What You Should Know About Buying a Franchise
Buying a franchise can present a great opportunity for you to run your own business – with a host of advantages over starting a company from scratch.
But, of course, like any investment buying a franchise doesn’t mean guaranteed success. If you’re considering purchasing a business concept, license or business model from a franchisor, here are several factors to understand and weigh as you decide whether to become a franchisee.
The most common forms of franchising are product/trade name franchising and business format franchising.
Product/trade name franchising is when you are buying the right to use the name or trademark of the franchisor. This typically focuses on supply chain management – products are manufactured or supplied by the franchisor and delivered to the franchisee to sell.
With business format franchising, the franchisor and franchisee have an ongoing relationship, typically focused on full-spectrum management, with franchisor-supplied services, such as site selection, training, product supply, marketing plans and even help identifying funding options.
What You Get in The Deal
As a franchisee, you have the ability to sell goods and services that already have instant name recognition -- thanks to the proven success of the established franchisor. Being able to use the name, logo, and products of a larger brand means your business benefits from brand recognition, promotions, and marketing.
“But it also means you have to follow rules from the larger brand about how you run your business,” says the Federal Trade Commission in its Consumer’s Guide to Buying A Franchise.
The training and support you get as a franchisee can help your business succeed. In addition to the right to use the format or system developed by the company, the franchisor may also provide you with help in finding a location for your outlet, initial training and an operating manual, and advice on management, marketing or personnel.
You may also get franchisor support through a newsletter, website, workshops or seminars.
Costs of the Deal
A franchise agreement will come with defined expenses, franchisor controls and contractual obligations, which will vary depending on the type of contract as well as the type of franchise you buy and operate.
Be sure to understand the costs outside the initial franchise fee, which could range from tens of thousands to several hundred thousand dollars.
Other possible costs include expenses to rent, build and equip a space as well as to buy initial inventory for the franchise. There may also be fees for operating licenses and insurance, advertising fees and royalty payments, which are based on a percentage of your weekly or monthly gross income.
The FTC warns potential franchisees that typical agreements have you paying royalties even if your franchise is losing money or if the franchisor doesn’t provide the services it promised.
The Limits on Your Control
Your agreement may also come with strict controls in place – such as the site selection, design or appearance requirements, and product restrictions. If you own a restaurant franchise for example, you may not be able to make any changes to the menu.
Your business may also be limited to a specific location or sales territory. If you have an “exclusive” or “protected” territory, the FTC says, it may prevent the franchisor and other franchisees from opening competing outlets or serving customers in your territory, but it may not protect you from all competition by the franchisor.
“For example, the franchisor may have the right to offer the same goods or services in your sales area through its own website, catalogs, other retailers or competing outlets of a different company-owned franchise.”
While your contract dictates the number of years you’ll operate your franchise – agreements can run as long as 20 years – you’ll need to pay extreme care to the list of contractual obligations to stay in compliance.
“A franchisor can end your franchise agreement for a variety of reasons, including your failure to pay royalties or abide by performance standards and sales restrictions,” the FTC warns.
And renewals are not automatic – the franchisor could decline to renew or may offer a renewal that has different terms and conditions as your original contract, such as higher royalty payments, new design standards, reduced territory, and sales restrictions.
“Any of these changes may result in higher costs, reduced profits or more competition from company-owned outlets or other franchisees,” the FTC says in its guide.