Investment Guide: Self-Employment
A Burger with a Side of Losses

Chana R. Schoenberger

You can get rich owning a restaurant franchise, if you know what you're doing. Too many new franchisees don't have a clue.

Two things enticed Edward Puskaritz into becoming a Subway franchisee: the chance to work for himself and the chance to make a lot of money. Well, at least he got to work for himself.

A trained accountant skilled in reading the fine print, Puskaritz, now 48, is cursing himself for signing the sandwich chain's restrictive franchise agreements. Those documents allowed Subway to lease him a mall store with expensive common charges, open other outlets near his location and avoid standing up for him against his landlord. "If I could only have done things differently," says Puskaritz, who has sunk $300,000 over 11 years into three struggling Subways north of Philadelphia.

You can make a fortune on a chain restaurant. Early McDonald (nyse: MCD - news - people )'s franchisees became millionaires. O. Gene Bicknell founded his Pizza Hut franchise, NPC International, in 1962 and took it public in 1984. Last year Bicknell bought back the 35% he didn't already own for $90 million. The franchise now operates 800 Pizza Huts.

Or you could wind up with next to nothing for a long workweek. The $300 billion food-service franchise business has saturated the landscape and is now resorting to price wars to keep the customers coming. McDonald's, Wendy's and Burger King (which parent Diageo (nyse: DEO - news - people ) wants to unload) are bludgeoning one another with ever-cheaper offerings as health-oriented upstarts like Salad Works and Panera Bread (nasdaq: PNRA - news - people ) nip at their heels.

High franchisee debt has made matters worse for fast-food entrepreneurs, says Nancy Smith, Denver-based cohead of the franchise practice at law firm Dorsey & Whitney. That's one reason that even McDonald's outlets get into trouble. Each month 20 of the burger giant's 3,000 U.S. franchisees now sell their rights back to the company under financial stress, says Richard Adams, head of the unofficial coalition of McDonald's franchisees, the Owner-Operator Consortium. That's 240 per year. (McDonald's counters that it has lost just 90 franchisees in 2002, many for innocuous reasons like retirement.) Cold comfort for anxious franchisees: While 30% of all restaurants fail within the first year, just 8% of brand-name franchise locations go under, says Christopher Muller, associate professor of restaurant management at the University of Central Florida who studies franchises.

 

Whataburger, a Corpus Christi, Tex.-based chain that sells $2.10 burgers, has gone through two sets of franchisees since 1996 for its three dozen Arizona restaurants. Businessmen Paul Thomas and Paul Cohen bailed out after two painful years, blaming the rapidly rising prices of labor, electricity, TV ads and land. Timothy Taft, president and chief operating officer of Whataburger, thinks Thomas and Cohen's weakness lay in underbudgeting for labor and repairs.

The second group, called Sun Restaurant Group, bought out the partners and then blew money on a marketing gimmick, spending $80,000 on an old city bus, which they had wrapped in Whataburger logos. This bunch filed for Chapter 11 in June 2001, and the chain bought the restaurants back.

If the perilous life of a food franchisee seems right for you, here are a few pointers.

Get ready to work hard. A new franchisee usually takes two years to earn any money. Then he might make just $35,000 to $50,000 yearly, says Donald Boroian, chairman of franchising consultants Francorp in Olympia Fields, Ill. That's why owning multiple restaurants makes sense.

Cynthia Booth, a former banker, has bought three McDonald's in Cincinnati since 2000 and works 60-hour weeks, supervising 170 employees. Her restaurants pull in annual sales of $1.7 million per unit and net her $150,000 in profits each, just above the chain's average.

Still, you can often pass on a franchise to the next generation, although some training of the young is required. At McDonald's even prospective franchisees who grew up behind the counter must graduate from Hamburger U. That's how former AT&T salesman James Lewis, 44, got into the business. He began working at his uncle's New York City McDonald's in 1986 and gradually bought him out, assembling an empire of eight Manhattan golden-arched restaurants and 500 employees. Lewis is fostering his own following as well: Five employees have gone on to own their own McDonald's.