There are many choices when starting a business — you can start a business from scratch or you can buy an existing business. Among the existing business choices, you can decide to team up with a franchisor that has a proven business model already.
The franchise business model proved its advantages during the COVID-19 pandemic’s economic uncertainty. The support from their franchise network allowed 50% of franchisees to effectively handle inflationary pressures and other challenges posed by the pandemic, as revealed by the IFA/FRANdata 2022 Franchisee Inflation Survey.
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In this article:
- Primary types of franchises
- Advantages of franchising
- Disadvantages of franchising
- Buying a franchise vs. starting a business
- Buying a franchise vs. buying an existing business
- Finding a franchise to buy
- Evaluating the franchisor
- Creating a franchise agreement
- Making the franchise decision
Primary types of franchises
First, let’s define the term franchising. Franchising refers to an arrangement in which a party, the franchisee, buys the right to sell a product or service from a seller, the franchisor. The right to sell a product or service is the franchise.
Here are some primary types of franchises for new franchise owners.
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Product and trade-name franchise: A product and trade-name franchise generally involve the distribution of a product through dealers. For example, auto dealerships are product and trade-name franchises that sell products produced by the franchisor. The most prevalent type of franchises in the United States are product or distribution franchises, constituting the largest proportion of overall retail sales.
Business-format franchise: Business-format franchises generally include everything necessary to start and operate a business in one complete package. Business format franchises provide the product, trade names, operating procedures, quality assurance standards, management consulting support, and facility design. Many familiar convenience stores and fast-food outlets, for example, are franchised in this manner.
Conversion franchise: A conversion franchise is when an established business becomes a franchise by signing an agreement to adopt a franchise brand and operational system. Business owners pursue this to enhance brand recognition, increase purchasing power, tap into new markets and customers, access robust operational procedures and training, and boost resale value. Real estate agencies, financial planning firms, independent hardware stores, and other service industries offer instances of conversion franchises.
Advantages of franchising
People are attracted to franchises because they offer a proven track record of success, as well as the benefits of business ownership and the support of a larger company. Franchises generally have a higher success rate than other types of businesses, and they can provide franchisees with access to a brand name, experience, and economies of scale that would be difficult or impossible to achieve on their own.
- Minimal risk. A reputable franchise has a proven, well-defined and tested business model.
- Name recognition. A well-known name gives instant recognition, bringing customers into the business and providing a competitive advantage for the franchisee.
- Training. A franchisor can provide a regimented training program to teach the franchisee about the business operation and industry even if the franchisee has no prior experience.
- Business support. A franchisor can provide managerial support and problem-solving capabilities for its franchisees.
- Economies of scale. Cost savings on inventory items can be passed on to the franchisee from bulk purchase orders made by the franchisor.
- Advertising. Cooperative advertising programs can provide national exposure at an affordable price.
- Financing. A franchisor will generally assist the franchisee in obtaining financing for the franchise. In many instances, the franchisor will be the source of financing. Lenders are more inclined to provide financing to franchises because they are less risky than businesses started from scratch.
- Site selection. Most franchises will assist the franchisee in selecting a site for the new franchise location.
Disadvantages of franchising
Purchasing a franchise provides the opportunity to leverage a well-known brand name, all while gaining valuable insights into its operation. However, it is essential to be aware of the drawbacks associated with buying and operating a franchise. If you are considering investing in a franchise, it’s important to take into account the following disadvantages of franchising.
- Franchise fees. Franchise fees are required to be paid to the franchisor at the inception of the franchise agreement. These fees can range from a few thousand dollars to hundreds of thousands of dollars depending on the franchise.
- Attorney and accountant fees. Prior to purchasing a franchise with a substantial fee, it is important to have legal professionals review all related documents. Additionally, hiring an accountant well-versed in franchise and business financing is advisable. An experienced accountant can assist in comprehending the financial data provided by the franchise owner, evaluate the tax implications of the investment, and aid in setting up essential systems such as bookkeeping and payroll services.
- Royalties. The cost of many franchises includes a monthly royalty (fee) based on a percentage of the franchisee’s income or sales and must be paid even if the business is not profitable.
- Loss of control. Franchise agreements usually dictate how the franchise operates. The franchisee must adhere to the standards in the franchise agreement, which thereby leaves the franchisee with little control over the operation, including branding and marketing.
- Required purchases. The franchise may require the franchisee to purchase certain materials for the purpose of producing uniform franchise products. Franchisees can be expected to work with the franchisor’s supply chain.
- Termination clause. The franchisor may require that it retain the right to terminate the franchise agreement if certain conditions are not met. The franchisor may then terminate the agreement and offer the franchise location to another buyer.
Buying a franchise vs. starting a business
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When deciding between purchasing a franchise and starting a new business, perhaps the best place to begin is to ask yourself why you want to own a business. The answer you give may provide some insight into which path you should +.
You want to be your own boss. If your answer is that you want to own your own business because of the freedom it will bring you, you probably shouldn’t buy a franchise. If you buy a franchise, the franchisor will dictate much of what you have to do, when you have to do it, and how you must do it. You’ll have far more control if you start your own business.
You have a business idea that you believe has a lot of promise. If you want to nurture an idea you have into full bloom, you probably shouldn’t buy a franchise. You won’t have much control or be given much of an opportunity to pursue your ideas (try telling McDonald’s that their golden arches ought to be bright green). You may be better off starting your own business.
You want to make a lot of money. If your answer is that you want to own your own business because of the financial opportunities it presents, you should look long and hard at a franchise. Franchises don’t necessarily make more money than other types of businesses, but they do have higher success rates. Of course, you’ll be paying for the higher success rate in fees to the franchisor. You should look particularly hard at franchises if you don’t have a great deal of hands-on experience running a business.
You have money, but you’re looking for something to keep you busy. If you have startup funds in hand, a franchise may be ideal for you, particularly if you lack hands-on experience. You’ll get help with everything you need to set up your business: site selection, inventory, management counseling, hiring practices, and every other necessary function for the operation of your business.
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