How to Get Rich by Buying a Franchise (Really)

How to Get Rich by Buying a Franchise (Really)

Dan Gagne has been a plumber for three decades, but it has been years since he held a wrench.

He has built a plumbing business in the Bay Area that generates $20 million a year in revenue and employs 100 people. The money his empire brings in allows him and his family to pursue other interests.

“The income is more than I’d ever imagined,” Mr. Gagne, 54, said. “I own several homes. We’ve invested in eight acres in Costa Rica and are going to build a health spa. We live there about six months of the year.”

He credited his wealth not to his skill as a plumber but to his being part of a national franchise, Benjamin Franklin Plumbing.

Franchises are promoted as a way to control your destiny and build wealth by getting a head start, as well as guidance in good times and bad, from the franchiser that created or controls the concept.

But when an economic cycle is at its height, there’s a risk that people will move too fast into a new franchising concept and not do enough due diligence, which could lead to a dream of wealth turning into a nightmare of loss in a recession.

Just since 2012, about 1,740 brands have tried the franchise model, according to FRANdata, a company that tracks and advises the industry. Opportunities include Sir Grout, which specializes in grout, tile and wood restoration, and Shack Shine, a house detailing service.

The costs for many of these concepts typically range from tens of thousands to hundreds of thousands of dollars (although a single McDonald’s location tops out at $2.2 million). But the comparatively low barrier to entry can cloud the risk assessment for entrepreneurs.

Franchises are often promoted as businesses that fare well in a recession, but Darrell Johnson, chief executive of FRANdata, said the research did not support that. (A new report from the National League of Cities found that two-thirds of city finance officials expect a recession as soon as next year.)

“Franchising is not an industry,” Mr. Johnson said. “What you’re really asking is, what industries are more or less susceptible to downturns? And within those industries, what’s the presence of franchises?”

If someone is inclined to buy a franchise, whether for the independence or the wealth, a cleareyed view of what is being pitched is important. Here are some questions to consider.

For starters, analysts say, investors should ask whether the underlying industry is growing. But even in growth areas, not every franchise is a winner.

Franchising, like the economy, is cyclical. Data shows that the top growth areas for franchising include fitness centers, children’s educational programs and the general health sector; food, as a broad category, is ebbing.

Potential buyers should look carefully at federal disclosure forms that are required for franchises, paying particular attention to Item 19, which addresses the return on investment and the unit economics, said Jeff Johnson, founder and chief executive of the Franchise Research Institute.

The second big factor is whether branding will matter. Darrell Johnson of FRANdata said most people know their primary physician’s name but probably not the name of the doctor’s medical practice. Yet in an emergency, people are highly unlikely to ask for a doctor by name, relying instead on the reputation of the hospital or ambulatory care center.

Branding counts in some franchise areas, too, like home health services.

“Senior care is one sector where branding matters,” he said. “It’s hard to arrange something if I’m six states away. But there could be a consistency and expectation around a certain type of senior care.”

Do you have a winning idea of your own? A better opportunity to create wealth may be to become the franchiser by setting up a business that creates and manages your concept and collects fees from licensing and revenue.

Coming out of the 2008 recession, Mr. Gagne followed the franchising company’s direction on marketing and creating efficient systems. And that, he said, helped take his business from $5 million in revenue in the downturn to $11 million in 2011 and double that today.

“Could I have done this on my own?” he asked. “Probably not. I would not have gotten all the knowledge that I’ve gotten.”

Unless the brand is already widely known, like 7-Eleven or Midas, what the franchisees receive in support from corporate headquarters can determine whether they build wealth.

The most successful franchises focus on technology and systems that create a repeatable experience for consumers, said John Carter, chief executive of Vonigo, which specializes in technology for mobile franchises like pet grooming and massage therapy.

“There’s a difference between a technician — someone with expertise in a certain field — and someone who has business expertise,” Mr. Carter said. “Just because someone is a great mover doesn’t mean they should be building a moving franchise.”

An entrepreneur needs to have some experience before starting a franchise. “It’s the business elements that count the most: sales, marketing, finance, technology, systems, human resources and who you have on your team,” he said.

Mr. Carter pointed to one of his clients, Velofix, which provides bicycle repair at people’s homes. “They’ve been able to scale their franchise operations with a centralized call center with just a handful of people,” he said. “They’re driving most of their people to book online.”

George Saldana has been an electrician for 42 years. In 2006, he bought a Mr. Sparky franchise. He credits the franchiser’s technology for his moving from a business that paid him well to one that has created wealth for him and his family.

“We spent the last five years developing our propriety process to run our business in San Antonio,” Mr. Saldana said. By being able to modify the franchise system, he said, he kept better track of service calls and provided service records to his technicians showing repairs that had been done and upgrades that were needed.

There are downsides, including the risk that the franchiser may not be well run. Jeff Johnson of Franchise Research said he had been an area developer for Schlotzsky’s Deli, a chain that grew after an initial public offering in 1995 to more than 750 locations before filing for bankruptcy in 2004. Franchisees lost all the wealth they had accumulated in the company’s stock.

To avoid this trap, he said, potential investors need to ask: “Do you believe the franchiser is looking ahead and around the corner when it comes to the competition, the economy, changes in customer tastes?”

“The best franchise opportunity may not be the one that makes the best hamburger,” he said. “It could be the one with the best purchasing, marketing and buying power. No one thinks a McDonald’s hamburger is the best, but McDonald’s has systems driven by technology: You’re getting the same experience at any location.”

In addition to the financial and franchise due diligence, Darrell Johnson said people should look for franchisees (not ones recommended by the franchiser) and ask them: “Would they do it again? Are they interested in buying another one?”

Another risk is oversaturation of a concept in one area, like four frozen yogurt shops in one small town. Jeff Johnson said that even if those shops were all well run and received plenty of corporate support, there were only so many frozen yogurt fans to go around.

“You just can’t have a fancy frozen yogurt stand on every corner,” he said. “When things tighten up, the strong will survive, but the ones that have problems with distribution and pricing will fail.”

And the franchisees will fail with them.

One way to mitigate this risk is to spread it around. Jeff Rahn invested in franchises in the Minneapolis area that focused on different essential services: heating and air-conditioning, electrical, and home cleaning. Combined, their annual revenue is close to $12 million.

“All of them follow the same blueprint: no new construction and very little commercial work,” he said. “We do service work, and we do replacements. You don’t have the ebb and flow of new construction, where you’re so crazy busy and then the economy takes a downturn.”

That’s a sound plan, Mr. Carter of Vonigo said. “You can’t expect the franchiser to do everything for you,” he said. “Ultimately, you’re an independent entrepreneur and have to work your tail off.”

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