Franchises offer a lot of benefits for entrepreneurs. The biggest benefit is the “system” that a franchise develops and then sells to franchisees. With a franchise, you get instant name and brand recognition, and the assistance of a team or professionals who have “been there, done that.”
But all that glitters is not gold in the world of big time franchises. Put on your thinking cap and ask yourself, why would a company wish to franchise its operations? Why would they give away their most closely guarded secrets, their unknown formulas for success, and their highly classified and confidential information? For money, of course.
Back several years ago I filled out all the necessary paperwork to get a Uniform Franchise Offering Circular from a well known sandwich franchise. After they crawled over my bank accounts, my credit history, my assets and liabilities, my grades from elementary school, and my sister’s cat’s first owner’s grandfather’s ex-football coach’s nephew twice removed, they told me everything I needed to know. Sort of. Most of what I learned, I figured out by talking to other franchisees, and what I learned made me say NO!
Why I didn’t buy a franchise
You have to pay to play
The up front franchise fees were horrendously large, and that was just for the “privilege” of using their name! Before you ever walk through a potential site, before you taste the first dollar, before you even open a business checking account, that fee has to be paid. It can be a large six figure number for the larger franchises and in many cases, it has to be paid every few years, just to maintain the “relationship.”
You have to pay each day
The royalty fee for the franchise I was considering was 7 percent, but I’ve seen royalty fees as high as 12 percent. I’m sure some are even larger and some are probably a bit smaller. This money is swept from your bank account each night. Sell 300 combo meals at 7 bucks each and the franchisor will debit your account that night $147. That might not sound like much compared to the $2,100 you grossed, but when your food costs were $1,260 and you paid three employee’s salaries of $240 plus the cost of utilities and the cost of advertising, and the cost of insurance, and the lease on your facility … you get the picture. You essentially have two new partners in your business and both have their hands out: Uncle Sam and the parent company.
You have to buy their stuff
As part of this franchise agreement, a franchisee had to buy 100 percent of all food items from the parent company. I can understand that. Franchises want consistency above all else and you can’t have some rogue franchisee selling Oscar Mayer bologna and passing it off as Black Forest Ham. But to demand that all napkins, straws, cups and paper products, the cash registers, the software to run them, tables, stools, benches, artwork, plastic silverware, the aluminum foil, uniforms, coffee filters, mustard packets, salt, pepper, and ANYTHING else used in the restaurant has to come from the parent company, well, it smells a little greedy to me, especially when their prices on those items are 10 – 25 percent higher than Costco.
Competition can be tough
Franchises claim to give franchisees an “exclusive” right to a certain geographical area, and many honor that agreement. Some do not but get around it legally. It’s in the franchisor’s best interest to get as many sales as possible in a given territory and it’s perfectly legal under many franchise contracts to amend the agreement so that the size of your geographical area effectively shrinks and competition moves in. If the parent company controls your prices, your profit is decreased while the franchisor’s is increased.
Financing means debt up to your ears
Many franchises don’t offer financing, but some do. If you need financing, I’d suggest obtaining it through a third party. Asking a franchisor to finance your entrepreneurial dreams is like asking the car dealer to finance your wheels. You DON’T get the best rate, even though the process seems easier than using a third party. Think about it, not only do they make money from you up front, and by the day, and from your purchases, but also from the interest you have to pay? Yikes, not me.
In many franchises, you cannot change anything. I understand that franchises don’t want some guy selling Harley-Davidson parts at a hamburger franchise, but in the long history of franchising, it was the franchisees that brought innovation to the table. That’s how McDonald’s came up with the Filet-O-Fish! Who knows the customers better than the guys that are nose to nose with them daily? Why is it that corporations refuse to listen? A system is great, but it shouldn’t result in slavery.
Beware of the real estate craze
Franchises generally determine where you will put your store. Though you can submit requests, they have the final say, and that can mean big bucks on the purchase or lease of land and buildings. Of course they want you to be successful, but many don’t recognize that there’s some balance to that! Sure I can put a store on an outparcel next to the shiny new mall, but I can’t sell enough sandwiches to cover my $30,000 per month lease!
Brand recognition cuts both ways
Imagine working night and day to build your business. Then one day, some crazy loon puts a cadaver finger in a chocolate vanilla swirl milkshake and promptly rushes to a lawyer … and to CNN. Suddenly there’s a lot of bad press and your business goes south as a result. Maybe the CEO of the parent company gets caught in some indiscretions with his 17 year old neighbor. Maybe the local church youth groups decide to boycott your store in protest. Brand recognition indeed does cut both ways.
Advertising don’ts and advertising dues
Some franchises won’t allow you to do any advertising unless you run it by them, their ad department, and their legal team first. The problem is that from the day you open you doors, you’ll be hit up for donations to schools, yearbooks, Little League, MADD, SADD, RADD, and Eagle Scout projects. Why do franchisors NOT want you advertising without their permission? Why, money of course! Many franchises demand that you contribute a percentage of your gross sales each month to the advertising pool, especially if the franchises advertises nationally. While this advertising certainly does instill brand awareness, for my money, nothing beats getting involved in the local community and helping out the people who will frequent your establishment.
The parent company has nothing to lose
What exactly DO they have to lose? You pay for the right to use their name. You pay them daily. You buy their products. You buy their services. You pay your lease, they don’t. You pay your employees, they don’t. You pay your insurance, they don’t. You pay YOUR salary, they don’t. You pay your utilities, they don’t. You pay for your FICA, medical insurance, building repairs and maintenance, office expenses, community organization dues, your accountant, your taxes, your depreciation expenses, your “lost” inventory, and all the other costs needed to effectively run the business. What do they pay? Nada. Who’s making the money? They are!
Maybe the best idea is to start your own sandwich shop, or chicken wing stand, or burger joint and sell franchises once you have it up and running. Trust me, people are doing it all the time.
While I’ve outlined a lot of the negatives I encountered, that doesn’t mean you shouldn’t do your own investigation into any franchise you’re interested in starting. Not all franchises are the same and if you have an interest, go over that UFOC with an extremely fine toothed comb, then have a lawyer look it over for any big negatives that might pop up down the road. No, not all franchises are bad, but not all of them have your best interests at heart either. Do your homework, get some professional guidance, and then do what you feel is best for you in your situation. For me, a franchise wasn’t it.
I guess it all boiled down to control. I didn’t want someone else telling me how I HAD to use my capital.
This article was included in the Carnival of Personal Finance at Sustainable Life Blog.