Mitigating Risk

Starting a business is fraught with risk, which is why an owner’s main job is to mitigate that risk as much as possible. We will examine various ways to mitigate risk, ensuring you select a business with the highest chance of success. All will require thorough research by reading the Franchise Disclosure Document (FDD), speaking to the franchisor, speaking to franchisees, and doing independent research.

Find a Growing Industry

Growth

You can be the greatest operator in the world, if you are in a dying industry it won’t matter. Find an industry that has projected growth for the foreseeable future and plays to a growing demographic or growing trend. A growing demographic example would be seniors and a growing trend example would be health consciousness.

Regional Preferences

Some regions experience more of a demographic or trend growth than others. Ensure your local region participates in this national trend. You can find this out with access to free or inexpensive data services as well as online or AI research.

Robust Against Downturns

Look at those same data sources for how the industry has done in previous downturns. Is this a needed service? Is it a high demand service no matter what? How do downturns affect B2B vs B2C businesses differently?

Ensure it’s a Strong Franchise

Leadership Team

Read the FDD and conduct extensive research on the leadership team. Do they have the experience to prove they can lead a franchise through growth, in good time and bad? A great franchise can spiral with the wrong leadership so check for recent turnover in leadership and speak to franchisees about how the new leadership has affected the system.

History of The Franchise

For new operators, I would never suggest a franchise less than 5 years old and less than 50 owners who have been around for at least a year. Also, check to ensure the franchise is financially supporting itself (this can be found in Item 21 of the FDD). For those who owned businesses before, you can take a bigger risk in this element of the franchise if you have thoroughly mitigated risk in other areas.

Failure Rates

In Item 20 of the FDD, you will find the number of closures by year. This percentage should be as low as possible with 5% being a yellow flag and anything above 7% being a big red flag. For franchises with less than 300 units open, I would immediately say no and for larger systems, I would be very careful.

The only possibility that this isn’t a major problem would be if legacy owners are leaving due to a disagreement with new leadership. For franchises in the 500+ range that have been around for over two decades, it is not uncommon for a private equity company to buy the brand and undertake a largescale rebranding that includes new service lines, new technology, and new branding. Major changes like this often lead to legacy owners leaving the system.

Other Important Considerations

Legal- Check for past litigation as well as the legal liability the business takes on in its day to day work.

Support- Speak to franchisees about the training and support the franchise offers.

Territory Size- Compare the territory to the average territory of similar franchises and double check the financial earning statements in Item 19 if they are per owner or per territory. Sometimes the average owner revenue looks great but then you realize the average owner had to purchase 4 territories to get to that level of revenue.

Right Fit Franchise

Match Skills and Experience

You need to get clear on what traits make a successful franchisee in this system and objectively decide how they stack up to the traits you have. A great system with an operator who is a bad fit can lead to underperformance. I have written a long series of articles called “The Art and Science of Selecting a Franchise” that go into more detail on this topic.

Financials

Businesses don’t start making money overnight. You have to figure out how long it will take for you to break even, including the salary you need to pay yourself. Do not assume you will be a top performer. As long as you have checked that its a strong industry with demand in your region, and it’s a good fit for you- you can reasonable project out an average performance. Remember, the financials in the Item 19 of the FDD are rarely first year financials. You need to speak to several franchisees to figure out what a reasonable projection for year 1 and 2 are.

Once you have these projections, you need to make sure you have the funding to last until break even and to pay you a salary so you can pay personal expenses. You also want to be sure you have a buffer in case you do perform less than average that first year. Underperformance can happen for reasons unrelated to business performance, such as illness or vehicle accidents in mobile businesses.

Right Territory

Customer Preference

A franchise often works within a specified territory, and even if it didn’t you can’t service an entire state from one location. Almost every small business is a local business. Even within a region that is experiencing certain growth patterns, your particular territory could be exempt for some reason. You have to find the KPIs that define a quality territory for that specific franchise then double check them with data acquired independently of the franchise.

Competition

You must mystery shop competitors in your area. You may have a great territory for a service but if it is overly saturated with high quality competition, it may not be a great choice. You do want there to be some competition because it proves there is a market for it, but you want there to be more demand that the competitors can handle or you want the competitors to be low quality so you can easily take away customers.

Conclusion

These are only the most important ways to mitigate risk when selecting a franchise. It is imperative you go through the entire franchise research process outlined in my free app: app.tracerfranchising.com

No business is risk free but if you follow the right steps, complete all the necessary research, and objectively consider your personal strengths and weaknesses, the risk can be significantly mitigated.