Who records franchise failure rates?
Having spent a huge amount of time recently looking into Franchises, one question that always intrigues me is who records franchise failure rates?
One of the common myths about franchises is that they are a ‘proven business model’ and therefore have statistically higher succes rates.
After doing considerable research I would tend to disagree. There are many reasons why this is a myth and some of the main ones are:
- Most franchise businesses operate under a seperate legal entity i.e corporation, sole trader and trade as the franchise. If there is a failure then it is the legal entity that closes down. This just gets recorded, if at all, as a standard business failure.
- Unsuccesful franchises are generally financially tied into the contract for the term of the agreement i.e 5 years. If they wish to leave prior to that then they can be liable for the full fees they would have paid over the franchise terms. Many franchisees are happy to sign non disclosure agreements with the Franchise to just be released from their ongoing commitments and walk away.
- Mnay franchisees just get to the stage where they ‘close the doors’ and walk away and want no more part of it.
What I really want to know is what statistical evidence is there to prove that franchises have a higher success rate? In an industry that is strongly focused on threatening lawsuits for saying anything negative about a franchise who would ever get to know the truth?
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This is a terrific topic and one that personally fascinates me. I wrote a book about how to buy a franchise during last year. While writing it, this very topic gnawed at me until I could find some hard statistical data on it.
Curiously, there is very little hard evidence to support this. If you search for “international franchise research centre” you will find an academic institute based in London (UK) that has done some research on it. Their research shows that franchises are LESS likely to be trading after 6 years than standalone startups with similar capital available.
The differences were marginal, but they were certainly not the “95% still trading after 5 years” rubbish you hear quoted by the franchisor community.
Cheers,
Lee Duncan
Business Coach & Trouble-Shooter
There is NO statistical evidence that franchiSEES have a higher success rate and, in fact, there is some statistical evidence that franchisees may fail at a higher rate than independent small business persons. This “higher success rate” is a myth that franchisors use to sell their franchises. Franchisors also spread the myth that 95% of franchisors are successful…but they don’t always indicate the period of time in which they are successful.
But! FranchiSORS, who are also often classified as small business organizations, do sometimes better survive the high and brutal odds of failure of startup businesses because they don’t share in the failure of their first-owner franchisees when the assets of the failures continue to serve the franchisor under new ownership.
This “churning” mechanism, which is a management tool for many franchisors, is not visible, looking at a franchise network from the outside. Many failed franchisees close down but don’t default on their loans and continue to pay on their business debt to avoid bankruptcy. These franchisees have signed confidentiality agreements and legal releases to the franchisors in order to get their permission to fire- sale-transfer their businesses to an approved 2nd generation franchisee. These franchisees don’t show up as failures in government statistics and are indicated only as transfers in the Franchise Disclosure Document, the FDD.
The real rate of failure of franchisees in any given system is hidden from the view of NEW buyers because franchisors are not required to disclose this material risk factor of franchisee failure to thrive, as known to the franchisors, to new buyers under government regulatory policy. Unit performance statistics, present and past, are not required to be disclosed by the franchisors to the new buyers under regulatory policy.
Due diligence with references supplied in the FDD in Item 20 is inefficient and ineffective and Item 20 acts as an artifice to protect the franchisor, himself, from making any representations about the success of the franchise to the new buyer. Obviously, if you act on the “misrepresentations” of the references who misepresented the “success” of rhe franchise to you, you have NO recourse against your franchisor after you have signed the frasnchise agreement, if your business is unprofitable and fails.
When the franchisor makes no “earnings claims” in Item 19 of the FDD, and the great majority of franchisors do not make “earnings claimsZ” they have 100% prortection from charges of fraudulent inducement to contract in arbitration or the courts because of misrepresenting the success or the risk of the investment to new buyers.
All franchise agreements require the new buyer to acknowledge that the purchase was made with no promise of success or profits and that they made the purchase without relying on anything that wasn’t within the four corners of the franchise asgreement.
In mature systems where “churning” is compounded over many years, it would take the FBI to determine the real failure rate of first owners of the franchise. LET THE BUYER BEWARE!!! of regulatory caputre and the hidden subsidy of the franchise industry.