Investing in franchises

I have studied over 100 franchises, including, food, dry cleaning, education, pack and mail, etc. And in most cases I reached the conclusion that the model in general is not doable in today's time and age. The main reason is the math. It no longer adds up.

If you are looking into buying a franchise, you are going to go through a whole lot of presentation to get to the FDD (Franchise Disclosure Document). This is tells you how the franchise is run and all the rules and regulations you have to abide by and agree to. Once you have your hands on the document, you must make your decision on the numbers in the FDD not on what you have heard or felt during the presentation face.

Let me share with you couple of things regarding the franchise idea. When the idea started, in the early 1920s, it made a lot of sense. Figuring out locations, supply chains, the right products, etc. was pretty hard at that time. Compare that to what you can do today in 1 hour using the internet. Also, the competition was in most cases local, so having a name and brand recognition could have paid off handsomely. Customers where more comfortable putting their money in the bank if the bank has many branches in multiple cities.¹

But the import math is the one that most people skip over due to all the pip talk they have been put through. Here is couple of rule of thumbs regarding almost any business you want to have, (1) - you need 500-750k of revenue to survive, regardless of the type of business. (2) most business operate on margins of 10-25%. And the numbers are closer to 10 than 25.

When you get the FDD you need to look at all the fees they are charging your business, let me share with you some of these fees:

One-Time Fees

• Initial franchise fee
• Initial training fee
• Site selection and approval fee
• Design, architectural, and construction review fees
• Equipment, furniture, and signage fees
• Initial inventory and supplies
• Initial technology setup fee
• Grand-opening marketing fee
• Territory or development fee
• Transfer or ownership change fee
• Renewal fee
• Contract amendment or processing fee
• Relocation approval fee
• De-identification or brand removal fee upon closure

Recurring Fees

• Royalty fees
• National advertising fund contributions
• Regional and local advertising fees
• Technology and software fees
• POS and payment processing fees
• Training and certification fees
• Ongoing support and maintenance fees
• Required purchasing and supply program fees
• Franchise association or cooperative dues
• Insurance-related fees
• Audit and inspection fees
• Annual meeting or convention fees
• Minimum royalty payments
• Special assessments or marketing contributions

If we just take a look at the recurring fees, they can add up to over 15% in some cases. Assuming that your business is doing pretty darn good and you profit margin is 20%. Here is the catch, if they take 15% of the total revenue² that is 75% of your profit. That is why that most of them are not doable as a business. And that is why most owners end up buying themselves a job rather than and investment.

1. Banks are not franchise, the example is given regarding name recognition.

2. The franchise fees are collected bases on your sales, so they are getting their percentages whether you end up making money or not.