Over the past 5 years I’ve had the opportunity to buy, operate, and sell five franchised restaurants.  The restaurant businesses, and specifically franchised restaurants, have provided significant additional cash flow for my family (on top of my earnings as a financial advisor 2002-2006, and VP @ Private Equity firm 2007-present).

 

I think the key is to realize that 9 out of 10 new business ventures fail in the first 12-18 months.  Conversely, a franchised business (franchised from an established, proven company) generally has a 90% chance of surviving that first year, and a 75% chance of surviving and/or thriving for up to 5 years.

 

The second key point is to understand the difference between franchises that require the owner to operate them day in and day out, and franchises that are designed to be operated by a manager and not requiring 8 hours of “on site” time from the owner.  I’ve confused these two in the past and it has cost me dearly. 

 

If you desire additional cash flow, you need to find a franchise concept that is designed to allow the owner to maintain their current career, but to “support and assist” a manager at their franchised business.  This is important, because if you purchase a franchise that is designed to have the owner live there, you have simply bought yourself an expensive job.  It will own you, you will not own it!

 

The key point of understanding a franchise as an investment is to employ the concept of return on equity.  Let’s say you purchase a hair care franchise for $100,000.  With good credit you generally will need to come up with $20,000 of your own cash (you, family, friends, etc.)…and a bank will usually give you the other $80,000 spread out over a 5 year repayment term.  If you hire a great manager your store may be profitable that first year.  To illustrate, let’s assume your store did $200,000 in haircut sales that first year.  You paid your manager, your employees, your rent, your supplies, utilities, franchise fees (royalties), taxes, interest on your loan, etc.  Then your accountant tells you that you have $20,000 left over at the end of the year…your profit!  You may look at this and say, “Wow, I made a 20% return, because this hair care place cost a total of $100,000…Great!”  But from the standpoint of Return on Equity, you have actually made a 100% return on your invested dollars!  The actual equity that you have into your business is only the $20,000 that you had to come up with to secure your $80,000 bank loan.  $20,000 invested, $20,000 profit, 100% annual return.  (If things go well…and there is a lot that can go wrong!  This is not for the faint of heart, no matter how much you like a franchise.)

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