- A franchise provides entrepreneurs with the opportunity to buy an established business with branding and processes in place.
- When you’re buying a franchise, it is critical to spend time researching the numerous options to find one that is the right fit for you.
- You should expect to pay anywhere from $10,000 to $100,000 in initial fees when buying a franchise. You will also pay monthly fees for marketing and royalties.
- This article is for people who are looking for a complete guide to buying a franchise business.
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.
What is a franchise?
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.
What types of franchises are there?
There are five main types of franchises you’re likely to encounter, each of which comes with its own opportunities and considerations.
- Job franchises: These franchises often require low investment and low overhead; some may even be home-based. Typically, relatively little equipment or stock is required. Common examples include cleaning franchises, lawn care services and children’s services.
- Product franchises: In this type of franchise, the franchise owner distributes the franchisor’s products. Typically, product franchise owners receive the franchisor’s trademark but none of their infrastructure. Automotive, machine and soda companies are common examples of product franchisors.
- Business-format franchises: This is the most common type of franchise, since it significantly eases the franchisee’s burden. The franchisor gives the franchisee access to all their systems, including marketing, operations and training. Fast food and business service franchises are among the most common business-format franchises.
- Investment franchises: These franchises require franchisees to invest their own capital. This could be through cash or the franchisee’s hiring and overseeing of their own management team. Hotels and large restaurant franchises are common examples.
- Conversion franchises: This type of franchise is basically business-format franchising with an acquisition component. It involves the franchisor acquiring other businesses in their sector and converting them into franchise locations. This way, the business can continue to exist while accessing the franchisor’s systems. The result is rapid scaling for the franchisee, and more profits (and less competition) for the franchisor.
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.
What is the difference between a franchise and a chain?
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:
- Ownership: A franchise is owned by a franchisee, whereas a chain store is owned by its parent corporation. Both ownership types follow similar guidelines and corporate policies.
- Financing: Franchises can seek help from franchisees to raise funds to cover their corporation and individual franchise location expenses. As a result, franchises tend to gain faster growth than chain stores do.
- Cost of operation: It generally costs less to run a franchise than it does to operate a chain store. Businesses that are owned by franchises have lower overhead and operations costs because franchisees can take on duties such as serving and cleaning.
- Profitability: Franchise business owners are required to share profits with their franchisees, which cuts into profits. Chain stores, on the other hand, have more control over ownership. That means the parent company may generate greater profits in the long run.
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.
How to buy a franchise, step by step
If you’ve decided that opening a franchise is right for you, follow these steps to get started:
1. Be sure about your reasoning.
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.
2. Research which franchises you may want to own.
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:
- A solid track record of excellent sales: It’s advisable to choose a franchise that has proof of being profitable.
- A growing market: For success, the franchise you choose should be in a market that is growing.
- Social responsibility: People want to do business with companies that are socially responsible. Find out what the franchises you are considering are doing to be socially responsible.
- Local competition: A little competition can be good, but too much competition nearby can break your business. The competition does not need to be in the form of the same franchise; too many local businesses in the same industry located in one area also can make it hard to drive sales.
- Repeat business: What is the likelihood that the franchise could bring you repeat business? For example, someone who owns a health supplements franchise can at least hope that every month, the same customers would come back to refill their vitamins.
- Opportunities to upsell products and services: McDonald’s is an excellent example of a company that excels at upselling products. Having a burger? How about some fries with that burger? Would you like to supersize that? These are examples of upselling customers to drive more revenue.
- Franchise fees: How much are the fees, and what do you get for them? You should hope to hear that you will receive excellent marketing, hiring and training support.
- What it’s like to work in that franchise: See if you can get a current franchise owner to let you shadow them. Shadowing an owner of a current franchise will help you get a better sense of your passion for this business and if it’s something you can and want to do.
3. Begin the application process.
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:
- Your finances, to ensure you’ll have enough funds to keep the doors open
- Your background, including your education, work history, and reasoning for starting the business
- Where you want to open the franchise
- Why you are interested in their franchise and what you already know about it
4. Set up your “discovery day” meeting.
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.
5. Apply for financing.
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.
6. Review and return your franchise paperwork very carefully.
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.
7. Buy or rent a location.
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.
8. Get training and support.
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:
- Products and services, including how to sell them and where to buy them
- Product placement and point-of-purchase displays
- Payment technology, such as credit card processing
- Sales tactics for this specific business model
What are the initial investment costs and franchise fees?
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.
How much money can I make by owning a franchise?
The amount of money you can make depends on a few factors:
- Loan payments
- Required business reinvestment (including franchise fees)
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:
- How much money have you made every year since the franchise’s inception?
- How much of that money did you pocket?
- What unanticipated expenses did you have?
- Based on what you’ve seen, what do you think is a realistic amount of money I can make by owning this franchise?
You’ll also want to consider the location. Having the same franchise, or a close competitor, within a few miles will affect your profits.
What are your financing options to pay for your franchise?
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.
Traditional and/or SBA-backed loans
“Hundreds of high-quality franchises are on the SBA’s registry, which usually helps to expedite that loan process,” Martin told Business News Daily.
Leveraging of assets to self-fund
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.
Partnerships with other funders
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.
Financing options include liquid capital, traditional or SBA-backed loans, your own funding or money from a potential partner. Each option has pros and cons.
What are the most popular franchises?
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:
- Wings Etc.
- Home Instead
- Visiting Angels
- Apricot Lane
- Oath Pizza
- CMIT Solutions
- Your CBD Store
- School of Rock
- A Place At Home
- Kiddie Academy
- Chem-Dry Carpet Cleaning
- Bruster’s Real Ice Cream
- Fresh Coat Painters
- Images 4 Kids
- Hounds Town USA
- Le Macaron
- Minuteman Press
- Oxi Fresh Carpet Cleaning
- Meraki Assisted Living
- 9Round Fitness
- Honest Abe Roofing
- Brightway Insurance
- Express Employment Professionals
- Always Best Care Senior Services
- Amada Senior Care
Should you hire a franchise attorney?
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:
- Education on obligations and expectations within the franchise system
- Knowledge of industry norms
- Additional insight into how a potential franchise system is structured and help in identifying potential future concerns
- Counsel for negotiating modifications
Starting your franchise the right way
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.