Small business is personal

It started out as a simple question: is a $75,000 liquidator’s fee for the $117,000 sale of a small shop appropriate? Thus I enter the disreputable world of business deaths and promises not met. One online search leads to another and I start to question whether my combing of court liquidation records is proving informative or simply entertaining (a type of schadenfreude). Then the suggestion is made that the business failure in question would not have happened had the shop been within a franchise – few franchisees fail, so it was claimed. Meanwhile the Franchise Association of New Zealand – the obvious next search target – is reporting “… around 4 out of 5 independent businesses cease trading within five years from their launch”. My quest now turns from one of checking the efficient use of time to a search into the efficiency of statistics – do the numbers being quoted reduce the data to information representative of the population of small businesses, be they franchises or independents?

  • It turns out that in the US and UK more than half the franchise systems disappeared within 10 years of starting during the 1980s (Stanworth (1998) and also Shane)
  • The same study reports US franchisee closure rates of around 4% p.a., rising to 9% if franchisee sales are also included, and something similar in the UK
  • A quick glance through the failure list of franchisee loans guaranteed by the US Small Business Administration (NB presumably a biased sample given they were seeking a SBA guarantee in the first place) shows some very large failures.

The picture emerging from these and other studies is that franchise systems can offer some real advantages – the obvious buying power and brand that comes with size, plus the financial management discipline that small businesses often lack – but it comes at a price and is no assurance that business will succeed. Some franchisors and some franchisees do fail but this proportion varies by sector, by age of the business and according to the business cycle. As for independents …

  • Of the small NZ business started in 2003, there were 47% of businesses with 1-5 employees still in existence by 2010 and over half still in existence amongst the 6-19 employee firms i.e. discontinuance of around 8-11% p.a. (Statistics NZ)
  • A look within some NZ shopping malls in the 1990s showed the rate of shops ‘closing to prevent further losses’ averaging 4% p.a., similar to an earlier study in Australia (Cox and Vos (2005))

These statistics are hardly definitive, but that’s the point. Small businesses vary a lot, be they franchises or not. There is a high churn – many closures but even more start-ups, and plenty of business sales – and a variable proportion ‘failing’; creative destruction at work, we trust. And here’s the rub: the business in question failed largely because of a death and a preference to seek an opportunity elsewhere. In other words, it was personal. Small business is personal, and we do things for reasons other than wealth maximization. So, no, a franchise was unlikely to have prevented this one failure but my colleague was on the right track: the signaling advantage of a franchise system would probably have prevented having to pay the exorbitant liquidation fee when it came to selling up.