Should You Buy a Franchise?

If you are looking to purchase an established business and forego the work of developing your brand recognition and customer list from scratch, you have a couple of options. One is to purchase a local or e-commerce business from the current owner. In that case, you can continue operating the business as is or expand according to your own business plan. The possibilities are, if not endless, limited only by market share and the strength of your vision.

Another option is buying a franchise from a company with well-established local, state, or national brand recognition. Here, you trade off control over the direction your business can take for the security of operating a known entity. 

This article comprehensively explains what is at stake when you decide to go the franchise route, including some pros and cons. 

Franchises Then and Now 

When a local business is successful, the owners may decide there is room in the market share for one or more additional locations. These “clones” of the original business are called franchises. You are already familiar with famous international giants like Mcdonald's, Hilton, and Starbucks. You might also be aware of local franchises with only two or three locations in your community.

The concept of franchising has been around since the Middle Ages when the Holy Roman Empire sought to expand its control by consolidating political power in seats throughout its territory. Individual nations also used this model to increase their wealth. Under the rule of King James I, for instance, England granted The London Company a charter to explore and colonize what is now the state of Virginia. 

It may not surprise you to learn that the ever-enterprising Ben Franklin inaugurated the first commercial franchise in the colonies by entering an agreement with Thomas Whitmarsh in 1731. Whitmarsh, a printer in South Carolina, assumed the costs of running his printing business independently but agreed not to print anything other than Franklin's materials. In other words, the franchise business model is as old as the United States itself!  

Proto-franchise agreements helped to build the nation’s infrastructure, put automobiles on the road, and distribute goods throughout the country. Some early franchises include Howard Johnsons, General Motors, and Coca-Cola. 

According to the Census Bureau, more than 300 industries currently offer franchising opportunities. The top sectors for franchise opportunities are fast food restaurants, diet and weight loss centers, car dealerships, brokerage firms, home services, hotels, and tutoring services. There are over 780,000 franchise businesses in the United States, accounting for around 3% of the national GDP. 

How Do Franchises Work?

The franchisor, or original business entity, grants a prospective franchisee the right to open and operate a single-unit franchise using the franchisor’s brand, logo, products, processes, etc., in return for an up-front fee. While there are three other types of franchise agreements (multi-unit, area development, and master) single-unit franchise agreements are the most common entered into by small business owners.

The franchisee does not permanently own the franchise; the arrangement is more like a lease that can last anywhere from five to 30 years. Like a tenant paying monthly rent, the franchisee must also pay a percentage of their gross income to the franchisor through ongoing royalties. Sometimes, you might also pay the franchisor for employee training, advisory services, and business equipment. 

No two franchise agreement contracts are the same. As a franchisee, you may have limited control over details as small as store decoration or the color of employee uniforms. 

Are Franchises Regulated?

Franchises are regulated by state law, just like any other business. Although many companies have franchises in more than one state, the federal government does not oversee their regulation. 

However, the Federal Trade Commission established the Franchise Rule in 1979 to give some protection to prospective franchisees. This rule requires franchisors “to provide all potential franchisees with a disclosure document containing 23 specific items of information about the offered franchise, its officers, and other franchisees.” Items in these mandated disclosures include a history of litigation against the company and a list of approved vendors or suppliers, and may include estimated financial performance projections.  

What Factors Should You Consider Before Buying a Franchise?

The most important factor is finances – what can you afford to spend, what can you afford to lose, and if you need to financing, what sort of credit do you have? 

You can acquire a franchise for as little as $10,000 or as much as $5 million, depending on factors like brand recognition, industry, location, and the type of franchise. Franchises of home-based businesses, like cleaning services, or dog-walking services, will typically cost less than hotels, dealerships, and full-service restaurants. 

Because you can’t expect your franchise to turn a profit immediately, you’ll also want to know if you have sufficient funds to support yourself and your family while you wait for the franchise to turn a profit.

The second important consideration is fit. Before you start researching potential franchise opportunities, you should ask yourself the following:

• Will the industry require you to undergo special training or acquire new technical expertise?
• Do you have specific industry experience?
• Do you have special skills that are in alignment with the business? 
• Are you prepared to put in long hours?
• Do you have managerial experience?
• Are you okay with operating a business where many decisions are out of your hands?

A final consideration is whether the business model is viable for the long term. Everyone contemplating purchasing a franchise should consider the fate of Blockbuster. As a former industry giant, Blockbuster met its demise because of reliance on obsolete technology and its failure to meet industry demand. The franchise you’re considering could be destined for a similar fate. Thus, it’s important to assess whether the franchisor’s business model is both flexible and solid enough to stand the test of time, as opposed to a fad that will burn out in a few years.

The Pros and Cons of Buying a Franchise

Pros

You’ll Enjoy Instant Goodwill and Brand Recognition

For many, this is the chief advantage of buying a franchise. Despite an oft-cited 1987 statistic from the International Franchise Association, which paints a rosy picture of franchise success rates, there may be no real way to know whether franchises fail more or less often than start-ups. 

As a franchise operator, however, you will be able to devote more of your time to making the business successful – as opposed to conducting market research and developing a unique business proposition. Others have already completed that work for you, so your sole focus can be getting customers in the door and keeping them satisfied. 

There’s No Need to “Reinvent the Wheel”

Not everyone decides to run a business because they are innovators with a vision. Some would-be business owners just want to earn money by following a proven formula and don’t mind letting someone else make the big decisions. In fact, they are more comfortable fitting into an existing niche in the market share. 

Cons 

There May Be Heavy Costs Involved

As already mentioned, you can acquire some franchises for relatively little money. But that is just the upfront (and often non-refundable) cost. As the franchisee, you may also be responsible for paying the operating license, renting or building the establishment, purchasing equipment associated with the business, and stocking inventory.

Once these significant start-up costs have been resolved, you still need to pay the franchisor an agreed-upon royalty based on a percentage of your weekly or monthly gross income. You must pay the royalties for the duration of your franchise agreement whether or not you are turning a profit.  

There’s Little to No Room for Innovation 

For born entrepreneurs, nothing is more frustrating than having great ideas for expansion and not being able to implement them. As a franchisee, your creative impact will always be limited. You will not be able to serve Thai food at McDonald’s or add a wine bar to Starbucks, even if you know these changes would be successful. Sadly, franchises can also fail – and do.

How many franchises fail is, again, an open question. A study conducted by FranNet suggests that 85% of franchises were still operating successfully at the five-year mark, as opposed to only 50% of independent small businesses. But no small business is guaranteed success, and even franchises of a successful company can fail due to location, poor management, and several other factors.   

Some Final Thoughts

Franchises can be a great fit for individuals who want to run an established company without being responsible for  developing a brand and trademark. Some research indicates that franchises perform better over time than independent start-ups, which makes buying a franchise a smarter choice for risk-averse investors. 

However, if you want to operate a business because you have a vision, the limitations inherent in operating a franchise may be too much to bear. For those with an incurably entrepreneurial mindset, founding a start-up or purchasing an independent small business might be a better choice.