Is Your Future in Franchising? Assess the Opportunity and Risk

Franchising is one of the hottest retail trends in small business today. Consider these statistics:

* Franchised businesses take in $1 of every $3 spent by Americans for goods and services.

* One of every 12 businesses in the United States is a franchise operation.

* Franchising accounts for about 40% of all U.S. retail sales.

That’s according to the latest statistics from the International Franchise Assn., a 32,000-member trade organization of franchisers, franchisees and suppliers.

Don J. DeBolt, president of the IFA, explains the basics about franchising, how to get started, why it’s so popular and how to determine if it’s a small-business opportunity for you. He was interviewed by freelance writer S.J. Kelly.

Question: What exactly is franchising?

Answer: It’s a business strategy or method of distribution that solves the two major problems for business expansion--people and money. The first franchiser was the Catholic Church. The way the Pope awarded various territories: Money was collected and forwarded to Rome, and part of it remained back in the particular area that the church operated. Today there are about 2,000 different kinds of franchises in 70 different industries.

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Q: Why is franchising so popular?

A: We have a very entrepreneurial culture. Many people want to be their own boss. Franchising truly gives them an opportunity to be in business for themselves and not by themselves. People are willing to invest in a franchise because they acquire a known and recognized trademark. They acquire an operating system that has already reached a level of perfection and they also receive ongoing training and support plus marketing and advertising support.

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Q: What is the biggest industry for franchising?

A: The hottest franchise industry and the fastest-growing today is food service. Upscale dining is an area that’s getting a lot of attraction. And you have emerging franchise concepts now that are serving needs in the home health-care area.

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Q: How can a person looking at various small-business opportunities know if franchising is right for them?

A: We like to say there is a franchise for everybody, but in truth, not everybody is appropriate to be in a franchise.

In a broad sense, attributes of a franchisee must include a strong commitment and desire to succeed, with an appropriate work ethic to back it up. They must have adequate capital and financing to make the needed investment.

Some people come into franchising with unrealistic expectations and think they can open the front door and there will be a pot of gold at the back door. But in between, there is a lot of blood, sweat and tears.

We use the caveat: Investigate before you invest. There are many types of franchises and varying commitments of financial resources with varying levels of risk.

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Q: What kind of financial commitment does a franchise require?

A: Financing commitments will vary from franchise concept to franchise concept. Take a service-area franchise--a maid or cleaning service. It initially could be started out of the home with little need for a huge investment or overhead. At the other end of the spectrum is an investment in the hotel field that takes $1 million or more. So there is something for every pocketbook.

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Q: With so many big players like McDonald’s and Einstein/Noah Bagel Corp., can the owner of a small franchise compete?

A: Most people think of franchising as a big-business activity. But 80% of all franchises have less than 100 units. A typical franchise unit might be a Midas Muffler shop or gift store with $300,000 to $600,000 in annual revenue.

The small franchise unit is in a niche market and it can compete if it’s in the right location at the right time. These people may not become rich, but the small-franchise owners are probably going to take home more money than if he or she was in an average job--say for the telephone company.

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Q: Is it difficult for the average person to get financing to open a franchise?

A: Financing for the average person can be a challenge in acquiring any business, including a franchise. If you talk to bankers who are involved in making franchise loans, you’ll typically find that most find prospective franchisees [are] a preferred risk. They have dealt with people in the particular franchise system. They find it a preferred risk over making a business loan to an independent businessperson.

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Q: What are the sources of financing out there?

A: Personal savings are your first source; family and friends is the second source; the third source is banks. You’ve got to be turned down by the banks before you can qualify for Small Business Administration loans. Some franchisers even offer financing.

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Q: There has been a lot negative written about franchises--from corporate restrictions on franchisees to unfair expenses and higher failure rates compared with other small businesses. What’s your response?

A: As we all know, statistics can be depicted to portray just about any result. We just urge people to be aware of all the studies that have been done in the field.

Franchising has grown tremendously because it’s successful in creating opportunities for people to engage in operating their own business. And if it weren’t doing that, it wouldn’t be growing at this pace.

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Q: Is a McDonald’s-size operation necessarily a better franchise because of its size?

A: It’s a risk-assessment question. The larger, more established franchise concepts certainly would be a lower-risk investment, but generally they would be higher investments. Emerging franchises, companies that are still perfecting their system, may carry a higher risk. But, having said that, I’m sure there are a lot of folks today that wished they had acquired one of the first McDonald’s franchises.

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Q: One complaint you hear about franchises is that franchisers dictate too much to franchisees. When a person buys into a franchise concept, aren’t they buying into the rules and regulations?

A: That goes back to the fact that people have to make sure that their expectations are realistic. With a franchise operation, part of what you’re paying for is an operating system that is consistent and part of a rule book. If you are not somebody who can comfortably make an investment that requires you to follow the rules, you shouldn’t make the investment.

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Q: What are some drawbacks of franchising?

A: [One] is the risk associated with it as there is in any business investment. But you can control the risk in franchising.

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Q: How can you do that?

A: By your investigation. Much of it starts with the IFA’s Franchise Opportunities Guide. We even publish the Federal Trade Commission’s guide to buying a franchise as part of our guide. Another source that people can access on the Internet is the IFA Web site that contains lots of basic information (https://www.franchise.org).

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Q: What are some questions someone considering franchising can ask to determine if they are heading in the right direction?

A: Am I committed to operating my own business is the first question. Am I committed to working the number of hours that’s required to make any business successful, including a franchise? Am I willing to take the risks? Is my family comfortable with my decision? Can I develop the financing that’s going to be adequate to acquire this franchise and operate it?

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Q: How do you determine that a franchise is a legitimate business offering?

A: First, make sure the company has disclosure documents that comply with federal and state laws. Second, I would go to the section in the disclosure documents that give the names and phone numbers of current franchisees and franchisees that have left the system, and start making calls. You’ll find out in three or four calls if you want to spend any time investigating this franchise.

We urge everybody, before they make an investment, to visit the physical plant of the franchiser to see what the training facilities are, to see whether it looks like a viable operation. Are you dealing with substantial people? What’s the chemistry like?

It’s just like anything else you investigate. You’ve got to accumulate all the information and then go by your instincts.

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Q: What if it’s a new franchise you’re considering?

A: Then you are also going to have to look at the risk assessment. If you are going to be among the first franchisees, you just have to accept that this is going to carry a higher risk. That’s not bad. Being in on the ground floor of any investment can reap huge rewards. But it also carries higher risk.

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Q: What’s the future for franchising?

A: The international opportunity for expansion is really what’s going to fuel the highly optimistic outlook for franchising in the next three decades.

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Largest U.S. Franchises

1. McDonald’s Corp.

Business: Fast food

Headquarters: Oak Brook, Ill.

Total units: 22,270

Franchised units: 17,621

Company-owned units: 4,649

2. Southland Corp. (7-Eleven)

Business: Convenience stores

Headquarters: Dallas

Total units: 16,286

Franchised units: 13,819

Company-owned units: 2,467

3. Subway

Business: Fast food

Headquarters: Milford, Conn.

Total units: 13,000

Franchised units: 13,000

4. Burger King Corp.

Business: Fast food

Headquarters: Miami

Total units: 8,253

Franchised units: 7,495

Company-owned units: 758

5. KFC Corp.

Business: Fast food

Headquarters: Louisville, Ky.

Total units: 8,187

Franchised units: 5,964

Company-owned units: 2,223

6. Pizza Hut Inc.

Business: Pizza

Headquarters: Dallas

Total units: 7,200

Franchised units: 7,200

7. Tandy Corp. (Radio Shack)

Business: Consumer electronics

Headquarters: Fort Worth

Total units: 6,779

Franchised units: 1,890

Company-owned units: 4,889

8. Jani-King International

Business: Janitorial, cleaning services

Headquarters: Dallas

Total units: 6,189

Franchised units: 6,156

Company-owned units: 33

9. Taco Bell Corp.

Business: Fast food

Headquarters: Dallas

Total units: 5,644

Franchised units: 2,600

Company-owned units: 3,044

10. International Dairy Queen Inc.

Business: Ice cream/fast food

Headquarters: Minneapolis

Total units: 5,347

Franchised units: 5,347

Sources for More Information

International Franchise Assn., 1350 New York Ave. N.W., Suite 900, Washington, DC 20045-4709; (202) 628-8000; https://www.franchise.org

“Legal Guide for Starting and Running a Small Business,” by Fred S. Steingold (Nolo Press, [800] 992-6656; https://www.nolo.com)

Small Business Administration, Los Angeles District Office, 330 N. Brand Blvd., Glendale, CA 91203; (818) 552-3210; https://www.sba.gov