Building a Business – Live
Join us each day this week at 1 p.m. to participate in one-hour live discussions with old hands in the world of business start-ups.
On June 29, Washington Post reporter Judith Evans talked with Scott Shane, associate professor of entrepreneurship at the Robert H. Smith School of Business at the University of Maryland, about how to match your skills and interests with the right franchising opportunity.
Franchising – buying the right to operate an established brand-name business such as Burger King – is flourishing. There are more than 2,000 franchise systems to choose from in the United States and figuring out which one to get involved with requires countless hours of research and soul-searching for any prospective business owner, experts say.
How should you go about choosing a franchise? What are the biggest mistakes that franchisees make? What are the risks and the rewards?
Hi, this is Judith Evans. We'll be getting on with our chat momentarily. Stay tuned.
Pittsburgh, PA: I am interested in purchasing a franchise from a company that has been successful in another city, but is just starting here. What sorts of things should I investigate prior to committing?
Scott Shane: The first investigate is how franchisees in the other cities have done, what they like about the system, what they don't like about the system and why? Second, if its a city where franchises are regulated by the state, check with the regulators for information about any problem that franchiser might have. Check for things that are similar and different about that business operating in other city. Will that business transfer well to your city.
Grand Rapids, MI: How much risk should one take in buying a franchise? In other words, is it worth a second mortgage?
Scott Shane: That depends on three things. One, it depends on how much tolerance for risk you have. Second, how much variance is there in the performance of a franchise. If you buy a McDonald's franchise, the company can tell you how much you will make. But for other franchises, profit information is not that readily available. Third, how much margin for error do you have if you failed. How badly would that place you if were want to start another business in the future.
Arlington, VA: Has the franchising business been affected by the recent success of .com entrepreneurs? I would think that tech start-ups would drain the talent pool for franchises.
Scott Shane: Actually, probably not. People who are potential franchisees have a different profile from people who are potential internet founders. Internet company founders tend to be young technology savvy people. Franchisees are generally middle-aged with significant amounts of management experience. What they're exploiting is their ability to manage a company. What Internet founders are exploiting is their ability to come up with a technology idea.
Monrovia, MD: What existing franchise do you believe has the most potential and which one would you recommend teaming up with?
Scott Shane: I'm not a financial advisor so I can't give specific recommendations about companies.
Washington, DC: What is the best source of data currently if I'm looking to purchase a franchise? Are there any websites you can recommend?
Scott Shane: The first source of information are the franchise regulators. In the state of Maryland, for instance, one can obtain information about specific franchisers from the Department of Corporations. Another source of information is the Bond's Guide to Franchise Systems. A third source is the January issue of Entrepreneur Magazine, which surveys franchises. A final source is the International Franchise Association in D.C., which has a variety of types of information about different franchise systems and about franchising in general.
Temple Hills, MD: Are there loans out there that are available to first-time franchisees? How much is usually needed to start a franchise?
Scott Shane: There are three big sources of financing for franchisees. The Small Business Administration loan program is a major source. Second, some of the big franchise systems will finance their own franchises. And third, there are specialized financial institutions that specialize in this if the franchise system meet their credit standing. As for amount needed to start one, that can range from a little as a few thousand dollars for a service franchise to many millions of dollars for a hotel franchise.
Roger Saavedra - Fairfax VA: What are the most common mistakes people make when considering franchise?
Scott Shane: The first is to fall in love with a franchise rather than evaluating it like a business. Often time what looks like a good product as a customer might not make for a good business to start. Another major mistake that people make is to shop almost exclusively on price and look for franchise systems which have low up front fees. Since up front fees have little affect on the performance of the outlet just buying a cheap franchise is a poor strategy.
Boston, MA: How do I determine the best franchise for my personality?
Scott Shane: The first thing to figure out is how much risk you can handle. If you can't tolerate very much risk, look for an old established franchise system with a strong brand name. The second thing to decide is how much support you need from the franchiser. If you feel you need a lot of support from the franchiser, look for systems that provide a lot of support services. Third, think about how much control and independence you need. If you need a lot of independence, I would avoid a franchise system that is very mature in which the rules and regulations have been fine tuned over many years.
Bowie, MD: Does the Smith School of Business at the University of Maryland offer any programs to help someone interested in franchising get started?
Scott Shane: The Business School offers courses in franchising for students enrolled in a program at the University of Maryland. For people not currently enrolled at the University of Maryland, the Dingman Center for Entrepreneurship offers a variety of resources including short courses written information and counseling and mentoring programs.
Ijamsville, MD: Should funds be acquired the same way when opening up a franchise as they are when starting a new business.ie-V.C.,angels
Scott Shane: Actually, you can acquire more debt financing if you start a franchise than if you start a business from scratch. So, with a franchise system it is often not necessary to give away equity to obtain angel financing. Instead, one can get a loan from a specialized franchise lender. The franchiser in many case or the Small Business Administration.
Chicago, IL: I submitted this earlier...before the chat. There was a hearing in DC last Thursday before a House Subcommittee regarding problems franchisees are having with their franchisers...what are the problems current franchise owners face?
Scott Shane: Probably the largest problem that franchisee face is franchiser encroachment. Encroachment is when a franchiser puts a new franchise outlet in a territory that belonged to a previous franchisee. The best protection that franchisees have against encroachment is to make sure that they obtain an exclusive territory when they buy the franchise.
Fairfax, VA: Are there any incentives from franchisers to help women or minorities to enter the franchise arena?
Scott Shane: Yes. Depending on the franchiser, many franchisers have special programs in which they will finance the franchise or reduce the fees for qualified women/minority franchisees. In addition to talking to franchisers about potential programs for minorities and women, the Office of Advocacy at the Small Business Administration has just completed a report on this topic. You can obtain it by calling that office.
Chevy Chase, Maryland: How would you suggest a prospective franchisee assess the risk and return potential of a franchise?
Scott Shane: The first thing to look at to assess potential return is to ask the franchiser for an earnings claims disclosure. Not all franchisers will provide that information but it provides the average returns across their franchises. A second source of information on returns is to ask existing franchisees. When asking potential franchisees, for earnings information, it's best to obtain to obtain a copy of the uniform franchise offering circular and randomly select franchisees listed in the back. If you ask the franchiser to supply a list of franchisees, they have a strong incentive to give you only the best performers.
Washington, DC: How many franchisers are there in the US? Does the government track this? Which agency? Do they know the exact number?
Scott Shane: There are approximately 1700 franchisers operating in the United States. Unfortunately, no one has an exact number because the Federal Government stopped tracking this information in the mid 80's. However, academics estimating this number have consistently found similar estimates.
Chicago, IL: If I get a protected territory for my first ten-year contract with the franchiser, how can I guarantee he-she won't take it away from me when my initial ten years is over? Won't I be stuck into signing whatever contract they put down in front of me at that point?
Scott Shane: This is a classic problem that academics have identified with franchising. There is no way for you to be sure that the franchiser won't try to renegotiate after the contract has expired. Your best strategy is to select a franchiser that has a reputation for maintaining good relationships with its franchisees and renewing contracts on the same terms that they were made previously.
Scott Shane: First, you need to determine whether your business can be franchised. Does it have a concept that is easily replicated? And can you easily write down rules and procedures for operating the business? If, you think the business can be franchised, I would recommend hiring an executive from a former franchise chain into your company or hiring a franchise consultant or franchise attorney who has established a large number of franchise systems previously.
Harrisonburg, VA: I live in a small college town -home of James Madison University- with a population of about 30,000. How would I go about finding a franchise that would be successful in a small community where there is not a large population base to draw on?
Scott Shane: My best advice is to go look at franchisers in the location of their outlets by obtaining copies of their uniform franchise offering circulars and mapping the location of their franchisees. Look for a franchise system that has had outlets operating for a long period of time in college towns similar to your town and approach those franchisers and see if they would be interested in their franchise to your town.
Judith Evans: Scott, we've talked a lot about where users can find information about franchises. Maybe, you could define what a franchise is?
Scott Shane: A franchise is any business in which one party operates the business under the trademark of another company and in which the party operating pays a fee of greater than $500 for that service. Most people commonly think of franchises as business format franchises in which the franchisee also gets an operating system for the business. For example, the layout and procedure for a MailBoxes Etc. Outlet.
Scott Shane: The person who asked the question about how to best franchise their business: If you send a note to me at the Dingman Center for Entrepreneurship:4321 Hartwick Road, Suite 300 College Park, MD 20740 I'll send them a short article of do's and don't of setting up a franchise system.
FAIRFAX, VA.: What categories or market segments are most successful for franchises in 1999-2000?
This will be our last question.
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