5/1/2013 8:00 PM ET|
Considering a franchise? Be wary
Off-the-shelf concepts make it easy to start your own business, but you can easily lose your shirt. And many chafe under the rules and restrictions.
Mary Pelach had a pretty good idea of the risks when she invested $175,000 in her first Batteries Plus franchise in Sioux Falls, S.D., 20 years ago. She and her husband, Gary, used savings, money gifted by his mother and a $100,000 Small Business Administration loan.
"Your hands are just shaking when you're signing document after document," Mary Pelach recalled. "It's worse than getting a mortgage."
Buying a franchise means buying a concept, along with training, marketing, support and often supplies. Instead of starting from scratch, franchisees can get a head start. Some people make a decent living. Some even get rich.
Then again, plenty of people fail.
Those who come out on the short end buy into an idea that's lousy or dated. They're hamstrung by company policies over which they have no control. Rather than get rich, they lose their investment and then some. Some failed franchise owners have even been sued by the companies that sold them their businesses for "liquidated damages" -- a percentage of all the revenue they were supposed to earn, but didn't.
"People lose their money, they lose their houses," said franchise marketer Sean Kelly, a former marketing director for the Auntie Anne's pretzel chain who publishes the FranBest and Unhappy Franchisee websites. "There's been this myth . . . that franchises are a safe route in business, and it's just not true."
Mary Pelach was 41 and ready to leave a corporate telecommunications job after her department suffered through three brutal rounds of layoffs. If keeping a job was this uncertain, she reasoned, maybe she'd be better off employing herself.
But she didn't want to go it alone. She liked the idea of someone else "inventing the wheel" and offering her support.
The couple investigated various franchise options, quickly ruling out fast food. "You have to throw out your inventory every 11 or 12 minutes!" Pelach said. She liked the idea of a one-stop shop for batteries, but Gary, then a 47-year-old airline pilot, initially dismissed the idea.
"My husband thought it was absolute hooey," Mary recalled. "I said, 'Think for a minute: How many battery-operated gadgets do we have in our home?'"
The couple took the plunge. Gary continued working as a pilot while Mary set up and ran the business. Within six months, she was able to pay herself a salary.
Two decades later, the couple owns four Batteries Plus stores in two states, and Gary has long since retired. Their son and daughter-in-law are working with Mary to learn the business. They'll take over when Mary's ready to retire.
"They will run it," Mary said. "We will continue to draw a check off it."
Franchises worked out well for her, but Mary warned that the model wouldn't be a good fit for someone who wants to call all the shots. You need to be entrepreneurial enough to take the risk, she said, but not so independent-minded that you would chafe under the franchisor's many restrictions.
"Make sure a franchise is what you want to do," Mary said. "With a franchise, you do have to follow their rules and their processes."
Franchises make up 10% of all employer businesses, according to the Census Bureau, employing 7.9 million people and accounting for one out of every six dollars spent at a business.
The possibilities go well beyond fast-food outlets, gas stations and convenience stores. Franchisees offer massages, scoop dog poop, inspect for bed bugs, sell sex toys, tutor kids and clean houses.
Investing in a franchise isn't cheap. The total initial investment, including the franchise fee, location expenses, supplies and equipment, typically runs $200,000 to $300,000, said Alisa Harrison, a spokeswoman for the International Franchise Association, a trade group. Creditworthy applicants can get SBA loans, but franchisees are typically required to contribute a chunk of their own capital -- often 20% to 25% of the total amount required.
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Some franchisees dip into retirement funds to come up with the cash, a risky move not to be taken lightly -- or too late in life. Certified financial planner Chris Fahlund of T. Rowe Price said those who gamble on a franchise in their 50s or even late 40s risk never being able to recover financially if the business fails.
And it's very much a "buyer beware" industry, Kelly said, despite the perception that franchising is heavily regulated. The best franchise companies focus on guiding their franchisees to profitability, he said. Some of the worst focus on selling as many franchises as possible without regard to whether the buyers, or the concept, have any chance of success.
"There are good franchisors, bad franchisors, mediocre franchisors," Kelly said, "and some outright scams."
Kelly tells of one company that required potential franchisees to make deposits of $35,000 to $50,000, with the assurance that their money would be refunded if they couldn't arrange the financing needed to start their businesses. When depositors asked for their money back, however, the company said it was gone.
"You can't go to the police, you can't go to the FBI," Kelly said. "Even if it's as blatant a theft as stealing your car out of your driveway, it's a civil matter. You have to hire a high-priced attorney and do battle that way."
So what can you do to protect yourself?
Schedule a visit with a fee-only financial planner. You need a clear-eyed assessment of your financial situation and advice about whether your pockets are deep enough to consider a franchise investment.
Do research. Due diligence is essential not just to avoid potential scams, but also to find a winning concept that's the right fit. The IFA and SBA sites are full of resources and advice for potential franchisees. The Unhappy Franchisee website details the trials, tribulations and lawsuits of many who have already invested.
Talk to the departed. Franchisors are required to give potential franchisees a detailed disclosure document that includes the names and contact information of every current franchisee, as well as those who have recently left. Kelly advised talking to as many of these former franchisees as possible to get a fuller picture of the company.
"Some of these people are wary of giving you too much information if it's negative," said Kelly. "If you talk to a lot of them, you'll start to get a picture."
Hire the right help. An experienced franchise lawyer is essential, since the agreements are complex. A franchise consultant can also be helpful in assessing the opportunities. Kelly warned that some of those who bill themselves as consultants are salespeople in disguise who are just trying to line up warm bodies for a fee paid by a franchisor. He was particularly scornful of "personality tests" some consultants give, which he said are often a way to figure out which pitch the client is likely to fall for.
"I hyphenate 'con-sultant,'" Kelly said. "They're really sales associates. They find out your hot buttons, what motivates you, and use that against you to sell you."
Consider the tradeoffs. Upfront costs can be high, and franchisors typically take 5% to 6% of each month's revenues. You're giving up your autonomy. On the plus side, you may be getting name recognition, the chain's buying power for supplies and access to their training and support programs. "You have to ask, 'Is this going to yield benefits, especially sales benefits, that outweigh the disadvantages?'" Kelly said. "I would say you would want sales that are 10% to 20% more than if you opened up your own place to make it worthwhile."
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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This stupid Jeep commercial background is placed so you can't read the story.
she needed to find a franchise to simply sell batteries?
she's such a part of the article that it almost sounds like a sales pitch to sell the particular battery franchise than franchises in general!
Yeah, I agree with dw9seattle, why do all the interesting msn money articles have partially blocked out text. I really wanted to read this one, and gave up on the retirement article because 1/4 of the text was block by an add.
Any wonder why Microsoft is rapidly losing market share.... good gawd...
How these hacks can sell out so blatantly is beyond my understanding.
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