Buying into success

Franchises are for many people the first step towards running their own business, removing some of the uncertainty by enabling them to become part of a tried and tested business. But there are also plenty of people for whom franchising has been anything but fail-proof, ending with them watching their investment simply disappear with the dishwater.

Under a franchise agreement, the franchisee buys the right to copy the franchisor's business, to benefit from head office support in areas such as marketing and training and, in the case of mature franchises, to benefit from brand awareness. A franchise provides tried and tested operational systems and pricing structures that hasten the newcomer's learning curve.

It is claimed, largely by franchisors, that taking on a franchise carries less risk than setting up in business alone, but this is not necessarily the case. Everything depends on the individuals and the franchises they choose.

Although the British Franchise Association releases average failure rates, these are too unspecific to tell the whole story. For example, evidence suggests that catering franchises are more risky than other types, such as print shops, and sectors of the catering franchise market perform less well than others.

When considering whether to take one on it is essential to investigate the market in which you wish to operate, the competitors within it, and what you will be able to offer. For example, whereas the burger market is now dominated by a few large players and franchisees tend to make good returns, a look at the pizza market would reveal a greater number of competitors and tighter margins.

It is also vital to do a thorough investigation of the franchisor. Verify his track record in business, as well as in franchising, and make sure that the company has a management structure with sufficient experience to be able to service the needs of franchisees.

Do not accept the franchisor's profit-and-loss figures without verifying them, and do not take the advertised "initial investment" cost as a final figure. Your own thorough financial investigation, ideally using the advice of an accountant or other expert, is essential. Franchise Development Services, based in Norwich, provides a franchisor-checking service for prospective franchisees.

The investment required to take on a franchise varies enormously, ranging from a few thousand pounds for a mobile catering unit to £500,000 for a reasonable-sized McDonald's.

Different franchises charge different licence fees - and this will tend to be reflected in what you get for your money. This should not be assumed, however, and it is essential to assess what you get for your licence fee. A franchisor is only justified in charging a high licence fee for a brand name if it is well known to the general public. If the name is only known in a limited area and you are planning to set up elsewhere then the brand will be of little benefit to you.

In addition to the licence fee, there are usually annual royalties of about 5% as well as other fees to cover advertising and marketing or other services. Royalties are based on turnover and you will have to pay them even if you have not made a profit on that turnover - so make sure you have included these in your costings. And remember that the franchisor's interest lies in your turnover growth, rather than your profitability.

When working out your costs, do not underestimate the amount of working capital you will need and your own living expenses for the first few months while you establish the business. And do not assume that taking on a franchise guarantees profits. The latest NatWest/British Franchise Association survey states that 86% of franchises are profitable within the first two years of operation, but that still leaves plenty that are not, and does not indicate whether those profits are enough to provide a reasonable living.

In addition to checking out the financial background of the franchisor, ask to talk to other franchisees, picked at random - do not simply go to those the franchisor suggests, he is unlikely to point you towards those having problems.

Banks tend to be happy to lend to franchisees, and usually offer about two-thirds of the finance needed - the other third has to be put up by the franchisee. Generally, this would be a loan secured against your house, but, because of the problems of negative equity, they will now lend unsecured. Don't take that to be an endorsement of the franchise's viability, however - up to 70% of the bank's liability is guaranteed by the Department of Trade and Industry should the business fail, so the bank cannot lose.

Fast food and franchising consultant Stuart Price conducted a survey of franchisees' accounts filed at Companies House. He found that a high proportion of catering franchisees had secured preferential loan rates at about 2.5 percentage points above base rate - much lower than that charged for lone start-up businesses.

Another important consideration is finding the right property from which to operate, and the basic rule of good location applies here as with any business. With fast food franchises, the best locations tend to be those where the level of pedestrian traffic is high but with few competitors close by. Usually the franchisor will insist on approving the site and, in some cases, will help you find it.

It is not just the franchise you need to check thoroughly - you also need to look at your own suitability. Even with the franchisor's help, running your own business is tough, involving long hours and requiring a resilient personality.

Also consider whether, if what you really want is self-employment, the restrictions of a franchise are right for you. Franchise agreements are invariably weighted in favour of the franchisor, giving him tight control over the product and the business operation.

On a day-to-day operational level, the amount of head office control varies between franchisors. Highly standardised fast food operators, such as McDonald's, control everything down to the notepaper. Others, such as Pierre Victoire, offer franchisees freedom to buy their own supplies.

You can never do too much checking before you sign on the dotted line. As Price says: "Franchising can be a marvellous way to set up in business, but some franchisees go into it not understanding the full risk."