How to Start a Franchise Business

Learn the pros and cons of owning a franchise business.

If you want to be your own boss but you're not sure you have the know-how to start a business from scratch, a franchise business might be the right solution for you.

What is a Franchise?

A franchise is an independently owned business that operates under the brand and business model of a large--usually well-known--corporation. The corporation sets many procedures and policies for operations, purchasing, marketing, and other aspects of running the business.

Call it entrepreneurship lite. Franchise business owners don't have many of the struggles typically associated with a startup. But they also don't have complete control over decision-making.

McDonald's restaurants, H&R Block tax preparation offices, and Ace Hardware stores are all franchises. The owners of the individual outlets are called franchisees and the corporations are called franchisors.

How Does a Franchise Work?

Under a franchise agreement, the business owner pays a franchise fee plus a percentage of revenues in royalties to the corporation, typically 4% to 6%. Franchisees may also have to kick into an advertising fund and contribute to other common expenditures.

Franchisees usually are also responsible for other costs such as rent, the build-out of the facility, equipment, and inventory. The initial investment to own a franchise can range from under $10,000 for a home-based business to $2 million or more for a McDonald's or Pizza Hut franchise.

What Types of Businesses Can be Franchises?

Fast food franchises might be the best known, but you can find a franchise for just about every product or service including:

  • hair salons (Supercuts)
  • home repair (Mr. Handyman)
  • auto services (Jiffy Lube)
  • real estate brokerage (Re/Max)
  • learning centers (Mathnasium)
  • fitness centers (Planet Fitness)
  • tools and equipment (Snap On, Big O Tires)
  • hotels (Hampton by Hilton)
  • shipping services (The UPS Store)
  • home nursing (Home Instead Senior Care)
  • pest control (Mosquito Joe), and
  • dry cleaning and laundry services (Tide Cleaners).

Why Buy a Franchise?

Buying a franchise has many advantages. A franchise gives you a leg up on the competition, removes many of the unknowns of starting a business, and provides a support system you typically don't have as an independent business owner.

A franchise is a proven business model with a track record of sales. While you should certainly do your due diligence on the franchisor, the question of whether the business idea works has already been answered for you.

A franchise gives you ready-made name recognition. The franchisor has already spent a lot to establish the company brand and develop a customer base. You get the benefit of instant customer recognition as well as ongoing marketing and advertising support, though the franchisor might charge an additional fee for these services.

As a franchisee you don't have to go it alone. Franchisors offer many types of support including training your employees, a roadmap for the design and build-out of your facility, inventory management, and other operational processes, and someone to call if you run into trouble or have questions.

You get the buying power of a big corporation. As a startup, you would likely buy your materials at the lowest volume levels and prices would be higher as a result. But a franchise is backed by the buying power of the corporation, giving you the most advantageous pricing from the start.

What Are the Disadvantages of Franchises?

Owning a franchise puts you in business with both the franchisor and the other franchisees in the organization, so you are not in control of many aspects of the business.

You're not the boss of everything. Franchisees control some aspects of day-to-day operations like scheduling employees, but they are also required to follow many rules and procedures set by the franchisor including hours of operation, location, facility design, the territory you can serve, and product and service offerings.

Suppose, for example, you own a donut shop franchise and your customers are asking for gluten-free donuts. You might not be allowed to make changes or additions to your product offerings even if you spot a trend that could mean more sales.

You get a brand for better or worse. The branding you get as a franchise owner is a big plus, but if something happens that negatively affects the brand anywhere in the organization, your business might be painted with the same brush. If there's a salmonella outbreak in another restaurant in the franchise or the franchisor is involved in a scandal, for instance, it might affect your reputation even if your location is not involved.

You can't shop around for the best prices. The franchisor might require that you buy inventory, supplies, and equipment from specific suppliers, and you won't be able to take advantage of a better deal if you find one.

Royalties are forever. If you buy a business or start one from scratch, you get to keep all your profits. Nearly all franchise businesses must continue to pay royalties to the franchisor for the duration of the franchise agreement.

Other Things to Consider Before You Buy a Franchise

Your franchise agreement only lasts for a specified time period, and the franchisor can choose to terminate the agreement when the term is up, or you might be required to make expensive upgrades in order to renew.

The franchise agreement may also put restrictions on your ability to sell your business. The franchisor may have the right of first refusal or the right to approve or deny a potential buyer.

What to Do Before You Buy a Franchise

Make sure you do your homework before you buy a franchise. Among the sources available to you are the Better Business Bureau, franchise trade associations, and current and former franchisees of the franchisor you choose. The Federal Trade Commission (FTC) also offers a guide to buying a franchise.

Know your skills and abilities. Some franchises don't require any previous experience. But you can't expect a franchisor to train you to be a hair stylist, for instance, or to give you a crash course in auto repair. Some occupations may also require special licensing in your state, so begin by determining what types of franchises are a match with your skills, experience, and abilities.

Do the research. Your due diligence should include research into the franchisor, the industry, and competitive environment in the location where you will operate. The franchisor will likely provide some market research, but you also want to look at the local market demand and competition.

Read the franchise disclosure document (FDD) carefully. Franchisors are required to provide you with an FDD that contains the franchisor's business and legal history, itemized costs for starting and running the franchise, income expectations, restrictions on the territories where you may operate and the goods and services you may sell, training and advertising services provided, financial information, and more. Be certain you have received the most updated FDD before you sign a franchise agreement.

Talk to other franchisees. Talking to other franchisees can help you evaluate the claims made by the franchisor and give you additional information such as how long it may take your business to break even.

Read the franchise agreement carefully before signing up. The franchise agreement is the actual contract between you and the franchisor. You should make sure the contract matches up with the FDD and you are comfortable with all the terms included.

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