Many people dream of being an entrepreneur. By purchasing a franchise, you can often sell goods and services that have instant name recognition as well as obtain training and ongoing support to help you succeed. Be cautious, however; like any investment, purchasing a franchise is not a guarantee of success.
The Benefits and Responsibilities of Franchise Ownership
A franchise typically enables you, the investor (franchisee), to operate a business. By paying a franchise fee, which may cost several thousand dollars, you are given a format or system developed by the company (franchiser), the right to use the franchiser's name for a limited time, and assistance. For example, the franchiser may help you find a location for your outlet, provide initial training and an operating manual, and advise you on management, marketing, and personnel. Some franchisers offer ongoing support such as monthly newsletters, a toll free 800 telephone number for technical assistance, and periodic workshops or seminars.
While buying a franchise may reduce your investment risk by enabling you to associate with an established company, it can be costly. You may also be required to relinquish significant control over your business while taking on contractual obligations with the franchiser.
Below is an outline of several components of a typical franchise system. Consider each carefully.
In exchange for obtaining the right to use the franchiser's name and assistance, you may pay some or all of the following fees:
- Initial franchise fee and other expenses. Your initial franchise fee, which may be nonrefundable, may cost several thousand to several hundred thousand dollars. You may also incur significant costs to rent, build, and equip an outlet and purchase initial inventory. Other costs include operating licenses and insurance. You also may be required to pay a grand opening fee to the franchiser to promote your new outlet.
- Continuing royalty payments. You may have to pay the franchiser royalties based on a percentage of your weekly or monthly gross income. You often must pay royalties even if your outlet has not earned significant income during that time. In addition, royalties are usually paid for the right to use the franchiser's name, so even if the franchiser fails to provide promised support services, you still may have to pay royalties for the duration of your franchise agreement.
- Advertising fees. You may have to pay into an advertising fund. Some portion of the advertising fees may go for national advertising or to attract new franchise owners, but not to target your particular outlet.
To ensure uniformity, franchisers typically control how franchisees conduct business. These controls may significantly restrict your ability to exercise your own business judgment. The following are typical examples of such controls:
- Site approval. Many franchisers preapprove sites for outlets. This may increase the likelihood that your outlet will attract customers. The franchiser, however, may not approve the site you want.
- Design or appearance standards. Franchisers may impose design or appearance standards to ensure customers receive the same quality of goods and services in each outlet. Some franchisers require periodic renovations or seasonal design changes. Complying with these standards may increase your costs.
- Restrictions on goods and services offered for sale. Franchisers may restrict the goods and services offered for sale. For example, as a restaurant franchise owner, you may not be able to add popular items to your menu or delete items that are unpopular. Similarly, as an automobile transmission repair franchise owner, you might not be able to perform other types of automotive work, such as brake or electrical system repairs.
- Restrictions on method of operation. Franchisers may require you to operate in a particular manner. The franchiser might require you to operate during certain hours, use only preapproved signs, employee uniforms, and advertisements, or abide by certain accounting or bookkeeping procedures. These restrictions may impede you from operating your outlet as you deem best. The franchiser may also require you to purchase supplies only from an approved supplier, even if you can buy similar goods elsewhere at a lower cost.
- Restriction of sales area. Franchisers may limit your business to a specific territory. While these territorial restrictions may ensure that other franchisees will not compete with you for the same customers, they could impede your ability to open additional outlets or move to a more profitable location.
Terminations and Renewal
You can lose the right to your franchise if you breach the franchise contract. In addition, the franchise contract is for a limited time; there is no guarantee that you will be able to renew it.
- Franchise terminations. A franchiser can end your franchise agreement if, for example, you fail to pay royalties or abide by performance standards and sales restrictions. If your franchise is terminated, you may lose your investment.
- Renewals. Franchise agreements typically run for 15 to 20 years. After that time, the franchiser may decline to renew your contract. Also be aware that renewals need not provide the original terms and conditions; the franchiser may raise the royalty payments or impose new design standards and sales restrictions. Your previous territory may be reduced, possibly resulting in more competition from company-owned outlets or other franchisees.
Before Selecting a Franchise System
Before investing in a particular franchise system, carefully consider how much money you have to invest, your abilities, and your goals. The following checklist may help you make your decision.
- How much money do you have to invest?
- How much money can you afford to lose?
- Will you purchase the franchise by yourself or with partners?
- Will you need financing and, if so, where can you obtain it?
- Do you have a favorable credit rating?
- Do you have savings or additional income to live on while starting your franchise?
- Does the franchise require technical experience or relevant education, such as auto repair, home and office decorating, or tax preparation?
- What skills do you have? Do you have computer, bookkeeping, or other technical skills?
- What specialized knowledge or talents can you bring to a business?
- Have you ever owned or managed a business?
- What are your goals?
- Do you require a specific level of annual income?
- Are you interested in pursuing a particular field?
- Are you interested in retail sales or performing a service?
- How many hours are you willing to work?
- Do you want to operate the business yourself or hire a manager?
- Will franchise ownership be your primary source of income or will it supplement your current income?
- Would you be happy operating the business for the next 20 years?
- Would you like to own several outlets or only one?
Selecting a Franchise
Like any other investment, purchasing a franchise is a risk. When selecting a franchise, carefully consider a number of factors, such as the demand for the products or services, likely competition, the franchiser's background, and the level of support you will receive.
Is there a demand for the franchiser's products or services in your community? Is the demand seasonal? For example, lawn and garden care or swimming pool maintenance may be profitable only in the spring or summer. Is there likely to be a continuing demand for the products or services in the future? Is the demand likely to be temporary, such as selling a fad food item? Does the product or service generate repeat business?
What is the level of competition nationally and in your community? How many franchised and company-owned outlets does the franchiser have in your area? How many competing companies sell the same or similar products or services? Are these competing companies well-established, with wide name recognition in your community? Do they offer the same goods and services at the same or lower prices?
Your Ability to Operate the Business
Sometimes, franchise systems fail. Will you be able to operate your outlet even if the franchiser goes out of business? Will you need the franchiser's ongoing training, advertising, or other assistance to succeed? Will you have access to the same or other suppliers? Could you conduct the business alone if you must lay off personnel to cut costs?
A primary reason for purchasing a franchise is the right to associate with the company's name. The more widely recognized the name, the more likely it will draw customers who know its products or services. Therefore, before purchasing a franchise, consider:
- The company's name, how widely recognized it is, and if it has a registered trademark.
- How long the franchiser has been in operation.
- If the company has a reputation for quality products or services.
- If consumers have filed complaints against the franchise with the Better Business Bureau or a local consumer protection agency.
Training and Support Services
Another reason for purchasing a franchise is to obtain support from the franchiser. What training and ongoing support does the franchiser provide? How does their training compare with the training for typical workers in the industry? Could you compete with others who have more formal training? What backgrounds do the current franchise owners have? Do they have prior technical backgrounds or special training that helps them succeed? Do you have a similar background?