Their homes are worth less than the equity they have in them, so they can’t borrow against their homes. They can’t sell their homes in this market, because there are no buyers. This makes the possibility of relocating very difficult, even if they were willing to move anywhere a position became available. The same is true of people caught in industries that are not expected to return to hiring modes for the foreseeable future, e.g., real estate, mortgage, and banking. One organization reported that changing industries reduced the success rate of a job search to 15%.
Under the above circumstances, many people are being encouraged to go into business for themselves, in the location of their choice. Some of them are using what is left of their retirement money to fund the business. If you are currently considering purchasing a franchise, you are probably already aware of the benefits:
• Being your own boss: never being downsized again
• Having the support of the franchisor
• A proven business model
• An owners’ network to tap into for advice
• Economies of scale in purchasing supplies and services
• Negotiating power of a large organization
• Name or brand recognition
• Training or instruction in managing the business
There are many other benefits, of course, that are generally well covered by the franchisors. The pitfalls, however, are usually not addressed in depth, if at all. Here are just some of the questions that you should consider....Is this franchise organization likely to survive the recession?
Seventy-five percent of franchise organizations go out of business in their first ten years. This is not 75% of franchisees; it is 75% of companies selling franchises. What does this mean to you? It means that just because the company has been in business for eight years, does not mean it is viable in the long-term, or even for the next two years. Why would a company that has been “successful” for eight years go out of business? One reason is that many are simply lucky enough to have started their franchise organization at the beginning of a period of economic strength. “A rising tide carries all boats,” as the saying goes.
Is the organization a mature one?
In other words, how many economic cycles has it been through? How did it weather previous recessions? If the company has not been through even one recession, have the key people at the top been in the same positions during a recession at another company?
Is management mature?
If the President of the organization does not have managerial experience at the helm of a similar organization during a full economic cycle, this is a red flag. If management has not prepared at both the corporate and the franchisee level for recession type declines in revenue, then the entire organization will be blindsided, and it will be unable to compete against others who have already lived through recessions and are well-prepared. If managerial experience during a recession is limited to board members, you need to ask: Does the Board of Directors have any real power?
Most boards of small companies are friends or acquaintances who may give valuable advice, but if they have no real power, the advice may go unheeded. A lot of boards of even major companies merely rubber-stamp policies and decisions made by management. Many board members are happy to serve as window dressing, because a board membership either dresses up their own resumes or gives them something prestigious to do in their retirement.
Is the franchisor upfront about the difficulties of running this type of business?
The franchisor should tell you, without your asking, what factors affect the industry in good times and bad—not just the positive influences, but the negative ones, as well. The revenue streams of even growth companies are affected by recessions, and this recession is already impacting them to a greater extent than in past recessions. You must know if there is any cyclicality to your expected income stream, and if so, how much? Don’t just ask, get proof. The tendency of sellers to emphasize the good and minimize the bad is natural, but not bringing up any negatives is a red flag.
Does the franchisor make money from selling franchises or from royalty income?
Don’t take the franchisor’s word on this or any question. A franchisor that expects to make money from royalties, and not just from selling franchises, would want to be sure that each franchise owner purchases with his eyes wide open. The franchisor’s reputation is at stake. The number of failed franchise owners goes into its prospectus, and a high number will make it more difficult to sell franchises to future owners.
This, however, does not stop some franchise organizations from trying to make money from selling franchises, rather than from helping franchise owners to be profitable. In some cases, it is because it is all but impossible to make money from the business model they are selling you. The model works for the franchisor because there are so many desperate buyers out there today.
Is the business model that they are urging you to follow a viable one?
In other words, is it going to make you profitable, and when? Legally, a franchisor cannot tell you how much money you will make, but many franchisors hide behind this legality. They help you to create pro forma cash flow projections that turn out to be more like wishful thinking. What you need to do is to contact other owners and ask if the projections are realistic. People hesitate to do this, because they believe it is too personal a question to ask a person how much money they are making, but what you can ask is:
• how long it took them to become cash flow positive,
• how long it took them to become profitable.
It is not enough for 5% of the franchise owners to be profitable. You need to believe that at least 90% of them are.
What skills are necessary to be successful in this business?
Most people who buy businesses have been successful in business. The talents, attitude, skills, knowledge, and experience it takes to be a successful business owner, however, are very specific. It takes an entrepreneurial spirit—the willingness to do whatever it takes—working 24/7. If you come from an industry in which you only worked 9 to 5, you may not have what it takes to be a successful business owner. If you were the President of a large company and are used to delegating to Vice Presidents, each of whom were making six-figure salaries, you might not have what it takes to manage people at a lower level of experience and ability. If you came up through sales, are you willing and able to take charge of the administrative, operations, human resources, accounting, and finance functions? Will you do what you enjoy and neglect the other critical elements of the business?
What will enable me to be a success in this business?
If you hear yourself answering this question with any of the following, you are using the wrong decision factors.
• “It’s not rocket science; I’m a quick study.”
• “If others have done it, I can do it.”
• “I’ll do whatever it takes; failure is not an option.”
• “I’ve never failed at anything else.”
Working hard and having a good attitude are necessary, but not sufficient to succeed as an entrepreneur. It is not enough to have some of the obvious transferrable skills. You need to know which are the critical skills, and you need to cover all of them, all the time, unless you intend to have one or more partners in the business who have the skills you lack or who enjoy doing the tasks that you dislike. Focusing on the human resources category, for example, have you had hiring experience and success in hiring, training, motivating, and holding people accountable? Do you have the ability to fire people, or will you make bad hires and then be unable to fire anyone until your business has gone right down the tubes?
Am I getting objective advice?
It is easy to see the abilities or transferrable skills that we do have; it is much more difficult to recognize the importance of the skills that we do not have. You need to be honest in your self-assessment, and you also need to get unbiased opinions about what you regard as your strengths and weaknesses.
If I run into difficulty, what will you do for me?
Whatever the answer is, get it in writing. Do not settle for assurances of assistance. If they will not put anything in writing, this is a red flag. Ask to speak to someone they helped when that person ran into difficulty.
Who has failed, and why?
Ask to speak to owners who failed. Ask for names of owners who are currently not doing well. If the franchisor is not forthcoming with names, this is a red flag. You also need to speak to multiple people. Don’t speak to owners whose failures can be attributed to heart attacks or divorces. Those are exogenous events and speaking to such owners will not be as helpful to you. Small business owners are usually very willing to share their experiences with others—both good and bad. They want to share their experiences in order to help others avoid their mistakes. When you speak to those owners, ask:
What is the most difficult part of owning this franchise?
Do you think you could have done anything differently and avoided the negative outcome? If the only people you are able to speak with were victims of illness or extraordinary circumstances, ask:
How did the franchise owner respond to your crisis?
Did they attempt to accommodate you in any way, or did they hold you to the exact terms and conditions of your franchise agreement, forcing you into bankruptcy? Did they attempt to assist you in selling your franchise, or help you in any way?
Have I got a good partner?
Most businesses fail because the partners cannot work together. Often, dishonesty is the problem. Husband and wife partnerships or parent and child partnerships suffer less from malfeasance of one of the partners, but familial relationships compound the difficulties of dual ownership. There are whole books written on this subject, so I won’t go into these issues, but many of these relationships have been permanently destroyed as the result of a business relationship.
Financing Your Franchise
We all know about the thousands of mortgage loan brokers and banking executives who made six- and seven-figure salaries selling mortgages to homeowners across the country. They were sold the American dream of home ownership through the use of “creative” financing that they didn’t quite understand. They were told all about the upside, but not the downside, of these mortgages. What if they lost their jobs? What if interest rates rose? What if real estate prices declined? We all know how that story ended for a lot of these people.
What has received very little attention to date is another loan industry that is selling a new American dream—business ownership. Many of these companies are franchises themselves. The owners take a few weeks’ training and then are put in the business of selling you loans that are personally guaranteed by you. The danger, of course, is that if your business should fail, you lose not just the business, but all of your retirement income as well.
Some of the loan brokers are working hand in hand with franchise companies. First, the franchise company sells you the dream of a business that is going to make you millions of dollars. Then, you are sold the even bigger fantasy of never having to pay any taxes on all that profit. Often, you aren’t shown the loan documentation until after you have laid out significant sums of money on preliminary investigation of the franchise “opportunity.” You may even be in the middle of franchise training class before a personal guaranty is put in front of you to sign. The deeper you are into the process, of course, the less inclined you are to decide against going forward.
There is a reason why credit is not easily available today. It is because in this economic environment, the risk of starting a business is impossible to calculate with any degree of accuracy. Over time, the percentage of businesses who survive is much higher among those who have little or no debt. As Warren Buffett has said, “If finance has to be creative to work, it probably shouldn’t be done.”
What else can I do to be sure?
Do intense research. Look up all the participants in your transaction—from the executives of the franchisor to the loan company’s officers.
Consult experts. If you are going into a new situation, you are unconsciously incompetent. In other words, you don’t even know what questions to ask. Seek expert counsel. Don’t just speak with a lawyer—find a franchise lawyer. Don’t just talk to the accountant who does your taxes—talk to one who understands the tax issues of the financing vehicle that you are using. Don’t just talk to the financial advisor who sells you stocks. Consult someone who understands your financing vehicle. There are also business analysts or consultants who can assist you. Speaking to friends or acquaintances who just give you generalities is not sufficient. Remember, sometimes free advice is worth the price you pay.
Don’t rely on your instincts or your “infallible” ability to judge people. Many people who are sold businesses by the unscrupulous later say, “…but they seemed like such nice people.” The reason these people are so successful is that they are so good at selling. Their greatest skill is in getting people to trust them.
Make sure your timing is right. The franchise you are considering might be a huge success for you if you bought it at the right time, but an unmitigated disaster if you purchased it at the wrong time. Just like a stock. If you bought McDonald’s at one of its tops, you could have had no gains for ten years, even though its earnings rose every year. If you bought it at a bottom, you could have doubled your money in less than a year.
Summary
There are good franchises and there are bad franchises. If you are contemplating buying a franchise, make sure you buy one that is right for you. And remember, you can never do too much research. Take your time, and study every aspect of what you are getting into, because forewarned is forearmed.