The Risks of Franchise Financing

Franchise financing is a popular method to start your own franchise business. With the influx of franchises in the marketplace, entrepreneurs are turning to financing now more than ever. While it can be successful, it is still a risky proposition. What are the risks associated with franchise financing.

Choosing a Bad Franchise

A huge part of your success rides upon the quality of the franchise that you choose. There are conferences, websites, and trade shows developed for the sole purpose of selling franchises to investors. Franchises are popping up everywhere and not all of them are good investments.

In fact, some businesses were designed for the sole purpose of selling franchises to other investors. If the support is not good, you could falter along the way. The product needs to be different from everything else in the marketplace. If you choose a bad franchise and finance it, the effects could be catastrophic to your financial life. Failing to conduct your due diligence on a potential franchise could have lingering effects for years.

Inappropriate Market

Sometimes business owners do all of their homework on the franchise itself. They followed the first rule and checked out the company thoroughly and everything seemed to be in order. The product was unique, the business model was solid, and everything looked good. However, they failed to do any research on the location of the business. Some markets are just not able to handle certain franchises. On top of that, the franchise owner might select a bad location in the city to put their business.

For example, putting a restaurant franchise next to the dog food plant is not a good idea. However, sometimes the location is ignored because of the promise of the franchise itself. Do not make this mistake as it can hurt you.

Bad Terms

Franchise financing requires a lot of paperwork to get started. When you are shopping around for the best loan, you might be confused. You might look at an SBA loan one day and a private sector loan the next. With so many terms being thrown around, you might not fully understand what you are agreeing to.

There are many loans out there with less than favorable terms. You might have agreed to an adjustable rate mortgage that fluctuates with the interest rate. When the economy goes bad, your payment may go up. As a result, your business can not keep up with the payments. There are many terms inside your financing agreement that need to be reviewed. It is probably a good idea to have an attorney that specializes in contract law to take a look at your loan before you sign it. 

Competition

Franchising is a competitive business. If you buy a franchise nothing is stopping another franchise from moving in right next door. If you do not run your business correctly, you might be out of customers quickly. The other franchise might be better equipped for your market and run you out of business. Make sure to inspect the competition before you decide to franchise. 

Also, many commercial leasing companies will generally add a stipulation that another “similar” company cannot open up next door. Be sure to include those stipulations to keep your franchise doors open, especially if you sign a multiple-year lease.