Advice On Buying A Franchise

By Lisa Kaplan Gordon. May 7th 2016

Franchising enables a good business idea to go viral. It allows the founder of a successful business to share the love and a potential revenue stream with others who, literally, buy into the dream for a predetermined amount of time.

There are more than 75 industries in the U.S. that rely heavily on the franchise model to operate, from restaurants to real estate agencies.

In the end, "franchisors," like McDonald's or MaidPro, sell the formula of their success to "franchisees," who recreate and manage a business with a proven track record.

How Franchising Works

The investor, or franchisee, pays a "franchise fee" that buys the name and reputation of the franchising company, and the franchisor's system, format or products.

Franchisors offer different deals. But fees sometimes also buy:

  • training
  • national advertising
  • marketing, management and personnel support
  • newsletters announcing latest developments
  • grand opening promotions

Franchising fees vary widely. The starting franchising fee for MaidPro, a housecleaning franchise, is $7,900; while a McDonald's franchise costs $45,000 just for the initial licensing fee. Many franchises, like McDonald's, require thousands of dollars in upfront investment.

The Costs

Franchise fees are only a small part of the initial costs of launching a franchise. Other franchising costs may include:

Royalty Payments: On-going payments based on a percentage of weekly or monthly sales.

Advertising Fund: Investors pay into a joint advertising fund that may pay for national advertising, rather than local advertising to promote a particular franchise.

Controls: Franchisors may require investors to renovate properties to meet a standard designed to create a uniform look and feel among all franchises.

Licenses: Most localities require business or operating licenses.

Professional Fees: This includes the accounting and legal fees necessary to run a business.

To make sure a potential franchisee can meet these financial obligations, a company may require an audit to determine that the investor has the required financing available to cover standard start-up and operating costs, such as acquiring a place to do business, buying machinery and inventory and hiring personnel.

One rule of a thumb is to double the amount an investor thinks he'll need to launch his business. McDonald's, for instance, requires a franchisee to have $500,000 liquid cash available. Allstate Insurance franchisees must have $75,000 minimum cash.

Is A Franchise Right For You?

Franchising is not for everybody, but it is a goldmine for some, who often buy more than one franchise.

Here are some pros and cons of owning a franchise.

Pros:

  • Buying a franchise of a proven company can be safer than starting a new business with an untested service or product. Franchisees are probably starting with greater brand awareness than if they opened a business on their own.
  • Franchisors provides a step-by-step guide to successfully running the business. This is the formula that has worked for others around the country, and even the world.
  • If problems arise, the franchisor often provides support. No one wants to see a franchise succeed more than the franchisor.
  • Investors can buy franchises in many industries without experience or training, which most franchisors provide.
  • Some franchisors help investors secure financing.

Cons:

  • Depending on the franchise agreement, an investor may have to pay royalty fees even if the franchise fails.
  • Even if an investor has a better way of running the franchise, he may be obligated to follow the rules and controls of the franchisor. This can throw a wet blanket on innovative ideas. Restaurant franchisees, for instance, may not be able to alter menus or decor. And the franchisor can dictate hours of operation, uniforms and even insist on particular bookkeeping procedures.
  • Franchisors may not approve of the location an investor has selected.
  • Franchisors can limit the business to a particular territory, limiting the business's reach.
  • At the end of the franchise agreement, the franchisor can raise fees, change standards or reduce territories.
  • Some franchisors demand that the franchise be owner operated, limiting the investor's business opportunities.

Franchise Questions

Launching any business comes with risk, and opening a franchise is no exception. Before buying a franchise, a prospective franchisee should ask himself the following questions.

  • Is there a demand for this business? If so, is the demand year-round or seasonal?
  • What competition already exists for this business? Is there an identical franchise nearby? Are similar products available online or by catalog?
  • How reliable is the franchisor? What is the company's reputation? How long has it been in business? What consumer complaints have been filed against the company? Has it ever been in bankruptcy?

Bottom Line

Owning a franchise is a great way for entrepreneurs-in-the-making to run a time-tested business. Instead of figuring out each detail of small business ownership, franchisors help new members of their family launch the business; then, franchisors dictate how the operation should be run to ultimately reach success.

But owning a franchise does not guarantee satisfaction. Entrepreneurial spirits can be squashed under volumes of rules and regulations.

In the end, a prospective franchisee will need to weigh the pros and cons before making a final decision.

Sources

Franchise.com

Entrepreneur

Entrepreneur

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