Balancing Franchise Risk for Small Business Success

There’s more than one way to strike out on your own, satisfying your entrepreneurial spirit. Buying an existing business is one approach, presenting several advantages for first-time business owners. Launching a start-up is another option, giving you a high level of control over every aspect of your commercial venture. Joining an organization as a partner or working investor provides a third alternative, enabling you to hit the ground running, in an enterprise that has already overcome some of the challenges associated with a brand-new business. Becoming a franchisee presents yet another viable entrepreneurial path for motivated self-starters.

With more than 750,000 franchise businesses operating in the US, the ownership model has become vital to many industries. It isn’t just a restaurant phenomenon; franchisees do business across the entire employment spectrum.

From fast-food chains to residential cleaning services and tax-preparation specialties, franchises comprise a unique group of business opportunities, well-suited for entrepreneurs willing to tread a proven path, while still exercising the spirit of self-employment. If you’re considering franchise ownership, advanced planning and thorough vetting can help you succeed, pursuing a profitable endeavor. For bankable results, consider all the risks and rewards of becoming a franchisee, before jumping in with both feet.

Risk Considerations for Franchisees

Mark Siebert wrote a compendium for would-be franchise entrepreneurs.  A recently published Entrepreneur article highlights excerpts from his book The Franchisee Handbook – Everything You Need to Know About Buying a Franchise, focusing on several risk factors of which you should be aware, when considering a franchise purchase.

According to Mr. Siebert, it’s important to consider franchise investment risk, before entering the field at the ownership level. He suggests the relative power of individual risk factors is secondary to the overall exposure associated with the cumulative impacts of various elements of risk. In his estimation, identifying individual factors and assigning each concern to its place on the risk axis, creates over-arching understand of broad risk exposure. Failing to account for the sum of individual franchise risks may be enough to undermine your venture.

Flash in the Pan?

Fads come and go, impacting commerce in various ways. When assessing franchise risk, concepts with lengthy track records and well-established markets may have greater staying power than ventures built upon passing fancy. Markets continually shift, so franchise longevity is never guaranteed. But established franchises offer greater likelihood for perennial performance.

New business concepts may carry greater initial risk, but getting in on the ground floor can also create strong upside potential. Mr. Siebert suggests that up-and-coming franchise ideas can help you make money, but he also acknowledges that getting out early may be a good strategy, when riding the wave of unproven franchise concepts. A captive market or prime location can help, in such cases, but he advises against investing in franchise fads that may not endure.

Regional and Seasonal Risks

Creative, forward-looking entrepreneurs are always searching for the next great business idea; the same holds true for franchise developers. When assessing franchise potential, it’s important to consider regionality and seasonality.

One Handbook excerpt asserts the notion of regional sway, providing an example pertaining to US barbecue specialties. While North Carolina barbecue may be conspicuously absent from the Texas culinary landscape, regional preferences may explain the void. Texas barbecue trends favor beef, while North Carolina’s signature BBQ is all about hogs.

The regional contrast doesn’t necessarily rule out successful cross-pollination of the two barbecue styles, but your franchise risk assessment should consider all the possibilities. Identifying a vacuum in a particular area can indeed indicate franchise opportunity, but there may be other factors at play, limiting a concept’s regional viability.

Seasonal factors should also be considered, when evaluating franchise potential.  A shave-ice business may thrive on Chicago’s Gold Coast, during a July heatwave; good luck selling gourmet Illinois snow cones in February.

Regulation and Oversight

Franchises are subject to regulation at the state, local, and federal levels. While compliance is straightforward in many cases, requirements are less clear-cut in other instances. In his book, Mr. Siebert points to the emerging Cannabis industry as a prime example of how shifting laws and regulations can muddy the waters for franchise investors. While the winds of state politics presently blow in the direction of marijuana decriminalization and commercial legitimacy within the industry, an unanticipated reversal could decimate your cannabis franchise investment, overnight.

Economic Flexibility and Fortitude

No matter when you launch your franchise business, you’re entering the market under a particular set of economic conditions. What if circumstances change? How will your franchise business fare, subject to different influences?

You can’t predict the future, but you can rest assured, economic conditions are forever in flux, sometimes taking turns for the worse. Some businesses are less affected by recession, than others. In fact, certain types of franchises thrive during economic downturns. Goods and services driven by perennial need are generally safer bets, when compared to business concepts closely tied to discretionary buying power.

When personal spending strength bows to economic pressure, discretionary purchases are often the first to fall. Your retail, entertainment, or service business may suffer, as a result. On the other hand, belt-tightening may not dramatically reduce revenue within industries such as health care, education, or burial services.

Capital Concerns

Undercapitalization impacts individual franchise units, as well as creating problems for franchisors. Before making financial commitments, you should examine franchise disclosure documents and vet franchisor’s credit strength. Mr. Siebert’s book suggests obtaining a Dun and Bradstreet credit report.

With the help of an accountant familiar with franchise finance, it’s important to accurately assess various financial reports and enter into your franchise agreement with thorough understanding of your capital risk exposure.

Franchise ownership presents a viable business strategy for committed entrepreneurs.  Advantages of becoming a franchisee include the benefits of an existing market presence, a proven business blueprint, and networking opportunities within franchisor organizations. Mark Siebert’s book on the subject, recently highlighted by Entrepreneur, provides risk assessment insight you can use to reduce your downside exposure.