BLOG - Before You Buy a Franchise

Bryan Cremeen AccountSource

AccountSource has a team of experts with a wealth of knowledge to share. Check back regularly for new posts on must-have information and best practices for your business and personal finances. We cover a variety of topics from tax law changes to client success stories to cool new products for you and your business.

Franchise ownership can be a quick, efficient way to enter into business ownership. Without all of the backend system building and front end design, product and customer education of a unique start-up, entrepreneurs can simply focus on starting and growing the business. Before signing with your lender and your franchise, it is wise to do some research on the success of the franchise and more importantly, the failure and default rate on loans granted to the brand.

BLOG - Before You Buy a Franchise

Franchise ownership can be a quick, efficient way to enter into business ownership. Without all of the backend system building and front end design, product and customer education of a unique start-up, entrepreneurs can simply focus on starting and growing the business. Before signing with your lender and your franchise, it is wise to do some research on the success of the franchise and more importantly, the failure and default rate on loans granted to the brand.

In a story recently published by The Wall Street Journal, “franchisees in the Cold Stone Creamery ice cream chain defaulted on 29 percent of working-capital loans backed by the government, costing taxpayers tens of millions of dollars.” And Cold Stone’s failure rates aren’t alone at the top of the high-risk heap.  Huntington Learning Centers, Quiznos, and Planet Beach franchises ranked among the top ten worst franchise brands in terms of their default rate on Small Business Administration loans.  The Cold Stone and Quiznos franchise failures alone left taxpayers holding a $72 million of the overall $121 million dollar price tax for franchise-loan charge-offs in the past ten years 2004-2013.

That’s not to say that all franchises are bad.  There are numerous franchise success stories such as McDonald’s, Pizza Hut, and the 2014 Franchise of the Year by Inc. Magazine, Anytime Fitness.  And America needs these success stories. According to the International Franchise Association, franchising and related businesses “employ nearly 17.5 million people in the U.S. and represent almost 10 percent of the nation’s gross domestic product.”  The secret is in finding the right franchise fit for your personal goals, skills and business mix.

Everyone advises researching a franchise before signing the contract, but in reality, it is hard to find accurate information regarding the financial success or failure of franchise businesses.  Franchises aren’t required by law to disclose their franchisee’s first-year average sales and failure rates.  A good researcher uses the back door. The Federal Trade Commission (FTC) does require franchise owners to share any recent bankruptcy filings and prior litigation. The Wall Street Journal had to make Freedom of Information Act filings in order to gain access to specific SBA loan data.

A Little SBA Loan History

The SBA 7(a) loan guarantee program is the most popular type of loans for franchisees to seek. It is intended for use by for-profit businesses that are not able to readily secure financing or loans from other lenders or resources.  The loans are provided to the business, not the individual owners, so the business must be for-profit, have a demonstrated repayment history and not already have internal resources to provide the requested financing.  Loans can be written for as little as seven years for working capital and as long as 25 years for real estate.  The maximum loan amount is $2 million.  The loan can be used to finance an existing business such as a franchise or it can be used to supplement a business already in operation such as a small business seeking growth funding. Ultimately, the 7(a) loan is meant to benefit the business and encourage growth and future success.

Where did the 7(a) loan process with franchises go wrong?

Of the nearly $18 billion in 7(a) loans written in 2013, $2 billion was for franchisees. Eighteen percent of all such 7(a) loans were charged off including 13 percent of the loans to franchisees. High risk franchises were allowed to continue to apply for and receive 7(a) funding even though the franchise’s health was in jeopardy. How this continued, according to the WSJ report, is due to a lack of “monitoring the risks.”

The SBA defines its failure percentage as the “number of loans in liquidation plus charged-off loans, divided by the total number of loans disbursed.” The SBA only considers franchises with 25 or more SBA loan disbursements as part of this equation.

Other Franchises at risk for loan default:

  • Planet Beach

  • Huntington Learning Centers

  • Quiznos

  • Cold Stone Creamery

  • Aamco Transmissions

  • Curves International

  • Cici’s Pizza

  • Minuteman Press

  • Sylvan Learning

  • Cartridge World

All franchises aren’t created equal.  For every franchise financial failure there is an equally inspiring success story. Here are some positives for considering ownership in a profitable franchise.

  1. Cash Flow and Funding – Many franchises offer a strong business strategy, marketing plan and forecast for growth potential making themselves an attractive form of investment for lenders.  Franchises also come with more tested and predictable costs for easier cash flow planning and growth opportunities. Research the financial history of not just the franchise headquarters, but talk with current and past franchise owners to learn their own stories for funding the business.

  2. Real Estate – Franchises will often provide suggested development sites or geographic regions that are favorable for new business opportunities. Leadership at the franchise will often act as mentors providing insight and feedback on potential sites.

  3. Demographic Sweet Spot – With some 10,000 baby boomers hitting retirement age every day in the U.S., franchises that focus on services for that market are thriving.  In-home healthcare, medical care, and assisted living franchises all continue to see growth and profitability. Make sure that the franchise you’re considering has not just a current demographic, but opportunities for future growth.

  4. Solid Business Model – There’s security in using a tested business model.  Franchises offer their franchisees with a stable model from which they can develop and grow their own business.

  5. Tested Infrastructure – more flexibility and more free time. Because many of the associated business tasks such as marketing are provided for the franchisee, there’s more time to devote to the business or even to just relax and spend time with family.

If you still have questions about franchising, talk with a PASBA Small Business Advisor in your area. 



Bryan Cremeen AccountSource

AccountSource has a team of experts with a wealth of knowledge to share. Check back regularly for new posts on must-have information and best practices for your business and personal finances. We cover a variety of topics from tax law changes to client success stories to cool new products for you and your business.