There's no doubt about it--franchises are popular. For someone looking to escape the confines of their boring cubicle, there's something definitely appealing about buying a "business in a box" that takes the mystery (and at least some of the risk) out of starting your own business. Quoted statistics on the success of franchises are also pretty impressive:
- Success rates for franchises are greater than 90 percent, making this the lowest failure rate of any type of business.
- A 1999 U.S. Chamber of Commerce study found that 86 percent of franchises were still under the same ownership and 97 percent of them were still in business after five years.
- A seven-year research study found that 91 percent of franchised businesses were still operating compared to a mere 20 percent of individual startups.
(Note: These statistics were taken from information found on FranchiseUSA.net)
You'll get no arguments from me about the benefits of a franchise business. Just understand that if you're going to need help financing the acquisition of that franchise, you'll probably find few takers in the professional investment community. Now let me emphasize that I do not consider banks to be part of the "professional investment community." Typically, banks will help finance the purchase of a franchise but if your credit's bad and you need an outside individual (angel investor) or venture capital firm to help you get the cash, there could be a problem. Here's why:
1. Franchises can be expensive. Generally, the more expensive the franchise, the more earning potential there is for you (simply put, "hot" franchises cost more because they earn more). To get started, you have to pay to obtain the right to use the franchisor's name and gain its assistance in helping you succeed. This fee may include all the following:
- Franchise fee. This fee, which may be nonrefundable, can cost several thousand to several hundred thousand dollars. In addition, there may also be costs to rent, build and equip an outlet and to purchase initial inventory. Other costs may include operating licenses and insurance. There may also be a "grand opening" fee to the franchisor to promote your new outlet.
- Royalty payments. The franchisor may charge royalties based on a percentage of your weekly or monthly gross income. This may be true even if your outlet hasn't earned significant income. Royalties are usually paid for the right to use the franchisor's name so even if the franchisor fails to provide promised support services, you still may have to pay royalties for the duration of your franchise agreement.
- Advertising fees. On top of everything else, you may have to pay into an advertising fund. Some portion of the advertising fees may go for national advertising or attracting new franchise owners, and some may even go to target your particular outlet.
So how much money will you need? It depends on whether your goal is to just own a single franchise or to purchase a master franchise that generally covers a specific geographic territory. For most, just the single franchise purchase will be daunting enough. Here's just a small sample of what some can cost, including working capital:
- Molly Maid: $65,000--$103,000
- Mr. Handyman, LLC: $86,000--$127,000
- AAMCO Transmissions, Inc.: $198,000--$222,000
- Carl's Jr.: $783,000--$1 million
- AIM Mail Centers: $110,000--$180,000
Granted, some franchisors may be willing to take a down payment as low as 20 to 25 percent of the total, but you'd better have excellent credit and a net worth in excess of $250,000.
2. The franchisor is king. Here's the real problem. If you're looking to get an outside investor to help fund your entry into this type of business, never forget that this is not your business! It's the franchisor who has built this business, made it successful and will always maintain control over anything that would threaten that. Thus, any outside investor is totally dependent on two uncontrollable variables: you and the whims of the franchisor. That's why most franchises are financed by second trust deeds on homes, loans from relatives, and/or borrowed money from IRA or pension funds (be sure to check with your tax advisor if you're considering this last option.)
3. The real money is in multiple franchises. Owning a single franchise will, generally, allow the franchisee to make a modest income for themselves but not offer a great return to any investor. Thus, if you want to pursue this strategy with vigor, you need to think multiple franchises. Such a strategy can be pursued on a one-at-a-time basis or can be attempted via acquiring what's called a "master franchise." However, the former strategy can be slow and costly, and the latter may not be possible for the older, more developed franchises.
As a private investor, the only investment strategy that might interest me would be to invest in a master franchise. The challenge, however, is in determining if my partner (the one who's going to do all the work) can actually be successful at building a franchise. Here, the decision is simple. As a private investor, I would only invest in a partner who has a clear and proven track record for building successful franchises in the past. I simply can't afford to invest in someone who's never done this before.
So what's the bottom line on getting an outside investor to invest a franchise with you? Unless you've done this before and are now looking to take over a large, multifranchise territory, you're going to have your work cut out for you. Outside investors are rarely your ticket out of your cubicle. For that, you're going to have to bite the bullet and dig deep into your own pocket.
Jim Casparie is the "Raising Money" coach at Entrepreneur.com and the founder and CEO of The Venture Alliance, a national firm based in Irvine, California, that's dedicated to getting companies funded.