11 Risk Factors to Consider Before Buying a Franchise

date icon 6 minutes to read date icon 17th October, 2022

Risk evaluation is one of the most important aspects of getting into business. And the same is true if you’re interested in pursuing a franchise opportunity. It must be remembered that every business venture entails some form of risk and franchises are not immune from these.

However, the risk of a franchise is considered much lower than independent startups. Despite this, you’ll want to be fully prepared as you conduct your market research, consult with legal and financial advisors, develop your marketing and business plan and consolidate all this information into a document you can make realistic decisions about.

To help you with this process, we’ve evaluated some of the most common risks of opening a franchise. We hope these will help you in your decision-making process.

Potential risks of a franchise business to consider

When answering the question “is franchising risky?”, it can be said that franchising entails much less risk than an independent startup. Startups have a much higher failure rate and as a result, it’s also more difficult to source financing for them from lenders.

However, there are some risks of buying a franchise that you must be aware of so that you can make the best decision for yourself. Here’s our list of the main ones.

1. What may seem to be a passing trend a.k.a. Longevity

One of the first risks in a franchise business that you need to consider is the franchisor’s longevity. Although there are some that have been operating in different industries for decades, others are newly established, offering up to five years of experience. These newer franchises should be looked at with great scrutiny if you want to gauge their success levels and expansion plans.

It’s also important to determine whether they are part of what is considered a passing fad or they are something with a high earning potential over the long term.

2. Size of the franchise network

A further franchise risk to consider is the size of the franchise network. The smaller the network is, the more room there is for expansion. The larger the network, the more diluted the brand might be, although it can also be considered a good thing because the franchisor has managed to attract and retain a large number of franchisees.

Also important to consider is the failure rate of franchisees. This is something that not many franchisors will be willing to disclose, but is important to help you decide whether other franchisees are happy and satisfied or whether they are looking for a way out.

3. Regional factors

To mitigate your franchise risk management, consider looking at which locations the franchisor’s presence is in. Do they cover vast swathes of territory or are they concentrated in a few major centres?

it’s important to notice that some regions may not have demand for the franchisor’s products or services. If you see a franchise unit being sold in such a location, you need to think about your long-term profitability capabilities in this regard.

4. Seasonality

Further risks to consider include a business’ seasonality. Seasonality can either refer to businesses that operate at full capacity throughout the year or those that are only prominent and see a high demand over certain seasons of the year. A lawn mowing business is one such example. It can see much higher demand during the summer as opposed to the winter months. This means inconsistent levels of profitability and is something you need to seriously consider.

5. Government and franchisor’s regulations

It’s always advisable to look at government regulations which govern certain business activities in different countries and locations. These can sometimes play a hindering role while at other times, they can play a facilitating role. It’s all a matter of looking at where your business will be located and what the local regulations for your business type are.

In addition to these, you’ll also need to consider restrictions imposed by your franchisor. These may relate to the business’ location, the hours of operation, holidays, pricing, signage, layout, decor, products, advertising and marketing and resale conditions.

6. Resistance to recessions

Many franchisors guarantee that their businesses can withstand the pressures of a recession. But these claims should be scrutinised carefully as this may not always be the case. Do your due diligence and see how and whether the franchisor dealt with the recent recession of 2008-2009.

In addition, check how they weathered the storm of the Covid-19 pandemic and the subsequent lockdowns. Did they continue to thrive or did their earnings suffer? Getting honest answers to these questions will help you make a better decision. If you’re doubtful, always consider opting for low-risk franchises.

7. Financial and earnings risks

When assessing the risks of a franchise business, you should also directly ask the franchisor to share with you their financial reports. You need to know what percentage of their turnover is pure profit, whether this is sustainably and consistently earned and whether there are any risks associated with earnings over time. You can do this by carefully studying the political, economic and industrial landscape.

It’s also important to know upfront what sort of royalties you’ll be expected to pay, the financial liquidity you’ll need to get started and if you can receive outside support with your financing.

8. Pending or past lawsuits

Pending or past lawsuits are another consideration to examine. If the franchisor is involved in numerous litigation cases, this should signal a cause for concern. Previous instances of near bankruptcy should also give you a clear idea of the amount of risk involved in purchasing a franchise.

9. Training and support

You also need to consider what sort of training and ongoing support you’ll get from your franchisor. Most offer the stars and the moon to help entice you to their business. But is the training and support of a quality nature? Is it ongoing? Consider looking at their operations manual to see the level of comprehensiveness involved.

10. Expansion planning

Also important to ask your potential franchisor is what their expansion plans are. Are they planning on a quick and rapid expansion or are they aiming for something with a slower, yet steadier pace? Look at their affordability for expansion and whether they actually can take on more franchisees. Is the market demand high enough? Are the territories to be expanded into full of potential clients or is it more like barren land?

11. Conflict management

Finally, ask the franchisor what their conflict management strategies are. Since being in a franchise relationship lasts for long periods of time (anywhere from 5 to 10 years or more), conflicts are bound to arise. However, unlike a job or an employment contract, you can’t simply give a month’s notice and walk away. This is why conflict management and dissatisfaction must be dealt with openly, honestly and proactively.

In conclusion

Just like any other business, investing in a franchise comes with certain challenges. This is when you can ask yourself whether franchises are a good investment at all. However, by being mindful of the possible risks and mitigating them as early on in the process as possible, you’re likely to have a much smoother and less risky endeavour. While it is true that the disadvantages of a franchise don’t come near to the advantages of a franchise, every business has some form of risk to be considered and doing your careful due diligence will ensure you set off on the right footing.