Buying a franchise business is an excellent alternative to starting a business from scratch. However, franchising is a business venture like any other, which means there is a degree of risk involved. This article will take you through six risk factors to consider before buying a franchise.
Trends
Many of the franchises we are all familiar with are successful because they have been in the industry for years and have stood the test of time. This demonstrates the importance of buying a franchise that has longevity in the market and is at a lesser risk of being labelled a fad.
Of course, many new franchises have not yet had the opportunity to prove their resilience. However, this does not mean you should be discouraged from joining a new franchise. Instead, you should approach such an opportunity cautiously and ensure the business can adapt to consumer preferences over time.
Seasonality
Seasonality is another potential risk factor. This is particularly the case if you are unprepared for seasonal business. Seasonal businesses include:
- landscaping services;
- ski resorts or ski hire shops;
- ice cream shops;
- hotels or other short-term accommodation; and
- holiday retailers, such as Christmas vendors or party hire shops.
Some seasonal businesses do well enough in their peak months that their revenue can help them survive during the off-season. However, you must prepare for this and ensure you save enough funds for the low seasons each year.
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Regionality
You might consider that opening a franchise in a region where the franchisor has not yet expanded is an advantage. However, it might be the case that there is no demand for the goods or services in that local area. Like many goods or services have a season, some are specific to a region. For example, an ice cream shop in a cold location is unlikely to be a great business venture.
You should be prepared to spend a lot of time and money on marketing materials if you choose to open a franchise in an area where the brand is either not well known or is not as relevant. Therefore, these extra costs should be considered when determining whether the franchise is worth investing in.
Resistance to Recession
Certain industries continue to perform well during difficult economic times. For example, food and healthcare are basic necessities that everyone needs, even those struggling financially. On the other hand, discretionary expenses are often the first costs people cut from their budget in a recession.
As such, the types of goods or services the franchise offers should be carefully considered when deciding if it is a good franchise opportunity. You should also carefully review the franchise’s financial history if it is made available to you. This will allow you to assess how the franchise fared during past periods of economic downturn.
Capital Risk
All businesses come with a degree of financial risk. When purchasing a franchise, you need to carefully consider whether you have enough funds to pay for the following:
- initial franchise fees;
- training costs;
- equipment and property;
- operational costs; and
- royalties.
One way to minimise your financial risk is to ensure the franchise is stable. Ideally, the franchisor will provide you with a disclosure document. You should carefully review this with an accountant to identify any weak spots in the business. An accountant will also assist you in determining if the franchisor appears to be meeting its growth plans.
Unfortunately, it is not mandatory for New Zealand franchisors to provide prospective franchisees with a disclosure document. As such, the franchise’s financial information may not be available to you. However, you can still assess your financial risk by assessing the market and talking to existing franchisees about their experience operating a franchise.
Government Regulations
Finally, government regulations are another external risk factor that must be considered when purchasing a franchise. All businesses run the risk of being at the mercy of government restrictions. Further, it can be difficult to foresee future government regulation changes. However, emerging industries are often at a higher risk of being impacted by new regulations overnight. As such, investing in a franchise that operates in an established industry that is less susceptible to compliance risk due to changes in laws and regulations tends to be safer.
Key Takeaways
All businesses come with risks. Such risks are not limited to a single factor. Instead, they are the combined pressure of multiple risk factors that can negatively affect your investment. Some risk factors to consider before buying a franchise include the following:
- trends;
- seasonality;
- regionality;
- resistance to recession;
- capital risk; and
- government regulations.
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Frequently Asked Questions
Some risk factors to consider before buying a franchise include whether the business is a trend or subject to seasonality and regionality. You should also carefully evaluate financial risks, such as the franchise’s resistance to recession and your capital risk. Finally, government regulations are another external risk factor to consider when purchasing a franchise.
You should also carefully review the franchise’s financial history if available. This will allow you to assess how the franchise faired during past economic downturns. You should also consider the industry the franchise operates in when determining if it is resistant to recession. Certain industries continue to perform well during difficult economic times. For example, food and healthcare are basic necessities that everyone needs, even those struggling financially.
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