10 Bogus Reasons to Buy a Franchise

This month Entrepreneur magazine has compiled ten reasons to buy a franchise. “We’ve gathered the best reasons to become a franchisee,” the magazine says. The only problem? The arguments, often perpetuated by novice salespersons and new franchising firms, are bad myths.

If these are the main reasons to persuade an entrepreneur to buy a franchise, the buyer should run in the opposite direction. Because if the salespersons for franchising firms are getting these broad points wrong, then how accurate can they be on the merits of their particular franchise chain?

Here are the ten reasons to buy a franchise, according to the cover story of October’s Entrepreneur’s Startups and the truth behind them that wasn't reported. Besides my comments, Craig Slavin, a 30-year veteran of franchising and CEO of Franchise Architects, a builder of franchise chains, has been asked to provide his insights.

1. ENT: “You are buying a proven formula.”

   DON: Buyers cannot assume that just because a chain is franchised that they are buying a "proven formula." There are a lot of ill-conceived, unproven, franchised lemons out there. Even the International Franchise Association asks its members, including salespersons of franchises, to refrain from using this line.

   CRAIG: This is a huge oversimplification of an ancient myth. Just because a company is franchising – or has been franchising, doesn’t mean the formula is either proven nor successful.  Further, even if the formula is in place it doesn’t mean the franchise company is either equipped with the talent or expertise to be a successful franchise company.

2. ENT: “Larger franchise companies offer in-house lending” 

   DON: Larger franchise companies can have special arrangements with banks or lenders such as CIT or GE Capital. But many of those same franchisors have also been having a tough time getting loans. Large franchise systems like Dunkin’ Donuts have found that its lender CIT sits on the precipice of bankruptcy, taking away an already dried up funding source for its franchisees.

   CRAIG: Most companies, large or small, do not want any type of contingent liability so they won’t guarantee any type of loans.  They might have preferred lenders but, unless it is disclosed, they cannot receive any type of remuneration from a lender.

3. ENT: “A franchise provides a built-in support system”

   DON: There are SUPPORT SYSTEMS and then there are “support systems,” where all a franchise chain does is transmit and enforce bad practices, taking the franchise investor quietly on a straight line to bankruptcy court. The question is: How robust and accurate is the “built-in support system” of the franchise chain that the franchise investor is looking at? If the buyer is new to the industry, that can be a tough thing to determine.

   CRAIG: Nothing is “built-in.” A franchisor must allocate proper financial and human resources to support its franchise owners.  The degree of “support” will also vary from franchisor to franchisor.  Here is where the conflict generally occurs with a new franchisor.  The original business was created and managed by an Entrepreneur. A franchise company must be managed by a professional business manager. The transition from one to another creates abnormal conflict within the company causing additional stress that some companies never recover from.

4. ENT: “A franchise is more attractive to the SBA”

   DON: False. The Small Business Administration, the SBA, thinks the opposite. It has warned its cadre of small business lenders and bankers that in its experience in providing SBA loans to franchises, franchisees are more at risk of not being able to pay back their loans than independent small business owners.

   CRAIG: Again, this is an age-old, archaic myth of franchising. Success or failure, in any business, can be attributed to many things. If a franchisor accepts the wrong profile or someone who is undercapitalized then failure, in franchising, is imminent.

5. ENT: “You can be your own boss (almost)… It’s not the same as being an entrepreneur, but it’s the next best thing.”

   DON: I sense that franchisees are being belittled. Franchisees are not “the next best thing (to being an entrepreneur).” According to the dictionary, entrepreneurs are those who own a business and assume its risk. In other words, franchisees ARE entrepreneurs. Now it just so happens that some entrepreneurs are gamblers and others are more risk averse. No matter how lopsided a binding license agreement might be in favoring the licensor, it is the franchisee’s money and their business that is at risk. Franchisees should not be lulled by franchisor employees into thinking like an employee. That  lens of looking at things doesn’t fit the hard realities of their situation.

   CRAIG: Being a franchisee does not mean the individual is an entrepreneur. IN fact, the reverse is true. An entrepreneur generally will not buy a franchise because they are too independent to follow the rules from someone else. In franchising, and the Franchise Navigator has validated this, you want someone with Entrepreneurial qualities but not the entrepreneur.

6. ENT: “Some low-cost franchises have strong ROI”

   DON: If this is the case, where’s the proof? Why doesn’t the article spell out what a typical return on investment is for a low-cost franchise? I’ll tell you why: Because very few franchise systems are willing to provide any meaningful franchise profit, cash flow statements or even average top-line revenues to calculate return on investments, even though they often collect these financial statements. So reporters and even seasoned gurus don’t know what a typical return on investment is. And the buyer is left to stumble in the dark to see if there’s any truth to what the reporter is saying.

   CRAIG: There is no correlation between low cost and high ROI; high cost and low ROI or any other combination for that matter. What affects ROI are unit sales and cost controls so margins are high.  You could have a low cost, low volume business with low ROI because there simply isn’t enough money to go around to everyone, including the franchisor.

7. ENT: “In a down economy, the buy-in prices are lower”

   DON: OK, this point has some merit. With a down economy and credit hard to come by, businesses are cheaper than they have been for quite a while. If you have lots of cash, you are king. But unless you feel like a turnaround king, be careful of really troubled assets.

   CRAIG: There are a few companies who offer “recession concessions.”  However, these reductions are generally pertaining to the soft costs, such as initial franchise or on going fees.

8. ENT: “Name recognition is what consumers look for”

   DON: But how many of 3,500 North American franchising firms actually have significant brand name recognition? Very, very few. Most of the time it is only the franchisor’s employees and sales staff that find it convenient to believe that they have significant brand recognition with consumers. Meanwhile, the brand isn't even a blip on the consumer's radar screen.

   CRAIG: This insinuates a market penetration strategy that results in brand recognition. Growth via concentric circles. There are, however, more companies who engage in a “sales” strategy where they sell franchises throughout the US, thus fragmenting their own distribution system and reducing brand awareness.

9. ENT: “Baby Boomers who can’t retire can be their own bosses and see solid returns on investment”

   DON: That’s a repeat of point 6, with the words “Baby Boomers” thrown in to get that demographic interested.

   CRAIG: Agreed. It is hyperbole.

10. ENT: “The chance of success is much higher.”

    DON: This is rephrasing point one. The article seems to be running out of myths to buy a franchise because it now just repeats itself.

    CRAIG: There are many reasons why someone should buy a franchise. Franchising should bridge the gap for the franchise owner and the stuff that needs to be done [to help them be a success].

Can't today’s trade journals update their tired, worn out arguments to fit today's more sophisticated business buyer?

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Related Reading:

• 2008's SBA Loan Failure Rates by Franchise Brand
• What Is The Success Rate of a Franchise versus an Independent?
• 10 Points of Probability in Selecting a Successful Franchisor
• Startup Failure Rates, The REAL Numbers
• Making New Franchises Work (pdf)
• New firm survival: An institutional explanation for franchisor mortality (pdf)