Click to Print

Turn it Up in the Down Turn

Bad economy? Forget about it. Why now is a great time to buy a franchise.
November 18, 2008
URL: http://www.entrepreneur.com/article/198682

There are 277 homes in the Clermont, Florida, neighborhood where Ronald Oliver lives, and he estimates that 80 of them are in foreclosure. But that gloomy news didn't stop Oliver from quitting his job as a supervisor at Universal Studios and becoming the co-owner of a Maaco paint and auto-body repair franchise in Kissimmee.

Since opening in July, Oliver and his partner, former Universal co-worker Kenny Lagreca, 39, have focused on aggressively marketing the business. Oliver, for instance, has handed out 1,700 business cards around town to local businesses. That legwork paid off not only in an exclusive contract to serve a local car dealership, but also in a steady stream of individual customers. In the shop's first 30 days, Oliver says they gave more than 600 estimates and worked on more than 100 cars, eventually making about $168,000 in the first two months.

Oliver says being part of Maaco gave the pair many advantages over starting an independent repair shop, from professional site-selection advice to a bankable brand name that helped get their $500,000 SBA loan approved. "We put our shop on a plot Maaco helped us find, put our sign out, and we haven't stopped since," says Oliver, 35. "We're starting out at a bad time, but it's working out really well."

When times get tough, franchising can offer many advantages over going into business on your own. "Buying a franchise makes more sense in this economy than either buying an existing stand-alone business or opening your own business," points out Michael Katz, president and CEO of The Franchisee Consulting Group. "You're getting a proven system and being taught how to do it correctly. You've got a leg up on any mom-and-pop competition."

Franchises also have a proven track record of powering through previous economic downturns. International Franchise Association figures for 2001 to 2005 show that despite the downturn that came after 9/11, the franchise sector's economic output had average annual growth of 9.7 percent, about three times greater than the economy as a whole.

Opening in a downturn, however, requires careful research and planning, says IFA Educational Foundation president John Reynolds. With franchise sector growth possibly ramping up slower in the next year than it would have a year or two ago, missteps can be fatal. So proceed with caution. Now's not the time to fall in love with a concept and, starry-eyed, take the plunge. "The finances have to work," says Reynolds, "no matter how much you love the business."

Good News, Bad News
The current economic decline has a couple of unique aspects compared with previous downturns. The good news? In many markets, commercial and retail real estate is cheaper and more available than it has been in a long time, notes Michael Seid, a franchise consultant and the co-author of Franchising for Dummies.

Many chains are scaling back or closing, from Bennigan's restaurants to Starbucks. That means landlords have empty spaces and are motivated to fill them. "I'm seeing something we haven't seen in years: landlords coming to the table with build-out allowances," says Seid. "Previously, if you'd mention it, they'd start laughing."

The bad news? Finding funds for your purchase may be tougher now than at any time since the savings-and-loan scandal of the '80s, Seid says, especially if you don't have good credit. The banking-sector subprime mortgage meltdown that began in the fall of 2007 means many banks have less money to lend and are skittish about making riskier loans. Many prospective franchisees are looking to alternative financing to get around this hurdle (see "Financing Gets Creative" on page 99), and Seid says lower-cost franchises are gaining popularity this year.

As entrepreneurs contemplate buying franchises, they should take care not to overextend themselves financially, says Reynolds. It's hard to predict how long it will take for a new franchise to turn a profit, especially now. To make sure you won't run out of cash, Reynolds recommends running your projects by a financial advisor. "If you put every dime into a startup and it takes you a while to get the business going, that's a huge risk," he says. "You should reserve a portion of that as working capital for the first year or two."

That philosophy helped Boston-based Edible Arrangements franchisee Chris Dellamarggio, 38, tough out the last downturn in 2002. The former market-research executive was the fruit-bouquet company's first franchisee and opened just months before 9/11. Dellamarggio took out a manageable loan against his condo to finance the purchase and kept his expenses low. He paid his two employees hourly and sent them home the minute work finished each day. He also kept up his marketing: During slow times, he sent free bouquets to businesses to keep word-of-mouth going. As the economy turned up again, he expanded and now has four locations doing about $2 million in combined annual sales. "I knew I had to muck through it," he says, "and if I kept getting the product in front of people, I would get there."

Time to Investigate
No one should ever buy a franchise without careful research. In a downturn, though, this step is especially important. You need to find out if your franchisor has the resources to help its franchisees through this difficult time. Rey-nolds recommends asking about services franchisees can tap, such as co-op purchasing, that will drive down operating costs and increase survival odds. Does the franchisor offer affordable software programs, mentoring or business coaching? "Ask them, 'What are you doing to help improve my bottom line?'" says Reynolds.

Each franchisor discloses details about its business in a Franchise Disclosure Document, or FDD, which you should study and use as a starting point for your investigation. From there, research franchise managers' backgrounds and talk with as many franchisees as you can.

Many franchisors won't disclose their earnings or will only offer partial information on franchisee results. So talk with franchisees and ask franchisors direct questions about how the business is faring this year. "They can tell you trends in same-store sales without giving numbers," says Seid. "Are they going up? That's a straight-out fact a franchisor can give you."

New PuroClean franchisee Brian Medaglia, 39, opened his Arlington, Virginia, franchise in July after interviewing franchisees and grilling executives about their ability to manage the chain's growth. He learned the CEO had previous experience running large franchise systems and that a key vice president had spent his entire career in the home-restoration business. "I asked franchisees, 'Are you profitable? Is the system working for you?' and 99.9 percent said yes," says Medaglia. "I could tell the 0.1 percent treading water weren't following the system."

While you're talking with franchisees and the franchisor, get a feel for the corporate culture and think about whether it's a fit for you, advises Lori Kiser-Block, president of franchise consulting firm FranChoice. "A tried-and-true franchisor probably isn't looking for a cowboy entrepreneur," she says. "But new and emerging franchisors are looking for risk-takers, and that ground-floor opportunity with the right franchise can be extremely rewarding."

Also find out the franchisor's expansion plans, says franchise attorney Terrence Dunn. Are they too aggressive? "Often they start encroaching on their own people and cannibalizing their territories," he says. "Even with a good concept, that can leave you struggling."

Another way to research a franchise is to check the price of any units for sale. If the price is lower than the franchise's startup cost, and the franchisee has been working the business for years, something's wrong, Seid notes.

While you're looking over sale prices, consider an existing franchise. During a slowdown, an existing business gives you a leg up: It already has a customer base and some name awareness in its market. "Plus, you can see if customers are happy and business is trending well," says Seid. "You also know what your staff looks like."

Picking the Right Concept
There's no question that generally some types of businesses fare better in a recession than others. Expensive restaurants tend to suffer, but people continue to need haircuts. Still-hot niches our experts identified include products and services tailored to Latinos, as well as child-care, elder-care and home-repair franchises.

Does that mean you should shop for a countercyclical concept? It depends in part on your own interests, income needs and long-term plan for the business. Medaglia, a former airline pilot, specifically looked for something that would be recession-proof and profitable right away. Because PuroClean focuses on helping homeowners with water damage and other house damage usually paid for by insurance, it's rarely affected by the downturn, he says. Medaglia was in the black within 90 days of opening, and he projects sales well into the six figures this year.

Others have done well with concepts that at first blush might not seem obvious choices in 2008. The success found by Scott Pekovich, a Salad Creations franchisee in Billings, Montana, points to a key fact about the current downturn: It doesn't affect every market in the same way.

Billings' economy has stayed fairly strong, notes Pekovich, 38. The PGA golf pro sensed an open niche for a healthy quick-serve restaurant, and despite the generally gloomy outlook in the restaurant sector this year, he opened his Salad Creations eatery in May. Since then, the restaurant has ranked in the top two in gross revenues in the roughly 50-unit chain nearly every week. Pekovich, who projects 2008 sales of $700,00, eventually plans to open about 35 Salad Creations throughout Montana, Idaho, the Dakotas and Spokane, Washington. "We felt the demand was there," Pekovich says. "It's unique and healthy, offering lots of choices."

Bad times can also provide opportunities to take advantage of others' lack of conviction or business savvy. That was Bob White's strategy during the 2002 downturn. White, 46, opened his first The Maids Home Services franchise just a few months before 9/11.

Shortly after the economy tanked, White got a call from another Maids franchisee in his Dallas-Fort Worth market who was looking to sell. In short order, White bought out four local Maids franchisees. Each let him pay for the franchise in installments, keeping his investment costs low.

Suddenly, White had a dominant presence in the market and began advertising aggressively. Moving operations into one office created efficiencies that made the expanded territory instantly profitable. Last year, his franchise brought in $2.3 million. "There was quite a bit of uncertainty back then," White says. "But I was confident in what I was doing. And I still believe there's huge upside potential in my market."

Seattle writer Carol Tice reports on business, finance and social issues for Seattle Magazine, Washington CEO and other leading publications.