Thinking about buying a franchise? Franchises are often touted as being a good way to own your own business, one with a proven business model so you don’t have to reinvent any wheels. You may even be looking at franchising opportunities and thinking some of them look too good to be true—provided you have the money to invest, that is. But as with most things in life and in business, there are downsides as well as upsides to buying a franchise business.
Starting a franchise is a commitment of not only money, but also time, and there are certain restrictions, costs and obligations about which you need to be aware. So while you may be tempted to jump into a franchise opportunity and start a franchise sooner rather than later, it’s best to do your research before making any kind of franchise investment.
What is a Franchise?
Franchise opportunities are everywhere, and you’ve probably seen franchises for sale online or in the business section of your local paper. At its core, owning a franchise is about licensing. In the franchise business model, you, as the franchisee, purchase a licence to use the trademarked names, logos and business format or system of the franchise business owner, also known as the franchisor.
There are two basic types of franchising. In product/trade name franchising, the franchisee obtains the right to sell or distribute the products bearing the franchisor’s trademarked name and/or logo. With business format franchising, sometimes known as package franchising, there is an ongoing relationship between the franchisee and the franchisor, and the franchisor provides a number of different services to the franchisee. These services may include things such as training, the supply of product, marketing and advertising, and perhaps even walking you through how to open a franchise.
What a Prospective Franchisee Needs to Know
While there are a lot of franchise ideas in the business world these days, buying a franchise business isn’t an investment to be taken lightly. While in many cases you do receive a lot of support from the franchisor, as well as a proven business model, all of this comes at a cost. Before you decide to invest in a franchise, you need to put on your researcher’s hat and consider a number of factors, including the following:
- The rights you will be getting under the franchise agreement. Rights you should obtain include the right to use the franchise’s name and trademark in your business, training assistance and management support, and the use of the franchise’s business format or system (for example, in marketing, facility design, layout and displays). You should also ensure the franchisor will not permit another franchisee to operate within a designated geographical area that might compete with your location.
- The experiences of current and previous franchisees. You will be in an ongoing business relationship with the franchisor for the duration of the franchise agreement. It often pays to contact past and current franchisees and ask them about their experiences working with the franchisor. A list of both past and current franchisees should be included as part of the Franchise Disclosure Agreement the franchisor must provide to you.
- Initial and ongoing costs. You will likely incur a number of initial costs, including deposits or franchise fees (which may be non-refundable), as well as the costs of your initial inventory, items such as signs and displays, your lease deposit and legal costs. Ongoing fees include costs such as royalty fees and advertising and marketing fees, and other costs associated with running a business, such as insurance, lease payments and employee salaries.
- Your obligations under the terms of the franchise agreement. The franchise agreement will most likely be more beneficial for the franchisor than it is for the franchisee. Be aware of what you will be required to do under the terms of the agreement. Often, for example, franchisees are required to meet a sales quota. Franchisees are typically also required to purchase product and equipment from the franchisor rather from another supplier, even if another supplier might be cheaper.
One of the first steps you should take as a prospective franchisee? Obtain a copy of the Franchise Disclosure Document.
The Franchise Disclosure Agreement
Under the Federal Trade Commission’s Franchise Rule, franchisors are required to provide prospective franchisees with a Franchise Disclosure Document; in fact, you must receive a copy of this document at least 14 days before you’re asked to sign a contract or make any payment of money to the franchisor. To help you in your investigation of the franchise opportunity, though, you may want to obtain a copy of the Franchise Disclosure Document when you begin your research into the franchise.
The Franchise Disclosure Document should have the following sections:
- Background of the franchisor
- Business background
- Financial history
- Litigation history
- Bankruptcy information
- Initial costs
- Ongoing costs
- Restrictions and limitations on the franchisee
- Termination, renewal, sale and assignment
- Training and assistance program
- Advertising and marketing costs
- Current and former franchisees
It’s important to go through the Franchise Disclosure Document thoroughly, and ask questions if there’s anything you find needs to be explained or clarified. It may also be helpful to obtain a review of the entire Franchise Disclosure Document by an attorney before you invest, in order to make sure you fully understand your costs and obligations. You may also want to enlist the assistance of an accountant to review the franchisor’s financial statements to make sure the franchisor is solid financially and shows steady growth. For an in-depth look at the questions you need to be asking and the evaluations you need to make, the Federal Trade Commission also offers a consumer guide to franchises.
Operating Your Business Under the Franchisor’s Control
Another area prospective franchisors sometimes fail to consider is how comfortable they will be operating their business under the franchisor’s control—and in most franchising arrangements, the franchisor retains a lot of control. Before you even start running your business, for example, you will often need the franchisor to pre-approve your site selection. Usually, a uniform appearance is of great importance to the franchisor, and you probably won’t be able to make independent business decisions, such as changing your product line, your employees’ uniforms or the décor of your establishment. And if the franchisor makes a design change—and some may do so on a seasonal basis—you’ll have to bear the increased costs of implementing this change in your establishment.
The franchisor’s control can extend to many other facets of the operation of your business, such as the accounting or bookkeeping system you use, your prices and whether you’ll be able to offer your customers any discounts, and even whether or not you can have your own website. If you’re someone who has a lot of ideas, the control exerted by a franchisor under a franchise agreement may become too cumbersome.
A franchise business may well be a good investment opportunity and a chance to run your own business based on a proven business model, but the smart entrepreneur will take a thorough look at all aspects of the franchise arrangement before making the decision to invest.
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