Buying an Existing Business Beats Starting a Franchise

Last Friday afternoon I was a guest on KSEV Radio AM 700 with host Aubrey Thoede and had the opportunity to discuss a subject that many call-in listeners wanted to learn more about....starting their own franchise. But buying a new franchise is not the best way to go about achieving the "American Dream."

Everyone reads or hears about big corporate mergers and large company acquisitions. However, big corporations aren't the only companies being bought and sold. Profitable, privately-held small businesses are changing hands everyday. These transactions are done behind the scenes and are not reported along with the daily stock market news. These business exchanges fly under the radar of the public at large -- which may be part of the reason that it is not commonly understood that buying an existing small business is the most viable path to being a successful business owner.

If you are considering your options for going into business for yourself, buying an already established profitable business should be the first option on your list and starting a new franchise the last. Here are six slam-dunk reasons why:

(1) The Real Scoop On New Franchise Failure Rates

The failure rate of franchises is greater than most people realize - far greater. Everyone has probably heard the rumor that new franchises only have a 5% failure rate. Well, I was somewhat suspicious of that standard. So, in order to back up my suspicions, I did the research. I was surprised to find that there is very little independent study out there. Most research and reporting about success rates of franchises is sponsored by the franchise companies themselves! So, with that in mind, there is good reason that we only hear about how successful new franchise are. Well, here's the real story....statistics:

• Companies that sell franchises go under at a rate of about 15% a year, meaning in any given five-year period, 75% of franchisors disappear.
• Thirty eight percent (38%) of franchise units fail over a four-year period, vs. only 32% of independent non-franchised startups.
• Franchises make lower profits than independent businesses.
• Many franchisees never make much money. Average profitability is poor, especially after taking into account the purchase price of the franchise.

Some of the reasons for not fully understanding the chances of failure of a new franchise include the fact that many non-performing franchise units are taken back by the franchisor or resold to a fellow local franchisee at less than start-up cost. The franchisor doesn't consider them failed enterprises and they never show up as a "closed" business thereby distorting the real story.

Armed with this knowledge, don’t mistake the information provided to you by the franchisor for a balanced consumer guide. It is a carefully engineered sales pitch. Getting hold of the information you need to make a rational buying decision is difficult, to say the least. So use your common sense and a healthy dose of cynical discretion. Franchise agreements always favor the franchisor. It is very easy to be swept away in the heat of the moment and get into a binding contract that is not in your best long-term interests. And it is very hard to get out of a franchise agreement without taking a big financial loss. Remember, the main purpose of franchising is to make the franchisor wealthy.

Compare the odds of starting a new franchise with buying an already established business. Seventy percent (70%) of companies that have been purchased by new owners are still in business five years later, as reported by business brokers/intermediaries and substantiated in a 2003 SBA Office of Advocacy Study.

(2) No Guarantee Of Succes Despite The Hype

Yes, franchises are a known entity and have proven concepts. When you buy a new franchise, it comes with franchise support such as national marketing campaigns and materials for local campaigns, has established relationships with suppliers, and established methods of operation. Training is provided and is usually substantial. You can obtain SBA financing and some franchise companies provide additional loans to new franchisees...sounds good so far. Many franchise companies will even provide a demographic study to assist with choosing a location for the new business. Population, drive-by traffic, potential customer base and a whole series of factors go into the results of the study that will indicate that "theoretically" the business should do well. Ah, but they can't guarantee your success.

An existing successful enterprise has a mature infrastructure and proven systems that include suppliers, methods of operation, and a trained staff already in place. Financing options include SBA backed loans, conventional lending institutions, sellers notes, and 401K plans to name a few. There is nothing "theoretical" about the company's market presence and location that is already established and proven. The proof? Cash flow and paying customers. As for training, all sellers provide at least two weeks training and assist in the smooth transition to the new owner. They may even stay for a longer period of time with agreed upon compensation and if personal circumstances allow.

(3) High Upfront Cost - Can You Repay The Debt

New locations can take a year or more to build and initial start-up costs of a new franchise can far exceed the cost of buying an already established business. Keep in mind that initial start-up franchise costs touted by the franchisor may not include such things as real estate, staff, payroll taxes, local licenses, advertising, or inventory.

On the other hand, all the expenses incurred by an existing business are known quantities. The bottom line -- when you examine the possibility of purchasing an existing business, expenses are already factored into the non-"theoretical" profits. You do not have to go through the trials and tribulations of trying to get enough customers to make a profit because established customers provide an established cash flow, aka money. With an established cash flow it is just a matter of managing the available cash to achieve your business goals. You do not have the extra pressure of finding enough business to pay the bills or hiring and training a new staff. Security and peace of mind goes a long way! When you buy an existing business, at least you know what you are getting for your money. You will know what kind of loans you can get based on the proven cash flow, if the investment will allow you to achieve the standard of living you expect, and if you will realize a reasonable return on your cash investment.

(4) Fees, Fees, and More Fees

A percentage of monthly gross revenues (yes, before expenses!) will be levied as royalty fees (forever!) for the privilege of using the franchise trademarked name and procedures -- which cuts into your profit potential. Other fees you will have to pay include a franchise fee, training fees -- and, in some instances -- a monthly fee for marketing materials and ongoing support. If you are planning future growth and expansion, you will be paying additional fees for licensing the rights for each additional market area.

When you acquire an existing company, the only required fees you pay are taxes. There may be licenses associated with certain types of firms or other regulatory requirements based on the industry. Yes, the debt will have to be paid, but there's an end in site -- a loan has a definite pay-off date. Growth potential of an independently-owned enterprise is only as limited as the market for its product or service and the financial capacity of the owner(s). You are not tied to some radius within which you are allowed to expand.

(5) No Entrepreneurial Freedom

Do you have an innovative entrepreneurial spirit? Do you dislike being told what to do? Do you want freedom with your marketing plan? If so, owning a franchise is not for you. Franchise contracts have very explicit standards, allowing little or no alterations or additions to the brand, stifling any creativity on the part of the franchisee. You must use their system and follow their rules. Some franchise contracts dictate how much to pay your employees and stipulate that you must buy supplies only from their approved list of suppliers, possibly at higher costs than you could find from other vendors. The reputation of your franchise is only as good as that of the franchise company, so any difficulties that the franchise company encounters will have a direct impact on you.

There are enormous growth opportunities with owning a non-franchised, independent company. You can acquire additional businesses, open up new locations, try new marketing campaigns, and add new products or services just to name a few. The fact that you can raise your prices whenever you deem necessary may seem like a luxury in comparison to the opposing reality when you own a franchise.

(6) When It Comes Time To Sell

There can be very restrictive terms if and when you decide to sell a franchise. For example, the buyer will be required to pay a transfer of ownership fee, pay for training, and must be approved by the franchisor.

If you own an independent business, and grow it, you can sell it for vastly more than you paid for it...which makes good investment sense. This is not the case for most franchises because of poor profitability and growth potential.

In Summary

There are some great franchises out there with solid business models but may have frigid rules and ongoing fees that can bog you down. Franchising has been around for a long time and will continue as a viable choice. But don't start a new one, buy an existing franchise, a resale - one that is already up and running successfully. Even though the disadvantages noted above will still apply, at least you will be able to review its sales history so you have some idea of whether it is a money-maker or a lemon.

Buying an existing independent business with all the ingredients for success already in place is a safe investment and a platform from which to grow and launch new ideas. By far a much more flexible and less risky avenue to successful business ownership. No matter which road you take, however, there are no guarantees. You still need to be a sharp businessperson to make it work.

You Decide

The articles below and our own experience for the past 32 years of selling businesses are the sources from which I derived my conclusions.

Hidden Risks of Franchises
Safer to Buy A Franchise? - Think Again
Franchise This
The Failure Interview with author of "Franchising Dreams"

Secrets and Snags to Franchising Success
2003 SBA Office of Advocacy Study

Driving While Being A Business Owner

I thought this story on WashingtonPost.com was humorous and I found myself laughing out loud. While I am not pleading guilty, I am sure most fellow business owners will relate. I certainly hope we don't start getting profiled and arrested for driving while BBO.

Survey Reveals Work Habits of Business Owners

Anyone who's ever been irritated by an erratic driver take heed - it could be a small business owner.

According to a new study, about half of U.S. small business managers admit to making business calls and checking e-mail while driving.

For most of the managers surveyed by International Communications Research at the request of office supply giant Staples, the standard 40-hour work week doesn't apply. Nearly two-thirds of the 300 small business owners and executives surveyed said they work well beyond 40 hours per week.

One in five, or 21 percent, work while eating dinner at least four to five times a week and 66 percent said they work after hours and at night. About 18 percent said they read work-related e-mail and documents while in the bathroom.

The companies surveyed had 20 employees or less -- that's a group that represents about 90 percent of all U.S. businesses.

Small Business managers - Do you conduct some of your business while driving?

Certified Business Brokers Completes the Sale of MVP Aero Academy

Certified Business Brokers today announced the acquisition of MVP Aero Academy, an FAA Licensed Flight School in the Houston area, by a local investment group. Terms of the sale were not disclosed.

Sheela Patel, new owner and Managing Partner of the investment group, stated she is pleased to be assuming the reins of the largest flight school in Houston. Dr. John Van Paasschen and Carol Maitland, the previous owners, and Harding Goodman, Operations Manager, will continue in their management capacities and will be actively involved in the operation of the business.

MVP Aero Academy operates a fleet of 25 aircraft from the Weiser Airpark in Northwest Houston and the Lonestar Executive Airport in Montgomery County just North of Houston. In recent years it has experienced significant growth as the needs of major airlines for highly trained pilots have increased.

Patel said, "We value each of our customers and will continue to stress quality academics and a fun flying experience. We will seek to continually improve our daily operations."

Certified Business Brokers (CBB) in Houston, Texas, facilitated the sale and represented the seller. The firm, the largest in Texas, links business owners throughout the Houston Metropolitan area to qualified buyers from around the world.

About Certified Business Brokers
Established in 1974, CBB is the largest brokerage firm in Texas. Its team of professionals has over 230 years of collective experience selling businesses, and has closed business transactions in excess of one billion dollars in revenues.

Houston Business Brokers Predict Buying, Selling of Companies to Grow in 2008

If you are looking to buy or sell a business in Houston, 2008 will see a wave of activity and be a year of great opportunities.

We have already kicked off the New Year with a bang, closing four businesses between New Year's Eve and the day after the Holiday. And, we currently have a record number of businesses scheduled to go to the closing table over the next two months.

The celebrating, enthusiastic freshly-crowned business owners are bullish on the Houston economy and have grand plans for growing their new acquisitions. As for the former proprietors, now retired former baby boomer business owners, are to be congratulated for their successful achievement and having been in the driver's seat that has helped steer our city's economy to its top status as one of the best in the nation. The diversity of our small business community is the backbone of the city's robust commercial health.

We fully expect business transfer activity to continue its uptrend here. We have seen accelerated momentum over the last few years. A good deal of the activity is linked to the baby boomer generation. Just as many boomers are looking to sell their businesses and retire, younger people, young retirees, private equity firms, and strategic corporate buyers are looking to acquire privately-held companies in Houston. It's a great combination, a perfect storm.

Nationally, more than 65 percent of small and medium-sized businesses are expected to change hands over the next decade. This number will certainly hold true for Houston enterprises. They are already targets for those looking to get a toe-hold in our world-class city's economic powerhouse that is predicted to flourish for the foreseeable future, according the Houston Business Journal's November forecast.

A variety of industry sectors are popular as acquisition candidates. Many of those in the individual buyer category with whom we are currently working are looking for commercial service companies such as freight/delivery, janitorial, landscaping/lawncare, and vending firms, to name a few. Service companies such as these are always in demand because they have recurring revenue streams, potential for growth, and relatively short learning curves -- thereby bringing the largest pool of interested acquirers. Of particular interest in Houston are medical and energy related firms due to Houston's position as a major player in these sectors of the economy.

Restaurants are of particular interest to individual buyers as well. Texas has the second highest restaurant revenues and the second largest number of restaurant-industry employees in the nation according to the National Restaurant Association's December news release. A good restaurant, just like any other solid business, will sell quickly in Houston -- especially in the current market with so many people looking to buy a restaurant. On the other hand, the failure rate amongst restaurants is rather high. Therefore, someone not experienced in the industry should educate themselves about critical issues to help insure their success as a new restaurant owner.

The strategic buyer and private equity buyer groups are asking for wholesale, distribution, logistics, storage & warehousing, manufacturing, and medical & health-care related firms. As the hub of the energy sector, Houston-area oil service companies are strategic targets of corporate buyers. Each buyer category has distinctive characteristics that correlate to the motivation behind their purchases. In addition, the price each is willing to pay for a company is directly proportional to the motive.

First-time buyers need to be cautious when evaluating buying opportunities. You just have to sift through, do your homework and figure out what the pros and cons are. A self-assesment will help you figure out what types of businesses would work for you and how much money you have as a down payment.

Company owners need to work hard to make their businesses attractive to potential buyers. This includes increasing your cash flow, keeping good records, getting a business valuation, and understanding who your potential buyers would be.

Buyers and sellers of businesses should consult with professionals, such as business brokers/intermediaries, attorneys, and accountants who have experience in the marketplace and structuring deals.

The more you educate yourself on the process, the better the outcome will be.