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The Self Employment Question - Should I Buy a Franchise, or Try to Go It Alone?

Written by : John McGavin
01-15-07
Many people at one time or another consider the possibility of owning their own business or buying a franchise. Although most people consider self-employment of one type or another at different times, not everyone is suited to owning their own business, and not all franchises are suitable for those that are. Confusing? Let's take it a step further: some people who are suitable for self employment may not be suitable for franchise ownership. Risk tolerance and desire for total independence can also be differentiating factors, but no matter which direction an individual wants to go, he should make his decision on good strong research. Considering risk, whether going alone or with a franchise, success is not guaranteed, so there is risk.

How much risk you can handle depends on you. Businesses cost money to start, so you will take a financial risk no matter what you do. But there may be ways to make it safe. And running a business takes talent and skill. Do you have what it takes?
Starting by understanding the different self employment categories, and their implications, will go a long way towards the decision that you will make.

In the broadest sense, there are really only 3 categories. These are very simply a startup business; buying an existing business; and buying a franchise.

A Startup

This is really most people's basic dream. It usually starts with an emotional thought or feeling, such as "I'd love to have a business where I..." and you can fill in the blanks. The individual usually has a background in the business, and feels that he or she can apply their skills and knowledge in this specific field and be successful. This format absolutely carries the highest risk – this is the category where most businesses fail. Why? Usually, lack of capitalization. Banks can be very reluctant to finance small startups, so many are financed solely by the entrepreneurs' own capital and backed up 100% by his personal collateral.

These are businesses started where the entrepreneur knows that advertising, accounting, etc. are going to be required, but to save money he'll do them himself. The trouble is, unless he's opening an accounting or advertising firm, he actually has no real experience in them. Or the time necessary to do these functions. Because if his business will require him to interact with his customers, let's say from 8 to 5 Monday to Friday, then when will he have time to do the administrative functions? Usually, in the evening and on weekends. After a few years, the entrepreneur realizes that he or she is spending so much time working in the business, and not growing, that they decide to stop. It doesn't necessarily mean that they have gone bankrupt, or that the business failed, but there comes a point when it just may not be worthwhile anymore, and the business quietly closes. Initial investments may have been minimal, but in all likelihood have been lost.

Buy an existing Business

Obviously, an existing business will cost more to buy that starting something up yourself, but you are getting something for it: licenses are already in place, the location is set, employees are already there, there will probably be cash flow already from an existing customer base, etc. These are definite pluses! But how much will you pay for this business? There is almost always a little thing called “Good Will" to consider, but how much is it really worth? After all, the previous owner created the Good Will, and he'll be gone!

What if the employees leave with the ownership change, or are just the wrong employees? And what of your customer base? You do have competition, and they will be very aware of a new ownership taking over. The customer base that you are paying for will be at higher risk than ever before from competitive pressure. Any losses here, through the transition period, can greatly affect the cash flow that you've paid for.

You may get very little training. After all, the current owner wants out. There may be an agreement to stay on for a while and assist you through the transition, but after that, you are usually on your own.
Finally, how difficult will it be to find a good business to buy, and where will you look? Have you considered financing the business? Banks can very often be hesitant to lend money for existing businesses. The records may not be completely up to date, and available records may be hard to verify.

Buy a Franchise

Again, there are pluses and minuses. The cash outlay for a franchise may be higher than for an independent business, and definitely more than for a startup. You aren't actually buying a business, you are buying the rights to use their trademarks, business systems, advertising, etc. A proven format for starting and staying in business, and that's why they call it “turnkey". Everything is there for you on opening day. Paid for up front through the initial license fee and on an ongoing basis through the royalty format, which can also be the two biggest barriers to people buying a franchise. Is there value for them? You are the only one that can make this determination, based on your own criteria. But banks know franchises, and franchising. As a rule, the history that the franchise has helps ease their concerns when lending money. As a result, it's generally easier to get financing for a franchise than it is for a private business or startup.

Here's what the differences between owning a franchise, and being in business by yourself, can mean: Ongoing support from the Franchisor and other franchisees in the system; formulated training systems; national buying power, brand name recognition, etc. All is developed to gain a disproportionate market share, and keep it.

What are the other disadvantages? You do need to follow a system. Some are stricter than others, depending on the industry that you're in, but there will always be a system to follow. If you don't intend to follow the system, then don't buy the franchise!

Beyond these more obvious things, franchising is a very different kind of business animal. Unlike standard laws governing business conduct, franchising often has very specific rules governing its operation. Franchising is the only business where you can actually find out about it, how you will fit, etc., before you invest in it. Disclosure laws require very specific information that must be provided to potential franchisees before they make any investment.

What must be disclosed? Start with who the principals in the franchise are, what they've done in the past; the financial strength of the franchisor; how long they've been franchising, how many franchisees there are where they're located and with their phone numbers so that you can call them and ask all kinds of questions about them, the business, if they're happy, and if they'd do it again. Then document also tells you who has left the system, and what legal actions they may have been involved.

No other business type has this type of information available, and it's usually mandated by law. As much as possible, you can take the surprises out of business investing if you do your homework first! Imagine your own private startup. Do you really have any idea how much money you can make? In franchising, there are already other people involved in the business, and at various stages of development. Through researching the business, you can get a good feel for your actual income potential. Find the people in a similar market to yours, with a similar background to you, and a similar business model. Are they successful? Can you, or will you, do what they have done to be successful?

Unlike startups or buying an existing business where background in an industry may be an important factor, franchises rely more on transferable skills to manage their business.
Three Key Questions to ask yourself are:

  1. Main function of the business?
  2. Main function of the owner of the business?
  3. Is the business a good fit for you?
Focus on Question # 2. In other words, working on the business instead of in it!

What will you have at the end?

The value of a business is often the most overlooked assessment factor. It is the selling worth of a business on the open market, and this may be what you want to focus on if your long term strategy may be to have a saleable asset. While an independent business may sell for one to two times their value, many franchises sell for three to five times their value! Is long term equity your goal? Then you need to take a hard look at this as well.

So should you buy a franchise or try to go it alone? Only you can decide, but whatever you decide, make sure that your decision is based on good, solid fact. Weigh out the pros and cons and determine what your long term and exit strategies are. Then make the best decision for you and your family.
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