This section covers the big picture of franchising, and also briefly touches on its history in the United States.
What is Franchising?
A franchise is a commercial chain that licenses rights to a branded product or service to others. Every franchise relationship consists of two key players: the franchisor, and the franchisee.
This is the person or business entity that founded the franchise chain. Most successful franchisors have worked hard to establish a successful business model before they choose to license out franchising rights.
This is the person or business entity that "buys in" to the franchise. In exchange for rights to the represent franchise brand and sell its products, the franchisee typically pays an initial franchise fee plus ongoing royalties.
A Brief History of Franchising
The first franchises were started by passionate entrepreneurs who firmly believed in the value of their product. Businessmen like Isaac Singer, one of the inventors behind the modern-day sewing machine, and Ray Kroc, early pioneer of the (in)famous hamburger chain, McDonald’s, successfully leveraged the franchise model to scale their businesses into world-recognized brands.
The franchising business model really took off in the second half of the 20th century, with dozens of franchises popping up across all major industries, from fine dining, to motor vehicles, to human resource services.
Today, franchises are responsible for nearly half of all retail transactions in the United States. With over 4,000 franchise options to choose from, many aspiring business owners opt to join a franchise instead of attempting to start their own business from scratch.
However, with the boom in popularity franchising has seen over the past fifty years, it is now more important than ever to be well-educated about the advantages and risks franchising involves.
Franchising is a proven business concept that can generate massive income for franchisors and a comfortable living for franchisees.
However, joining an existing franchise isn’t always the best option for would-be business owners. There are many different factors to consider, and you should know that joining a franchise does not guarantee financial success.
In this section, we cover the major pros and cons of franchising to help you make an informed choice.
The Advantages of Franchising
There are many advantages to joining a franchise, including:
A Proven Business Model
Many franchise chains have been around for decades, and over the years they have refined their products or services to improve business processes and maximize customer satisfaction.
Whereas owners of a brand new business face a steep learning curve, often investing tens of thousands of dollars, if not more, into testing and improving operations, a new franchisee starts off with a time-tested business model. This saves franchisees an enormous amount of time, money, and stress, and lets them focus on running their new business.
An Established Brand
One of the key advantages offered by a franchise is their highly recognizable brand.
Unlike new business owners, who have to build up their reputation from scratch, successful franchise chains have a nationwide customer base. New franchisees can reap the benefits of the franchisor’s success.
A Nation-Wide Marketing Network
Successful franchises are able to pool resources from dozens, if not hundreds, of franchise branches to fund powerful and often highly effective marketing campaigns. This “power in numbers” approach benefits each franchise on the local level.
The most successful franchises have learned the value of offering in-depth training for new franchisees. Strong mentorship and business management training are invaluable assets, especially early on in the life of a business.
Increased Purchasing Power
One of the greatest benefits a franchise can offer franchisees is significant discounts on the costs of supplies, ingredients, and other business expenses. Because a franchise can purchase these items in vast quantities, they often get a much better deal than the individual business owner.
Many franchises have predetermined layouts that franchisees can utilize when designing their store. This can save a great deal of money and time in the initial phase of launching a business.
A Supportive Network
The challenges a new franchisee might face will typically be familiar to an experienced entrepreneur. Most franchises have clear-cut operational guidelines, and they offer ongoing support to make sure each individual location has the best chance of success.
Easier Access to Capital
Due to the widespread success of the franchise model, it is often easier to get small business loans when starting a franchise versus starting a business from scratch.
While it is uncommon for a franchisor to directly lend to franchisees, many will help set up franchisees with third-party lenders who can assist with financing the initial startup costs.
Disadvantages of Franchising
Although joining a franchise can be a great option for some people, it’s not without its drawbacks:
The downside of having a predetermined business model and operating procedure is that you, as franchisee, aren’t actually the business owner. You don’t call the shots. Franchises have all franchisees sign a legally binding agreement that they will not alter certain fixed standards related to the brand.
For persons who have a strong entrepreneurial, independent spirit, and who wish to bring their creative side to running a business, franchising may not be the best choice.
Dependent Financial Success
For better or worse, the financial fate of a local franchise is largely intertwined with the success and goodwill of the franchisor.
Franchisees rely heavily on the brand reputation of the franchise as a whole. If a legal issue or some other PR snafu ever arises for any of the franchisees, it can have serious consequences for everyone in their franchise network.
It is a widespread misconception that franchisors are always supportive of their franchisees. Quite the contrary, some franchises deliberately run their franchisees out of business. In the industry this is known as cannibalization. Franchisors are known to deploy self-serving tactics to promote their own financial growth, often turning against their own franchisees.
Franchisors know that they are offering potential franchisees an attractive package. With all of the benefits of joining a franchise, many franchisors charge hefty fees, including:
- An initial franchise fee of $20,000-$50,000
- An ongoing royalty fee of anywhere from 3-7% of gross sales
- An ongoing advertising fee that varies by franchise, but can be up to 5% of gross sales
Zero Long-term Equity
As Robert L. Purvin writes in his book, The Franchise Fraud: How to Protect Yourself Before and After You Invest, once a franchisee joins a franchise, they can virtually "never leave."
This is because most franchisors require franchisees to sign a non-compete agreement, preventing them from continuing to work in their industry if they ever choose to terminate the franchise agreement.
Once you decide if franchising is fits with your personal and professional goals, the next step is to find the franchise that fits you best.
There are a handful of important factors to consider when looking for your perfect franchise. In this section, we cover the biggest questions you will want to ask yourself when making your choice.
Evaluate Your Personal Situation
The first thing to think about is your personal situation as a prospective franchisee. How much money do you have set aside? What are your core business strengths? What are your weaknesses?
Sketching out your personal profile will help you identify a selection of franchises that match what you’re looking for. In addition, you will be able to present yourself as an attractive candidate to franchisors.
How Much are You Prepared to Invest?
Joining a franchise and launching your business can cost anywhere from $5,000 to $1 million in initial investments, depending on the type of franchise you join.
If you don’t have a lot of startup capital, consider looking for a service-based franchise. These are often much less expensive to start up, since you can often run the business out of a home office.
Keep in mind that the more popular the franchise, the more expensive it will be to join.
What are Your Principal Strengths and Weaknesses?
Are you an outgoing person with great networking skills? Are you self-motivated and independent? Or do you prefer managing a team?
Every franchise offers a unique challenge. An extrovert with strong social skills may do well in a B2B service-based franchise. Others who prefer to manage from behind the scenes may thrive in retail.
Knowing what you do best as well as your personality type will help you weed out franchises that aren’t a good fit.
What are Your Personal Goals?
Some people join a franchise because they want to work independently and have more time for their family. Others dream of building up a small empire by opening multiple branches in their metro area.
When looking for the perfect franchise, think ten to twenty years into the future. What do you want your life to look like? Franchising is a long-term investment, and it may not start to pay off until a number of years down the line.
Planning ahead can help you avoid obstacles that could otherwise ruin your business.
Pick Your Franchise Format
Prospective franchisees have the option of choosing between two common types of franchise relationships: the business franchise and the product-distribution franchise
This type of franchise relationship is what most people commonly associate with franchising. In the business-format franchise, a franchisor licenses its brand, products, business model, and operational procedures to franchisees, in addition to offering initial and ongoing training and support.
The business-format franchise is ideal for those who want to be guided through every step of launching their business.
Common business-format franchises include restaurants, coffee shops, retail stores, and so on.
Product Distribution Franchise
Product distribution franchises license franchisees to sell their branded products, but typically do not supply an entire business model. Soft drink and automobile companies, such as Coca Cola and Ford, are examples of such franchises.
These franchises afford franchisees a greater amount of independence in terms of how they choose to structure and run their business. However, these freedoms will vary greatly according to the franchise.
Find the Right Business Model
Once you have a good sense of your personal profile as a prospective franchisee, the next step is to consider the different types of franchise operations that are available.
In this section, we cover the four broad business categories you can choose from: basic retail, advanced retail, business service (B2B), and customer service (B2C).
This is the most straightforward business model. In a basic retail business, you operate from a storefront that sells goods or local services to your customers. For example, a grocery store, electronics store, or a gym could all be considered a basic retail business.
Basic retail businesses rely heavily on foot traffic and high visibility to attract customers. For this reason, they work particularly well in populated areas or city centers.
Similar to the basic retail model, advanced retail businesses sell goods or services to in-store customers. However, unlike basic retail businesses, advanced retail businesses rely on a greater level of expertise to meet customers’ needs. For example, a car repair shop, dental clinic, or tutoring center could all be considered an advanced retail business.
Advanced retail businesses must actively promote their services through email marketing, referral reward programs, and other outreach efforts in order to ensure a steady flow of business.
Business Service (B2B)
Business service businesses operate out of an office or small storefront, selling their services to other businesses. For example, a recruiting agency, marketing firm, or web development agency could all be considered business service businesses.
The major difference between this model and the retail model is that a business service business must heavily promote their business, often through cold-calling and online marketing, in order to secure customers. Additionally, you or your team members will need to travel to others business locations to present your services and attempt to close sales.
Customer Service (B2C)
Like business service businesses, customer service businesses are run out of a small office, sometimes from the owner’s home, and require active marketing. You or your team will most likely travel to client’s homes to provide your service.
Home repair, musical training, and pet-sitting businesses are all examples of customer service businesses.
Choose Your Ownership Model
As a franchise owner, you will be able to decide how much direct involvement you want to have with the day-to-day operations of your business.
Generally, those who have more capital to work with choose to hire managers to handle the on-site affairs of the franchise. This allows you to simultaneously open multiple units at the same time. However, if your startup budget is limited, you likely will want to act as your own manager. This means you’ll be starting out with just one location.
Based on these considerations, franchisees can choose to follow one of three basic models of ownership:
Owner-operator: You play a central role in managing the day-to-day affairs of your franchise, and hire additional help to assist with all the necessary tasks.
Absentee Executive: You own the business but hire one or more managers to run your franchise locations. Your physical presence is not required at your store(s), and your unit managers will report to you.
Semi-absentee Executive: Somewhere between the owner-operator and absentee executive approach, this model often sees owners spending one or two days per week at their franchise location, while having a manager run the show the remainder of the week.
Pick Your License Type
Learning about the different types of franchise licenses will help you pick the one that makes the most sense for your business goals. Here are the most common types of licenses:
This is the most common license type for new franchisees. With the single-unit license, a franchisee has rights to operate a single franchise location within a given area. The single-unit franchise operation can be a great learning opportunity for those who have long-term dreams of owning multiple locations.
Another common license type is the multi-unit license, which allows franchisees to operate multiple franchise locations within a given region. Some franchises even offer multi-unit licensing right off the bat, to give new franchisees greater incentive to expand their business.
The geographic license allows franchisees to open a specified number of franchise locations within a geographic region—sometimes a city or even a whole county. Unlike the multi-unit license, the geographic license often includes a designated timeline within which the franchisee agrees to open new locations. The advantage of the geographic license is that franchise fees and royalty fees are often reduced.
With the master license, a franchisee has franchising rights within a large geographic area. This is typically given to seasoned franchisees who are now breaking into new territory. In addition to opening franchise units, a master license often grants the right to sell off single-unit and multi-unit licenses to other prospective franchisees in that region.
Franchise Life Cycle
A final factor to consider when determining what you are looking for in your idea franchise opportunity is how many years the franchise has been operating. While there are some advantages to joining up with newer franchises, including lower franchising fees and the excitement of pioneering a new business, there are also certain risks involved. Older franchises have a time-tested business model and a well-established brand, whereas newer franchises are still developing these.
Before signing on with a franchise, make sure you consider where it is at in its life cycle, and the likelihood that it will continue to grow to maturity as a business.
Now that you know what you’re looking for in a franchise opportunity, the next step is to look for a franchise that fits your criteria.
In this section, we offer valuable tips on where to look for franchise opportunities, and also how to evaluate your options to pick the one that fits you best
Where to Look for Franchise Opportunities
Each year the franchise industry sees steady growth. With hundreds of opportunities available, there are bound to be at least a handful of franchises out there that fit your search criteria.
Here are three ways to start your search:
Virtually all franchises have a website with contact information where you can call to ask questions about their franchise program.
In addition, there are many websites that list franchise opportunities by industry, region and/or cost. However, some of them tend to steer visitors towards the highest paying affiliate partners, rather than providing an impartial overview of all the opportunities available.
We had a chance to speak directly with Matt Biskup, the Chief Marketing Officer for franchiseopportunities.com, and highly recommend their site as a great place to start.
If you prefer meeting in-person to ask questions directly to a franchising representative, then attending a franchise expo is for you.
Make sure you do your research beforehand so that you know which franchises will be present, and so that you can make the most of your experience. We recommended making a list of the franchises you want to meet with, and also a list of the questions you want answered to help narrow down your search.
Here you can find a list of upcoming expos around the U.S.
Hire a Consultant
Asking the advice of a franchising expert can be incredibly useful as you try to find your ideal franchise opportunity.
Franchise consultants are typically seasoned franchisees themselves, and they know the ins and outs of the franchising industry. This allows them to recommend a number of different franchises based on your personal profile.
Additionally, franchise consultants offer their services free of charge. They are paid directly by the franchisor once you finally find your franchise and close the deal.
What to Look For in a Franchise
As you narrow down your search, it is important to keep in mind that every franchise is different. If needed, spend extra time thinking about what exactly you are looking for in a franchisor-franchisee relationship.
Do you want a franchise that is focusing on aggressive growth? Or one that goes out of its way to care for and support its franchisees? Do you want a franchise that is newer and allows for more experimentation in business practices? Or do you want an established franchise that controls every aspect of your business operations?
Every franchise has its own culture and expectations, so keep searching until you find a style and approach that suits what you want.
How to Talk with Franchisors
One of the most important steps in finding the right franchise is actually talking to the franchise representatives. Do your research so that you can present yourself as a desirable franchising partner. Here are some things to keep in mind:
When to Reach Out
The ideal time for connecting with a franchisor is when you have enough capital to get started. You should be prepared to invest and begin launching your business within approximately three months.
Franchisors get calls from all kinds of people, many of whom are nowhere near ready to actually join a franchise. Having your finances in order will make a big impact and greatly increase your odds of being accepted.
What to Expect
In many respects, your initial contact with a franchisor is like an interview. Both you and the franchisor will be evaluating each other to see if it is a good match.
The franchise representative will likely ask you a series of questions about your professional history, your family commitments, your financial situation, as well as why you want to join their franchise, and your longer-term professional goals.
Pay attention to the interaction—does the representative sound professional, organized, and knowledgeable about the different levels of the franchise’s operations? Your initial can serve as a litmus test for the quality of the overall organization.
Important Questions to Ask
Here’s a list of questions you can ask as you evaluate whether or not a franchise is a good fit for you:
- What are your company’s core values & mission?
- How long has your company been in business?
- How many units do you currently have?
- What is your growth trajectory?
- What makes your business stand out from your competition?
- How do you market to your customers?
- How large is your industry and what are the industry trends?
- What do you look for in a potential franchisee?
- What kind of support do you offer your franchisees?
If you are still interested in your chosen franchise after you have had a chance to get your questions answered from one of their representatives, the next step is to interview multiple current franchisees.
This is an extremely valuable opportunity, as it gives you an on-the-ground perspective of what it is like owning and operating the franchise. You can often learn a lot from franchisees that you wouldn’t hear from a franchising representative.
Once you have spoken with a franchise representative and are confident you’ve found the right franchise for you, the next and final step is closing the deal.
In this section, we walk you through this final phase of selecting your franchise and getting started as a franchisee.
Reviewing the Disclosure Document
Before you sign the franchise agreement, you will be given a franchise disclosure document (FDD). Reading over the FDD is truly the final step in determining whether or not you have found your ideal franchise. It is a long and sometimes complicated document, but it is important to pay close attention to each of the twenty-three items listed so that you know exactly what you are getting into.
A few things to watch out for include:
- Is there a recurring history of legal claims against the franchise?
- Has the franchise had any recent (or current) bankruptcies?
- Does your allotted territory sufficiently protect you from competition with your fellow franchisees?
- Does the FDD include any financial incentives, discounts, or bonuses that you were promised by a franchise representative?
- Overall, does the document reflect a balanced relationship, wherein both franchisor and franchisee are mutually benefiting? Or does it seem one-sided?
For more tips on reading through the disclosure document, check out this article.
If you notice anything in the franchise disclosure document that seems unreasonable or unfair, don’t be afraid to negotiate better terms. Check out this article for tips and how to negotiate and also a list of common concessions franchisors are willing to make.
Congratulations! You have signed the franchise agreement and are ready to launch your new business. Here are some additional resources you can check out for tips and assistance in the upcoming stages of running your franchise:
Finding an Ideal Location: This is an important step and can make or break a franchise. Don’t assume your franchisor will do all of the work for you. Do your research and make sure you get advice from people who have experience in real estate and the franchising industry.
Here is an article you can check out to get started.
Financing Your Franchise: You probably have already given your finances a lot of thought, but franchise expenses can continue to accrue over time.
If you find that you might need more capital to work with than you initially anticipated, consider applying for a small business loan through one of the special programs funded by the SBA.
Additional Resources: There are many resources online that offer assistance to prospective or current franchisees. Obviously the first place you should look if you are in need of help is your own franchisor. However, in case you want other perspectives, the International Franchise Association has articles, FAQs, and other valuable resources for anyone in the franchise industry.