Franchising

A good way to reduce your risk of failure is to purchase a franchise because franchises typically have a higher success rate than other types of small businesses. Conventional wisdom holds that franchises have a failure rate of about five percent, compared to the 50 percent failure rate of independent entrepreneurs. Note, however, that the five percent rate doesn't take into account the fact that franchise failure rates vary widely by the type of business. It's best to do some research into the particular type of business before drawing much comfort from this conventional wisdom.

Warning You should be aware, however, of studies that question the five percent rate. For example, a study by Dr. Timothy Bates, a professor at Wayne State University in Detroit, found that the franchise failure rate actually exceeded 30 percent and that franchises made lower profits than independent entrepreneurs. Dr. Bates' study also found that the average capital investment of franchisees was $500,000, compared to $100,000 for independent entrepreneurs. Blue MauMau, an online franchise news journal, compiled statistics on franchisee failures based on the amount of SBA loan defaults, sorted by franchisor. While failure to repay a loan doesn't indicate that an individual franchisee has gone out of business, it is an indicator. While only 585 franchise brands out of 3,500 are on the list, the information can help pinpoint risky areas of business--as well as risky franchaisors. The failure rate varied from a low of zero percent for almost a hundred franchises, to a high of 94.12 percent.

Successful franchisors have developed "formulas" for starting a new business. The good franchisors want your new business to succeed. If you fail, they fail.

Normally, when you purchase a franchise, you must follow guidelines on what you have to do as a franchisee. These guidelines will decrease your new business startup errors. The franchisor will provide you with guidelines on site specifications, the maximum that you should pay for your location, and other useful information.

The franchisor will also provide you with lists of equipment and fixture requirements for your new business, which might keep you from purchasing too much equipment. For example, if you are going to open a franchise submarine sandwich shop, the franchisor will provide the exact type and size requirements for all your refrigeration and baking equipment needs.

An experienced franchisor with a long track record will be able to provide you with the failure rate of the specific business. This will give you a much clearer idea of your chances for success when making the decision to start a new business.

On the negative side, a franchised operation will typically be more expensive than other types of startups. Also, some franchises will require you to purchase supplies and various items through the franchisor that may cost you more.

For more detailed analysis, see purchasing a franchise.