a number of hoops for Franchisors to jump through in order to do this and many simply choose not to make any claims of performance to their prospective franchisees.

The Franchisor will provide you with an FDD (Franchise Disclosure Document). This document is required by the FTC and has many required sections that the Franchisor has to provide. One of these areas is a list of existing franchisees. I would suggest you call as many franchisees in your area and outside of your area as possible. They may be willing to provide you with more specific performance numbers. Some will be of help, others may not but you'll likely glean a lot of good information from talking to a number of franchisees. We'll discuss the FDD in detail in another article.

 

"Everyone has a plan until they get punched in the face"  - Mike Tyson

There is no way to know or accurately forecast how soon you will make a profit? -.or if you will make a profit. The bank likely will ask you for 3 year Pro Forma projections. You will of course put together numbers that show you not making a profit for 3-6 months and then over time you forecast the upward trend of your business and suddenly, lo and behold, you are profitable. The problem with Pro Forma's and projections is that they have the success rate similar to Crystal Balls.Many independent businesses will expect to not make a profit for 3 years. While you might expect a Franchise business to turn a profit sooner than an independent there is certainly no way to know that will happen.
Can you live without an income for a while? 
I would generally advise new franchisees to plan on not making a profit for at least 6-12 months. There are a number of ways you can help set yourself up for a higher likelihood of success and profitability and we'll talk in more detail about this in another article.
But what happens if you don't actually make money right away. It's very likely that you will not make money immediately after opening your doors. If you're a two income household can you live without one an income for any period of time. A good test is to start living on one income for 6-12 months prior to starting your business - ideally prior to signing a franchise agreement. See if you can adjust your lifestyle to accommodate the reduced income. Maybe it won't be a stretch for you at all but you need to feel what it's like prior to being forced into that position.Reduce your monthly bills as much as possible. Consider paying off car loans or selling items that would reduce your monthly cash expenditures. The idea is to purposely sacrifice now so you can set yourself up for long term success. If you're making a really good income from your current job you should realize that you may not be making that same income again for a while - or possibly longer.Do you have other means of financial support? If your spouse works it's a good idea that he or she continues to work until at least until you know that the business is doing well and you're making a good profit. I would highly recommend that both partners do not quit their jobs to open a business together. This is a very risky strategy.If your partner doesn't work or you're single, where else can you turn to for financial support if you need it? Could you move back in with your parents for a while. Do you have a retirement plan you could tap into in case of emergency (don't do this unless you absolutely have no other choice)? Can you take a 401k loan or home equity loan? Do you have assets you can sell? Don't take on any new debt prior to opening your business.Don't buy new cars, houses, jewelry, etc. I've seen a number of newly minted franchisees go out and buy new cars. They're flush from the high of starting a new business - and they want to seem like successful business people. I've fallen prey to this myself and it was a very bad idea to take on that new debt while starting a brand new business.Lastly, consider how you will get your health care. If your spouse works can you be added to their plan? If they don't work can they take a part time job, such as at Starbucks, where they can get healthcare for family? Obtaining health care as a business owner can be quite expensive. Figure this out before you decide to start your business. If you have family with children this is incredibly important to consider and address early on.
 

What if you don't make a profit? 
Ok, you've opened your franchise business and you've been working it for a couple years now but you're still not making a profit - what do you do? If it's a franchise where you're working as the de facto manager and you're able to pay those wages to yourself then at least you're getting paid something. Although it's probably not commensurate with what you were making in your previous job. So, maybe you have discovered that you have basically bought yourself a job and it might even be a lower paying job.
The question is, do you enjoy this job? Is it fulfilling to you? If so, then maybe you're ok with the lower pay for now. However, you probably won't be satisfied with lower pay forever. We'll explore in another article how to turn around a struggling business. For now, what do we do when there is no profit.
Staying the Course 
You're already in the business and working it. If you enjoy it then it may be worth continuing in the business so long as it's not a huge negative cash flow and draining you of your savings or other income every month. If you're paying yourself any amount for managing the business then at least you're making something. One thing to consider is what your income looks like when the loan is finally paid off. It's likely you took a loan of 5, 7 or 10 years. If your loan is, let's say $5,000 a month, then when it's paid off you should get that $60,000 a year directly to your bottom line. Additionally, you will now OWN the business entirely and we would expect the business has some actual value if it was sold. Let's assume the business is worth $500,000 if sold on the market.
The calculation on whether it's worth staying in the business does not always depend on what you are making today but also what you expect to make in the future and what you expect the business to be worth in the future. However, do be realistic about these numbers.
Many people greatly over inflate what they think the value of their business is worth. Don't fool yourself. Find out exactly what similar types of business with a similar revenue stream actually sell for in your area.
Talk to the Franchisor
If you are struggling in your business then you should talk to the Franchisor. There are very few Franchisors that would not care if you are struggling to be a successful part of their brand. They most likely care a lot about your success and want to help you be successful. However, remember that this is your business and while they can give you guidance and some support, they are not there to run the business for you. That's your job.Make sure you're following all the proper processes and procedures. Take the advice of the franchisor and implement it. Many times the franchisees that struggle the most are the ones who do not adhere completely to the rules, processes, procedures of the franchise. So make sure you're at least running the business in the manner that they taught you.If you're running the business correctly and your out marketing your business and you continue to struggle you might ask your franchisor if they have any special programs to help struggling franchisees. They certainly are not obliged to do so but they may have a program to help with additional marketing for your location or perhaps a limited time of waiving your royalties. Do not expect or demand this since, again, they are not required to give up what's owed to them but they may be willing in certain circumstances. This kind of assistance usually tends to go to those who try to help themselves first. Also, even though you're struggling you should still be kind and fair to your franchisor. This is likely not their fault either. And you're less likely to get extra, above and beyond assistance if you're a jerk towards them.
Selling the Business 
We cover this more extensively in another article because it's a big topic on it's own, but for now let's briefly explore the prospect of selling your business. You've discovered that you're either not making a profit or not making as much money as you would like or perhaps you just don't enjoy the business or being a business owner. It's time to sell. Make sure you understand your Franchisor's requirements regarding selling your franchise business. They probably have the right to approve any purchaser as well as require training and possibly updates to your business. There may be other requirements as well. They may have right of first refusal. I would advise that you fully understand what they require prior to signing a franchise agreement.
Also, your landlord may have requirements on assigning the lease or subleasing, assuming you have a leased location. If you have a loan and a lender, will you be able to sell the business for enough money to pay off the loan? If not, what happens with the remainder of the loan? Will the lender let you continue making payments until it's paid off? Will they force you to sell assets to pay the remaining balance? Do not try to sell your business for less than you owe and think you can walk away from the balance. Talk to the lender. It's likely they will try to work something out with you. They don't really want your house or car, they just want their money back.
Look to other franchisees in your area as potential buyers. They're likely already qualified by your Franchisor and possibly even your lender. A lender is more likely to loan them money to buy your business or assume your loan since they already know how to run your type of business. Consider that if you have to find a buyer outside of the other existing franchisees, that it will likely take time for your buyer to qualify as a franchisee and go through any required training. If you're considering selling your business then you should start really thinking about it 6 months before you're completely desperate. You don't want to try and pull together selling your business in a short period of time such as a month or two. Plus if you're desperate then you're in no position to negotiate for the best deal.
Don't go down with the ship.
There's no pride or glory in doing so. If you see the business is heading for disaster and there's no way for you to turn it around, try to get out as soon as you can. Find another franchisee that is successful and is confident they can make a go of your business. Make them a deal, try to pay off as much of the loan as possible and get out before it sinks to the bottom with you on it.
Does this sound like I'm painting a dire picture? Well - I am - but I'm doing this so that you are fully aware and considering what could happen. I'm not saying it will happen, but it does happen sometimes to good people just like you. If you're going to be an entrepreneur and business owner then you have to understand the risk and realize that it can happen. This should help to motivate you to work your butt off in order to make sure it never happens to you.A franchise business can be a great type of business to start but a great deal of the success or failure of a franchise business, or any business, depends on you as the owner/operator. An established brand name with processes and procedures may help to bring you initial customers but it's up to you to service those customers in a way that keeps them coming back. Also, you can't rely on an established brand to bring you all your new customers. You will likely have to go out and market your business. Having a franchise alone is not enough to assure a successful business, it's up to you to build the business to its greatest potential.

As found in 
https://franchisebusinessmastery.com/2018/05/05/should-you-open-a-franchise-business-101/
Thank you, Franchise Business Master, for allowing us to share this with our readers. 
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