Franchising is a great way to start a business, but before you decide to spend the thousands of dollars needed to buy one, you must do your due diligence. It is essential to understand what a franchise is and how it differs from a chain or independent business. Owning a franchise does not work the same way as a business that comes from an original idea you have.
Our guide will give you everything you need to know about what it takes to be a franchise entrepreneur, also known as a franchisee. We cover franchise examples, how to buy a franchise, financing options, why you should consider hiring a franchise attorney and other key considerations.
A franchise is a business that is owned by one or more people who provide products or services under the branding and rules set forth by a parent corporation. As a part of ownership, the corporation assists its franchisees with marketing and inventory, charging the franchisee fees in return.
The International Franchise Association defines a franchise as a “method of distributing products or services involving a franchisor, who establishes the brand’s trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.”
Opening a franchise is not the same as starting a business from scratch. The benefits of a franchise are brand recognition and support from the parent company, but the drawbacks are franchising fees and limited control.
There are five main types of franchises you’re likely to encounter, each of which comes with its own opportunities and considerations.
Not all franchises are created equal. Different types of businesses are well suited to various types of franchise models. Carefully consider the franchise type before you decide to move forward.
A chain consists of two or more stores that have the same brand and follow similar corporate store policies while offering the same products or services from their parent company. That may seem similar to a franchise, but franchises and chains differ in several key areas. Here are some of the differences:
There are several differences between franchises and chains, specifically in how ownership is set up, the financing options available, the cost of operation and their profitability.
If you’ve decided that opening a franchise is right for you, follow these steps to get started:
Owning a franchise (or any business, for that matter) can be a large undertaking emotionally, physically and financially. Before you dive into buying a franchise, be confident in your reasoning for wanting to own one. If you think owning a franchise may be easier than owning any other type of business, keep in mind that business ownership in general comes with its challenges.
Just because a franchise is popular doesn’t necessarily mean it is the right one for you. When you’re choosing a franchise, do significant research into how the parent company works with franchisees, as well as the local market in which your franchise will operate. Expect to dedicate several weeks to this process, and look for the following criteria:
Once you’ve decided on a franchise, it’s time to begin the application process. This is an area where an attorney could be helpful. Just as you’ve screened franchises, you’ll be getting screened as a part of the application process. Franchisors will look at the following considerations:
Prior to the COVID-19 pandemic, the corporate office of a franchise would hold a standard face-to-face meeting with the prospective franchisee. During this meeting, commonly known as the “discovery day,” you get to know each other better and you can ask all the questions you’d like before making a commitment to buying a franchise.
Since the pandemic, however, discovery days are more often held virtually. As a part of the virtual meeting, you should hope to get a virtual tour of the franchise. When your discovery day is held depends on the franchise; some choose to schedule the meetings during the very beginning of the recruitment process, while others prefer to hold them toward the end.
As pandemic restrictions wane, don’t be afraid to request an in-person discovery day meeting, as it can shed more light on whether the partnership is right for you.
Most franchisees will need financing to launch their franchise. For many, this will come in the form of a bank loan. If you’re in need of funding for your franchise business, consider the best business loans we recommend, including our Biz2Credit review and our Rapid Finance review.
These contracts tend to be long and can include confusing verbiage, so it may be beneficial to consult an attorney to help with this process.
At this point in the process, you will have already chosen the town or city for your franchise. Now, it’s time to physically go out and buy or rent a commercial space.
You are joining an established brand; it has a logo, messaging, guidelines and products. This is the step you’ll take to really entrench yourself in the business. Get training on the following aspects of the franchise:
As you may expect, owning a franchise usually involves spending money before you can make money. Franchise ownership involves franchise fees – what you pay to operate a franchise location. Consider the franchise fee your rite of passage; you pay to get a piece of the pie.
The cost of owning a franchise varies. Some franchises require franchisees to pay an initial fee, which can range from $10,000 to more than $100,000. Then there are the ongoing marketing and royalty fees, which are often determined by how much money your franchise location makes each month.
The U.S. Small Business Administration (SBA) offered this example: “If your average monthly revenue is $25,000 and the franchisor charges a 2% marketing fee, you’ll have to pay your franchisor $500 a month.” The SBA also noted that franchise royalties range from 4% to more than 12% of your revenue; the type of franchise determines the specific percentage.
The amount of money you can make depends on a few factors:
These three expenses must be paid before franchise owners can pay themselves. As of December 2021, franchise owners earn, on average, about $93,000 per year, according to Glassdoor. This includes a base annual salary of about $63,000 and annual additional pay of around $30,000.
To get more information on how much money franchise owners make, you may want to ask existing franchise owners the following questions:
You’ll also want to consider the location. Having the same franchise, or a close competitor, within a few miles will affect your profits.
Despite the required upfront fees, you don’t have to have all of the money before getting started with a franchise business; there are several financing options to consider.
Blake Martin, owner and president of FranNet of The Heartland and a local franchise owner with more than 20 years of experience in the franchising industry, described four financing options for franchisees:
Liquid capital should make up roughly 25% to 30% of any loan you request. It might be cash on hand; assets you leverage, like home equity; or cash infusions from family or silent investors.
“Hundreds of high-quality franchises are on the SBA’s registry, which usually helps to expedite that loan process,” Martin told Business News Daily.
Lines of credit, the leveraging of real estate assets, and business startup programs that allow you to roll over portions of qualified retirement funds tax- and penalty-free are possible solutions to cover the money you’ll need for startup and operating capital.
As a last resort, you could try to obtain partnerships with other funders, but Martin said most franchises will require any shareholders to sign the franchise agreement as a legally binding commitment.
The Small Business and Entrepreneurial Council reported that 5.3% of small businesses and 9.6% of larger employers are franchises. Here are the 30 best franchises of 2022, according to Franchise Gator:
Before you buy a franchise, consider hiring a franchise attorney, who could serve as an excellent resource during the due diligence process. In fact, having a franchise attorney assist in reviewing and explaining key provisions in the franchise agreement is imperative to ensure you are fully educated about the obligations and responsibilities you are undertaking as a franchisee, said Schuyler “Rocky” Reidel, a managing attorney who specializes in franchise law for Reidel Law Firm in Galveston, Texas.
“The greatest benefits to franchisees is education about franchising and the system they are considering in particular, getting insight into franchise industry norms and customs and counsel in negotiating the franchise agreement for modifications,” Reidel said.
From a franchisor’s perspective, Reidel said, a franchise attorney is necessary for drafting and maintaining the franchise disclosure document, which is required by law before you can sell franchises in the United States.
“A franchise attorney assists the franchisor with navigating the legal compliance maze at both the federal and state levels,” he said.
Because franchising is a heavily regulated industry, it is essential to have counsel who is familiar with the franchise industry. This ensures you don’t fall into a compliance trap, such as failing to have a franchise disclosure agreement, encountering sales compliance issues, and conducting annual renewals/maintenance of the system disclosures, Reidel said.
He noted these additional benefits of having professional help when reviewing a franchise agreement:
Franchise ownership can lead to a fulfilling career, but before you commit to opening a franchise, be sure to do your due diligence. Conduct ample research, figure out how much money you’ll make and consider all your financing options. It’s often best to hire an attorney as well. That way, your journey toward becoming a franchise owner will go as smoothly as possible.