Contributed by Celia Keating
In 2020, 780,000 franchises created $670 billion in economic output and provided jobs to more than 7 million people.
Owning a franchise is similar to but also different from owning a corporation.
So what is franchising?
Franchising is a business arrangement between a brand’s owner, called the franchisor, and an investor, who is called the franchisee.
Buying into a franchise system means you’ll be leveraging the benefits of an established brand using processes that are proven to work.
The franchisee gets to use valuable assets that the franchisor developed. These include:
- the brand name
- intellectual property
- business model
- supplier networks
- personnel training
- operating manual
- management guidance
- marketing systems
The franchisee uses these resources to open a location that will operate according to the brand owner’s system. With business infrastructure already in place, a newly-opened franchise won’t have to endure growing pains like a new venture or deal with the same level of startup risk.
In exchange, the franchisee pays the franchisor a one-time payment for the right to use these resources. Many franchises require franchisees to pay a percentage of their gross revenue and some fees for ongoing marketing expenses that directly benefit franchisees.
Thousands of corporate brands are available for franchising. According to the US Census Bureau, there are 300 industries offering franchise opportunities.
Next, we’ll cover how to choose a franchise and what it takes to buy a franchise.
1. Look for the Right Industry
When searching for franchises in which to invest, select a sector you’re familiar with or one that interests you. Some investors research the latest consumer trends to find the most promising opportunities. If you can find a franchise that’s right up your alley, so much the better. If not, you can always hire the right people.
The food and restaurants sector offers an enormous number of enduring, popular franchises. Other top industries for franchising include health and fitness, automotive, retail, rental, and service-related businesses.
Before studying a business in depth, check to see if the franchise is available in your area. Sometimes a territory has already been purchased, or a franchisor simply isn’t looking to expand into a given area. These restrictions are beneficial for you. You don’t want to purchase a franchise in an area with steep competition or where the demographics are just not ideal for the brand.
Lastly, consider your budget. How much cash do you have to invest? Franchise upfront costs can vary wildly from $20k to $2 million.
2. Be Aware of Fees and Other Costs
An upfront fee, the franchise fee, is typically payable upon signing with the franchisor. The franchising fee can vary among franchisees of a particular brand because one location may be in a prime area and thus more profitable than other franchisees in secondary areas.
Separately, a franchisee will have to cover the expense of building a location and purchasing inventory.
You can get more details on the fees and other costs by contacting the franchise you’re interested in. Next, study the Franchise Disclosure Document (FDD) carefully. If any wording is unclear to you, ask for clarification. It’s essential that you know what to expect including monthly royalty payments, grand opening fees, and marketing fees, and any other fees down the road.
3. Talk to Other Franchisees and Read Reviews
Ask other franchisees about their experiences to get an idea of what it’s like to be a franchisee, and what they’ve learned since starting their franchise. You can also check with the Better Business Bureau, an organization that rates a company’s trustworthiness.
4. Make the Most of Discovery Day
Many franchises set up an in-person meeting with prospective franchisees called a discovery day. On this day, the franchisor shows prospective franchisees around the corporate headquarters or an active franchise location. You’ll get to observe the company culture and learn what to expect from daily operations. The franchise will get to know you, too.
A discovery day is a great chance to ask questions and see if the franchise is the right fit for you. You can ask questions about topics like the number of franchised outlets, franchising costs, franchise locations, the controls the franchisor imposes, and the technical and management support that headquarters provides to franchisees.
5. Secure Financing
Consider the amount you’re prepared to invest and your limit. Whether alone or with a partner, you’ll need a financial plan on how much you’ll need and where to get it. If business loans are an option for you, there are several types that a franchisee can use.
- Small Business Administration (SBA) loans: SBA loans typically have reasonable interest rates and are often ideal for first-time entrepreneurs.
- Commercial bank: You can apply for a loan from a bank or any financial institution. Make sure you have a good credit rating and a business plan.
- Retirement accounts: Loan applicants can sometimes use their retirement accounts such as an Individual Retirement Account (IRA), 403 (b), or 401(k), with no upfront taxes or penalties.
- Home equity: Substantial assets like a home can be used to secure a loan. Home Equity Lines of Credit (HELOC) and home equity loans allow your home equity to be tapped for cash and used as collateral. HELOCs can be used for a revolving line of credit that you can dip into as needed.
- Securities-Backed Line Of Credit (SBLOC): Like home equity, this loan offers a revolving line of credit with your investments as collateral.
6. Search for a Location
Franchises usually have a set of criteria for their prospective franchisees to follow when selecting locations for their outlets. While franchisors have final approval on locations, the actual search for the site usually falls on the franchisee.
Start by assessing the demographics of your area, and then choose a franchise that aligns with those demographics. If you have a particular franchise in mind, look for a location that will have the demographics where that franchise will thrive.
Consider your target customers’ income levels, age groups, ethnicities, gender, as well as their social, educational, and economic backgrounds.
A good location – one that is accessible and has lots of traffic – will cost you. However, a reputable franchisor can often help in your lease negotiation.
Finally, research the local laws in the area, including permits required and regulations.
7. Review Your Franchise Agreement
The franchise agreement is a formal contract, so be sure to review everything carefully before signing. The franchise agreement typically lists the following details.
- Operations: how your franchise is expected to be managed
- Location: your assigned territory and assurance of exclusivity rights within the territory
- Franchise fee: the upfront fee you’ll pay the franchisor
- Training and continued support: the training, technical support and administrative support provided by the brand owner for the franchisees and their personnel
- Duration: length and duration of the agreement
- Royalty fee: the percentage of total weekly or monthly sales paid to the franchisor
- Brand identity: how franchisees can use the corporate logo, signage, patent, and trademark.
- Marketing and advertising: the franchisor’s advertising commitment and the fees franchisees are required to contribute to the advertising fund
- Cancellation, termination, and renewal rights: how the franchisee can terminate or renew the agreement, usually including an arbitration clause in the event of legal action
- Resale policy: details about how the franchisee can sell their franchise. Some franchisors include a first refusal clause that enables them to match the potential buyer’s price or purchase the franchise at a price determined by the brand owner.
Have your own, independent legal and financial advisors review the Franchise Agreement. Discuss the fine print with your advisors before finalizing the agreement.
8. Accept Corporate Training
Many franchisors offer training for their new franchisees. The operations manual usually functions as your primary textbook during training. Typically, there’ll be talks about corporate culture and history, daily operations, vendor relations, reporting requirements, and the pre-opening process. You’ll also be shown a prototype franchise where you’ll get hands-on training.
Expect training to be a continuing process. Chances are, the franchise you buy into will incorporate new technologies and update their processes to keep your franchise competitive.
Franchising is often less risky than starting a business from scratch.
There are thousands of franchises to choose from. To narrow down your choices, select from industries where you have the expertise or that you’re interested in.
Next, find out everything about fees and other costs, and research the franchisor by reading online resources and talking to other franchisees.
The last phase includes securing financing, determining your location, and reviewing the franchise agreement.