How Start-up Franchisors Fail

More companies than ever are going the franchise route -- and learning the hard way that it is not always paved with gold.

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Franchising has long been a popular growth strategy, especially with small companies short of the capital required to finance their own expansion. Money aside, a well-run franchise program also offers the advantages of an efficient distribution network, with fewer levels of management than a centralized company, and it relies on a work force of business owners who have a built-in incentive to succeed. With the right kind of support, they can help a business to grow at a breath-taking pace.

For all these reasons, many more firms are trying to expand via the franchise route. What they are finding is that it can be a treacherous journey, particularly in the early stages, thanks to changes in the franchise-business landscape.

For one thing, it's increasingly expensive to launch a franchise program, in part because of government regulations that force franchisors to retain high-priced consultants and lawyers for guidance during the start-up phase. Then there's the problem of finding qualified franchisees with the capital and expertise to run a business. Even if you get your franchise program up and running, there are no guarantees of success. While statistics on franchisor failure are sketchy, experts agree that the number is growing. Some franchisors fall victim to the increasing competition with deep-pocketed big companies, which have been moving aggressively into the franchise business. If they don't sink the start-up, internal disputes may do it in. Nothing will destroy a franchisor faster than lawsuits by franchisees, which are more common now than ever before.

While the problems vary from case to case, most of them can be traced back to the franchisor's failure to provide adequate support. A successful franchise operation requires, above all, a broad-based support system for franchisees, including training, sales promotion, and computer systems. Without it, the franchise is doomed. Franchisees will soon start to flounder. Eventually, they will fail, or break away, or go to court, or all three.

In order to provide that kind of support, you need more than a good idea for a business, something that many would-be franchisors fail to realize. "It's surprising how quickly someone who's worked hard to build a company will go into franchising," says Lewis Rudnick, a Chicago franchise attorney. "What many people don't understand is that franchising changes the basic nature of a business -- how you spend your time, the control you have." Unless you're prepared to treat franchisees as partners in a joint enterprise, franchising may be a big mistake.

It may also be a mistake if your business is not ready to be franchised. Experienced franchise experts use a checklist to determine a concept's readiness. First, a franchise must be a well-tested business with no major unsolved operating problems. Second, a franchisor should have sufficient financial resources for funding beyond the start-up stage. Third comes management depth. But perhaps most important is the economic viability of the overall plan, the business's potential to provide a sufficient return to both franchisor and franchisee. Too often, would-be franchisors look at only one side of the equation, viewing franchisees as a captive market for overpriced products and services. That attitude invites disaster. Unless both parties stand to benefit, neither will succeed.

It is essential to get sound advice at this preliminary stage of the process. A competent specialist will tell you if your concept or company is not ready for franchising; an incompetent one won't. Unfortunately, there are many of the latter around these days. The franchise boom has created a growth industry of franchise consultants. They are not accredited, monitored by government agencies, or held to a professional code of ethics. As a result, their work and their qualifications vary widely, as do their fees.

Consultants offer services ranging from simple marketing advice to a complete set of the legal documents, selling brochures, and operations manuals needed to launch a franchise. Some claim to be able to provide the full menu for as little as $20,000. Others charge as much as $250,000 for similar fare. The only way to evaluate the different offerings is to ask the consultants for names of previous clients and then do some investigating.

The same holds true for franchise attorneys. Lawyers have assumed a broader role since 1979, when the Federal Trade Commission ruled that franchisors must produce an offering circular with a financial history and offer information for prospective franchisees. You probably shouldn't use your regular attorney to prepare the necessary documents: franchise law is a hybrid specialty, involving trademarks, contracts, and registration in 14 states. As convenient as it may be to use a lawyer who understands your business, it's critical to have one who knows the nuances of franchise law. Incomplete state registration papers can delay the franchise sales process. Even more dangerous is a flawed franchise agreement, which may not be discovered until conflicts erupt with franchisees.

As with consultants, however, you can't judge a franchise attorney by his fees. One experienced franchise lawyer in Phoenix charges $20,000 to prepare a franchise offering circular and a franchise agreement. A Washington, D.C., law firm does the same work for $80,000. The burden is on the franchisor to find out what the fees cover.

Probably the best people to turn to for referrals are experienced and successful franchisors in your area. You would, in fact, be wise to get them involved as investors or board members, too. When Tom Reichman bought Seattle-based Scandia Down Inc. in 1980, he convinced Frank Carney, the founder of Pizza Hut Inc., to invest in the company and serve on its board. Reichman now meets quarterly with Carney and other board members, who also have experience in franchising. "They are my best source of information," says Reichman.

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