I’ve been an unemployed engineer for 3 years. I’m told I have too much experience (meaning I look too old and cost too much.) If I have to do something myself, are franchises worth looking at?
I like your question because you ask about “worth.”
Unfortunately, I get too many letters from franchise owners, especially Veterans, who “want out.” They realize they overpaid for a franchise usually within the first year after purchase and now have to live with big debts and big regrets.
Why does this happen so often? The overly eager franchise buyers didn’t pay attention to the quantitative issues where they could lose hard cash because the people selling the franchise kept their attention on all the feel-good lifestyle reasons to become a franchise business owner. At the end of the day, they didn’t make any money and didn’t have any fun as a business owner. Actually the reverse was true.
At the top of the reasons why franchise owners experience buyer’s remorse is they wildly overpaid for the franchise. It’s like buying a used Chevy for the price of a brand new BMW. Just because a franchise company says one of their franchise units is worth X, doesn’t mean that it is really worth X.
Our approach to buying a business or franchise is to always buy on purpose rather than passion.
Are there some good deals in the franchise arena? Possibly, but you have to be willing to work hard to negotiate the purchase price down to a sensible price. This means not just accepting a discounted price but a price at or below market price.
Here are five recommendations to get you started on your search.
- Set higher standards.
If your objective is to merely “go into business for yourself” or “own a franchise” then your aspirations are not high enough to be a successful business owner. After all, you will achieve your goal of business ownership the day you sign the franchise contract! Then what?
A more purposeful objective is to own a franchise that will make money for you. When you set high standards for your financial return on your invested time and capital your due diligence questions become more precise and thoughtful.
- Understand sales rep motivations.
When you start to explore different franchise opportunities, you will come in contact with franchisor representatives and business brokers who have just one purpose—to sell you a franchise as fast as possible at the highest price possible. They are on the side of the franchise, not on your side. No matter how “supportive” they seem, they are not your trusted friends or unbiased financial advisors.
Certainly don’t sign any franchise agreement without prior review from an experienced corporate attorney who also understands franchise valuations and royalty obligations.
- Add up the total cost of acquisition.
Sneaky franchise brokers are adept at hiding the true investment cost of owning and managing a sustainable franchise. If you sign up to buy a franchise, your cost of acquisition is more than the down payment. Include the amount you have to borrow to acquire the franchise plus other savings you may have to apply to the business until it achieves at least cash flow breakeven.
When you know your true cost of owning and operating a business, compare it to other investment opportunities. What free cash flow is the business likely to generate? Would you be better off buying a less risky S&P 500 stock that pays a stable 2% dividend?
- Include your compensation.
Another trick of franchise sales reps is to present impressive financial projections of average franchise unit performance. Look closely at these projections. Do they include a budget allocation for the owner’s salary, healthcare, adequate insurance and other real world expenses associated with running a business? If there is no allocation for an owner’s salary and benefits and you intend to work full time in the business, beware!
Remember, year-end profits should be your financial return on your invested capital, not your sole source of compensation for working 40 to 70 hours a week to keep the franchise alive! And remember, many new franchises don’t ever generate a profit. Double ouch!
- Understand market value.
Buy low, then sell high. If you pay $25,000, $50,000, or $100,000 to buy into a franchise, then you should find evidence that other franchises can be sold at least for that much or more. Unfortunately, the opposite is true.
Research the market for different franchise brands. What are the average resale purchase prices in your state? Who buys up franchises when the owner wants out? Does the corporate office buy back franchises? What does the franchise agreement call for? Frequently, one regional franchise operator buys distressed properties at deep discounts.
Given all the risks associated with owning a business and personal obligation to repay debt, you should walk away from any franchise that cannot eventually be sold for at least two times your invested capital and of course pay you an interim salary in each year you own the franchise.