To Build, To Franchise, or to Buy an Existing Business……That is the Question
Should you be the architect of a new business and start from scratch, buy a new franchise, or buy an established existing business?
Every year, thousands of people consider going into business for themselves and these are the three routes to get there. Each course has advantages and disadvantages that one should consider.
Starting your own new venture can be very rewarding but needs to have a unique product, technology or service, and a planned operating procedure. One would need to complete a thorough evaluation of the marketplace, competition, availability of employees, suppliers, marketing collateral would need to be designed and printed — to name a few. An in-depth Business Plan would need to be formulated. If you start your own business, you will not be paying for Goodwill, Bluesky, Royalty Fees or Franchise Fees. You could, perhaps, even start from your home with no employees and greatly reduce the initial capital requirement. With modern technology today a one-person show can seem like a large operating enterprise.
However, you will need to support yourself (and family) from personal savings. There may be months or years before profits are sufficient to provide the level of income needed. Mistakes will be made along the way and new approaches will need to be taken as the business takes shape. Obtaining financing may be very difficult as there is no track record and no customers. For quite some time the general belief and “rule of thumb” has been that 95% of new business start ups fail within the first five years. After doing some research, the most recent study on the subject that I was able to find was published in 2002 in a report by Brian Headd, an Economist with the SBA Office of Advocacy. Headd cited that a more accurate assessment of new business start ups is a 60% failure rate within five years based on the premises he used. Here is the 11-page report — Redefining Business Success: Distinguishing Between Closure and Failure.
This is a far cry from the previous long-held belief that 50% of businesses fail in the first year and 95% fail within five years (Patricia Schaefer, in The Seven Pitfalls of Business Failure and How to Avoid Them).
Buying a New Franchise
Franchises are a known entity and have proven concepts. When you buy a new franchise, it comes with franchiser support such as national marketing campaigns and materials for local campaigns, has established relationships with suppliers, and established methods of operation. Training is provided by franchisers and is usually substantial, and some franchisers provide loans. With a new franchise, a good Master Franchiser will do a demographic study to assist with choosing a location for the new business. Population, drive-by traffic, potential customer base and a whole series of factors go into the results of the study that will indicate that “theoretically” the business should do well but they can’t guarantee your success.
New locations can take a year or more to build and initial start-up costs of a new franchise can exceed the cost of non-franchised business start-ups or buying an already established business. You will have to pay part of your monthly gross (yes, before expenses) as royalty fees (forever), reducing your profit potential. You will also have to pay a franchise fee and, in some instances, a monthly fee for marketing support. Franchise contracts have very explicit standards, allowing little or no alterations or additions to the brand, stifling any creativity on the part of the franchisee. You must use their system and follow their rules. Some franchise contracts stipulate that franchisees must buy supplies only from an approved list of suppliers, possibly at a higher cost. The reputation of your franchise is only as good as that of the franchiser, so any difficulties that the franchiser encounters will have a direct impact on you.
There’s always risk in starting any new business and a new franchise is no exception. Everyone has heard that new franchises are safer and less risky than non-franchised start-ups and only have a 5% failure rate. Well, I was somewhat suspicious of that standard. So, in order to back up my suspicions, I did the research. There really is very little independent research out there. But what I discovered was not surprising. Since franchisers sponsor most research about franchise success rates, it is important that you ascertain the sponsorship of the information you read. Some of the reasons for not fully understanding the chances of failure in a new franchise include the fact that many are taken back by the franchiser, taken over by a third party by purchasing the assets, resold to a fellow local franchisee, or recapitalized by banks using the assets as collateral. They fall under the radar of failed enterprises. Due diligence is very important before embarking on any new venture. You may want to read the the findings of these five studies that disagree with the assertion of only a 5% failure rate for new franchise start-ups.
Hidden Risks of Franchises
The Failure Interview with author of “Franchising Dreams
The Truth About Franchising
MIT Sloan Management Review
Buying an Existing Business
Buying an established business may be a more efficient way to business ownership. Here’s a list of the advantages of buying an existing business:
aGoodwill and Reputation
aA Historical financial track record
aEstablished customer / client base
aEstablished suppliers & vendors
aFurniture, Office Machines & Communication Equipment are in place
aRelationships with professional advisers, insurance companies, advertisers
aLocation has already been market tested & proven
aPolicies and procedures are in place
aPricing and competition are a known quantity
aBank Finance Options
The advantages of buying an existing business generally outweigh the disadvantages. Existing businesses can normally obtain financing from financial institutions because they have an established history, assets, and a proven idea. The seller will quite often provide training and a portion of the financing in the form of a loan. Seller financing is beneficial to both buyer and the seller. SBA Financing is also a strong possibility provided the business has good financial records.
In summary, the first two options have higher risks and no proven track record in the new location you choose. In a new business start-up, however, if your idea is a winner, the personal satisfaction and monetary rewards may be worth the gamble. Inc Magazine reported in October 2002 that 14 percent of Inc. magazine’s 500 fastest-growing companies in the United States started with less than $1,000.
On the franchising side, there are some great franchises out there but may have frigid rules and ongoing fees that can bog you down. Finding an existing business with all the ingredients for success already in place is a safe investment and a platform from which to grow and launch new ideas. By far a much more flexible and less risky avenue to successful business ownership. No matter which road you take, there are no guarantees. You still need to be a sharp business person to make it work.
I have been fortunate to experience two of these types of business ownership. First, turning a vision into a new business venture and nurturing its growth until its sale 15 years later. And, second, purchasing an outstanding existing enterprise that fulfills the entrepreneurial spirit almost as much as the former.