Buying a franchise is a risky business. Seventeen percent of franchise loans guaranteed by the U.S. Small Business Administration failed from 1991 to 2010, new data show. At the end of the period, almost one in five franchise owners went splat.
The loans, made by private lenders, weren’t merely delinquent. Failed loans are those charged off by the SBA, which guarantees as much as 85 percent of the value of working-capital loans through its 7(a) program. Even after liquidating collateral, which can include franchise owners’ homes, the government had to use taxpayer dollars to make the lenders whole.
Some franchises are worse bets than others. Meineke (22 percent), Quiznos (25 percent), and Huntington Learning Center (31 percent) had some of the highest failure rates among well-known brands.
So yes, running a business is harder than franchisors sometimes make it sound. Beyond that headline finding, the report is interesting for a couple of reasons.
First, it was compiled by the Service Employees International Union, the labor group that’s been fighting to raise pay for fast-food workers. That campaign would seem to put the SEIU in opposition to franchise owners, who are at least nominally responsible for setting wages. Increasingly, however, the union has been aligning itself with those franchisees, on the theory that corporate franchise systems wield a lot of influence over store owners’ budgets.
“We believe the high failure rate is due to a severe imbalance of power between franchisees and franchisors that contributes to a system of too many unstable businesses and low-wage work in the franchised fast-food sector,” says Tia Orr, senior legislative director of the SEIU California State Council.
The union ended its analysis in 2010 because newer loans have had less time to go bad, making them difficult to compare with older loans. It consolidated the findings into five-year periods to smooth out spikes in failure rates, which were particularly dramatic during the recent recession. Data provided to Bloomberg by the SBA show that working-capital loans to franchises haven’t performed as well as loans to nonfranchise businesses:
John Reynolds, president of the International Franchise Association Educational Foundation, says the union was “cherry-picking” data, and that the focus should be on the tens of thousands of franchisees who used SBA loans to successfully expand their businesses and add jobs to the U.S. economy. “I think [the SEIU] have an agenda that’s focused around casting doubt or criticism on the fundamentals of the franchise model,” he says.
Loan failure rates for individual franchise systems are hard to obtain, even though they could be useful to entrepreneurs deciding whether to invest in a franchise system. The union filed a Freedom of Information Act request to get its hands on the data. A recent paper co-authored by the SBA’s chief franchise counsel, Stephen Olear, said that “franchisors who do not provide financial performance representations to prospective franchisees but want to provide information to prospective lenders, or who wish to provide additional information to these lenders, are free to do so.”
When statistics do see the light of day, the numbers are often scary.
Why does the government keep guaranteeing these loans? The agency has argued that banks tend to stop approving loans for struggling franchises and that franchise failure rates are similar to failure rates for the overall lending program.
Yet failing franchises often continue selling new units. Over the last five years, the bottom 25 percent of franchise systems have opened more than 42,000 new outlets, according to Jeff Lefler, chief executive officer of research firm FranchiseGrade.
“On one hand, franchisees aren’t doing enough due diligence,” Lefler says. “On the other, unhealthy systems are marketing themselves loudly and aggressively to franchisees.”