How to Manage Risk as a Franchisee

I’ve been getting a lot of questions lately about how to manage risk as a franchisee. I think those are the times we’re living in. With the pandemic still looming over us and our economy still struggling, people are nervous about the idea of striking out on their own.

I get it. Becoming an entrepreneur was scary for me, too. Even though I grew up in a family of entrepreneurs, I’d been a corporate man for more than 20 years by the time I became a franchise owner. Giving up my “guaranteed” paycheck was a wrench. As I’ve mentioned before, though, it was also the best career choice I’ve ever made.

People’s questions about risk are partly what prompted last week’s blog post on how to choose a recession-resistant franchise. But I think there’s more to say on the subject, so this week I’m sharing additional tips on how you can manage risk as a franchise owner.

First Things First

Before I go into these tips, I think it’s important to make one thing clear: you can never completely eliminate risk. It’s an inherent part of life–or any life worth living, anyway. “Nothing ventured, nothing gained” is a very old saying, but it’s also very true. Entrepreneurs of any kind have to assume some risk in starting a business. Franchisor support and a proven business system help mitigate this risk for franchise owners, but there is always the chance that your business won’t succeed. Instead of thinking in terms of no risk, think in terms of reasonable risk.

More than likely, you also won’t completely eliminate fear. In fact, I hope you do feel a little fear at the prospect of buying a franchise: it means you recognize the significance of the decision you’re making. Again, the trick is to think about what’s reasonable. Don’t ignore your fear or pretend it doesn’t exist. Instead, harness it to create energy and awareness, then push past it to move toward your goals.

Steps to Manage Risk

Now for the practical part: though you can’t eliminate risk entirely, and some fear is normal, you can still make some smart choices to manage your risk.

Be Honest With Yourself

Start with an honest assessment of your goals, abilities, and resources. If you know what you really want to accomplish (a more fulfilling day job? money to buy a second home? better work-life balance?), you have a better chance of finding a franchise that fits your goals. And the more your franchise fits your goals, the more motivated you’ll be to get up each morning and do the work necessary to make your business successful.

You should also be honest with yourself about your abilities and resources. Franchises vary in the level of business experience and the financial investment required to launch and operate them. By honestly assessing your experience and resources, you can increase your chance of matching with a franchise you can operate successfully. Don’t be afraid to stretch yourself a bit–after all, part of the joy of franchising is the learning experience–but don’t get in over your head. If you have no idea what to do or you run out of money, you’re sunk.

Do Your Homework

You should also make an honest assessment of the franchises you’re considering. Don’t get sucked in by fancy marketing, shiny branding, or claims of “hockey-stick” growth. If your priority is to manage risk, dig deep into the franchisor’s financials, take advantage of every opportunity to network with franchisees, and keep a weather eye out for red flags. Established franchisors that thoroughly support their franchisees and have a record of steady, incremental growth will be the safest bet.

Choose Your Funding Carefully

To reduce your risk, reduce your debt. I know that businesspeople often think of debt as a low-risk strategy: after all, you’re using someone else’s money to make your investment. That money has to be paid back, though–you’re signing away some portion of your future revenue to the lender. If your franchise takes longer than expected to reach profitability, or hits a slowdown, that obligation can prove problematic. The less debt you carry, the more of your revenue belongs to you. You essentially gain margin in your business and reduce the overhead you have to maintain in case of a slowdown.

Of course, not everyone can open a franchise using cash on hand. After all, between franchise fees and other startup costs, the initial investment can run into the hundreds of thousands or even more than a million dollars. Smart borrowing can also be a way to help you quickly take advantage of a great opportunity. The key word there is “smart.” If you borrow money, mitigate the risk associated with debt by not borrowing more than you need to and by seeking out the most favorable loan terms you can obtain. Your franchisor may offer financing options, but also check sources such as the Small Business Association.

Have a Backup Plan

Cash is also important as a cushion for your business. If you want to reduce your risk, you should plan to maintain a rainy-day fund for your franchise. You can draw on this to help pay operational expenses during downturns, or you can use it to cover unexpected expenses, such as disaster recovery. Ultimately, aim for a rainy-day fund of 6-12 months’ operating expenses. You probably won’t be able to set that aside right away, but do what you can and then add to it as your franchise becomes profitable.

Additional locations can also serve as a backup. Multi-unit ownership or area development requires a larger up-front investment, but it improves your per-unit economics and provides a failover option. If one location slows down or even closes, you’ll still have the others to generate revenue and income. Depending on how close together your franchises are, you may even be able to shift customers from one location to another, minimizing the negative impact on your business.

Ultimately, I give my clients one iron-clad rule when it comes to franchise risk: don’t invest what you can’t afford to lose. The risk of total loss is very low, but don’t put yourself–or your family–in a position where a failed franchise will leave you with nothing. For instance, many franchisees fund their startup costs by leveraging their retirement savings or home equity. I can think of reasons in favor of either option, but I generally wouldn’t recommend doing both.

Need help assessing reasonable risk? I’m here to assist! Book some time on my calendar, and we’ll get the process started with just a 15-minute phone call.