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Apr62021
INDUSTRY

5 Risk Factors to Consider Before Buying a Franchise

There are many advantages of buying a franchise rather than building your own business from the ground up. Finding the right small franchise to invest in can provide the added security of a proven business model and built-in brand equity.  However, any business venture involves a certain degree of potential risk. To get a better idea of just how much risk is associated with any franchise opportunity you’re considering, seek the assistance of an experienced professional advisor and keep these top five risk factors in mind.

Fads

Successful and well-known franchisors have usually been in business for several years, but there are certainly some newer franchise brands that are doing very well. Business needs and consumer preferences change over time (and sometimes quickly, as the last year has proven). Established franchise brands that have stood the test of time are skilled at evolving to meet ever-changing customer needs, but new brands haven’t proven their resiliency. Thoroughly investigate every franchise opportunity you’re interested in to assess its longevity and ensure it’s not just a fad at risk of burning out.

Don’t be discouraged from joining a new franchise system with a booming market; just approach it with extreme caution. There are advantages to getting in early or securing a prime location, but there is also more risk involved with new opportunities. Weigh your options and how much you need to invest, and always prepare yourself for the consequences if the trend turns out to be only temporary.

Regionality and Seasonality

Every product has its place and season. You may think opening a franchise in a region where the franchisor is not yet established will give you an advantage, and it very well might, but it depends on the industry and local preferences. A franchisor may not be located in a specific area for a reason and going against the grain may not afford you the success you anticipate. If you choose to establish your franchise in an area where the brand is not as well known, be prepared to take on more advertising and promotional activities since you won’t have that initial brand equity to lean back on. Consider if the franchise’s potential is worth the extra marketing efforts you’ll need upfront.

Seasonality can pose a risk if you’re not prepared for it. Some seasonal businesses do so well in their peak months, that revenue can carry them through the off-season. If this is your plan when you buy a franchise, be prepared to hit the ground running during your busy time and save for when things slow down. You could also consider promoting a secondary product to keep the dollars flowing in to sustain your business even when profits aren’t as high. Another option is to add an additional seasonal business and potentially take advantage of overlapping customer bases.

Whether it’s investing in a small franchise in a new area or buying a franchise that sells seasonal products, planning for down time and ways to keep the cash flowing are key to your success.

Recession Resistance

Some businesses perform better than others in difficult times. Certain products and services will always be needed, regardless of the state of the economy. For example, food, health care and education are necessities and the least likely to be cut by a customer if they are struggling financially. But in tough financial times, discretionary purchases are more likely to be avoided or greatly reduced.

Thus, determining whether the products and services a business provides are essential or optional is a big factor in deciding what franchise to buy. Also review the franchisor’s financial history carefully. Pay special attention to how it faired during past recessions and find out what safeguards, if any, are in place when the economy becomes unstable.

Capital Risk

Any business venture comes with some financial risk. When you buy a franchise, you need to ensure you have enough capital to pay the required startup fees along with training costs, equipment and property. But, before you invest, take a close look at the Franchise Disclosure Document (FDD) of your potential franchisor, focusing on the last few years of financial statements. Have an accountant look it over with you to help spot possible weaknesses in the franchisor’s business, any additional risk that you may not have anticipated and determine whether the franchisor appears to be meeting their growth plans.

Government Regulations

External risk factors like government regulations can be challenging to evaluate but have a significant impact. Every business is at the mercy of government restrictions and it’s often difficult to foresee changes that result from current events. However, emerging industries run a higher risk of being affected by new regulations that could cripple a business overnight. Similar to regional franchises and fads, it tends to be safer to invest in a well-known, experienced brand since these are typically in established industries less susceptible to compliance risk due to changes in laws and regulations.

As with starting any business, when you invest in a small franchise it’s important to remember risk isn’t limited to a single factor. It’s the result of combined pressure from multiple risk factors that can have a negative impact on your investment. Ensure that assessing potential risk is included in your due diligence process to thoroughly evaluate any franchise opportunity before signing on the dotted line.