Franchising is a business model with a lower failure rate than an independent business. However, this is not a risk-free business model, and there is always the possibility that the company will fail. What are the risks of buying a franchise is a topic that will interest all entrepreneurs who are considering starting a new business venture.
Risks of Buying a Franchise
Choosing a wrong franchisor
The support package of the franchisor is that what makes the differences between franchising brands. Choosing the wrong franchisor can reduce the chance of success of the business.
Your future franchisor must have a good franchise package that covers all business segments. Therefore, you must read the Franchise Disclosure Document carefully before closing the franchise agreement.
A good franchise package will cover assistance and support in resolving business issues, choosing a sales location, arranging the space, and helping with the procurement of raw materials.
It is necessary to choose proven business concepts that are well-known in the market. By choosing tried and tested brands such as Subway, McDonald’s, KFC, etc., the franchisee knows that he will receive support across the whole duration of the franchise agreement.
However, these brands have an enormous start-up cost, so investors more often get into partnerships with franchise companies that are less known on the market.
It is crucial not to rush when choosing a franchisor. It is possible to buy a franchise that has a low starting cost and a good franchise package.
Before signing a franchise agreement, study the Franchise Disclosure Document and gather as much information as possible. It is also wise to hire a franchise consultant; a consultant can help you if you don’t know too much about this type of business.
Choosing a wrong franchise
Buying franchise risk can also be when a franchisor has a good franchise package, but other businesses meet all the demand on the market. This most often happens when the market is oversaturated with similar types of services or products.
We are all informed about the advantages and disadvantages of franchising. However, only a few future franchisees will perform market research before starting a franchise.
It is wise to take time to analyze the market. There is nothing worse than remorse when we realize that we have started a business venture in the wrong business niche. So, take as much time as needed and explore more franchise options in different areas of operation.
Some options may seem ideal to us today, and tomorrow after a good night’s sleep, we realize that it was not a good choice. Also, it is good to start a business in a niche for which we have passion.
When we mention franchise business, a lot of people immediately think about fast food restaurants. Franchising can give much more options than that. The fast-food niche is only one of the many franchising directions.
Fast food franchises often have too much competition in the business territory; this affects the profit because a particular market can only handle a certain number of outlets.
This oversaturation of the market reduces profitability and often carries the risk of business failure.
So, every investor should investigate which services and products are missing in his city, country, or state. If the market is analyzed correctly, the investor will create all the conditions for a self-sustainable business, and it will bring profit to the owner in the next few years.
Franchises have a lower failure rate, but this does not mean that this type of business cannot fail. We often hear success stories, and stories about failure are pushed aside.
So don’t have unrealistic expectations regarding this business model. Buying a franchise has a lot of risks, and you must be aware of them.
Don’t be fooled that by starting a franchise, you are sure that you will be successful. This is not a business model that will provide you with absolute security, and that is why you must work hard if you want to own a profitable business.
Investors often think that a franchising business is much easier than an independent business. But, after buying a franchise, they realize that this is a business like any other.
The franchisor will not do all the work for the franchisee. Franchise owners must take advantage of the franchise package and implement that knowledge of the franchisor in practice if they want to reduce failure risks.
Too many on-going costs
By signing a franchise agreement, the franchisee agrees to pay monthly fees: royalty and marketing fee. These two fees together usually range between 6% to 12% of the gross revenue.
On-going costs can cause a significant financial burden for a franchise that does not make enough revenue. If the franchisee does not pay these fees, the franchisor can nullify the franchise agreement. So this is one of the most significant risks of starting this type of business.
Before signing the agreement, every investor must determine what percentage of the on-going monthly fee is obligated to pay.
In addition to these costs, franchisees often must procure goods from manufacturers or companies that are directly related to the franchisor. This practice, in most cases, has a positive effect because this can reduce costs, but sometimes it can make additional costs.
Some franchise concepts try, through suppliers, to extract more profit for themselves through the goods that their franchises procure. So it is wise to research more about this before choosing the franchisor.
Complicated exit strategy
In any business, there comes the point when it is time to say goodbye. But when you want to exit the franchise business, this can be a highly complex process.
It is possible to return the franchise to the franchisor or sell it to another entrepreneur. Selling your franchise only can be done after the franchisor has agreed to it.
There is always a risk that the franchisor will not approve an investor, so it is much harder to sell a franchise than an independent business. This sale process is specific because three parties have to agree; the franchisor and the franchise unit’s current and future owner.
So when buying a franchise, every investor must keep in mind that the exit strategy is much more complicated than in a classic business. This may seem irrelevant now, but in the end, this will be very important.
It is good to hire a franchise lawyer who will assist thru the selling process. This can be an overwhelming process, so it is good to have someone on your side.
A franchise attorney will be a must-have if you want to terminate the agreement before it expires. This can occur if you are not satisfied with the franchisor, which is not so unusual as it seems.
It doesn’t happen often, but the franchisor can fail and go to bankruptcy. This is one of the risks of a buying franchise that every investor should take to consider.
Nowadays, franchising is not as secure as it was a couple of years ago, so this must be mentioned when we are assessing risk. More prominent players on the market will not go bankrupt, but some of the small brands have big problems with business liquidity.
When a franchisor fails, a liquidation process starts in which all the franchisor’s assets are sold off. The main assets of franchisors are trademarks (intellectual property) and franchise agreements. After liquidation, the highest bidder acquires the ownership of the brand’s intellectual property and franchise contracts.
The franchise agreement is still valid if the franchise brand continues to be presented in the market but under a different owner.
Such a devastating thing as bankruptcy will significantly impact the whole brand and not only the franchisor. It can happen that the situation completely turns upside down.
If this buying franchise risk becomes a reality, you must take some steps to secure that you can continue your business operations. So, it is wise to hire a franchise lawyer who will help you with legal advice.
Not adapting to franchisor demands
People often do not understand how franchising works; people are not aware that by signing a franchise agreement, they consent to work according to the instructions given by the franchisor.
The franchisee doesn’t have too much space to show his creativity, and he must follow the requirements and tasks determined by the owner of the concept.
If you are not ready to adapt to the franchisor’s requirements, then this is not the business model for you. The franchise contract will outline the obligations and tasks you must complete to be part of the franchisor brand.
The franchisee has an obligation to:
- Arrange the space by the requirements of the franchise provider
- Have working hours that are directed by the franchisor
- Procurement of goods from certain manufacturers or brands
- Sell only products that are under franchisor trademarks
- Pay initial and ongoing franchise fees
Also, and the owner of the concept has its obligation toward the franchisee. Every franchisee unit must have support in different aspects of the business.
As you can see, this relationship is highly regulated. So for the entrepreneurs who want more independence, they can consider buying a license.
Franchise and license have many differences, so it is good to learn about this topic.
Other franchisees can affect your business reputation.
By signing a franchise agreement, your business has become part of the collective. This is an advantage because you have more support, but it is also a disadvantage because other owners’ bad decisions can affect your reputation among the customers.
For example, we all know the McDonald’s franchise as a collective; rarely do any of us know who owns the franchise in which we eat every day. If you have had a bad experience in one outlet, it will affect your perception of the entire brand.
This is one of the risks of buying a franchise that you need to consider. So, it would be wise to choose a franchisor with a strict policy about how services can be provided to customers.
By choosing a franchise concept that takes a significant effort to maintain the same quality service in every unit, you will ensure that some franchise owner that mistreats customers will not affect your business performance.
Now when you know what are the risks of buying a franchise, you can be prepared if any of these risks become a reality; as we said before, this is not an easy business model as it seems at first glance.
You must choose wisely if you want to have a profitable business that will bring you profit in the many years that come. Every model has its own risks, and everything depends on us at the end of the day.
If you do all the necessary preparation tasks before buying a franchise, your chances of failure can be brought down to a minimum.