4 Things to Consider Before Starting a Franchise
Franchising, or opening a location of an existing company that sells goods or services, can be a great way to start a business. For a fee, you get to build a personal business on an existing framework and may also get the benefit of a well-known brand name and their marketing. While you often get to set your hours and policies and can handle your own hiring decisions, you still have to meet requirements set by the parent company or franchisor. Having a franchise can be the best of both worlds, but just like anything else in life, there is no guarantee of success or a return on your investment.
Before you get too far along in the franchise buying process, spend some time understanding how a franchising opportunity works, the pros and cons, and do some inner reflection to ensure that your personality and expectations align with the business model.
Listen to this week’s episode of the rich & REGULAR podcast about franchising to help you understand the basics and keep reading for some things to consider before signing on the dotted line.
Questions to ask yourself
Much like investing money in the stock market, it’s essential to understand your motives and beliefs about owning a franchise and going into business for yourself. If your reasons don’t align with the realities of owning an existing company, you may be in for a rude awakening when things don’t go as planned.
Remember that owning a franchise is not a get-rich-quick scenario and is highly unlikely to make a lot of money quickly or without your involvement, especially at the beginning. Before you start the process, do some soul searching to help you understand what you want out of the opportunity.
What’s your timeline?
Before going too far in the process, consider your time horizon and how much time you plan to spend daily or weekly with this business. Are you interested in working for five years and then transitioning away from the company, or do you plan to stick it out for 10-plus years?
Understanding your time expectations can help you determine if a franchise is right for you and even what type of franchise to look into. Some franchisors may expect you to complete some initial training and be actively involved in running the business on a daily basis, while others may require less involvement. Depending on the type of franchise you choose, you may need to be hands-on for quite some time, even if you hire employees to manage or perform much of the labor.
What’s your work personality?
You also want to consider your personality, and how you function within a structure you don’t design. While the prospect of walking into established systems might be comforting to some people, many franchisors don’t allow changes to be made by individual operators or stores. If you like being in control and developing your own processes, you may not be a good fit for a franchise, especially one that doesn’t have a lot of flexibility.
It’s not just the policies and procedures that the franchisors may control. You may also be contractually obligated to get approval for things like what you can or cannot sell (i.e., changes to a menu or adding additional auto services to a tire shop), where your business is physically located, and even how often you’re allowed to make upgrades to your location or equipment.
Can you handle the costs?
You may know that you must pay a franchise fee of several thousand dollars to start, but remember that you are also responsible for additional start-up expenses associated with running your store. Depending on the terms of your agreement, you may also be required to buy any necessary equipment and supplies, cover payroll and marketing expenses, and pay for the cost of construction to convert or build your physical location.
According to the Federal Trade Commission (FTC), it may take up to a year to become profitable with your new business, and you need to have enough in the bank to cover any gap in profitability. The franchisor must list any additional working capital expenses under item seven in the Franchise Disclosure Document (FDD). They usually include what three months of costs may look like within that section, but remember that is just an estimate.
Have you done your due diligence?
If you decide that a franchising opportunity is something you want to pursue, do your research before going too far down the path. Consider the following as a starting point:
Read the FTC’s Consumer Guide to Buying a Franchise: This guide, put together by the Federal Trade Commission, offers insight into the franchise process, the legal requirements of both the franchisor and franchisee and what to expect from each section of the Franchise Disclosure Document. Knowing how the process is supposed to go can help you spot any red flags or understand the questions you must ask before applying.
Read the FDD: Request and study the Franchise Disclosure Document (FDD) if you’ve selected a franchisor and are considering an application. The document should contain 23 topics, ranging from the franchisor’s background (section one), bankruptcy disclosures (section four), initial and ongoing costs (sections five through seven), and financial statements (section 21). Be sure to read everything carefully, and don’t be shy about asking questions or for clarifications.
Talk to a lawyer familiar with franchises: According to Forbes magazine, franchise contracts are often non-negotiable, so it’s important to know what you’re signing up for. You’ll want to consider the royalties you’ll owe the franchisor, what you’ll need to pay for supplies and services before you’re profitable, and how long your contract with the franchisor is in effect. Having a person available to offer advice and alert you to problems can be invaluable, especially if this is the first franchise you’ve purchased.
Understand your motivations before becoming contractually obligated to a franchisor, and use the questions above as a start to your research. Consider consulting a lawyer familiar with franchising and a tax or business professional to help you make the best decision for your situation. Owning a franchise can be a great business opportunity, but knowing what you’re signing up for is crucial.
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