Before Buying a Franchise
In opening a business, you have three primary options: 1) start your business from scratch, 2) buy an existing business, and 3) buy or lease a franchise. Each approach has advantages and disadvantages. In general, the differences relate to startup costs, establishing customer and vendor bases, staffing, and determining appropriate fixtures and equipment.
What is a Franchise?
Franchising involves at least two levels of people: the franchisor, who contributes a trademark or trade name and a business system; and the franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system. Technically, the contract binding the two parties is the “franchise,” but that term is often used to mean the actual business that the franchisee operates.
How Popular is Franchising?
Franchising is said to account for more than 40% of all U.S. retail sales. Industry analysts estimate that a new franchise outlet opens somewhere in the U.S. every 8 minutes, and approximately 1 out of every 12 retail business establishments is a franchised business.
Most towns have many franchises; some you may be familiar with are AAMCO Transmissions, Dunkin’ Donuts, Lawn Doctor, Dollar Discount, McDonald’s, H&R Block, and The UPS Store.
Choosing the Right Franchise for You
Choosing the right franchise for you is absolutely critical to long-term business success. Benefits vary considerably from one franchise program to another. To make the right choice, consider the following:
Your Interests and Abilities
- Does this line of business interest you?
- Do you have the experience, education, and skills required?
- Have you ever owned or managed a business?
- Are your personality traits in sync with the needs of this business?
- Have you set business goals?
- Have you established what your annual income requirements are?
- How many hours a week are you willing to work?
- Are the preceding answers realistic in relation to the franchise being considered?
- How much capital do you have available to invest?
- Will you do it by yourself or will you have partners/stockholders?
- Will you need financing? How much? Where will it come from?
- Initial franchising fee (can be several thousand to several hundred thousand dollars)
- Building and/or improvements
- Initial inventory
- Royalty payments (may be a percentage of gross income)
- Advertising fees
- Site approval
- Design or appearance standards
- Restrictions on goods and services offered for sale
- Method of operation (may include hours, signage, advertisements, accounting procedures, and suppliers)
- Sales area (may limit competition to you, but restrict your ability to open additional outlets or change your location)
Franchise Termination and Renewal
- Your franchise contract is usually for a limited time (typically 15-20 years). You may not have a renewal guarantee.
- If you breach the contract (fail to pay royalties or abide by performance standards), you may lose the franchise.
- Renewals need not provide the original terms and conditions (e.g., royalty payment rates, sales territory).
In addition to considering the terms referred to above, you should evaluate:
- Are other franchises/company-owned outlets in your area?
- Does the franchise have name recognition?
- Is training and support being offered (before/after opening, or for new employees)?
- How long has this franchisor managed a franchise system?
- How many franchised locations do they have? How successful are they? Have you checked them out?
The Franchise Offering Circular
The Federal Trade Commission (FTC) requires that you receive a uniform franchise offering circular (UFOC) at least 10 business days before you are asked to sign a contract or pay any money. In the UFOC are 23 different categories of information about the franchise, including the franchisor’s experience, prior litigation, claims against the franchisor, and any bankruptcy involvement.
The circular should also disclose possible limitations included in the franchise agreement, such as goods or services you may offer for sale, from whom you may purchase goods, to whom you may offer goods or services, and the territory in which you may do business.
The circular will define any conditions under which your franchise could be terminated, and conditions under which you can renew, sell, or assign the franchise to others. It will also include information about training and assistance, and advertising — the costs and potential benefits.
Other Things to Do
Contact Present and Former Franchisees
Find out what their experience has been. In speaking with them, use a checklist that includes all the questions you want to ask on topics such as:
- Length of time in operation
- Hidden or unexpected costs;
- Satisfaction with cost, delivery, quality
- Quality of franchiser’s training
- Evaluation of advertising support/programs
- What did they like about this franchise? Dislike about it?
- Would they invest in another outlet?
Consult Expert Advisors
Have both the UFOC and the franchise agreement examined by an attorney. It’s important to work with an attorney who understands franchising, especially the antitrust laws, the trademark laws, the Federal Trade Commission Franchise Rule, and applicable state laws.
It’s also recommended that you ask a competent accountant to examine your anticipated expenses, your financing needs, and your prospects for achieving your desired level of profitability before you sign any agreement.
More Sources of Information
Federal Trade Commission (FTC)
To obtain information from the FTC or to order their free publication A Consumer Guide to Buying a Franchise, call 202-326-2222 or visit www.ftc.gov .
U.S. Small Business Administration (SBA) When you visit www.sba.gov and search for “franchise,” you’ll find a wide variety of articles and publications on this topic.
Tennessee Department of Commerce and Insurance, Consumer Affairs Division Phone 615-741-4737 (Nashville) to determine whether there are any complaints about a particular franchisor.
International Franchise Association
1350 New York Ave. NW, Suite 900 Washington, DC 20005 Web site www.franchise.org Phone 202-628-8000 Bookstore 800-543-1038 The IFA Bookstore offers many sources of information, including the publications Franchise Opportunities Guide and Investigate Before Investing.
By performing a search on the Web (for example, using Google), you can find many additional sites that offer franchise information and opportunities. Just a few of the ones we came across are listed below. The Greater Knoxville SCORE Chapter does not endorse any particular site or organization; we offer these simply as examples of the type of sources that you may find helpful.
www.ifb.com International Franchise Bureau
This handout is based on an article written by SCORE Counselor Gerald Weinerman and published in the Knoxville News Sentinel. Mr. Weinerman is a retired Vice President of Philips Consumer Electronics Company.