Franchising is a long term relationship. It requires significant commitment of capital and personal time, and does not guaranty success. You should:
- investigate thoroughly, and
- seek professional advice, such as from attorneys and accountants
Franchising is often viewed as a way to start a business with decreased risk of failure, and reduced time to become operational and then profitable. This is particularly likely to be the case if you lack sufficient business experience to strike out on your own. While studies support that franchisee businesses have lower failure rates than non-franchise start-up businesses, that does not guaranty success for all franchise systems or the individual new franchisee.
Franchising likely will NOT achieve you being the owner of your own business
- Franchisor generally “licenses” your use of their business model and they own the business concept. They may specifically “own” the “goodwill” and have a “right of first refusal” to purchase your franchise operations if you want to sell.
- Franchisor retains substantial control over your operation.
- Your right to operate the franchised business is tied to your continuing to be a franchisee.
- Even a lengthy license period normally ends, likely leaving you with no renewal rights beyond expiration of the license and unable to continue the franchised business outside of the franchise system.
- You are generally prohibited from competing with the franchised business after the termination of your franchise license.
- Your ability to sell or transfer the business is likely limited, including, e.g., leaving the business to your children or spouse on your death.
Is the opportunity a good match for your “style” and personality ?
- Will you be happy performing the tasks a particular franchise requires ?
- Do you have necessary personnel, management, sales and other skills ?
- Does being the franchise business owner match your view of your place in the community ?
Due diligence investigation
Your investigation before purchasing a franchise should include contacting current and former franchisees (listed in the required disclosure document) regarding their experiences and satisfaction with the franchise. But, be cautious in accepting what they tell you. People are often are reluctant to admit they made a mistake in purchasing the franchise or to tell you they are not a success. Current franchisees may not be forthcoming with you for fear of repercussions from a franchisor with whom they must continue to deal. Former franchisees may have agreed not to “disparage” franchisor or want to put the experience behind them. Pay particular attention to lawsuits between current or former franchisees and franchisor (listed in the required disclosure document). Are there numerous suits ? What do they involve ?
You should determine that the franchise offers sufficient income opportunity at a level satisfactory to you. This may be difficult. Regulatory restrictions on franchisors’ ability to make “earning claims” often results in franchisors not providing any financial information on franchisee operations. Inconsistent franchisee accounting practices make review of financial information obtained directly from franchisees difficult. Again, franchisees may be motivated to distort financial information, e.g., by pride and wanting to appear more successful, or understating income, and or overstating expenses, to avoid tax, royalties, etc.
Franchising is a long term relationship
It needs to be beneficial to both parties. Franchisors earn income through royalties from ongoing franchisee operations, and so depend on franchisees being profitable and continuing in operation. Initial franchise fees may be largely consumed by costs of the sale and training and assisting the new franchisee to become operational. A franchisor’s dependence on franchise sales rather than royalties for income is reason for caution. A significant number of franchisees failures or lawsuits between franchisees and franchisors (disclosed in the franchise offering circular) are also counter-indicators that a quality long term relationship exists.
Does the franchisor provide continuing value for ongoing royalties
You may be happy early in the relationship, feeling the initial fee was worth the head start franchising provided. But, royalties continue through the franchise relationship and are paid to franchisor “off the top” whether or not franchisee makes a profit. Franchisees often become discontent after several years as they continue to pay royalties and feel franchisor does not continue to provide value in exchange. What will franchisor do years after you are up and running to “earn” the royalties you will be paying ?
- advertising or promotions (Note: you may pay an advertising fee, which may NOT guaranteed to be proportionately spending in your area)
- research into new or improved products or services or updated trade dress (which may require you to spend money refurbishing your premises)
- research consumer trends
- substantial system leverage in purchases required to operate the franchised business not available to non-franchisees