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Hidden risks of franchises
Franchising looks like a safe route to entrepreneurship. But looks can be deceiving.
November 23, 2005: 1:56 PM EST
By Anne Fisher, FORTUNE Small Business
So you want to franchise your business?
Others do the hard work while you sit back, watch your brand grow, and collect a tidy royalty stream. It sounds like a can’t-lose proposition, but does franchising truly make sense for your small business? (Full story)

NEW YORK (FORTUNE Small Business) - Ever daydream about how great it would be to run your own business and be your own boss?

Let's say you've saved up a nice chunk of change and you're ready to make the leap and become an entrepreneur. Here's a question worth pondering: Which would you say is more fraught with risk, buying a franchised unit of an existing business, or starting your own company from scratch?

If you said starting your own enterprise is riskier, think again. Hundreds of thousands of people across the country who have sunk their nest eggs into franchises have discovered, to their chagrin, that making the investment pay off is far tougher than they thought it would be.

That's partly because, in many respects, buying a franchise ensnares would-be entrepreneurs in the worst of both worlds: You get all the financial exposure, headaches and stress of business ownership -- but the company that has sold you the franchise collects royalties on every nickel that comes through the door, not to mention charging fees for marketing, fees for this, fees for that, more fees for anything you can imagine (and some stuff you can't).

All the while, the franchisor usually dictates virtually every detail of what you can do, including how you price your wares, what kinds of signs you can put up, how much overtime you may pay your employees, and who will be your suppliers. Violate the franchise agreement, even in some tiny particular, and the franchisor can, and often will, snatch your franchise back without reimbursing you a dime.

To hear the experts tell it, a widespread misconception is the idea that running a franchise means being your own boss -- whereas, in reality, you're just leasing a trademark, and the real boss is the company that has sold you the privilege.

"If you really want to be your own boss, choose a business you'd like to go into, and then go to work in that industry until you learn something about it," says Gerald Marks, a franchise attorney in Red Bank, N.J. "Then go and start your own company."

The scant research that exists suggests you'd be better off. Consider: In the early '90s, Timothy Bates, a professor at Wayne State University, studied Census Bureau data on 20,000 new enterprises and found that 38 percent of franchises failed within four years of opening their doors, vs. 32 percent of independent start-ups that went belly-up.

In some industries the gap was much greater. In retailing, for instance, 45 percent of new franchise units lasted less than four years, while just 23 percent of independent stores flopped. Bates' study is now a decade old. Does he have any plans to update it?

"My God, no," he says. "After that paper came out, I was inundated with so many sad stories from bankrupt franchisees they were so relieved to know they were not alone -- that it interfered with my ability to live my life."

Of course, not all franchises fail. Four ways to cut your risk of flaming out:

Read the contract -- or, better yet, hire an experienced franchise attorney to read it for you. This document, called the Uniform Franchise Offering Circular (UFOC), is so crammed with fine print that it may be the size of a phone book. But you need to know what's in it before you sign anything.

Do your homework. Gather all the information you can about the market you're thinking of entering, and don't neglect to talk with people who already own franchises similar to the one you're mulling. Says Terry Tryon, who owns a Tutor Time day-care franchise in Wyomissing, Pa., "I talked to lots of other franchisees, both some who had succeeded and some who had failed. I think I learned more from the ones who failed."

Be ready to sell, sell, sell. If you have no flair for sales or marketing, you'll be at a disadvantage from the get-go. When Karen Brinker bought her AlphaGraphics print-shop franchise in Greenwich, Conn., now a $2-million-a-year business, the first thing she did was "go out knocking on doors. I wore out a lot of shoe leather. You really need to be able to do that, at least until you can hire someone else to do it."

Choose a franchisor with a proven formula for generating profits -- and then follow the system down to the letter. "One of the biggest causes of franchise failure is, people go off on tangents," says Bruce Sharpe, CEO of a diet-and-exercise franchise chain called Slender Lady. "If you don't want to follow the system the franchisor has set up, then buying a franchise is insanity. It's a waste of both the franchisor's time and money and your own."

Read the complete story on Fortune.com.  Top of page

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