Financial Education Clearinghouse

Guide To Buying A Franchise

What is a franchise?

A franchise is a format, product, or system developed by the franchisor. By paying a franchise fee, you receive the right to use the franchisor's name and receive assistance. A franchise may cost a few thousand dollars to several hundred thousand dollars.

One of the biggest benefits of purchasing a franchise is the name recognition. Consider carefully the following outline of a typical franchise system.

Understand all the costs associated with a franchise

In addition to your franchise fee, which may be non-refundable, you may have to rent, lease, build, advertise, and equip an outlet, including the purchase of inventory. You may have to pay license fees, or a "grand opening" fee to promote your new franchise.

You may be required to pay royalties based on a percentage of your gross income. Royalties are usually paid for the right to use the franchisor's name and may need to be paid even if you haven't earned any income or if the franchisor has failed to provide promised services.

Some franchises require that you pay into an advertising fund. A portion of the advertising fees may be for national advertising, and not to specifically target your franchise area.

Things to think about before buying a franchise:

  • Control of the franchise

    Because of the name recognition, franchisors typically control how the individual franchisee runs their business. It insures uniformity but may restrict your ability to exercise your own business judgment.

  • Site approval

    Franchisors may require pre-approved sites for your franchise. The franchisor may not approve the site you wish.

  • Design or appearance standards

    Many franchisors have a certain look that is easily recognizable and will impose that look upon you. You may have to conform to seasonal changes or periodic renovations. One of the biggest reasons for investing in a franchise is that people know what to expect no matter where they are when they come into the outlet.

  • Restrictions on goods and services offered for sale

    Franchisors may control the goods and services you can provide. A fast food franchise can normally only sell the franchisor's menu, they cannot add or subtract items. As the franchisee of an automobile lube, you may not be able to offer additional service like brake or muffler work.

  • Restrictions on general operation

    You may be obliged to have your employees wear certain uniforms or to only use company advertising. You may have to run only company wide specials during specific times on specific items. This may hinder you from running your business as you see best. Some franchisors may require you to purchase supplies from approved vendors only. This may impact your profit margin if these vendors are more expensive.

  • Territories

    Many franchisors will limit you to a certain territory. This could limit your ability to open more outlets or to move to a more profitable location.

  • Termination and renewal

    If you fail to comply with the franchise contract, you can lose the right to your franchise. Franchise contracts are for a limited time and there is no guarantee that you will be able to renew your franchise when the time comes.

  • Franchise terminations

    If your franchise is terminated, you could lose your investment. The franchisor may cancel your contract if you fail to pay royalties, or abide by sales restrictions or performance standards.

  • Franchise renewal

    A typical franchise agreement will run for 15 to 20 years. There is usually no provision that says that the franchisor must renew the agreement. Another thing to be aware of is that the franchisor doesn't have to renew the agreement under the same conditions as the first agreement. They may impose higher royalty fees, new sales restrictions, or may even reduce the size of your territory.