The Sure Thing
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While franchises offer investors a proven concept and tested business model, they don't offer guarantees of success. For further insurance, many prospective franchisees select more established systems with a known name and reputation, and steer away from newer franchise concepts. But is older always better?
We spoke with Kevin Lewis, president and CEO of hotel chain Suburban Franchise Systems of America Inc., about the pros and cons of joining new and existing systems. Here's what Lewis had to say about picking the best opportunity for you.
Franchise Zone: Is it better for franchisees to join new or established systems?
Kevin Lewis: It depends on the product and the market. For instance, if a concept has high barriers to entry and a unique selling proposition with a lot of upside potential, I may consider it. However, a lot of franchise systems come into existence where the barriers of entry are easy, and the value proposition goes away quite quickly when the concept is either easy to copy or the market changes. Given that and the amount of the investment, I would recommend people really sticking with companies that are tried and true, have a proven track record, a good balance sheet and [proven] profitability. You have to really understand the management people involved and their philosophy, because you're buying into that corporate culture.
What are some of the benefits to being part of an existing system?
The bugs have been worked out; you're not a guinea pig. You've got critical mass, systems in place, a franchise culture that already exists. Startup franchises typically come from people who had their own corporate stores but don't fully understand how to deal with the relationship side of the franchise business.
Are there any downsides to buying into an existing system?
There's probably less [of an] upside when you look at opportunity. There's more risk on a startup, but when you look at some of the hot concepts, [the first franchisees] made a lot of money. There comes a point in time where saturation can occur and those systems don't do quite as well.
What questions should someone considering a newer system ask to see how stable the company is?
I'd like to know their financial status, who their major competitors are, what the barriers to entry are. Is it a product that can be easily copied, and is the market moving in that direction? Does there seem to be adequate demand?
Are there any other advantages to being part of a new system?
First franchisees typically can get more favorable terms, because the franchise organization will be looking to make better deals or discount franchise fees in order to encourage development. Being first in and a pioneer isn't all that bad--there is risk, but you're going to gain some benefit as to prime territories and locations. In a more mature system, you don't have that opportunity, because somebody else has already taken that risk and those locations.
Is there a certain type of franchisee who is better suited to joining a newer system?
People who are real entrepreneurs, real risk takers. Or it may not be the only franchise operation they're involved with--they're diversified, they understand how the game is played and can afford some risk. But for a first time out of the box, I wouldn't recommend it. I wouldn't learn how a franchise system works on a risky venture.
Are there risks involved with buying into established systems, too?
No question. You have to look at their history as far as terminations. Every franchise organization is required by law to report how many businesses have left the franchise system, so you can get a feel for the flow of in and out. Look at the litigation section of their offering circular, see what types of litigation are against the company. Also, I would contact some of the existing franchisees involved in that type of business. Ask them the hard questions, because a lot of the sales material franchisors give out may paint a rosy picture, and it may be a very good opportunity, but you still want to know the risks.
How would you find out if the market for an existing franchise is getting saturated?
If you like the business model, ultimately you'll probably do some sort of market analysis that entails hiring a third party. In our business, we require, and lenders typically require, a third-party feasibility and market analysis that looks at the depths of the market. Every franchise system or any product or service you're selling has certain criteria you can look at.
Is there any simple way prospective franchisees can figure out for themselves whether it would be better to be in a new system or an existing system?
Really, I think it all comes down to how much risk you are willing to take. There are some people who want something tried and true; they don't want to be a pioneer. Then there are those who say, "I'm a risk-taker. I like the concept, and I'll do it." Some people are pioneers and some like the comfort of knowing someone's gone before them.
Are there any other issues to consider when looking at new and existing franchises?
It's important, whatever you choose, to do your homework. Also, be aware that your ability to access capital sometimes is dependent on whether the product is proven. Lenders also evaluate risk; if a concept isn't proven, your capital profile is related to that.