Why Do Franchise Owners Really Fail?

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How Do Franchises Go Bad?

Franchises start out with an initial cash requirement - initial fee, business set up costs and working capital. It is not unusual for this to be $ 500,000 to $ 1,000,000. The money comes from liquidating a lot of family assets plus SBA guaranteed loans or start up loans that are not SBA guaranteed.

Franchisees always have to personally guarantee the full performance of the agreement. In addition to the regular operating costs, there is the ongoing cost of being a franchisee, nominally in the disclosure materials around 10 % of gross sales.

Because the disclosure materials never tell the whole story, the cost of being a franchisee begins at around 15 % of gross sales.

Hidden franchise fees include the additional cost of having to buy from designated vendors who have no competition when selling to the franchisees and can charge more than competitive prices. Some parts of some franchise systems are franchised separately under add on licenses with additional royalties. Software is often licensed separately for additional charges per month.

The list is long. When I tell franchisee clients to go back and refigure their business plan pro formas using 15 % of gross sales as the true royalty and advertising cost and then come back and talk about whether the working capital number is adequate or whether they can come out at all, they are often in disbelief that people would do something like that to them.

As the franchise matures, imaginative franchisors find other things that can produce additional revenue streams from the systems at the cost of the franchisees. So called improvements, remodels, and miscellaneous fee add-ons drive the cost of being a franchisee to over 20 % of gross sales. Franchisees cannot survive.

The businesses cannot be sold to others in most instances. Avarice has bled the system dry. There are other nuances in the mix, but I think this shows the pattern of what is happening in scores of tough franchise systems today. Oddly enough, some of the profit that is removed by the franchisor resulted from franchisee cheating.

There is no difference in the honesty rate between franchisors and franchisees. Business information tracking capability has so improved over the last 35 years that cheating is harder, but it still happens. If this was about telling war stories I could use up a lot more space on the subject of shenanigans.

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3 Comments

Franchising has helped create millionaires!

And some of them are franchisees.

It's not about is franchising good or bad it's how well you choose and perform.

Richard: while I agree with the spirit of this post, there are several other costs and expenses that need to be considered in cash planning. Debt service (principal repayment and interest) franchisee overhead and maintenance CAPEX are real "beyond opening the doors" costs that must be quantified and funded.

Aside from this, most fundamentally, there is a ramp up of period of x years, where operating lossses are likely during the business building phase.

Joe: it is about chosing well but also finding where there has been a proper business foundation built by the franchisor.

@John writes - "it is about choosing well but also finding where there has been a proper business foundation built by the franchisor."

I agree.

You need evidence that the franchisor's franchise concept is worthy of your investment capital.

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About this Entry

This page contains a single entry by Richard Solomon published on January 8, 2014 12:32 PM.

Are You & Your Franchisees Violating the FTC Franchise Rule? was the previous entry in this blog.

Are You an Effective Team Leader? Especially with a Lousy Team? is the next entry in this blog.

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