How Franchises Work: The Complete Guide For Entrepreneurs
Are you interested in running your own business and being your own boss, but don’t know how to get started? You’re not alone — starting a business from scratch requires a solid business plan and plenty of capital. Even with careful planning, there’s no guarantee that your business will be a success.
But what if there was a way to increase your chances for success with a tried-and-true business model?
Fortunately, that’s where franchises come in. A franchise helps simplify the process of launching and operating your own business. You’ll get the freedom of owning your own business without having to build it from the ground up. However, as with any other business, there are some challenges you may encounter. In this post, we’re going to dive into the world of franchises. We’ll review what a franchise is, how it all works, and help you decide if franchising is the right fit for you.
Table of Contents
What Is A Franchise?
Even if you don’t think you know what a franchise is, you’re almost certainly familiar with franchises in some capacity. You’ve probably seen many franchises in your city or town. Fast food restaurants, fitness centers, coffee shops, auto repair shops, retail stores, and other types of businesses may be franchises.
A franchise is a business structure that allows a third-party entrepreneur (also known as the franchisee) to legally operate a business using the trade name, standards, and processes of the business owner — the franchisor.
The franchisee is considered an independent operator, and the franchisor is not involved in the day-to-day operations of the business. However, the franchisor may provide ongoing support in exchange for fees paid by the franchisee. We’ll go into more details on the specifics in the next section.
To put it simply, an entrepreneur can use the name, branding, products, services, and procedures of an established business. This allows the entrepreneur to own a business without starting from scratch while also expanding the franchise.
How Franchises Work
Now that you have a general idea of what a franchise is, let’s explore the specifics of how these business entities work.
A franchise is simply a business entity that is licensed by the franchisor to a third-party — the franchisee. The franchisee can then legally use the trade name, processes, procedures, products, and services of the business. The franchisee gets to take advantage of a turnkey business model that also has minimal startup costs.
What’s in it for the franchisor? In addition to startup costs, there are a number of ongoing fees that the franchisee pays throughout the duration of the licensing agreement. The length of the licensing agreement varies by franchise, but in general, many initial licensing agreements are set for a period of five years with the option to renew the agreement. However, some agreements may be as short as three years, while others may be as long as 20.
As the franchisor builds more relationships with franchisees, the business expands. While the franchisor isn’t directly related in the operations of the business, it does provide training and support — something we’ll cover a little later.
One of the biggest benefits of purchasing a franchise is that startup costs are typically lower than building a business from the ground up. You also have a better idea of what to expect in terms of costs. For example, you may map out the costs of a new business built from scratch, but it’s not uncommon for business owners to find that their actual expenses are much higher than estimated. With a franchise, you have a clearer picture of your startup costs and ongoing fees and expenses. Some to expect include:
- Franchise Transfer Fee
- Training Fee
- Royalty Fees
- Auditing Fees
- Renewal Fees
While buying a franchise can certainly be less expensive than starting a business from scratch, there are significant fees associated with starting and operating your franchise. As a rule of thumb, expect to pay one-third of your pre-tax earnings toward these one-time and ongoing costs.
Fortunately, there are plenty of funding opportunities that can help cover these costs, which we’ll explore a little later in this post.
Training & Support
When you purchase a franchise, another benefit is the training and support that you receive from the franchisor. This is built into the royalty fees that are paid on an ongoing basis. Your franchisor may provide tech support, customer support, marketing materials, and training. This training and support are based upon the franchise’s proven systems and methods, taking out the guesswork and the added expenses for you.
While the franchisor does have standards in place for operations, the franchisee does have some flexibility in some areas of operating the business. This includes employment standards, disciplinary actions taken by management, who you hire, and the rate of pay employees receive.
What It Takes To Buy A Franchise
While purchasing a franchise takes out some of the guesswork of owning and operating your own business, planning, budgeting, and knowing what to expect are all critical to your success. Before you make the next step toward buying a franchise, consider the following points.
Pick Your Sector
Don’t think that food is your only option when it comes to opening a franchise. While fast food, quick-service, and full-service restaurants are certainly options, there are plenty of other opportunities for you, including:
- Salons & spas
- Gas stations & convenience stores
- Automotive services
- Clothing stores
- Pet stores
When pinpointing what sector is right for you, first consider your own personal preferences. Is there something that interests you, or a sector where you have experience? You should also take into consideration market and industry trends to bolster your chances for operating a successful franchise.
Seek Out Other Franchisees
Still on the fence about what franchise is best for you? Seek out other franchisees and learn more about their experiences — the good, the bad, and the ugly.
There are a number of ways to find other franchisees. During the pre-sale process, you’ll receive the Franchise Disclosure Document, which gives information about the franchise, franchise locations, and other franchisees. Online message boards can also provide information about franchising. Finally, you can connect with franchisees by attending industry conferences, expos, and other events.
Set Your Budget
What you’re willing to spend to own a franchise may help you narrow down your selection. Do your research to learn more about the associated costs with purchasing a franchise. Compare your options, and understand what you can comfortably afford.
Like any other type of business, a franchise might not be profitable for up to one year. In some cases, it may take even longer before you see a profit. Calculate what you can afford, and keep in mind that you will need extra access to capital to keep your business running until it becomes profitable.
One last thing to note is that purchasing an existing franchise is typically much less expensive than buying a new one. However, you should determine if the money you save is best for the long haul. For example, a franchise that is struggling may take much longer before turning a profit.
Another positive aspect of buying a franchise is the funding opportunities available to new franchisees. There are many long- and short-term funding options available including:
- Franchisor financing
- Small Business Administration loans
- Installment loans
- Rollovers as Business Startups (ROBS)
- Lines of credit
Unsure of which option is right for you? Check out our post about the best franchise loans.
Determine Your Location
You’ve determined your budget, you’ve selected a franchise, and you’ve explored financing options. Now, it’s time to consider where your franchise will be located. There are a number of considerations to keep in mind when selecting your location, including:
- Convenience to customers
- Proximity to competitors
- Price to purchase or rent commercial space
Many franchisors will help you identify suitable locations for your business that also follow your franchisor agreement.
Select Your Franchise
If you’ve made it this far in the process, you should know what franchise is right for you. You should do your research before you make your choice, as well as due diligence through the pre-sale process. This includes identifying your Unique Selling Proposition and reviewing the Franchise Disclosure Document. Learn more about this process by checking out our article, The Step-By-Step Guide To Buying A Franchise.
Prepare For Opening
Before you open your doors to the public, there are a number of steps you have to take. This includes selecting the right business software, including project management software and restaurant POS software.
Training is also critical before opening your franchise for business. Many franchisors offer a variety of resources, including extensive in-person training. Connecting with other franchisees, attending industry events, and doing online research are additional ways to boost your knowledge and expertise.
Open Your Franchise
Once you’ve covered the previous steps, you should be ready to open your doors to customers. Consider having a “soft opening” to see how everything goes and to overcome any potential challenges that may arise once the franchise is operating. Once you’ve overcome these hurdles, you can host a grand opening for your customers. Make sure to increase your traffic by offering free samples, special rates, coupons, or other incentives that can help get your business off to a strong start.
Is Owning A Franchise Right For You?
At this point, you should have an idea of whether or not a franchise is an opportunity that’s appealing to you. However, if you’re still on the fence, there are a few additional considerations:
- Reduced Risk: There’s a lower risk of failure with a franchise since you’re utilizing tried-and-true systems/processes and a familiar brand. This isn’t to say that you’re guaranteed success with a franchise. You will, however, have access to resources and tools to help you through your entrepreneurial journey, including marketing campaigns, training, and other assistance.
- Potentially Low Startup Costs: While startup costs vary, many franchises have low initial investment costs. Franchises including Jersey Mike’s, Great Clips, and The UPS Store all require an initial investment os less than $250,000.
- More Funding Opportunities: Getting a business loan can be difficult if you build your business from scratch. However, franchising opens up more opportunities for financing, including franchisor financing and other loans specifically for franchisees.
- Be Your Own Boss: If you want to become an entrepreneur but you don’t know where to get started, purchasing a franchise may be a great choice for you. While you should at least have some industry experience for the franchise you choose, this isn’t required. You won’t have to think of an idea, find suppliers, and do everything on your own, but you still get to be your own boss.
However, becoming a franchisee isn’t the right choice for everyone. Keep these considerations in mind when making your decision:
- Ongoing Royalties & Other Fees: Ongoing fees and royalties paid to your franchisor cut into your profits.
- Limited Creativity: If you want a business that’s truly your own, a franchise isn’t the right option. As a franchisee, you’ll have branding limitations that could prevent you from putting your own personal stamp on your business.
- Tarnished Reputation Affecting Profitability: The actions of one franchise could spell trouble for your business. A case of food poisoning or food tampering, bad behavior by employees or management, or a news-worthy negative event could damage the brand’s reputation — including your own franchise.
- Shared Financial Information: Your financial information is shared with the franchisor. If you don’t wish to have this much transparency in your business, consider taking another route.
- Risk Of Non-Renewal: Once your franchise agreement runs out, the franchisor has the option to not renew the agreement.
If the drawbacks of a franchise outweigh the benefits, consider starting your own business from the ground up or acquiring a business that isn’t a franchise.
Becoming a franchisee takes a lot of the guesswork out of owning your own business. You must remember, though, that even though you’re not going at it alone, you still have to invest time and to ensure your franchise is a success. While a franchise does provide the blueprint for aspiring entrepreneurs, it’s up to you to put in the hard work required to build a successful, profitable business.