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A recent article in The Wall Street Journal suggested that a number of prominent U.S. franchise brands are suffering higher than average default rates under the Small Business Administration (SBA) loan program.

In fact, these brands had a failure rate more than double the rate for borrowers investing in other chains. Among the well-known brands were Quiznos (30-per-cent SBA default rate), Planet Beach tanning (41 per cent), Cold Stone Creamery (29 per cent), AAMCO Transmissions (26 per cent), and Curves (25 per cent).

The brands that were interviewed claimed that failure rates were generally due to recent economic hard times. The franchisor of Quiznos itself recently declared bankruptcy. One can imagine that Planet Beach, operating in the tanning industry, is suffering from recent damning evidence linking tanning to skin cancer.

No one is pretending that the study is scientific. The SBA suggests that the data may be flawed because some borrowers don’t indicate if the loan is for a franchise, or don’t indicate for which chain the borrower is seeking the loan.

These kinds of failure rates fly in the face of the widespread belief that owners of franchise outlets are more likely to succeed than those who establish a similar brand independently. It seems to make intuitive sense that franchisees would fare better. After all, they have the benefit of the franchisor’s experience, systems, manuals, marketing, staff, suppliers, etc. The independent operator has to learn from the school of hard knocks, unless he or she has prior related business experience.

One possible explanation is that some franchisors may simply be extracting too much in the way of fees, royalties or rebates from their franchisees. Of course, this doesn’t make good business sense in the long term. Those franchisors will kill the proverbial goose, and find it more difficult to sell franchises in the future.

Another explanation is that many of the locations that failed may have been sold to the operator by a former franchisee, and not by the franchisor. Many franchisors don’t control the resale price of their units, creating the prospect that outgoing franchisees can overcharge for their business. This leaves the new franchisee over-leveraged and – sometimes – doomed to failure.

My own personal experience in Canada and the U.S. does not reflect the SBA statistics. It may be that I’m fortunate to represent a lot of ethical and/or profitable franchise systems. It may also be that Americans, being the inveterate entrepreneurs that they are, take more risks and suffer a commensurately higher failure rate.

One thing is for sure: franchising is not a license to print money. Many people investing in franchise systems – both franchisors and franchisees – start from the delusional mindset that merely identifying themselves to the public using a well-known brand will ensure their success. The reality is quite different. Successful franchisees excel by being present on a full-time basis (or more), keeping a sharp eye on expenses, and tirelessly promoting the business within their communities.

For franchisors, the imperative must be to avoid the tendency to sell franchises to highly leveraged individuals. Adequate working capital must be available until the business obtains positive cash flow, which in many cases may take a year or two. Franchisors must also be willing to “share the wealth” with franchisees, ensuring that discounts for inventory and supplies are passed on, and that superior training prior to and following opening remains a high priority.

While franchising may not be a get-rich-quick opportunity, it remains an excellent means to distribute goods and services, and for individual franchisees to earn a superior livelihood and build a capital asset.

This article was originally posted on AdvocateDaily.com.

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