New Report Reinforces How Risky Franchising Can Really Be

New Report Reinforces How Risky Franchising Can Really Be
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Opening a franchise might be easier than creating a concept on your own, but it’s still a risky business -- even if you land a loan from the Small Business Administration. Nearly 17 percent of franchise loans made through the SBA from 1991 to 2010 ended in failure, according to a new report released by the Service Employees International Union.

Even more concerning: the figure is rising. In the most recent five-year period -- 2006 to 2010 -- the average actually was 19.3 percent. Perhaps the recession is partly to blame but the SEIU says it represents a more long-term trend.

“We believe the high failure rate is due to a severe imbalance of power between franchisees and franchisors that contributes to a system of too many unstable businesses and low-wage work in the franchised fast-food sector,” Tia Orr, senior legislative director of the SEIU California State Council, said in a statement.

Related: Why do so many franchises fail?

A representative from the SBA did not immediately return an email seeking comment.

The top culprits of SBA loan failure include Quiznos, Coldstone Creamery, Matco Tools, Blimpie and Huntington Learning Center. This appears to be in line with a 2014 report by the Wall Street Journal on franchised brands most likely to default on their loans.

Franchisees often turn to franchising because they believe it to be a way to start a business with less financial risk. The truth is more complicated: the SEIU asserts that nonfranchise SBA loans outperform franchise loans, but different studies report vastly different failure rates for American businesses. The U.S. Bureau of Labor Statistics revealed that American businesses founded in 2003 had slightly more than a 55 percent five-year survival rate, while those founded in 2006 had less than a 50-percent chance of survival.

Failure rates for venture-backed companies is between 40 percent and 75 percent.  

Related: What You Can Learn From a Failed Franchise Investment

Further, franchise industry insiders argue that comparing failure rates across the franchise sector is like comparing apples and oranges. "Franchising is just a way of doing business; it's not a script for success," Robert Purvin, the chairman of the American Association of Franchisees and Dealers and author of The Franchise Fraud, told Entrepreneur in an article on the subject.  

The study is part of a larger effort by the SEIU to create change in the realm of franchising. The union, known for its fast-food targeted work to raise the minimum wage, launched an initiative earlier this month to highlight how the franchise system negatively impacts franchisees. As part of this, the SEIU is lobbying for a franchisee rights bill in California. The International Franchise Association has opposed these efforts, and dismissed the union’s efforts as a manipulative means of convincing the government to allow the unionization of employees at fast-food franchises.

Still, despite the SEIU’s apparent motivation to publish the study, it does illuminate something any potential franchisee needs to know: franchising can give you a support system when done right, but opening a business will always have an element of risk. So, if you’re opening a franchise because you think success is guaranteed, it’s time to do a little more research.

Related: What Is the Real Survival Rate of Franchised Businesses?

Edition: October 2016

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