First-Time Franchisees Face a Tougher Road

Franchisees who fold early, for instance, are often on the hook for the royalties they would have owed if the business succeeded…

The Wall Street Journal
November 7, 2006

First-Time Franchisees Face a Tougher Road
Jaclyne Badal

Amid strong profits at franchising giants such as Domino's Pizza, Yum! Brands and McDonald's, buying a franchise may sound like an attractive way to go into business for yourself.

But be careful. A franchise is an investment, and like many complex investments, it merits a big "buyer beware" sticker.

Buying the right to operate a business under a nationally recognized name can give you a leg up compared with starting a restaurant or other business from scratch. But start-up fees can be steep, ranging from under $50,000 to over $1 million. Later, advertising fees and royalties will cost about 8% of gross sales, on average, according to the International Franchise Association and FRANdata.

Franchise fans often boast that buying a franchise increases the odds that you'll be a successful entrepreneur. But Timothy Bates, an economics professor at Wayne State University in Detroit, found that's not necessarily the case. He found that 38% of young firms that open a franchise fail within five years, compared with 32% of young firms that go it alone.

Mr. Bates says franchises have a high overall success rate because they're usually opened by veteran operators with multiple locations. New entrepreneurs who open a single franchise face much bleaker odds. (To be sure, these failure rates are tough to measure; some studies put the overall small-firm failure rate higher.)

To increase the likelihood of being a franchise success story, Mario Herman, a Washington, D.C., franchise attorney, recommends scouring the franchise offering circular for fees and possible penalties, as well as earnings projections. Prospective franchisees are supposed to get the disclosure document 10 days before they're asked to sign the contract.

Mr. Herman notes that franchisees often leverage everything they own — borrowing against the house or dipping into the retirement fund — only to fail later because they can't meet ongoing obligations to the franchiser.

"The franchiser makes money whether you do or not," Mr. Herman says. Make sure you know what you'll pay for royalties, advertising and other fees. Experts also suggest talking to people who have already bought into the franchise — especially those that failed.

The interests of franchisees and franchisers don't always align, says Peter Horan, chief executive of, an online guide for small businesses. Discuss the company's support network, past problems and ongoing challenges. Find out whether the franchisee would do it over again, given a second chance.

Franchisers are supposed to disclose who is in the system, but the list may be pared down to include only veterans or successful business owners. Prospective buyers can get a more realistic picture if they ask for the entire list and talk to people who have quit, as well as those who have done well.

As you vet possible business opportunities, also take a hard look at yourself. A franchise is "not for the creator or the tinkerer" who will chafe at working within a system and playing by the company's rules, says Nick Bibby, a principal at the Bibby Group, a Shreveport, La., consulting firm.

A franchise consultant or broker may be a good resource for people who want to consider several opportunities. But buyers should know that a consultant may get commissions from the companies, which can color advice.

Your best bet is to work with a franchise attorney and an accountant, who can run the numbers and check the contract for problems. Franchisees who fold early, for instance, are often on the hook for the royalties they would have owed if the business succeeded, says Mr. Herman, the attorney. A pro can sometimes add an addendum to the contract that will spare the franchisee from paying future royalties.

To learn more, start with the Federal Trade Commission's "A Consumer Guide to Buying a Franchise," available at, as well as at the Small Business Administration's site, and The Wall Street Journal's free also have how-to sections devoted to franchising.

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