The Step-By-Step Guide To Buying A Franchise
Owning a franchise is a career path some people look into when their life circumstances change. For example, recent retirees or veterans returning to civilian life often turn to franchising. But really, you don’t have to have any special circumstances or qualifications to become a franchisee. You do, however, need to know what you’re getting into before you make such a major decision.
While there are plenty of benefits to owning a franchise, there are some downsides too, and you’ll need to determine which things you can live with and which will be dealbreakers for you.
There are specific perks to purchasing an existing franchise, also sometimes called a “franchise resale,” as opposed to opening a new franchise location: you will start out with a cheaper initial investment and an established customer base with minimal setup or hiring requirements, provided that equipment and employees are included in the sale.
However, when buying an existing franchise, you’ll also need to do careful pre-purchase research to make sure the franchise is a good investment—the owner could be selling because the franchise is underperforming due to a poor location, for example.
In this post, I’ll go over the pros and cons of buying a franchise to help you figure out whether you should make the leap to becoming a franchise owner. I’ll also give you some useful tips on how to start down the path of owning your own franchise business.
Table of Contents
- Should You Buy A Franchise?
- Be Strategic When Choosing Your Franchise Sector
- Talk To Other Franchisees
- Determine Your Budget & Learn About Financing Options
- Find A Location
- Choose A Franchise & Perform Due-Diligence
- Get Business Software For Franchises
- Learn How To Run Your New Franchise
- Open Your New Business
- Final Thoughts
Should You Buy A Franchise?
Buying a franchise is not for everyone. But there are some unique benefits to this career move, making it perfectly suited to the right type of entrepreneur. Whether or not you can live with the downsides of franchise ownership will determine whether becoming a franchise owner is right for you.
|“Turnkey” businesses are easy to start||You have to pay fees and operating costs|
|Franchises have minimal startup costs||You could lose business to other franchises in the area|
|You will have built-in support||You don’t have as much control over the business|
|The brand is already recognized||It’s possible for the franchise to terminate your contract|
|It’s relatively easy to get loans||Negative brand image could hurt sales|
Pros Of Buying a Franchise
1. Turnkey Business
A franchise can be considered a “turnkey business,” which means that it has pretty much everything you need to start operations immediately. All you need to do is “turn the key,” so to speak, to open up for business and start selling.
With a franchise purchase, the sale typically includes the facilities, equipment, and software systems (including the point of sale and accounting software), and even the (already trained) employees in most cases. Your raw materials suppliers, operating procedures, and advertising strategies are already in place as well, requiring only your capital investment and personal labor to get started.
Besides having all the ingredients to start operations, as a franchisee, you open for business on “Day 1” with a proven and successful business model. This helps undercut the risks of owning your own business, especially if you are new to business ownership.
2. Minimal Startup Costs
Aside from the cost to purchase the franchise, and sometimes the franchise transfer fee (you should try to get the selling franchisee to pay this if you can), there are negligible startup costs to get your franchise resale up and running, since, well, it’s already up and running!
You will, of course, have to start purchasing your own raw materials to keep operations going, though you will need to invest less startup capital overall than you would if you opened a franchise from scratch.
While business acquisitions have lower startup costs in general compared to new businesses, this is especially the case with franchise acquisitions, as the uniform nature of any franchise brand allows for few, if any, significant changes in operations from one owner to the next.
Note that when you buy an existing franchise, most franchisors will not have you pay a franchise fee—the costly fee required to open a new franchise—but they may require you to pay for initial training.
3. Built-In Support
Technical support, customer support, and other assistance is an inevitable and potentially costly part of just about any business endeavor. A big benefit of being a franchise owner is that you don’t have to figure these things out for yourself. The parent company typically provides training, marketing campaigns, assistance with management, and customer support. And when purchasing an existing franchise, support channels such as technical support, employee support, etc., will already be open and readily accessible, so all you’ll have to do is learn them.
Aside from an initial training fee when you join the franchise, the cost of training and other support channels is included in the royalty fees you pay the franchisor from your gross sales.
As a franchisee, can also easily access a network of support and advice from other franchisees online. Even if you just want to vent or relate to other franchise owners, there are plenty of websites and message boards where you can do this.
4. Brand Recognition
Everyone already knows your franchise brand and you already have tons of fans on day one. A well-known product advertises itself, meaning you will need to devote very little time and energy to marketing.
Though you will be required by the franchisor to spend some of your profits on advertising, you can rest easy knowing that your personal efforts will not be the only way people will find out about your business. In many cases, you simply pay the franchisor an advertising fee and do not undertake any marketing efforts yourself.
There’s also always a chance your franchisor will come up with a new product or viral national marketing campaign that could make your product even more popular, with no blood, sweat, or tears required on your part.
5. Easier To Get A Loan
It is typically much easier to get a loan to buy a franchise than it is to get a loan to buy an independent business. A franchise is seen by lenders as less risky, as there is an established business model; with a franchise acquisition, there is an established revenue stream as well.
Many franchisors provide their own financing programs for franchise owners, and there are also alternative lenders who specialize in franchise financing. You might even be eligible to get a low-interest loan through the Small Business Administration if your franchise is listed in the SBA Franchise Directory.
For quick capital at somewhat higher interest rates, you will find plenty of alternative online lenders willing to help finance your franchise purchase or provide you with working capital or line of credit, should you need a loan later down the road.
Cons Of Buying A Franchise
1. Fees & Expenses
Although there aren’t too many startup fees involved in a franchise resale, there are still significant fees and operating costs involved in franchise ownership overall.
It is a general rule in the franchise world that after various fees are taken out, about one-third of pre-tax profits go to the franchise. Some one-time and ongoing costs of franchise ownership include:
- One-time franchise transfer fee (if the seller does not agree to pay it)
- Initial training fee when you first start working for the franchise
- Royalty fees, which allow you to use of the franchise’s logo and proprietary assets; often calculated as a percentage of gross sales, e.g., 5% of all sales, but may also be a fixed amount that is charged periodically, irrespective of sales
- Advertising fees to support franchise-wide marketing campaigns (even if you don’t have any say over how your advertising dollars are spent)
- Proprietary product costs—usually, you’ll have to purchase your products and/or raw materials from the franchisor or from their dedicated distributor, even though you might be able to find the materials cheaper elsewhere
- Audit fees for periodic financial audits of your franchise
- Renewal fee charged to renew your franchise contract once the current contract expires
All of these ongoing expenses cut into your margins, and if you’re not meeting your sales goals, it’s possible that your franchise will lose money and not be profitable, at least not right away.
Because of the various costs and fees associated with running a successful franchise, you need to have some money saved or another source of income that you can live off of and use to help pay these costs until your franchise starts making decent money.
2. Competitive Threat
As a franchise owner, whenever a new location of your franchise opens in your area, you will wince and worry about how much of your business will be lost to the competing location.
Franchisors do maintain strict control over franchise territories to prevent market oversaturation, but they will err on the side of opening more locations in a territory to squeeze every last dollar out of that region, even if an individual franchise’s profit margins suffer.
Thus, every time a new franchise location opens in your territory, your market shrinks, and you have no recourse against your competitor; it’s not like you can just decide to move your franchise in a place of your choosing, or change up your product offerings, as you could with an independent business.
3. Less Control Over Business
Running a business where all procedures and policies are mapped out for you can be easier in some ways. You don’t have to figure out how to run your business effectively because business-critical decisions have been decided for you, and are typically based on significant market research.
However, if you are a creative thinker or are used to managing a business on your own terms, franchise ownership might make you feel trapped and frustrated. Individuals who love coming up with innovative business solutions or who excel at finding more efficient ways of doing things will likely have more success as independent business owners.
4. Possibility Of Contract Terminations & Changes
One of the areas you don’t have any control over as a franchise owner is your business’s future as dictated by your franchise contract.
At the end of your contract term, the franchisor might cancel your contract if they’re not impressed with your franchise’s performance, or they could amend the contract to terms you don’t agree with. In such cases, you could be forced out of business or see reduced profits due to contract changes such as higher royalty rates, territory shrinkage, or others.
Although it is possible to negotiate the terms of any franchise agreement with the help of a franchise attorney, it is inevitably a David vs. Goliath type situation when going up against a big corporation with a lot of money and resources at their disposal.
5. Negative Press Can Hurt Sales
Yet another aspect you have little control over as a franchise owner is the company’s overall reputation. Consider how the following events could affect your business:
- The company makes a tone-deaf advertising campaign that offends a lot of people
- Employees at another franchise do something shocking/illegal
- A company executive says/does something controversial or offensive
All of these are potentially newsworthy and hashtag-worthy events — you can probably think of several recent examples just off the top of your head.
Through no fault of your own, any bad press that attaches to your parent company in the public eye could hurt your franchise’s sales and even cause people to boycott your business.
Be Strategic When Choosing Your Franchise Sector
Food—particularly fast food—is typically the first thing that comes to mind when thinking about franchises, but there are plenty of franchising opportunities even if you don’t want anything to do with food service.
In addition to quick-service and full-service restaurants, other major players in the franchise industry include:
- Gas stations & convenience stores
- Clothing/shoe stores
- Beauty salons
- Janitorial services
- Real estate agencies
- Car dealerships
- Vision centers/optical goods
- Private postal centers
- Children’s services (e.g., daycare, preschool, kids’ sports)
- Pet stores and services
- Medical services
When determining which type of franchise you’d like to purchase, you have to consider market trends in addition to your own personal preference.
- Which franchise sectors are growing, and why?
- Which sectors are shrinking?
- Which franchise brands have been doing well in recent years? Which ones are suffering?
These are just a few quick market research queries you can answer with some targeted Google searches.
Besides weighing industry trends, you should also consider a franchise belonging to an industry you already have some experience working in.
Talk To Other Franchisees
Of course, you will want to talk to the owner of any franchise you’re considering buying and ask them why they’re selling and other pertinent questions. But it’s also wise to get feedback from other franchise locations so you can get a well-rounded view of the particular perks and pitfalls of owning that type of franchise.
You can find the contact information for other franchisees in the Franchise Disclosure Document (I’ll talk more about that document in a moment) and also check message boards and blogs to find whatever “dirt” you can about the franchise. This way, you can know more about what you can expect and decide for yourself whether you’re willing to risk having a similar experience as other franchisees.
You can also meet other franchisees at industry events, such as conferences, trade shows, and franchise association meetings. Here are some professional industry organizations where you might be able to network with other franchisees:
- International Franchise Association — The world’s largest independent franchise association, the IFA hosts a large annual conference which includes both educational sessions and networking opportunities. Their website (franchise.org) also has a lot of educational resources as well as franchise purchase opportunities.
- American Franchisee Association — 7,000-member group which advocates for franchisee rights. The AFA also sponsors events where you can gather information about franchise ownership and make contacts in the franchise world.
- Franchise Expo South/West/Midwest/International — These are large franchisee events that take place annually in different regions of the U.S. The International expo is held in NYC. At these shows, you can get franchise education, meet franchisees, and find franchise opportunities.
Expos and other franchise industry events are also good opportunities to evaluate different franchise purchase opportunities and find a franchise you want to buy. Different franchises usually pay to be a part of the expo, and have booths, printed materials, and seminars to give potential franchisees more information about joining their brand.
Determine Your Budget & Learn About Financing Options
Before you get too ahead of yourself, you need to know all the costs involved in purchasing a franchise and what you can afford.
Besides the cost of purchasing the franchise, startup fees, and working capital, you also need to factor in your personal expenses. According to the FTC’s Consumer’s Guide to Buying a Franchise (a must-read for any potential franchisee), it could take a year for your franchise to become profitable. Potentially, it could take even longer to turn a profit if the franchise was not profitable at the time of purchase. As a buffer, you should have access to enough capital to ensure you will be able to survive even if your franchise doesn’t!
Types of Franchise Financing
Once you have a rough idea of how much money you need, you can look into franchise financing options, if necessary. My posts on the best loans for franchises and how to get business acquisition loans are required reading if you’re researching loans to acquire an existing franchise.
- Franchisor financing: Some franchisors offer their own financing programs. Before you start looking for a loan from an outside lender, make sure you find out about which if any financing options are offered by your franchise brand.
- Installment loan: This is a traditional business loan, repaid in installments over a set amount of time, with a set amount of interest. Often, these are long-term loans procured from a bank.
- SBA loan: A type of installment loan backed by the U.S. Small Business Administration. As a result of the SBA’s backing of the loan, you can get more forgiving rates and terms than you would with a regular bank loan, as long as you meet all the requirements. Check that your franchise is in the SBA franchise directory, as only franchises in this directory are eligible for SBA franchise financing.
- Short-term loan: An online loan repaid in less than a year. These fast, easy loans have more relaxed borrower requirements compared to a regular installment loan, but carry higher fees as well.
- Line of credit: A set amount of capital you can draw from over time as needed, and repay in monthly or weekly installments. You are only required to repay and pay interest on the funds that you actually borrow.
- Equipment financing: If equipment is the main franchise expense you need to finance, you can get financing on the equipment itself, in the form of a loan or a lease.
- ROBS (Rollovers As Business Startups): This type of business financing that involves rolling over your existing 401K or another retirement account so that you can use that cash to finance a business venture. Various ROBS providers can help you do this (for a fee).
Which Franchises Can You Afford?
Keep in mind that if you need to borrow money to open a franchise, certain franchise options are probably out of the question. For example, Pizza Hut requires its franchisees to have a net worth of at least $1 million as well as $350K in liquid assets. Other popular fast-food chains, like McDonald’s, KFC, and Wendy’s, have similarly high or higher net worth and liquid capital requirements, and the initial investment is upwards of $2 million. However, there are plenty of other franchises that only require you to be worth $50K or less, and with an initial investment of around $250K, or less if you purchase an existing franchise.
According to Forbes 2019 Franchise 500 list, some top-50 franchises that require an initial investment of less than $250K include:
- The UPS Store
- Great Clips
- Kumon Learning Centers
- Jersey Mike’s Subs
- Merry Maids
- Stratus Building Solutions
- RE/MAX LLC
- Snap-on Tools
Again, it costs more to open a new franchise than it does to purchase an existing franchise. To get a good idea of what existing franchises you can afford, research franchise purchase opportunities in your local area.
Find A Location
Franchise location can have a major impact on your market size and competition. Ideally, you want a prime location that will be attractive and convenient for many people to get to. It’s also important that you don’t have too much competition from similar businesses. For example, depending on an area’s population density, you might not want to open a coffee shop franchise right next door to a competing franchise or a mom-and-pop coffeehouse. (However, in a high-density area, this might not matter so much.)
As far as proximity to other locations of the same franchise you’re a part of, it’s even more crucial to keep your distance. Franchisor agreements usually stipulate how many franchises can operate in a given area, or “territory,” but franchisees say that these rules often allow for too many locations that are too close to each other. This type of “oversaturation” maximizes the amount of business a franchisor can get from that territory, while individual franchises within the territory (and even in neighboring territories) make less money and often fail.
Of course, the cost to rent or buy is also a consideration when choosing a location, as is whether the franchisor approves of this location. When purchasing an existing franchise, you should find out if the seller is exiting due to location-related issues.
Choose A Franchise & Perform Due-Diligence
When looking at specific franchise opportunities, it’s important to do your research to make sure that franchise has certain characteristics that will help make it a successful endeavor. After that, you’ll need to perform pre-sale due diligence.
What Is The USP?
When it comes to any business, the USP, or Unique Selling Proposition, is crucial in determining the business’s success. This is especially true with franchises, as the brand’s uniform nature makes it difficult to differentiate one franchise from the next. With that said, there can still be significant differences between different franchises within the same brand, and you need to figure out if the franchise you’re considering purchasing has something that makes it unique. Some examples include:
- Prime Location: Is the franchise right off a popular freeway exit? How close is the nearest location of this franchise?
- Added Features: For example, some McDonald’s restaurants have play structures and others do not.
- Unique Building Or Business Space: A building’s age, design, and layout can all affect how attractive it is to patrons.
It may also be possible to add your own USP to a franchise. When working within the confines of a franchise contract, it can be difficult or impossible to offer something unique in terms of your products or services. However, there are still ways you can make your franchise location outshine the rest.
For example, you can keep your gym franchise much cleaner than the other gym locations in your city. Or, if you read online reviews saying that the tax preparation franchises in your town have incompetent staff, you can take efforts to make customer service shine at your tax prep franchise. You may also be able to invest in structural improvements before your grand reopening, such as improved equipment or a new franchise point of sale system.
The FDD & Other Pre-Sale Due Diligence
Once you determine which franchise interests you, you’ll need to do various pre-purchase due diligence, such as reviewing financial documents, performing a business valuation, and making sure the franchisor approves of the transfer (they may not approve in some cases). Assuming you don’t have a legal background, hiring a franchise attorney can help you with most of these pre-purchase tasks.
Another significant part of the pre-sale process reviewing the Franchise Disclosure Document (FDD). This document contains vital information about the entire franchise brand as well as individual franchise locations and franchisees. If you find out in the FDD that the franchise you want to buy has had a lot of owners in the past few years, this may indicate that the franchise location is not profitable or that the franchisor has not provided adequate support to this location.
Get Business Software For Franchises
Finding the right business software can help your franchise run more effectively. While some franchises have specific software systems they require their franchises to use, others leave software decisions up to the franchise owner. Some examples of franchise business software include:
- Franchise management & POS software
- Restaurant POS software
- Accounting software for your franchise
- Project management software
- Email marketing software
Before buying a franchise, it’s a good idea to find out if the brand requires you use a specific point-of-sale/franchise management software system and if so, which software you’ll be working with. For example, Cinnabon uses an excellent iPad POS system called Revel, while The Athlete’s Foot uses another highly rated cloud POS system called ERPLY. Some franchises like McDonald’s have their own custom-made POS systems, while unfortunately, a lot of other franchises use clunky, Windows-based systems that may be slow and outdated.
Learn How To Run Your New Franchise
A lot of people want to buy a franchise because they think it will more or less run itself, but this is not the case at all. Like any other business, running a franchise requires both industry knowledge and management expertise.
Learning how to operate your franchise successfully isn’t something that’s going to happen overnight, but you need to start learning the ropes as soon as possible so that you hit the ground running. You’ll, of course, want to use any resources the franchisor supplies you, which usually includes extensive in-person training to get a new franchise up and running, as well as ongoing remote support. However, there may be fewer training resources available for franchise resales. You also need to do your own research in terms of talking to other franchisees, reading up on franchise ownership online, and possibly attending franchise owner business seminars.
Open Your New Business
Even before you open your doors to the public, you can hype up the opening of your franchise so that customers are ready for you. Depending on your marketing budget and what kind of marketing your franchisor allows, a Grand Opening event can be a great way to introduce your franchise to your target market.
Prior to the big Grand Opening, it’s usually a good idea to have a “soft opening” to work out any startup kinks, get employees up to speed, and make sure all processes are running smoothly.
For the Grand Opening itself, it can benefit you a lot to make it into a major event for the community where you’ll have the chance to remind people why they love your franchise brand, let fans of your franchise know where they can find you, and also convert new prospects. (If you’re purchasing an existing franchise, the event could be a “Grand Re-Opening.”)
Think eye-catching signage, free samples, and giveaways of your product or service that you can advertise ahead of time via targeted mailers or other media. Community involvement is also key. For example, a couple of weeks before the Grand Opening, you could help sponsor a local community event such as a sports game or concert in the park, where you can hand out samples and/or coupons redeemable at your Grand Opening.
Buying a franchise is not right for everyone. However, it might be right for you if …
- You want to own a business that is already successful
- Lack of control over how to run your business doesn’t bother you
- You have savings or additional income to live on until your franchise opens and becomes profitable (for example, retirement income)
- You are a hard worker by nature and good at following the rules
- The franchise you’re considering purchasing is a successful one and/or you have something unique you can add to make it successful
If you follow all of the tips I’ve laid out in this post, you will be well on your way to becoming a successful franchisee.
For more information on lenders that will help finance your franchise purchase, contact us and we’ll be happy to suggest a suitable lending service to help you get that franchise loan.