Franchising is a great opportunity especially for those who wants to be an entrepreneur and don’t have the desire or capability to start a business from scratch. Essentially, a successful business owner called the franchisor allows others to franchise its business, allowing franchisees to own and function independent locations under the franchisor’s name and model—providing framework for the business. However, it’s the franchisee’s decision to run the business itself and money on it.
There are many fundamentals factors in the course of exploring, acquiring, and running a franchise business. In this guide, we’ve included everything from what a franchising is and how it works, to help you conclude whether buying it’s the right option for you.
What Is Franchising?
Franchising is an agreement where the franchisor (business owner) gives the right to the franchisee to sell the franchisor’s products or services under its business name and model. The franchise agreement also contains obligations and restrictions along with the timeline for which the franchisee can function and retains rights. To put it simply, the franchisee functions using the franchisor’s current framework and operational procedures, while retaining accountability for the upkeep and operation of their own branch.
In order to run a franchise, the understanding of franchisor’s business operations, including inventory management, quality control techniques, hiring standards, service techniques, market conditions, regulatory or legal requirements and the right skills and management experience are essential for the franchisee. After the franchisee develops an understanding of essential factors, the franchisor authorizes the franchisee to operate in a location. The franchisee will work as they would had started their own business, and is responsible for their location’s daily operations, upkeep, and administration, along with continuing support and direction from the franchisor.
Eventually, the franchisor decide how the franchisee will conduct their business including site approval, design or appearance standards, constraints on products/services, operational methods, and restraints on the franchisee’s sales region. Certainly, the franchisee is legally compelled to function under the rules (non-competes and trade secret protections and standard franchisor controls) establish by the franchisor in the franchise agreement.
What are Franchising Fees?
Every franchisee must pay a fee in order to sell the franchisor’s products or services. Here’s an overview of three major franchise fees that will be defined in the franchise contract:
- Initial Franchise Fee
The initial franchise fee is a one-time, upfront fee that the franchisee has to pay after signing the franchise contract. By paying this fee, the franchisor allows the franchisee to retain the rights to sell the franchisor’s products or services under the business name and model. The initial fee vary with the industry and doesn’t cover utilities such as inventory, tools and furnishings. According to the FTC Franchise Rule, the minimum initial fee should be $500, and can be over $100,000 in case of a Master Franchise purchase.
- Royalty Fees
Royalty fees are continuing fees that the franchisee pays monthly for constant support. Royalty fee is calculated as a percentage of your revenue with range from 4% to 12%, but the exact amount changes based on the industry and volume.
- Advertising Fees
Advertising fees help fund the franchisor’s marketing budget. It might seems like an unnecessary fee, but eventually, franchisees cash in on the franchisor’s marketing efforts—since this is where the franchisee’s entire customer base will comes from. This is calculated as a percentage of monthly revenue, and will be lower than royalty fees.
Considerations While Buying A Franchise
While searching for the right business to invest your money in, it’s best to exercise due diligence to decide which company is a sensible investment. Here are few considerations to cling to when you’re buying a franchise.
A successful franchise management requires capital. If you don’t have the required capital in hand, look for franchises according to their investment requirements on Franchising.com. You can also contact the franchisee directly to learn how much capital you’ll need to purchase and run a branch.
You don’t necessarily have to bootstrap your franchise, you can secure franchise financing from other sources as well. Readout guide on basics of franchise financing and what you should consider before applying for franchise financing. Although you may not be able to get funding immediately, understanding eligibility requirements for franchise loans can help you plan beforehand.
In order to make money, franchisor name recognition plays an important role. The more recognized the brand is, the more you’ll be able to earn. Apparently, it’s best to invest in a franchise with a solid brand image and reputation, both nationally and regionally. The more name recognition your franchise has, the less marketing efforts you’ll need to put in to attract customers.
On a similar note, investing in a franchise that’s popular in your particular demographic is important. If the demand is low for a franchise’s products or services in your area, extra efforts and capital will be required to make the brand recognized. Location is important so try investing in a franchise that’s popular with your local demographic.
Training and Support
Before finalizing a franchise business, evaluate your potential franchisors’ training programs carefully. In addition, check is your expertise, education, and existing training is helpful to working with a particular franchise. Although, you’ll get all the necessary training to operate your location, you’ll likely feel more relaxed if you don’t need to struggle with arduous learning curve. Moreover, you should also calculate whether your franchisor has the resources to support you in the long term. You need to make sure the franchise is capable to sustain support and supervise over their existing franchisees as they develop.
Working with a reliable, qualified, and trustworthy franchisor is also important. Therefore, it’s best to explore all options to see the franchisor’s reputation, along with any complaints filed against the company. You can start your search by checking the franchisor’s BBB (Better Business Bureau) ratings. You can also check the franchisor business credit and financial standing if they’re registered with Dun & Bradstreet. For local franchisor, you can contact your state’s franchise authority to check franchisor compliance with state laws, and whether they’ve had any lawsuits or bankruptcies.
Your Personal Preferences
You should also consider your personal preferences while deciding a franchise business. The fact of starting a franchisee is same to the fact of starting a new business: It takes time, effort, and commitment to keep your operation going. Of course, you don’t want to have a business that you weren’t 100% passionate about. Only go for the industry that motivates you, whose routine you can easily follow, and whose goals and objectives align with yours.
Choosing a Franchise: The Next Steps
After careful search and review of the franchise business and the goals, the next step is to assess each franchise opportunity. Start with having a detailed conversation and requesting copies of their business plan, operations manuals, and marketing material. The information you collect from the interaction will construct the research you’ve conducted by yourself.
Read through the Franchisor’s FDD
Once you’ve decided to take a particular franchise, get their copy of Franchise Disclosure Document (FDD). Under the FTC’s Franchise Rule, franchisors are bound to provide potential investors with their FDD at least 14 days before investors sign a contract. This period allows investors to gauge their decision of signing the contract. While selecting a franchisor, you can request a franchisor to provide an FDD before submitting an application.
The FDD includes critical information about the franchisor concerning their financial position, background, capital requirements, and more. Particularly, you need to review the following pointers:
- The franchisor’s background,
- The franchisor’s competition,
- Any legal, permit, or licensing requirements
- Litigation history
- Startup and operational costs requirements
- Restrictions on suppliers
- Where what, and how you’re permitted to sell their products or services
- Franchising fees
- Training qualification and requirements
- Renewals, transfers, terminations, and dispute resolution rules
- Three most recent audited financial statements
- A list of existing and earlier franchisees and associations whom you can interact with
Consider Getting Professionals Support
Although you have done your thorough research before buying into a franchise, this also process involves a few complex financial and legal facets that can be difficult to understand or to ride out on your own.
Getting assistance from an accountant or legal expert can help you understand the process and to navigate it easily. Get help from an accountant to become clear of the franchisor’s financial aspects provided in their FDD, including a realization of your potential earnings if you pick to invest in that franchise. You accountant can also help you choose a franchise by evaluating your current resources—making it a practical investment for your existing financial position. Lastly, your accountant can help you outline a franchise business plan, and decide a business structure after you’ve signed the agreement.
Getting help from a legal expert is also important, especially when you receive your franchise contract. A franchise legal expert can examine your franchise contract to make sure it is align with your best interests. The franchise contracts are conclusive contracts for many years, so it’s critical to carefully understand what you’re signing on for. Legal experts can help you interpret the legal facets of a franchisor’s FDD, along with your compliance with state laws regarding franchising and the FTC’s Franchise Rule.
Is Franchising Right for You?
To decide whether franchising is right for you, evaluate the pros and cons before making the leap into being a franchisee.
- Solid brand recognition and loyal customer base is the biggest benefit of buying into an established franchise
- Established national and local support for campaigns and prepared marketing materials
- Access to reputable suppliers for all the materials franchisees need
- Access to an established network of support
- Effective management and technical training
- Financial support in terms of franchise loans
- Access to proprietary trade secrets
- Ongoing support along with research and development from the franchisor
- The perks of being your own Boss
- Little risk than starting a new business
- High initial franchise fee and start-up costs, sometimes more than starting a new business
- Monthly royalty payments, reducing your profit potential
- Payment of monthly marketing/advertising fees to receive marketing support from the franchisor
- Some franchise contracts have explicit standards, permitting little or no changes or additions to the brand
- Some contracts specify that franchisors must buy supplies from an approved list of suppliers, maybe at a higher cost.
- Franchise contracts are binding contracts, so you may be stuck for many years if you get on the wrong side of it.
- Your success is dependent on the success of your franchisor
- There’s no guarantee and you might have to work smart and sensibly to make it work for you
- There are always risks in starting any new business
The Bottom Line
Finally, it’s up to you to decide whether you’re able to run and grow a franchise business, or the liberty to build and operate your own business as you see fit. It is always in your best interest to get assistance from professionals, friends and family members and/or other franchise professional. It’s best to exercise due diligence initially in order to make an informed decision as opposed to finding yourself stuck in a contract with a shabby franchisor.