Buying a New Franchise Opportunity

by Eric Stites

Question: What are your thoughts on investing in a fairly new franchise and what are the risks. The franchise I am looking into is less than 2 years old. The issue I'm having is that there are not a lot of current franchisees to interview. Also the franchise does not provide any earning report in Item 19 of the FDD — not sure because they are a new franchise and don't have the data or they don't want to disclose. Also, this is a mobile video game franchise — G2U. What are your thoughts on the concept and its potential. Seems like there is a target audience for it. Thanks — Jason

Dear Jason -

Thanks for your email. This is a question I get asked a lot. The beauty of investing in a franchise business is that — in theory — you are investing in a proven business model with established systems, good training and support, a team of other successful franchisees and brand awareness. This obviously lowers your risk of business failure rather significantly. These benefits are what you get in exchange for the initial franchise fee you pay.

With a new franchise business that is only a few years old, there are rarely any of these benefits. In this case, the franchise fee you are pay is really only funding the company's startup costs, and your risk of business failure is just as high as starting your own business from scratch. In the case of startup franchise, you need to approach the investment more like an angel investor: less than 25% of new business startups (franchise or otherwise) will succeed long-term. Does the concept you are considering have what it takes to succeed? What will be your return on the investment for putting your hard earned capital at great risk??

Over the last few years, more than 1,000 new franchise concepts have launched, all of them hoping to be the next McDonalds. Many of these new franchise concepts have failed, leaving their franchisees with nothing to show for their investment. Statistically, less than 250 of them will be around in 5 years and many of those that do survive will only be marginally profitable.

That said, being entrepreneurial minded myself, I'm not against investing in a startup franchise if the concept is unique and their business plan is sound. However, since you are taking on a substantially greater risk compared to investing in a more established franchise system, the franchise fees and other costs should be significantly lower to off-set this risk.

What has always bugged me is "copycat franchises" — those startup concepts that ride on the coattails of more established brands. Comparing a 500 unit franchise to a 10 unit startup franchise is apples and oranges — yet many of these startups charge similar fees to their much larger competitors. In my opinion, a startup franchise with little or no track record should have a franchise fee of $10,000 or less since your risk is so high. They should also offer some sort of reduced royalty fee program until your business is profitable. If they are not willing to negotiate such terms, walk away!

My other piece of advice when investing in a startup franchise is to purchase a unit/territory close to the home office and/or other new franchisees. There is definitely strength in numbers when it comes to building a successful franchise system. If the corporate office is on the east coast, you are on the west coast, and a handful of other franchisees are spread around the country, this is a recipe for disaster! Smart franchisor will grow slowly on a local/regional level before going national.

For a complete list of established franchise opportunities with extremely high franchisee satisfaction, please visit http://topfranchises.franchisebusinessreview.com

Thanks again for your question, Jason. Good luck with your franchise research and please contact me with any other questions.

Happy Franchising!

Eric Stites
Founder and President
Franchise Business Review
Direct 207.439.1621
Cell 207.450.7678
Office 866.397.6680