Episode 42: Three Reasons Franchisors Fail

Why do franchise systems fail? April is talking about it from the perspective of why do new franchisors never make it over the hump to actually be able to have a thriving, sustainable established franchise system.

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On today's episode of the infinite franchisee show, we are talking about why franchise systems fail, and we're talking about it from the perspective of why do new franchisors never make it over the hump to actually be able to have a thriving, sustainable established franchise system. There are three reasons that we're going to be discussing. Number one is that the current business model is not proven. That's kind of a crazy statement to say, right? Because the entire purpose of investing in a franchise instead of going in alone is that you're making an investment in a proven model, which would make the chances of success higher, if that's the case. But so many times it's actually not a proven model. It's more of an idea, an excellent idea. So how could a franchise even happen if there's no proven model? Well, franchising is an industry that has lots of opportunity to make lots of money in a lot of different ways. And the reality is that there isn't no criteria for who can help someone franchise their business. There's no licensing that is required, there’s no classes that have to be taken, there's no continuing education that has to be kept up on. So what we have is we have franchisors that are franchising themselves, using a freelancer on Upwork to write up their FTD and paperwork. We have franchise development firms who are helping people get their paperwork in order and selling their experience on helping people get their paperwork in order, but have no other qualifications or vetting or regulatory practices that they have to abide by. And then we have attorneys, franchise attorneys - they are the actual ones that have a license, a law license - they are qualified, certainly, to write agreements,  but that is their sole purpose is to write the paperwork, they are not going to help the future franchise or figure out their operations, figure out how to become a franchisor. They're not going to help them become a better business owner, they're not going to help them sell franchises, they're not going to help them with marketing or any other aspect of business. They're simply there to create the paperwork. And because of this lack of regulation and lack of process within the franchising industry to make this a vettable scenario, there are people, franchise development firms, attorneys sometimes and even just independent business owners who are starting the franchise process before they have a proven model. And so without a proven model, what ends up happening is maybe you get a few early investors, probably friends and family that think it's a fantastic idea and really believe that it's truly going to be the next big thing. So they come in as your first franchisees and invest it, but then you're building the plane as you're flying it. And sometimes that can be a really good thing in business, in fact, that can be encouraged, except for the fact that when there is no quantifiable metrics to show how this idea is going to perform.  So that's number one is that the business model is not proven. And as we continue today, I'm going to tell a story that highlights all three of these things happening in a single scenario to really help illustrate this problem fully. 

So number two, is that the future franchisor, they may have a proven business model, and by proven they have a location, hopefully more than one location, showing that this particular product and service delivered in this manner is very profitable, and can be scaled. And that's really what a proven model means. Not just that it's doing well, but that it can provide livelihood to people that people desire that's worth the investment or franchisee is going to make into owning this business. But also that it can be scaled - that a person could own multiple locations and that actually, spreading the model across multiple locations is doable and makes sense. So that's the crux of a proven model. So in this scenario, we're going to assume that the business owner has a proven model, but yet they fail because they don't know how to be a franchisor. And being a franchisor is actually learning how to run a completely different business than the one that they've created successfully and grown to the heights that it qualifies as a proven model. 

So let's talk in an example. Let's say somebody has a donut shop and they have this nice little donut shop in a local small town and they just kill it every morning. That's where everybody goes for breakfast. And they're making money hand over fist, their customers are extraordinarily happy. And they decide to open in a couple more locations. And this person would go open in a large city. So they know it works in a small town, but is it going to translate to a larger urban area? And they have the same type of success there. And they take it to another part of the geographical area to maybe somewhere that's more a large suburb, right? So now we have a small town, a large suburb, and an urban location. And the model just works in all three. So that's what we call what we would say qualifies as a proven model. But now the donut maker decides to become a franchisor. And the doughnut maker has always been very passionate about donuts, and passionate about this family secret recipe that creates the doughnuts that people come from miles around to enjoy, and knows every in and out of that business has created processes and procedures for that business. But now that donut maker has to become a franchisor, and a franchisor’s job is selling franchises. So it's a salesperson, b2b. And because you're selling to a new business owner, so it's b2b sales, instead of that b2c sale, which is a customer, you know, consumer type of sale, now responsible for looking at metrics and tracking numbers and holding people accountable and vetting who's going to be successful or not. And maybe that's just not their cup of tea. Or maybe they're just not as good at that, as they were at donut making, or maybe they don't want to do it, and they want to focus on the donut making so they don't give it the attention it deserves. Or maybe they don't even understand that that is their new responsibility, and that they have to learn how to become a franchisor. And they keep focusing on the day to day operations and thinking that that's going to take their franchisees to the next level is if they are teaching them being in the stores with them and helping them every step of the way on the doughnut making itself. So all of these factors could play into why a franchisor has a very successful proven model, but cannot translate it into a franchise on their own. And number three, the number three reason that people fail at becoming franchisors is that they're undercapitalized. Franchising is an expensive endeavor, not only do you have to have the capital to keep your corporate locations running the way that they always have in the way that they should. But you have to have capital now to create an entirely new business, to create processes and procedures, to invest in marketing, to invest in what new website design, a new CRM to test out things before you roll them out to your franchisees. And it's a heavy investment in new legal counsel, accounting, or your CPA, there are a lot of professional services that you need to invest in, in order to protect an entity that is as large and has as many moving parts as a franchise. 

And so the third reason that people fail is being undercapitalized. So let's talk about an example scenario. Now a story that just came to our attention. We've heard dozens of them. But this is the most recent one, a story that really illustrates this, all three of these things being a reason that is setting someone up for failure. So let's stick with the donut shop as the example. But let's say that someone has a family recipe and family secret recipe. They've been making donuts, and they've been selling very successfully to the community, and to little breakfast shops and schools for their events. So they built a good, profitable business, but they've been doing it mostly out of their home, they'd have not had a retail location. Or maybe they had a kitchen that was a commercial kitchen they paid for but not a retail location. So they have numbers to show that their doughnuts perform well, they have the customers to show you know what their customer avatar is, things like that. And they can show that it's profitable. They decide to franchise and they go to a franchise attorney and say can you help me with my FTD and my franchise agreement? And the franchise attorney says absolutely, I can help you with that. What's your plan for territories and everything else? 

Well, I don't have a physical location, but my plan is to that my franchisees will open up physical locations. Okay, well, you actually need a physical location then as your flagship store to show that that's going to work and just show them how to train people in to create the processes, things like that. Okay, then I'll open a location. This is actually happened. We talked to someone who this happened to this past week. And so the attorney starts getting to work on the FTD and the franchise agreement that details how franchisees will run their donut locations and all the rules that they will abide by in running their donut locations. Although there has never been a doughnut location, while the business owner signs a lease to open her first donut location. Now while the attorney is working on the paperwork, while she's finding commercial space and signing a lease, she also has a franchise development person who is creating her build out manual and her operations manual that will go to onboarding the new franchisees. In addition, this franchise development person is going to sell her first franchises. And between the two of them, it's costing her tenths of thousands of dollars. So she hasn't done a build out yet. But this franchise development person has assured her he can create a build out manual. She has no operations for the store yet, although the franchise development person has assured her that he can create an Operations Manual for her and the franchise development person is also beginning to market to bring in leads to sell franchises to. Now, does that sound like it's going to work? Well, here's another wrench that we're throwing in. Because it's cost her tenths of thousands of dollars to hire this attorney in this franchise development person, and to build out a brand new store and to acquire the new employees it's going to take to run this store and just show the model, she's out of capital. So how on earth can she possibly market and grow a business that's not proven yet? With no capital? How can she find the franchisees to come in and to sign up for this concept? And the answer is, it's going to be very, very difficult. And if you were a betting person, would you bet on this horse? I'm gonna let you answer that question, would you bet on this horse. But this is the problem that we're seeing in the franchising industry. And it's not new. This is how franchising has happened since its inception in the 1950s. The problem here is that there's no entity that saying you need to have three locations that are profitable, before you can submit to be a franchisor. There's no one that saying what criteria would be met within those three locations to show that the model is proven, no profitability numbers, no earnings numbers, nothing of that nature. There's no regulation or entity saying that as a franchise development entity, you must have a certain education or you must have certain qualifications in order to lead someone through this process. Now let's think about this for a moment, if you want to buy a house and use a real estate agent, that real estate agent has taken classes specifically, so that they can help you navigate through a real estate contract and real estate negotiations. They have to submit to a test in order to get a license. And every year they must do continuing education to maintain that license. But yet we have people who are buying businesses who are putting their entire livelihoods on the line, their entire life savings, their 401K',s everything and the people helping them.

Now compare that to starting a franchise, to becoming a franchisor where not only are you making a huge investment to change your business from the small entity that got you to where you are now into a huge entity. But you're also going to become responsible for the livelihood of all of your franchisees that invest with you. And let's think about the fact that the person who helps you turn that small business into a franchise entity does not have to have any particular qualifications, licensing or experience to do so. Doesn't it make sense that someone who's investing to become a franchisor would benefit from a process similar to the real estate process where you have a qualified person walking you through everything? Of course it does. But let's put that aside because many of the franchise development people out there, they have been doing this for a while and they have also been taking courses on how to sell franchises so they have some experience in the franchising industry. The attorneys obviously aren't qualified to be creating the paperwork, but who's looking at the paperwork? Who's verifying that the terms of these agreements that the franchisor is going to make with the franchisees meets certain criteria? Who's verifying that the model was proven? The answer is no one, no one. Now in some states, you do have to register to become a franchisor, to sell franchises in that state, you have to register with the state authority. But the state authority isn't testing your model to see if it's proven, they're just looking over the paperwork to make sure everything's in order, and that you're paying the registration fees to become a franchisor in that state. So to sum up, what we talked about today, this is where the downfall of franchises begins. There's a very beginning process that the franchisors are going through in order to establish their franchise sets up the entire franchise for success or failure and making the wrong moves in this piece of the puzzle can be completely detrimental in the long run. So how do we do it right? Well, we've got to educate business owners on what a proven model looks like and help them create a proven model, we have to educate them on what it looks like to be a franchisor and help them become an actual franchisor. Help them understand the differences between the business they have been running and the franchise business. And we have to help them understand what the actual capital needed is, how much money do they need to be successful? And where do they get it from? Those are the questions that need to be answered. If you're thinking of franchising your business, that's where you want to start. And you want to start with a professional who can help you work through that strategy, work through those questions and answer them and also a strategy of how to make your model proven, and how to how to be a franchisor. How to get the money, right? So you don't just want to ask questions, and for someone to ask you questions, and you have to say, “oh no, I don't have any of that. I guess I can't be a franchisor”. That's not the case. It's just that you need someone to help you get those three things to set you up for success, because you certainly don't want to spend tenths of thousands of dollars and have nothing to show for it. So I know we have a lot of franchisees that listen to this podcast, and today was a little bit more about the franchisor side. But I'm sure you can see how setting up a franchise in this way really trickles down to franchisees having a hard time and the brand. Something to keep in mind is are you asking the right questions and due diligence to discover how did they set up their franchise at the very beginning? Because it may give you some insight into are they hurting now for capital? Is the model still not proven? And do they really know how to be a franchisor? And if the answer is no to any of those questions, then it may not be a franchise you want to risk your investment on as a franchisee. So I would love to know your thoughts on this topic. If you haven't connected with us yet in the Facebook group, please do so and give us a little shout out as to what you think about this or if you've recognized any of these red flags in your brand. Talk to you next week.