Thinking of buying a franchise? Here's the basics you need to know.
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 or more.
One of the biggest benefits of purchasing a franchise is the name recognition.
Costs associated with a franchise
There will probably a number of costs associated with owning a franchise, such as:
- Franchise fee, which may be non-refundable,
- Rent or lease for building
- Advertising, some franchises require you to pay into an advertising fund for national advertising
- Equipping a building
- Purchase of inventory
- License fees
- "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.
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.
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.