The Practical Entrepreneur: Buying a Business and Franchising, Part I

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I have never bought into an existing business. Presumably, had I done so, I would have had the benefit of the vendor's experience to guide me. Whether mine is a good or bad policy is irrelevant, I wanted the challenge (and lower cost) of building a business from scratch. Sometimes it worked, other times it didn't. But along the way, I have also been a student of other peoples' successes and failures in taking over a going concern.

You're new in the business, and say you need $50,000 for inventory, and more, and can only come up with $40,000. You are better off than if you had $60,000. There is a fundamental rule in business that says you should always be short of capital. Nearly every new enterprise that I provided with sufficient working capital lost money. The businesses that I've starved for cash, instead prospered. One must substitute ideas and hard work for money. Rely on your common sense and gut-feeling about where your enterprise is going. Disregard all statistics, favorable or unfavorable. Avoid like the plague anyone or any outfit in the consulting racket. You can't afford their fees and they can't help you.

An interesting aside: Should you get sound advice for free from a friend or relative, you are not likely to follow it. It seems that only when one pays for advice does one proceed on the advice.

It will serve no purpose to discuss the acquisition of large firms by other large firms, but I would like to touch briefly on your buying into a franchise operation. As far back as 1995, the following is the result of surveys of hundreds of franchisees:

32 percent got full value of ad fees paid to the franchiser
80 percent broke even
62 percent earned less than the franchiser promised
40 percent of the time the franchiser has encroached them with other business
91 percent saw their profits suffer as a result

In order of gravity, here are common complaints by franchisees:

1. Inaccurate pro forma financial statements.
2. Contract length too short to recover investment.
3. Poorly defined franchise agreement.
4. Lack of startup assistance.
5. Inadequate marketing or operations manuals.
6. Insufficient training.
7. Poor communication.
8. Poor dispute resolution.
9. Creative accounting.
10. Broken pre-contractual promises.
11. Uncompetitive pricing of supplies.
12. Breach of territory.
13. Unnecessary renovations at unreasonable cost.
14. Unreasonable payments to franchiser.
15. Ineffective advertising.
16. Impediments to selling the business.

Aggressive businesspeople are uncomfortable working within a franchise system. They are required to buy all supplies through the franchiser though they can be gotten elsewhere for less. There is the cost of royalties (3 percent to 10 percent) plus contributions to an advertising pool. The franchiser also keeps all suppliers' rebates. Hours, decor, prices, and staff uniforms are all by formula—a formula that has obviously proven itself. The franchiser knows your sales and net take-home profit. Should you be lucky to exceed projected earnings—watch them plant another outlet just blocks away. Your ideas and input will be appreciated if you are a success within the organization. Having said that, if you want a degree of safety, a good franchise may be the route to take.

Most franchise operations are of the “waiting for the customer to come to the shop” variety. An inexperienced, lazy, or sloppy franchisee can ruin a potentially good outlet. Good franchisers, like the Body Shop, screen their franchisees carefully.

Manny Drukier has been in business, from manufacturing to publishing, retail to real estate, stocks to stockpots for the past 60 years. He is the author of two books and resides in Toronto, Canada.