- A franchise provides entrepreneurs with the opportunity to buy an established business with branding and processes in place.
- When 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 critical to understand what a franchise is and how it differs from a chain. 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 more.
What is a franchise?
A franchise is a business that is owned by one or more people who, under that business, provide a solution following the branding and rules set forth by its corporation. As a part of ownership, the corporation assists its franchisees and charges a flat fee along with fees based on profits or sales of its franchisees.
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."
Key takeaway: A franchise provides entrepreneurs with a ready-made business that already has processes, procedures, strategies and branding in place.
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, according to franchise.com.
Ownership: A franchise is owned by a franchisee, whereas a chain store is owned by its parent corporation. Both ownership types involve following similar guidelines and corporate policies.
Financing: Franchises can seek help from franchisees to help 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 and, therefore, have the potential to "return more profits to the parent company in the long run."
Key takeaway: 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 franchise ownership 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. Do not take your franchise research lightly. 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 can also destroy sales.
- Repeat business. What is the likelihood that the franchise could bring you repeat business? For example, someone who owns a GNC 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?
- Franchise fees. How much are the fees, and what do you get for them? Be sure to ask those questions. You should hope to hear that you will receive excellent marketing and 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. As part of the application process, just as you've screened franchises, you'll be getting screened. 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 do you already know about it.
4. Set up your "discovery day" meeting.
Prior to COVID-19, 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.
During the pandemic, however, discovery days are being held virtually. As 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.
5. Apply for financing.
Unfortunately, if you cannot get the financing you need to open your franchise, there's no reason to proceed any further for now. Apply for financing, and wait until you've been approved for enough to cover all of the franchise fees and other expenses.
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 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 entering into 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:
- Branding.
- Products and services, including how to sell them and where to buy them.
- Product placement and point-of-purchase displays.
- Payment technology, ie. credit card processing.
- Sales tactics for this specific business model.
Key takeaway: The process of buying a franchise is lengthy. Do your due diligence on all of the franchises you are considering, find the necessary funding, choose a location, and get the training and support needed to open.
Should you buy an existing franchise?
Purchasing an existing franchise can set you up for success by offering a quick return on investment. In addition, buying an existing franchise can mitigate some of the initial growing pains that come with opening a new franchise. In deciding whether to buy an existing franchise, consider the following:
- The motivation for selling.
- The success of the business.
- The business's valuation.
Key takeaway: If you are thinking about purchasing a franchise location from the current owner, make sure you understand why the owner is selling and how successful the business is before moving forward.
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 right 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 upfront initial fee, which can range anywhere 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 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% of your revenue to 12% or more; 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
- Taxes
These three expenses must be paid before franchise owners can pay themselves.
The Franchise Business Review found that the top 16% of franchise owners make more than $200,000 each year. The study also included the following findings:
- The average annual income reported by all of the food and beverage operators surveyed was $120,000 for businesses that had been open at least two years.
- When startup costs were included, the median annual income was around $70,000.
- More than one-third of all food franchise owners earned more than $100,000 last year.
- Men made 34% more than women, on average; more men than women were multiunit owners (61% versus 51%).
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 owning this franchise?
You'll also want to keep location in mind. Having the same franchise, or a close competitor, within a few miles will affect your profits.
Key takeaway: Depending on the franchise, the initial costs can be significant. You can expect to pay anywhere from $10,000 to $100,000 (or more) to get started. You will then pay ongoing royalty and marketing fees, which are typically a percentage of your monthly revenue.
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
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.
Key takeaway: 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 SBE Council reported that 5.3% of small businesses and 9.6% of larger employers are franchises. Here are the 30 best franchises of 2020, according to Franchise Gator:
- Mathnasium
- FastSigns
- Tropical Smoothie Cafe
- Sport Clips Haircuts
- Visiting Angels
- The Joint Chiropractic
- Kiddie Academy
- Lawn Doctor
- Budget Blinds
- MaidPro
- Oxi Fresh Carpet Cleaning
- NaturaLawn
- ComForCare
- Touching Hearts at Home
- Mosquito Joe
- Chem-Dry Carpet Cleaning
- Tailored Living
- British Swim School
- Kumon
- Focal Point
- Rosati's
- DreamMaker Bath & Kitchen
- CarePatrol
- Wings Etc.
- LeafSpring Schools
- Glass Doctor
- Electric
- Made in the Shade Blinds & More
- Home Cleaning Centers of America
- Teriyaki Shops
Key takeaway: The highest-ranked franchises in 2020 are in a wide range of industries, including education, restaurants, cleaning and 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 very regulated industry, it is critical to have counsel who is familiar with that industry so you don't fall into one of the compliance traps, such as failing to have a franchise disclosure agreement, encountering sales compliance issues, and conducting annual renewals/maintenance of the system disclosures, Reidel said.
Reidel 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 for a client.
- Counsel for negotiating modifications.
Franchise ownership can lead to a fulfilling career, but before committing to opening a franchise, be sure to do your due diligence.
Key takeaway: When moving through the franchise purchase process, it can be beneficial to hire an attorney who specializes in franchise law to help you fill out your application and review your final contracts.