Should I start a franchised business? This is what I was asked recently. So I received a communication from my favorite online business broker today. To my surprise this had to do mostly with franchises. They were pushing a California startup Mexican restaurant franchise group. This was quite enlightening since I had just been communicating with a bunch of my students regarding franchises. In fact one of my students asked me whether or not it was a good idea.
Now I assumed, and he concurred, that he was starting a brand new business and the theory was that he would buy into the franchise program and pay the startup costs. This involves spending a lot of money that you may not have. Indeed you can buy an existing business with a franchise such as a McDonald’s or Wendy’s or Dunkin Doughnuts. This also involves spending lots more money you may not have. But we will just talk now of doing the startup.
So here are my comments to my students that were interested in starting a franchise business.
Generally speaking, I do not like franchises, for a variety of reasons. Most of the reasons have to do with the amount of startup money that is necessary. Then beyond that, there is the matter of the ongoing franchise fees. Then beyond that there’s the inherent risk in a startup. Then beyond that there is the matter of having to worry about the reputation of the franchisor. Then beyond that, if you want to buy a an established franchise business, you are likely to pay an exorbitant price. So I am not a big fan of franchises in any form, startup or established.
If somehow you were dropped from an airplane and woke up up owning a chain of McDonald’s then that would be the best way to make an entry into franchises.
That does not mean you will fail at a startup. After all, good franchises give you a fast head start to achieve a profitable business. However, compared to other possibilities in business acquisitions, the franchise company tends to incur a great deal of startup risk for very little immediate return. The world happens to be littered with embryonic franchise startups that fund themselves by using the cash of embryonic entrepreneurs. So you can go out and collect prospectuses from every new franchisor, of which there are many, and take your pick of many different retail establishments that pop up.
Should you have any question about how much money an operation like this would cost before you earn a dime, I have the numbers right below. I have gone to the said CA new franchise operator’s website and collected some data about what it costs to go through their program. As eye-popping as these numbers are, they are likely quite typical of pretty much any franchise where there is bricks and mortar and physical locations. This is why there is so little competition and high barriers of entry when buying an actual established business.
Yes, this says you will need to spend as much as $700,000 to start a restaurant up from scratch while not paying yourself. Sound like fun? Note that the ongoing franchise fees are a healthy percentage of the gross revenues. Note that the initial franchise fee is also pretty hefty. Now they will tell you that there is financing for these amounts but I am guessing not everyone qualifies and the average person might not want to roll the dice with that amount of money and hope that it becomes a success.
Aside from the fixed assets, ads, franchise fees and equipment you will need to arrange a location and negotiate a real estate lease arrangement for a piece of property. If you haven’t done this before you could use a lawyer as well. And the expenses above don’t seem to point out that you will have to pay rent along the way either. Or you could buy the real estate but then you will want to bring a banker along for the ride. My cynical attitude towards franchises comes from many years of encountering bad ones that fail. Plus I wouldn’t want to mess with anything that makes me read a prospectus. Prospectus = scam usually. It is what initial public offerings use to pedal garbage shares of stock that crash.
So anyway I advised my people not to do startups for the simple reason that it won’t get them a salary unless they pay themselves before the store even opens. Of course franchises can work but the price of entry is too high and the entrepreneur must have a lot of staying power.