What is a Franchise?
**Check out our Introduction to Franchising for young entrepreneurs in our learning center!
A franchise is like a temporary lease or contract with an established company for the rights to sell the franchisor’s goods or services using their established business model and trademark.
A franchisor is a business that grants the license or agreement to franchisees (investor).
Starting any business can be a risk. An estimate of twenty percent of new businesses will not survive beyond the first year. Fifty percent make it to five years and thirty percent make it ten years or more. A possible way to minimize the risk of starting a new business is to consider a franchise agreement with a company that already has a well-established name brand and business strategy to follow.
In the nineteen-eighties I worked at a McDonald’s restaurant. As an entrepreneurial spirited teenager, I imagined one day owning a franchise of my own. At the time, it cost the owner of the restaurant one-hundred thousand dollars to get on a six-year waiting list for a franchise contract. While I was babysitting a sizzling vat of French fries, I thought back to when I was eight years old and bought a pair of hamsters with grand plans to breed them and make money. If I sold the babies for a dollar each and used some of the money to buy more breeding pairs, I’d make thousands of dollars, I had calculated, as surely every kid in school needed a soft, fuzzy hamster. Thank goodness for a mother with a low tolerance for smelly, short-tailed mice.
How does a franchise work?
There are many costs involved in owning a franchise. Firstly, you must pay the franchisor a franchise fee. This allows you the right to sell goods and services under the franchisor’s brand name for a limited time with support for a specified number of years. These said contracts or agreements do not give the investor (franchisee) any rights or ownership of the franchising company.
Contracts between the franchisor and franchisee can vary and are complex. Depending on how the contracts are written they can last five years and up to thirty years often with heavy penalties for premature termination. Support from the franchisee may include helping you find a suitable location for the business, training, operation manuals, newsletters, a website, access to workshops, and seminars.
Besides the initial startup fee there is an annual licensing fee and ongoing royalties paid to the franchisor. Depending upon the industry, royalties can vary from 4.6% to 12.5%.
A good thing to know is the Federal Trade Commission’s (FTC) has set rules for franchisors and require that they must give you a list of documents to evaluate any potential investment opportunity. https://www.ftc.gov/legal-library/browse/rules/franchise-rule
What are the risks to owning a franchise?
Owning the rights to sell a brand name or goods is no guarantee of success. There are risks. The financial costs alone can be overwhelming and may include:
- Grand opening or other initial business promotions
- Business and operating licenses, food handlers permit and ongoing inspections for certain businesses.
- Product or service supply costs like foods for a restaurant or production line clothing for a retailer.
- Real estate and leasehold improvements to house the business.
- Required equipment such as a computer system, machinery, security systems, visual displays may be required and leased from the franchisor.
- While the franchisor may provide this, it may not be free and can include travel expenses to seminars or training facilities.
- Business insurance
- Compliance with local ordinances, such as zoning, waste removal, fire, and other safety codes
- Employee salaries
- Advertising cost locally and or a contribution requirement for national campaigns.
Other risks may include:
- Limited sales territory
- Restrictions on goods or services the franchisee can sell or supplier they must buy from
- Contract terminations and renewal
- Demand for the product
- Internet limits on services, areas, and customer solicitation
Ultimately, like any company, success relies heavily on the investor having the skills and business savvy to make it all work.
What are the benefits of owning a franchise?
Owning a franchise can bring instant name recognition that a new upstart business may take years to establish. Take McDonald’s for example, in the right location the reward can be worth the expense. Not only is the name well established, but they also have their own university to help train and educate the franchisee about how to run a successful business. With a time-tested brand, surviving a downturn in the economy can be less risky. Established products and methods of selling can help cut the learning curve of a new business venture.
Which type of franchises make the most money?
It’s no surprise that I have yet to see a single hamster factory franchise make the list, but according to Hubspot the top franchises to buy in 2021 were:
- Dunkin’ Doughnuts
- The UPS Store
- Sonic Drive-In
- Great Clips
- Taco Bell
- Kumon Math and Reading Centers
- Sports Clips
While evaluating a business opportunity, knowing if the investment is worth the risk, is paramount. Consider the following:
- How many franchise locations have opened in recent years?
- Check out the success rate. What percentage of the newest franchises are still open?
- Factor in real estate costs. A successful business franchise in one location may not be profitable if you are paying a higher lease or property expenses in a different area, or if traffic is limited.
- Be sure to read the financial disclosure the FTC requires that franchisors must provide to potential investors. This as well as more information can be found at the FTC Business Guidance Resource Center.
If you are interested in starting a franchise or if you have questions about what type of franchise is good for your skill set, we can help! Please contact us at the Small Business Development Center – SBDC – Serving Paris area: Lamar, Hunt, Hopkins, Delta, and Red River counties.