The prospect of owning a franchise business may seem promising, but what happens when it fails? Unfortunately, failing franchises can have serious repercussions for those involved.
For investors and financiers, failed franchises can mean the loss of considerable amounts of money or investment capital.
If a collapsed franchise has borrowed money to finance its operations, creditors will often seek repayment through the sale of assets, litigation, or bankruptcy proceedings.
In this article, we will discuss the potential consequences of a failed franchise and explain how to protect yourself from financial losses in such a situation. Read on to learn more.
What Is the Failure Rate of Franchises?
The failure rate of franchises is notoriously difficult to estimate accurately.
Studies suggest that the annual failure rate of new franchises is between 5% and 50%, with an estimated 50% of all new franchises failing within their first five years.
While these figures may be disheartening, there are also many successful franchise businesses operating all over the world.
It’s important to note that failure rates vary significantly depending on the type of franchise and the industry it operates in.
For example, franchise businesses in highly competitive industries such as retail, restaurant, or technology tend to have a higher rate of failure than those in other sectors.
Additionally, larger franchises may have more resources and thus are better equipped to withstand challenging market conditions than smaller ones.
Other factors can influence a franchise’s success or failure rate as well.
The quality of management, experience level of franchisees, location, and marketing strategies are all important considerations when evaluating potential risks associated with owning a franchise business.
Franchisors must also continually evolve and stay up-to-date on changing trends or risk falling behind competitors and ultimately leading to business failure.
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What Happens When A Franchise Fails?
When a franchise fails, the consequences can be devastating for everyone involved.
Franchise owners may be forced to close their doors and lay off employees, causing considerable distress for those affected.
In addition to potential job losses, creditors will often attempt to reclaim money owed through the sale of assets or legal proceedings.
Investors may also find themselves out of pocket if the franchise fails to meet its debt obligations.
The franchisor may also suffer losses as a result of a failed franchise operation, particularly if they have invested considerable amounts of money into marketing or other operational costs.
In such cases, the franchisor may be forced to close its operations and seek compensation through legal action.
Here’s a closer look at everything that happens when a franchise fails:
- Notify Franchisees
One of the first things that happen when a franchise fails is that the franchisor must notify the franchisees of the situation in a reasonable time period.
This usually involves sending out detailed information regarding the closure of the business and offering guidance or support services to those affected.
The franchisor should strive to ensure that all franchisees are aware of their rights, obligations, and options available to them following the closure.
The exact timeline for notifying franchisees will vary depending on the type of franchise, its location, and its size.
For example, a large international franchise will likely have more complex notification procedures than a smaller local operation.
In any case, it’s important for franchisors to take swift action when closing their business and ensure that all stakeholders involved are well-informed about what is happening.
2. Selling Assets
When a franchise fails, the franchisor typically has to sell off its assets in order to pay back creditors or other stakeholders.
The selling of assets is often done through public auctions or private sales and can involve anything from vehicles to office equipment and real estate.
The money generated from asset sales helps offset any losses incurred by the franchisor.
It may also be used to compensate investors or other stakeholders who have experienced financial hardship due to business failure.
In some cases, the franchisor may decide to keep certain assets that could be used for future operations if they intend on re-opening the franchise at some point down the road.
It’s important for franchisors to consider all options carefully before selling any of their assets and to ensure that any assets sold are in the best interests of all stakeholders.
3. Legal Proceedings
When a franchise fails, it’s not uncommon for legal proceedings to occur.
The franchisor may be forced to take legal action against creditors or other stakeholders in order to recover money owed or to protect their rights and interests.
Furthermore, if there has been any wrong going on the part of the franchisor, such as fraud or negligence, then this could result in civil or even criminal charges being brought against them.
It’s important for franchisors to seek legal advice before engaging in any type of legal proceedings and to fully understand the risks and implications involved with taking such action.
The financial costs associated with going through the courts can quickly add up and could have a huge impact on the business.
Reasons Why A Franchise Fails
Both franchisees and franchisors have seen major success in the franchising industry, but some have also experienced total failure.
Take Toys R Us, for example – the company filed for bankruptcy in 2018 after decades of operation.
In any industry, there is no such thing as guaranteed success, and a franchise is no exception. There are multiple reasons why a franchise may fail, including:
- Unmet Expectations
When a franchisee enters into an agreement with the franchisor, they have certain expectations of what that business will look like.
If those expectations are not met due to a lack of training, inadequate resources, or poor ongoing support, the franchise will likely suffer financially and eventually fail.
New franchisees often have unrealistically high expectations and may not be aware of the amount of hard work and dedication it takes to make a franchise successful.
It’s important that franchisees are adequately prepared to run a business before they sign any agreements.
2. Poor Management
Poor management can be one of the biggest causes of failure in a franchise.
This could include poor decision-making, lack of experience, or not having a comprehensive understanding of the business and its operations.
The franchisor should provide adequate training and ongoing support throughout the life of the franchise agreement to ensure that the franchisee has all of the necessary skills and knowledge to make informed decisions on behalf of their business.
3. Poor Location Choice
Choosing the wrong location for a franchise can have disastrous consequences.
Factors such as rent, local competition, access, and visibility all need to be taken into consideration before signing any agreements.
If the franchise is located in an area that doesn’t match its target demographic or if it’s too far away from major retail outlets, then it’s unlikely that it will be able to generate enough foot traffic to remain profitable.
Tips To Avoid Failure
As a franchisor or franchisee, there are a few steps you can take to help ensure the success of the business. This includes:
- Having Realistic Expectations
It’s important to understand the reality of the franchise and to set realistic expectations for its success.
Don’t become overly confident and assume that the business will succeed without putting in hard work and dedication.
An example of unrealistic expectations could be assuming that sales will skyrocket within the first few months of an operation simply because it’s a franchise.
A more realistic approach would be to expect steady growth over time if proper marketing efforts are put in place and the products/services offered are of good quality.
2. Investing In Training
Franchisees should invest in training their staff members so that they have the skills necessary to successfully run the business.
Regular training sessions should be held to ensure that everyone is up to date on the latest industry trends and processes.
In addition, franchisors should focus on providing comprehensive training programs as well as ongoing support to franchisees in order to ensure that they are able to meet the expectations of their customers.
This will help build customer trust and loyalty, leading to increased sales and profits.
3. Having A Plan
Franchisors and franchisees should have a comprehensive business plan in place that outlines the goals and objectives of the business as well as strategies for achieving them.
This plan should be regularly reviewed and updated to ensure that it is still relevant to the current market conditions.
For franchisees, having a plan can help them identify potential risks and take proactive steps to mitigate those risks.
It can also help them determine which strategies are working and which ones are not so that necessary changes can be made in a timely manner.
Ultimately, a franchise failure can be a difficult and complex situation for any business owner to manage.
To protect their interests and stakeholders’ interests, franchisors should take proactive steps to assess the situation, evaluate all options carefully and ensure that all decisions align with their company’s objectives.
By having a clear understanding of the potential risks involved and taking proactive steps to mitigate them, franchisors can help ensure the success of their businesses for years to come.
Amit Gupta is an experienced expert in digital marketing and co-founder of DrFranchises. With more than 11 years of knowledge in franchise digital marketing, SEO, email marketing, and social media marketing, Amit has helped many brands achieve incredible success online. As a passionate entrepreneur and owner of 7 franchises, he continues to study franchise models, looking at costs, revenue, and profitability to guide brands toward profitable growth. When he’s not working on digital marketing, Amit enjoys spending time playing with his beloved dog.