Franchising

Buying a franchise is an option for those who don’t want to start their own business from scratch, or take over an existing business. This article addresses the important aspects of franchising that should be considered during the decision-making process. If you already own a business and you would like to franchise it to other people, that’s a separate topic not covered here.


Basics

Some of the biggest and most familiar American companies expanded through franchising. Among them are McDonald’s, H&R Block, and 7-Eleven. There are also many home-based franchises that require far less capital investment: System4, Matco Tools, ServiceMaster Clean, Cruise Planners/American Express, Jazzercise Inc., Snap-on Tools, CleanNet USA Inc., Stratus Building Solutions, and Vanguard Cleaning Systems are examples.

As the franchisee, you pay an upfront fee and royalties to the owner of the franchise (franchisor). In exchange, you get the rights to sell the products and services under the existing brand name and system of doing business. You benefit from a proven business model, and you’ll receive ongoing support from the franchisor.

Advantages

You get to piggyback on an established trademark with instant brand awareness. Beyond that, there are many other positive factors:
  • Unites independent retailers behind a single business formula
  • Less start-up risk for new franchisees
  • Creates uniformity of customer expectations at all locations
  • Standardized products and packaging
  • Uniform accounting and finance systems
  • Lower operating costs due to group purchasing power for materials and supplies
  • Facilitates smooth expansion
  • Corporate-sponsored training programs
  • Local and national advertising campaigns across multiple media platforms
  • Helps to avoid the common pitfalls and mistakes of starting a business on your own
  • Assist you with differentiating your business from the competition
Many franchisors will also perform market research to assess consumer demand and couple that analysis with site selection. Once a site has been chosen, ensure that you’re granted exclusive franchising rights within an established geographic perimeter. Franchisees benefit from strength in numbers and economies of scale. Having a franchise behind you may provide leverage in negotiating favorable lease terms or purchasing real estate.

You may also receive financing assistance for construction, signs, opening inventory, tools, supplies, equipment, and working capital. To help you manage your franchise, you may have access to consulting advice, strategic marketing, sales tips, company operations manual, and continuing product research and development.

Disadvantages

Franchising means a loss of control since you are bound by the rules and procedures of the franchisor. This won’t make sense for those who start their own businesses because they want total control. Here are some negative factors:
  • Loss of independence and some decision-making authority
  • Some franchises are weaker than others, so research is required
  • Training programs may not exist, or are inadequate
  • You may not agree with new products and advertising campaigns
  • You operate under a binding contract enforceable in court
  • The growth of your business is limited to what you can do under the contract
  • You may be required to pay for things that you don’t want to buy
  • Problems with the franchisor and other franchisees reflect on your business
  • You pay royalties that would otherwise be profit
Legal Requirements

In 1979, the Federal Trade Commission implemented its Franchise Rule requiring full disclosure of relevant information to prospective franchisees. The highlights of this rule are:
  • Disclosure must occur during first contact where franchise is discussed
  • Disclosure must be at least 10 days prior to signing contracts or exchanging money (“cooling off” period)
  • Contracts must be provided at least five days prior to signing to allow for thorough review
  • The disclosure information is contained in a Franchise Disclosure Document (FDD) that includes all material information needed for a rational investment decision
The Federal Trade Commission doesn’t require registration of franchisors, but 15 states do. Thirteen of those states require the filing of the Franchise Disclosure Document (FDD) or Uniform Franchise Offering Circular (UFOC). The 15 states are: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin.

The fact that a franchisor is registered doesn’t guarantee that you are protected from scams or failure. Registration simply means that the franchisor has filed necessary documents and paid any mandatory fees. Due diligence is required, and review of all documents by an experienced attorney is highly recommended. Consultation with a financial expert in the field of franchising may be needed to review the financial data and tax consequences. A complete understanding of the costs of starting and running the business is needed before forging ahead.

Summary

Not all franchises are alike. One might help you with financing, and the next may not. The fee structures are different, and it’s critical to read and understand the fine print. The fact that a franchise makes good money in one location doesn’t mean it will do the same five miles away.

A less structured alternative to a franchise is a “business opportunity.” This may be attractive to those who want to minimize the upfront investment and retain control over the business.

Whatever path you follow, don’t let unrealistic expectations drive your decision. Don’t think that franchising is for you because you have no prior business experience. You still have to know what you’re doing even though you’ll get help along the way.

__________________________________


Michael Sanibel is a freelance writer specializing in business, marketing, personal finance, law, science, aviation, sports, entertainment, travel, and political analysis. He graduated from the United States Air Force Academy and is also licensed to practice law in California and New Hampshire. Michael wrote this feature article exclusively for Debbie May.com (www.DebbieMay.com), an organization dedicated to helping small businesses succeed.