Part 1 of 6 - This is part one of a six part series on buying a franchise.
Buying a franchise often allows you to sell products and/or services with instant name recognition. It also may allow you to get the critical training and support that can help you succeed in your new business venture. But use caution and remember that purchasing a franchise is just like other investments: there is no way to guarantee success.
Franchise Ownership - Benefits and Responsibilities
As a franchise owner you, the franchisee, are allowed to operate a business. Once you’ve paid the franchise fee you get a formula or business system that was developed by the franchisor (company). You also get the right to use the company or franchisor’s name for a limited time, and you will receive assistance in getting your new business up and running. As an example - the franchisor may provide you with the assistance you need to find a location for your business; they may provide initial training on operating the business and provide an operations manual. Other items you can expect to receive are advice on management, marketing, or personnel. The franchisor may also provide you with support through other forms of business assistance such as; periodic newsletters, a toll-free telephone numbers, an online presence / website, and scheduled workshops and seminars with other franchise owners.
Buying a franchise may be a way to reduce the investment risk because it may enable you to partner with an established business, but the cost of the franchise may be substantial. Remember that you will also have other “soft costs” involved in setting up and running your new franchise business. For example, you will probably be required to give up significant control over some (if not all) of the creative and independent portions your business while you also will take on contractual obligations to the franchisor.
Typically, franchise systems have several components. Let’s explore them…
Franchise Costs
In exchange for the right to use the businesses name and for the assistance we described, you will pay some if not all of the following fees to the franchisor:
The cost of the initial franchise fee, which can range anywhere from several thousand dollars to several hundred thousand dollars, will probably not be refundable. You will probably also incur significant costs to rent, build, and equip your franchise outlet and to buy the initial inventory required for startup. Other costs that you also incur are operating licenses and insurance, and you might required to pay for a “grand opening” fee - this is paid to the franchisor so they will promote your new location.
- Royalty Payments (the gift that may keep on giving)
In some cases you will be required to pay the franchisor ongoing “royalties”. These royalties may be based on a percentage of your weekly or monthly gross income or on some other formula that is set by the franchisor. You should use caution in evaluating these costs because often, you must continue to pay these royalties to the franchisor even if your business isn’t earning an income. Remember that as a rule, you will have to pay these royalties just for the right to use the franchisor’s name. Another word or caution is that even if the franchisor doesn’t live up to it’s end of the contract and doesn’t provide the services they promised; you may still be required to pay the royalties to them for the duration of your franchise agreement. Even if your agreement allows for a voluntarily end or early termination, you may owe all of the royalties provided for in the agreement for the remainder of agreement term.
- Advertising Fees and Expenses
Another common fee that franchises incur is that you will probably be required to pay into an common or pool advertising fund. These fees are collected be the franchisor and can sometimes be used for national advertising of the franchisor to attract new franchise owners, rather than to promote your particular outlet.
Business Controls
Remember that to ensure consistency and uniformity of the business from location to location, franchisors normally control how you as the franchise will conduct your business. These controls will significantly restrict and limit your ability to exercise your own business judgment. Here are a few examples.
- Approval of your Location
Many franchisors require that they pre-approve sites for outlets or stores. This is done so that they increase the likelihood that your location will attract customers. At the same time you must remember that the franchisor may not approve the site you’ve already selected and you may have to work with them to find and alternative.
- Standards for Design or Appearance
Franchisors will also probably impose their standards for the design and appearance of your location to ensure that there is a consistent look and feel among all of their stores. You should also be aware that some franchisors will require you to implement and complete periodic renovations or makeovers at your facility and install seasonal design changes or motifs. In order to comply with these standards you may see a significant increase your costs.
- Restrictions on Products and Services
The franchisors may restrict or limit the products and/or services you are allowed to sell. Here are some examples: If you own a franchise restaurant, you may not be allowed to make changes to the menu. If you own a franchise for an automobile transmission repair facility, you may not be permitted to perform any other type of auto repair work (e.g. brakes or muffler repairs).
- Restrictions on Methods of Operation
Franchisors will probably require you to operate your business in a very particular manner: they may dictate the hours of operation; require pre-approved signage, uniforms for employee, and specific advertisements. They may insist that you use particular accounting or bookkeeping processes and procedures. In some cases, you may be required to sell products, goods or services at specific prices which may restrict your ability to offer discounts to your customers. You may be required to buy your supplies and products only from a list of approved suppliers - even if you can source and purchase similar (or the same) products and goods elsewhere at a lower cost.
- Restrictions on where you can sell
The franchisor may restrict or limit your business to a specified territory or region. These territorial restrictions are there to ensure that you will not compete with other franchisees for the same customers but they can also limit your ability to open additional stores or to move your business to a more profitable location. Another limitation may be that the franchisor limits your ability to design and host your own website. This could limit your ability to have an online presence and attract online customers. Beyond this limitation, the franchisor itself may retain the right to sell product, goods or services in your territory from its own website or through the use of catalogs and/or telemarketing campaigns.
Terminations and Renewal of your Franchise
Be aware that you can lose the right to your franchise if you breach your franchise contract. Also be aware that most franchise contracts are for a specified and limited time period and that your right to renew is not usually guaranteed.
There are a variety of reasons and conditions under which a franchisor can end your franchise agreement. These include your failure to pay royalties or your failure to abide by preset performance standards and/or sales restrictions. Take caution to understand these clauses in your franchise contract and to understand what conditions may cause your franchise may be terminated and if you may lose your investment.
The period or term of your franchise may vary but it is not uncommon for franchise agreements to run for as long as 20 or more years. At the end of the contract remember that the franchisor may decide to decline to renew with you. In most cases renewals are not automatic, and if you do renew the new contract may not have the same terms and conditions as the original. The franchisor may raise the required royalty payments or alter the calculation of royalties; they may impose new design standards for your store and may impose new sales restrictions, or alter your territory. Any of these changes could result in changes to your competitive environment and even perhaps to competition from company-owned outlets or other franchisees.
To be continued in part 2 ...
EDIT: (Link to Part 2) http://therazzor.com/2008/12/30/buying-a-franchise-part2/
