Evaluating a Franchise Part One

It is often quoted that after 5 years, 80 percent of small businesses fail, but conversely 90% of franchises are still in business. While that sounds good, that figure is not being quoted nearly as much as it used to be. In the early '90s, Timothy Bates, a professor at Wayne State University, studied Census Bureau data on 20,000 new enterprises and found that 38 percent of franchises failed within four years of opening their doors, vs. 32 percent of independent start-ups that went belly-up. While there are current studies as of the writing of this article, it is generally accepted that franchise failure rates are a lot higher than most people think.

Under federal franchise disclosure requirements, Franchisors are required to disclose franchises that are no longer in business as a result of "terminations", "sales / transfers" or "transfers". This information is located in the Uniform Franchise Disclosure Document, UFDD, which replaced the Uniform Franchise Offering Circular, or UFOC in July of 2007 when the new franchise law of 2007 was passed. What is not known is how many of these "terminations", "sales / transfers" or "transfers" are actually failures. This way of reporting can really "hide" the true failure rate.

That said, how can we truly evaluate a franchise before buying one?

In reality there are three components to purchasing a franchise. One the the actual business concept itself, the second is the franchisor and the third one is you. The most basic definition of a franchise is that it is a "proven business concept". I know that sounds simple, but it is not and there are a lot of variables. Most successful franchises and franchisors for that matter say that the best franchisees are people that "follow the system". Well, what if you are a person that does not have the aptitudes or personality the "follow the system"? That is just one reason why it is important to consider all three variables when one considers purchasing a franchise. 1. Is the franchise model a proven business concept? 2. Is the franchisor solid? 3. Are you a good fit for the franchise and prepared to "follow the system"?

Let's go through each of these in order and in separate posts and see.

Is the franchise model a proven business concept?

One would like to think that all franchises are proven business concepts but in reality that is not true, or suffice to say that some are a lot more proven than others. Here are some good questions to ask and consider.

Was the franchise founded on a company store or was it a franchise just birthed from an idea?

Any franchise that was founded on company owned location with a track record has in my estimation a much better chance of success than one that is not. A franchisor owned location permits the franchise company to test and come up with new ideas, to see what obstacles are in the ever changing business environment that we all find ourselves in. How can you sell me a system if you have never done it yourselves? I should say here that most franchises are founded on owned locations and also that the vast majority of retail concepts have company stores as their beginning.

How long was the operator in business before they decided to franchise?

Hey, you are buying a proven business concept, right? How long has the person selling you "the system" been doing what it is that they are telling you can do or should I say selling you what they say you can do? It's important to look back as far as you can at the history of the franchise.
Many service franchises can be start and run from the home where as retail franchises cannot. You want to see some significant business history. Ask questions like, how many deals do you do a year in the company office? How many clients do you have or what is an average day like for you? Ask as many questions as you can think of about how the business works and then think about how you and your skill set fits into what they are doing.

How is the franchise affected by ups and downs in the economy?

Seriously think about how the business does in different economic cycles. At this time the housing market is in the crapper, but that will not last forever. Also, just because housing is down does not mean that people are not remodeling homes, doing home improvements or putting additions on their homes. These things are done in good and bad markets. No matter what the state of the economy people have to live, buy food, get their cars repaired, take care of their kids etc. The number of units and age of them can give you a lot of insight into how the business model weathers economic downturns.


Would you pay or use the services of the franchise, and how big is the market?

This is a big question to consider. Would you buy there? If so why? Remember, not everyone thinks like you think. Not everyone buys because you would and not everyone does "not" buy because you would not. Try to be objective and think about what the franchise really offers, why it is unique and what they do to leverage that uniqueness into a high probability of success business model.

These are just some of the questions that should be considered when evaluating a franchise prior to purchase. Please stay tuned for parts 2 and 3 in the coming days, I hope.

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