The following excerpt is from franchise expert Mark Siebert’s book, The Franchisee Handbook. Buy it now.
Conducting a thorough risk assessment is a key element of buying a franchise. So as you begin to narrow your list of potential franchise opportunities, you should first identify sources of risk in your investment decision.
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Evaluating your risk tolerance
One of the first concepts taught in business classes is the “risk-reward” paradigm. In short, it means the greater the reward, the greater the risk.
There are at least two different categories of risk you should consider. On one hand, different franchise businesses will carry different levels of risk based on how well a particular concept does in a competitive marketplace. Think about Joe’s Burgers vs. McDonald’s, and you will instantly understand the idea of concept risk.
On the other hand, risk can also be quantified based on the total amount of money you devote to an investment. While the concept risk of a low-investment franchise might be similar to the concept risk of a high-investment franchise, from your perspective, you will be putting more dollars at risk with the latter.
There are other questions you should address in assessing your risk tolerance, too. For example, are you willing to risk your career by walking away from what might be a secure job (and which, at minimum, does not require you to invest capital) to start this new venture? Are you willing to potentially risk your personal life by working 60+ hours a week?
With that in mind, let’s look at some of these risk factors so you can measure the risk associated with the franchises you are considering.
Start by asking the question of if the concept is a fad. If it’s been around for years and has an established market, it will probably be around in the future — absent other changes in the market.
But if it’s new to the market, be careful. Remember, new can often mean “higher risk.” Franchise fads can allow you to make money, especially if you jump in early (and perhaps get out early, too) or secure a location that gives you a captive market for a popular product. But be careful about jumping on any bandwagon if it seems faddish.
If there are few intellectual property protections, it will be easier for competitors to enter the market. If there are low financial barriers to entry, this will make a proliferation of competition even more likely. Ultimately, the more competitors there are in a market (or the more there will be in the future), the greater your risk. So if your potential franchisor does not have a sustainable point of difference, consider whether you should include the “fad factor” in your risk calculation.
Regionality, seasonality and predictability
You must also evaluate whether the concept will work well in your chosen market. Let’s say you’re from North Carolina and just love the local barbecue. When you relocate to Texas and see that there aren’t any restaurants serving North Carolina-style barbecue, you may think there’s a real opportunity — and maybe it is.
But perhaps there’s a reason North Carolina barbecue isn’t well-known in Texas. In North Carolina, barbecue means pulled pork on a bun with coleslaw. (The sauce varies depending on which part of the state you’re from.) But in Texas, barbecue means beef with a spicy, tangy sauce. So while North Carolina barbecue might work in Texas, it could also be a very high-risk venture.
Likewise, consider the seasonality of a business. Some businesses will work better in warm climates and others in cold. Looking to get into a lawn-care business? Perhaps you will do better in Miami than you would in Chicago.
If you are in the temporary help business or the senior home-care market, for example, it may take weeks or even months before you generate your first client. But since the average client will require service over an extended period of time, the repeat nature of the business provides very predictable revenues (and ultimately profits) as the business grows. It is incumbent on the franchisee to start with an adequate capital reserve to sustain the business until they achieve cash-flow break-even.
Other businesses require their owners to constantly hunt for new clients. While a home-remodeling company, mortgage brokerage or landscaping business may be very profitable, if it does not have a strong repeat business component, you will need to count on your franchisor’s marketing expertise and your own sales skills to continue to grow the business.
Case in point: The more predictable the cash flow is over time, the easier it will be to manage your business — and the less risk you will incur in running it.
Concept and market shifts and risks
Another thing to watch out for is potential changes in the marketplace caused by disruptive technology.
Take Blockbuster Video, which had one of the better runs in the history of franchising. At one time, Blockbuster had close to 10,000 franchise locations worldwide. But with the advent of various pay-per-view services, the market changed dramatically. After Dish Network’s 2011 acquisition of the brand, almost all 1,700 remaining locations were shuttered, except a few in select markets, mostly in Alaska, and those finally closed in July 2018.
Market risks are different from concept risks in that they reflect things happening outside the franchise in question. They might include competitive strategies, changes in market demand or changes in the market as a whole.
Ask yourself if there are trends in the marketplace that could negatively affect demand for the franchisor’s services. For instance, if you are considering a McDonald’s franchise, ask yourself if there is a noticeable consumer trend toward eating healthier. You might also be concerned with the aging of the U.S. population, as that might mean proportionately fewer young customers — a market that McDonald’s targets aggressively.
Drawing the line
It’s ultimately up to you to predict what might happen in any market. You may not be able to precisely quantify the amount of risk, but you should do your best to understand it and decide whether you can live with it. If anything on your list looks too risky for your tolerance level, draw a line through it and move on.
Get started with The Franchisee Handbook
In The Franchisee Handbook, franchise expert Mark Siebert walks you through the process of vetting and buying a franchise, helps you ask the right questions of franchisors and yourself and gives you the resources you need to decide if franchising is right for you. Siebert shows you how to do your homework before making what could be the greatest financial decision of your life. You will learn how to:
Accurately assess the risks of buying a franchise
Determine if a franchise is a good fit for your personal goals
Research and vet potential franchise opportunities
Create a startup plan that meets your business goals
Prepare your franchise for success
Why dream about owning a franchise when you can take concrete steps to make it happen today? With The Franchisee Handbook as your guide, you have the power in your hands to start your own franchise journey right now.