While owning a franchise can be profitable, it is debatable that franchise ownership has made “countless Americans rich,” as claimed in a recent article published by The Economist. This also ignores data suggesting that the average single-unit franchise owner earns less than $100,000 annually, and that for new owners, the average is closer to $50,000. Additionally, around one in ten franchises fail completely within the first two years.
The Economist recently published an article titled “Franchising Has Quietly Made Countless Americans Rich.” The article begins with the story of Greg Flynn, the billionaire owner of “more than 3,000 franchise outlets across seven brands in three countries.” While it acknowledges that Mr. Flynn’s story is not representative of the norm, the attention-grabbing headline nonetheless raises false expectations about the realities of franchise ownership. Learn more from national franchise attorney Jeffrey M. Goldstein.
Owning a Franchise Can Be Profitable
Owning a franchise can be profitable. Many franchised businesses have been successfully operating for a decade or more, and there are many millionaire multi-unit franchise owners. But whether franchising is making “countless Americans rich” is another story.
First, most franchisees own a single unit. Buying a franchise involves a substantial investment, and a single unit is all that most prospective franchisees can afford (typically with SBA financing or an early retirement withdrawal). Owning and operating a franchise also requires a greater time investment than most people realize—and this limits new franchisees’ ability to expand beyond a single unit. While single-unit franchise owners can earn enough to build (or rebuild) their retirement savings over time, those who amass a substantial fortune are few and far between.
Then, there is the fact that “countless” and “rich” are both subjective terms. Are franchisees getting “rich”? It depends on your definition of what it means to be wealthy. Are there many wealthy franchise owners? It depends on your definition of a lot. Proportionally, there are far more franchisees who are watching their retirement balances than there are franchisees who are sailing on yachts and jet-setting around the world.
Owning a Franchise Can Also Lead to Financial Ruin
When discussing the financial benefits of franchise ownership, it is also important to address the financial risks. While owning a franchise can be profitable, it also can (and does) lead to financial ruin.
While different sources provide different figures, it is generally understood that about one in ten franchises fail within their first two years. While franchise industry advocates are quick to point out that this is lower than the commonly understood average failure rate for independent startups (around 20 percent), this overlooks some key considerations.
Among them, investing in a franchise is often significantly more expensive than starting an independent business. Franchisees often must make substantial initial investments to meet their franchisors’ system standards and pay royalties and advertising fund fees in addition to their normal business expenses.
Additionally, when a franchise fails, moving on isn’t simply a matter of shutting down the business. Franchisees who fail can face early-termination litigation with their franchisors and will often be liable for “lost future royalties” and other damages. This—combined with the fact that most franchisees are subject to post-termination non-competitive covenants—means that closing a franchise early can have significant financial ramifications.
Prospective Franchisees Need to Make Informed and Introspective Decisions
With all of this in mind, it is critical for prospective franchisees to make informed and introspective decisions when buying a franchise. Prospective franchisees need to conduct thorough due diligence and an honest assessment of their personal chances of success as franchise owners. If you have a plan and you are confident in your ability to succeed, then buying a franchise (and perhaps multiple franchises) could be a good option. On the other hand, if you feel like you are in over your head before you have truly begun, then buying a franchise might not be the right choice for you.
Of course, there are resources available, and individuals who are not ready to buy a franchise now can prepare to do so in the future. The key is to avoid moving forward too soon—as this can prove to be a very costly mistake.
FAQs: Making Informed Decisions About Buying a Franchise
How can I ensure I am making a smart decision about buying a franchise?
Making a smart decision about buying a franchise involves conducting thorough due diligence and working with qualified professionals throughout the process. Among other things, this means talking to many current and former franchisees, attending franchisors’ “discovery days,” and hiring an experienced franchise attorney to help you understand the Franchise Disclosure Document (FDD) and the franchise agreement.
What if my franchise isn’t successful?
If your franchise isn’t successful, this can have serious consequences. As discussed above, terminated franchisees can often face substantial financial liability even after they stop operating, and they often have limited post-termination options due to restrictive covenants. For those who took out loans to finance their franchises, being unable to repay them can pose serious financial risks as well.
How can a franchise attorney help during the buying process?
During the buying process, a franchise attorney can help by explaining key risks in the FDD and franchise agreement and providing additional insights into the legal and financial risks of franchise ownership. A franchise attorney can also assist with negotiating the franchise agreement—which can be critical for mitigating franchisees’ post-termination risks (among others) in many cases.
Buying a Franchise? Schedule a Free Initial Consultation with Franchise Attorney Jeffrey M. Goldstein
If you are considering buying a franchise and would like to learn more about the legal and financial risks involved, we invite you to get in touch. To schedule a free initial consultation with franchise attorney Jeffrey M. Goldstein, please call 202-293-3947 or request an appointment online today.
