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Buying a Franchise vs. Starting a Business ©

Written by: Dennis Gerschick

Article Overview: During economic downturns, many employees get laid off from their jobs. They are then faced with the question of what they do next. They may file for unemployment benefits and look for another job. Others may consider buying a franchise or starting their own business. This article discusses the advantages and disadvantages of buying a franchise versus starting a business from scratch.

Buying a Franchise vs. Starting a Business ©

During economic downturns, many employees get laid off from their jobs. They are then faced with the question of what they do next. They may file for unemployment benefits and look for another job. Others may consider buying a franchise or starting their own business. A key factor to consider is the entrepreneur’s prior work experience. What have they done in the past? Do they have experience in operations, marketing, finance or accounting? Is their prior experience relevant to the type of business they want to start? Which is the best option for them? Like most things in life, there are advantages and disadvantages to each.


Buying a Franchise

In theory, when you buy a franchise, you are buying a well-known name, a brand, and an established and presumably successful way of operating a business. The franchisor has already done some of the heavy lifting by demonstrating that their concept works; it is saying, “We’ve already done it, and you can do it too. Customers know our brand name and they will come to you.”

In starting any new business, there is a “ramp-up” phase and learning curve. Buying a franchise allows the franchisee to expedite the process by benefitting from the franchisor’s experience. The franchisor can help in numerous ways by giving advice about a location, telling the franchisee what equipment and supplies to buy, providing training in operating the business and complying with the franchisor’s requirements. Franchisors, however, differ significantly in the level of help they provide. Some franchisors start franchising too soon when they might have just a few of their own stores or operations. The franchisor’s name and brand may not be well known yet so the value of them may not be worth the requested franchise fee.

There are federal and state laws applicable to franchising. Failure to comply with the laws can have adverse consequences for the franchisor. The law requires the format and content of the disclosure document to comply with certain requirements. In short, the purpose of the disclosure document is to give potential franchisees enough information to make an informed decision as to the potential upside and the risks involved if the franchise is purchased. Franchisors often require franchisees to personally guarantee obligations under the franchise agreement and to have a specified minimum personal net worth. The disclosure document will include information on the franchise fee to be paid and the royalties to be paid to the franchisor (typically a percentage of the franchisee’s gross revenue). It will also set forth the other requirements a franchisee must comply with to avoid having the franchise agreement terminated. In short, the franchisee must do things the franchisor’s way, so the franchisee’s creativity and flexibility are limited. A potential buyer of a franchise should read the disclosure document carefully. They should consult with a competent attorney and financial advisor about the risks and the assumptions that are included. In short, focus on what benefits the franchisor provides and the real cost of such benefits. Can the potential buyer do better by starting a business from scratch and doing it themselves?


Starting a Business

Starting a business from scratch is challenging to say the least. The owner should consider, if there is a demand for the product or service. How does the owner know? Has any market research been done? The owner will have to bring together all of the necessary ingredients to make a successful business. What will be needed? How will the business be marketed? What advertising will be done? What technology is needed? What supplies and/or inventory are needed? What equipment is needed? Is a tangible location needed? Will space be purchased or leased? Will it be a good location for that type of business? How many employees or independent contractors? What expertise is needed from each individual? How do you find the qualified people? Will all of them mesh well and work as a team? The owner will need to address numerous details. Is the owner detail oriented? Do they have the experience and know-how to bring everything needed together? Are they really an entrepreneur who is willing to assume all of the risks and do whatever is necessary to reach the level of success they desire? Many people prefer the perceived security of a fixed salary, set working hours, and fringe benefits provided by an employer. Many people do not want the responsibility of owning and managing a business. Not everyone is a leader; some prefer to be a follower. By simply following orders, they do not have to think as much or assume the risk that their decisions will be wrong. Aspiring entrepreneurs should ask themselves honestly, are they a leader, or a follower. Are they a self-starter or do they need to be told what to do?

A well written business plan will address all of the above and many other questions. In short, the owner should consider how much time, money, and employees are required to get the business going. Financial advisors can help potential owners tremendously by helping them produce a monthly cash flow projection and questioning each assumption that is made. What are the fixed costs? What are the variable costs? What is the expected revenue? What are the gross and net margins? I’ve managed a venture capital fund since 1999. I learned long ago about the “2 & 4 rule.” It takes twice as much money and four times as much time to implement a plan as the entrepreneur expects. There must be enough capital available to subsidize the business until it reaches the needed profit and positive cash flow levels. Many businesses fail because the owner does not have the necessary capital. Obtaining a bank loan may not be a viable option, especially in 2009’s economic environment. Many entrepreneurs turn to family and friends for start-up capital. Selling securities means that federal and state securities laws are applicable; onerous penalties can be imposed for failing to comply with them. Entrepreneurs should consult with a competent securities attorney before taking money from any investor. There are numerous ways to structure an investment and entrepreneurs should consider the advantages and disadvantages of each before proceeding.


Which Option is the Best?

Starting a business from scratch allows an entrepreneur to do things their way. They have total control and do not have to report to a franchisor or meet its requirements. The entrepreneur will save the amount of the franchise fee and the monthly royalty. Franchisors will provide some help in getting started, but going it alone means the entrepreneur has to find the help they need. They will need to build a brand and attract a sufficient customer base. They will need to learn as they go and adjust their plan based on what works and what doesn’t. Buying a franchise costs more, but it may reduce stress and save time. Entrepreneurs need to evaluate all of the trade-offs.

Entrepreneurs should acknowledge that they do not know it all and get the help they need. Buying a franchise can be beneficial in this respect too, because franchisors often provide training programs. In contrast, many entrepreneurs try to learn as they go and tend to do too much themselves. Time really is money. Good advisors can expedite the process and help entrepreneurs avoid the pitfalls. Unfortunately, in an effort to reduce expenses, entrepreneurs do not always seek advice which is often penny wise and pound foolish.

Conclusion

Desperate times may require desperate measures. People usually do whatever is necessary to survive. However, when people get desperate they do not always think things through carefully. Haste does make waste. Many issues should be considered. Aspiring entrepreneurs should seek advice from experienced business people who have gone through the process before. They should ask, what am I overlooking? What can go wrong? Advisors can help people work through these issues and improve the odds of their success.

Related Articles
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  Franchising Continues To be a Safe Way to Go in Troubled Economy
  A Research Report: Good Reasons for Buying a Franchise Business
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Article Tags: accounting, brand name, buying a franchise, consequences, disclosure document, economic downturns, entrepreneur, failure, finance, franchise fee, franchisee, franchisor, heavy lifting, learning curve, new business, own business, ramp, state laws, unemployment benefits, work experience



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