FRANCHISES

5 Reasons to Be Skeptical of Franchises

Franchising is a near-guaranteed way to start a successful small business, right? Wrong.
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Many entrepreneurs feel the siren call of a franchise. You buy into a brand, a proven operation, and have a greater chance of success, right? Not quite. Franchises can come with a list of potential problems that can depress profits, cause dissatisfaction, and drive owners out of business.

Beware the success claims.

The biggest reason to embrace a franchise is that you supposedly have a higher chance of success. Except that you don't. A study from 2007 found that franchise restaurants fail at about the same rate as independent restaurants within the first three years of operation. Another study of Small Business Administration default rates showed that franchises defaulted at slightly higher numbers than nonfranchise businesses, although that appears to be a best-case scenario: The data may have underreported the franchise status, so the difference could be more marked. A study from the early 1990s actually found independent young businesses more likely to survive and more profitable than franchises. According to the International Franchise Association, the oft-quoted high survival rate numbers are incorrect. They were the results of 1980s studies from the U.S. Department of Commerce that have questionable relevance today. So, no, you aren't necessarily going to see a higher rate of success.

The brand may not always benefit you.

That can be true. It can also be false. When something goes wrong at one franchise location, it can hurt everyone else who owns one. Look at the cases of food poisoning at Taco Bell. Or the fast-food worker strikes that often effectively target major brands like McDonald's through the franchise owners. Being associated with a visible name isn't a guarantee of warm and fuzzy feelings. On the other hand, a small or new franchiser's name might mean nothing to most people, leaving you to do the heavy marketing work.

Be wary of the operational numbers.

A growing number of franchises seem to include aggregate operational numbers across all their franchisees in the financial disclosure document, or FDD, that all states require. That is good, because it gives you some grasp on reality, though don't take it at face value. Look at where the franchises largely are. If the franchiser wants to expand operations into your area and there aren't many representative locations, then the figures might be of little use. One multi-unit franchisee in San Francisco I've spoken with said that the construction, wage, and real estate figures for his area are much higher than what most other franchisees deal with. It's another good reason to call a large sampling of the franchise owners, and recent former owners, who must be listed. As for the franchise operations that don't want to pass on the operations data, why don't they? Is there something to hide?

Sole sources of goods and equipment can be expensive.

There are franchisers that insist the franchisees buy all their goods, equipment, or stock from them. This is often a bad idea--Quiznos has faced lawsuits over the practice. Although some chains with imposed central buying do impose standards on the chain (go back to the bad brand reference) and can actually provide lower prices than local purchasing offers, there is always the danger that the temptation to create another revenue source from franchise owners becomes too great.

Some franchisers don't care about your success.

This is the biggest issue. Talk to enough former franchise owners and you'll run across those whose experiences of the central franchiser were less than positive. Perhaps there was too little guidance and assistance in vital areas like selecting the right real estate. Or maybe the franchiser was happy to sign up anyone who had the cash, even if someone had no experience in the industry and was likely to fail.

No one wants you to succeed as much as you do, and there is no such thing as guaranteed success. Only by being skeptical can you see if your business plans actually make sense to someone who is looking to preset you with an invoice.

Last updated: May 12, 2014

ERIK SHERMAN | Columnist

Erik Sherman's work has appeared in such publications as The Wall Street Journal, The New York Times Magazine, and Fortune. He also blogs for CBS MoneyWatch.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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