Owning a franchise might seem like a dream business. You're buying into a well-known name and seemingly already have a built-in customer base and proven business model—things you'd need to build if you were starting out on your own. But owning a franchise isn't for the faint of heart. While potentially very profitable, it's a steep climb that requires a large initial investment and professional and legal sacrifices.
Let's discuss the difficulties you might face when starting a franchise.
1. Questionable profitability. Most franchise owners don't provide much information to potential buyers regarding earnings possibilities. Even the franchisors who do supply this information usually give only average sales figures and profits before expenses are deducted. These numbers aren't very helpful when trying to determine whether your individual franchise will be successful.
2. High start-up costs. Before opening your franchise, you might be required to pay a non-refundable initial franchise fee, anywhere from several thousand to several hundred thousand dollars. In addition, you'll have to pay a lot to furnish your franchise with the necessary inventory and equipment. It can easily take several years to recoup all these business expenses.
3. Encroachment. Imagine that you've just spent thousands of dollars opening your own GasMart station when another GasMart station opens across the street. There goes half your customer base. This type of thing happens to franchisees all the time, as nearly every franchisor reserves the right to operate anywhere they want.
4. Lack of legal recourse. As a franchisee, you have little legal recourse if the franchisor wrongs you. Most franchisors make franchisees sign agreements waiving their rights under federal and state law, and in some cases allowing the franchisor to choose where and under what law any dispute would be litigated. Shamefully, the Federal Trade Commission (FTC) investigates only a small minority of the franchise-related complaints it receives.
5. Limited independence. When you buy a franchise, you're not just buying the right to use the franchisor's name, you're buying its business plan as well. Most franchisors impose price, appearance, and design standards—limiting the ways you can operate the franchise. While these standards can help promote uniformity, they can also stifle your creativity and ability to cater to local tastes or needs.
6. Royalty payments. Most franchisees must make royalty payments to the franchisor each month based on a percentage of sales, eating into the franchisee's net profits.
7. Inflated pricing on supplies. In many cases, the franchisor can designate your franchise's supplier of goods and services. They argue that this is to maintain quality control, but almost all franchisors receive kickbacks from the vendors. By not allowing you to shop around, you're forced to pay higher prices for supplies.
8. Restrictions on post-term competition. Let's say that you decide to purchase a hamburger franchise, but after a couple of years, you determine that you could run a higher-quality, more profitable burger joint on your own. Unfortunately, due to noncompete clauses built into almost every franchise agreement, franchisees aren't allowed to become independent business owners in a similar business after the franchise agreement ends. By purchasing a franchise, you could be unwittingly limiting your business opportunities for years after the expiration of your contract.
9. Advertising fees. Many franchisees are obligated to make regular contributions to the franchisor's advertising fund. But will they use the money to advertise your franchise? Quite possibly not! Franchisors maintain broad discretion over how to administer the advertising fund. In a case against Meineke Discount Muffler Shops, for example, it was discovered that Meineke was using the advertising fund for costs wholly separate from advertising. Yet, the court ruled in Meineke's favor, saying that the franchisor has no fiduciary duty to its franchisees.
10. Unfair termination. Even the slightest impropriety on your part, such as being late on a royalty payment or violating the franchise's standard operating procedure, can cause the franchisor to terminate your agreement. While most franchisors aren't this strict, the possibility of losing your entire investment for being late on a payment is downright scary.
If you know the risks and still want to start a franchise, do your research. Ask yourself which area of business you're most knowledgeable about. For example, do you know more about restaurants, gyms, or car washes? If you need advice, reach out to others who can help. Other franchise owners can give you insight into everyday operations. An accountant can run the numbers to see what sort of investment you can afford to make into the franchise. And a lawyer can help you through the negotiations and signing of the franchise agreement.
If you're interested in learning more about franchises and business in general, check out Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo).