Franchising can be a great option for people with an entrepreneurial spirit but who don’t have the bandwidth or desire to go through the process of starting a small business from scratch. But how does a franchise work, exactly?
Essentially, a successful business owner (known as the franchisor) franchises their business, enabling franchisees to own and operate separate locations under the franchisor’s name and operating systems. So the franchisor provides the framework for the business, but it’s up to the franchisee to run the business itself—and to make money on it.
Franchise as a business model allows beginners to sail peacefully into entrepreneurial waters. Apart from the fact that this business model does not require too much business experience, it will also give you all the needed support and help from the franchisor itself. The franchise business model works to make it easy to learn, replicate and implement the success of the well-known brand.
By buying a franchise, you get a well-established turnkey business. The franchisor gives you the right to use its brand’s trademarks, and it gives you entry into the proven business system. On the other part, you agree to pay a franchise fee (a fixed amount paid to enter the business) and royalties (a percentage of total turnover).
The franchisor is usually an established company that has standardized and tested its business concept on the market. Franchise as a form of business works most often in the food industry. Still, the franchise model of business operation can also be used in other industries, from retail to professional services and manufacturing.
In this guide, we’ll break down all about how does a franchise work—as well as provide some additional resources—so you can determine whether buying a franchise is the right business move for you.
How Does a Franchise Work
In a franchise arrangement, the franchisor agrees to give the franchisee—or, you, the new business owner—the right to sell the franchisor’s goods or services and to use its business name and model. Also, you must be aware that franchise and license business models are two completely different things.
Franchise contracts also include the length of time for which the franchisee retains these rights.
Let’s break down the details on how does a franchise work:
- Put simply, the franchisor owns the business itself, while you own the right to sell the contents of that business. So under this arrangement, you operate under (and takes advantage of) the franchisor’s existing infrastructure and operating procedures while retaining responsibility for maintenance and operation of your own branch.
- Buying a franchise, therefore, requires that you undergo extensive training in the franchisor’s business operations, from inventory management to quality control methods to hiring standards and service techniques.
- Once you’ve completed your training, the franchisor entrusts you with a location to own and operate. Just as you would if you had started your own business, you are responsible for the location’s day-to-day operations, maintenance, and management, though you’ll receive ongoing support, direction, and oversight from the franchisor.
- Ultimately, the franchisor has the final word in determining how you can conduct the business. A few elements that the franchisor may control, according to the Federal Trade Commission (FTC), include site approval, design or appearance standards, restrictions on goods or services you can sell, methods of operation, and limitations on your sales territory.
Of course, you are legally obligated to operate under whatever regulations the franchisor set forth in your franchise contract. That may include non-competes and trade secret protection, in addition to standard franchisor controls. We highly recommend that you work with a business attorney before signing any franchise agreement.
The Costs Involved In Franchise Work
In order for you to retain the rights to the franchisor’s goods or services, you’ll need to pay for it. There are three major franchise fees to look out for, all of which will be outlined in your franchise agreement:
1. Initial Franchise Fee
This is a one-time, upfront fee that you make once you’ve signed the franchise agreement. You can think of the initial franchise fee as the franchisee’s “cost of entry”—essentially, with this fee, you’re buying the right to use the franchisor’s name and operating system.
In most cases, this fee doesn’t cover necessities like inventory, a hiring budget, tools, and furnishings.
Initial franchise fees vary depending on the industry. According to the FTC Franchise Rule, that fee must be at least $500, but it’s often much higher than that.
Most franchise fees are tens of thousands of dollars; but if you’re purchasing a Master Franchise, that fee can be over $100,000.
2. Royalty Fees
Franchise royalty fees are ongoing fees that you pay the franchisor for their continued support.
Franchisors usually collect royalty fees on a monthly basis, and they’re often calculated as a percentage of your revenue. Royalty fees typically range from 4% to 12%, but the exact amount varies depending on industry and volume.
3. Advertising Fees
Advertising or marketing fees are exactly what they sound like: They’re fees you pay the franchisor to help fund your advertising budget.
This may seem like an extraneous fee, or at least not within your jurisdiction, but ultimately, you reap the benefits of the franchisor’s advertising efforts—after all, that’s where your entire customer base comes from.
Marketing fees are also typically calculated as a percentage of monthly revenue, but it’ll be a smaller percentage than royalty fees.
Pros and Cons of Franchise Work
There are numerous advantages of entering entrepreneurial waters by purchasing a franchise compared to self-employment. In addition to operating under an established brand and using an already proven business model, you will also receive professional assistance in choosing a location, training employees, and supplying raw materials.
The franchisor also ensures quality standards (certificates), access to innovation, marketing activities, and management training- all this will significantly reduce operating costs.
All the above benefits will increase your chances of business success, which is confirmed by the statistics; according to Forbes, 90% of startups will fail. In contrast, more than 70% of all franchises are still in business after five years. Now you can see for yourself that the franchise business model works better than starting your own business from scratch.
On the other hand, the franchise model does not give much space for your own initiative. You must strictly adhere to the trademark rules and standards, participate in a joint marketing system, share documentation with the franchisor, and pay franchise fees regularly.
Now that you have a better sense of how does a franchise works, you can evaluate the pros and cons of buying a franchise to determine whether or not this might be a worthwhile business opportunity.
Pros of work under a franchise agreement:
- You won’t have to build a business from the ground up
- Take advantage of the franchisor’s existing framework of operating systems, suppliers, marketing initiatives, name recognition, and business model
- Less risk and guesswork than there is when starting a business from scratch
- Receive relevant training, so don’t necessarily have to have extensive experience in your franchisor’s industry
- Access to ongoing support from your franchisor
Cons of work under franchise agreement:
- Inherently limited by the franchisor’s rules and regulations
- Restrictions on operating procedures, the types of goods and services you can sell, pricing, how you can decorate and furnish your location, etc.
- Contractually bound to comply with the franchisor’s regulations
- Can require a large upfront investment
Ultimately, you’ll need to determine whether you more strongly value the prospect of owning your own business (according to a proven and successful model), or the freedom to build and operate your business however you see fit.
That said, you’ll likely want to consult with an accountant, attorney, or other franchise professional as you consider this option.
How to Choose the Right Franchise for You
If you do decide you’re interested in investing in a franchise, you’ll want to perform thorough research and due diligence to determine which company is worth your time and money. Here are just a few considerations to keep in mind as you begin the search process:
1. Estimate Startup Costs
In addition to the franchise, royalty, and advertising fees we covered above, purchasing and managing a franchise requires a good amount of capital—just as it takes a good amount of capital to run any other kind of business.
And as we mentioned, most franchise fees don’t cover the costs required for necessities, like inventory, supplies, and equipment, hiring staff, and potential renovations and build-outs of your franchise location.
Each individual franchise will have estimated startup costs, so take the time to research costs and which companies might fit best with your budget.
2. Think about name recognition
As a franchisee, you’re dependent upon the strength of the franchise’s name recognition to make money. Obviously, it’s in your best interest to invest in a franchise with strong branding and a solid reputation, both nationwide and regionally.
The more name recognition your franchise has, the less lift you’ll have to take on in your own marketing efforts to draw in customers.
3. Survey your location
Along those lines, it makes sense to invest in a franchise that’s popular in your particular area. If there’s no demand for a franchise’s products or services where you live, you’ll need to invest more time and money into marketing than would be necessary if you’d partnered with a franchise that’s more popular with your local demographic.
Gauge the level of competition in your area, as well. You don’t necessarily want to buy a franchise in an area that’s already saturated with similar businesses—but if there are no franchised locations in your area, that may not bode well for the demand for your potential franchise’s goods or services.
4. Evaluate training and support
Look into the level of support and training your franchisor provides, both initial and ongoing. It’s useful to compare all your potential franchisors’ training programs to evaluate their thoroughness.
Evaluate whether your background, education, and existing training are conducive to working with this particular franchise, too.
5. Research your franchisor’s reputation
It’s crucial that you work with a franchisor who is trustworthy, experienced, and reputable, so take the time to look into other franchisees’ experience working with your potential franchisor, as well as dig into any complaints filed against the company.
You can start by checking the franchisor’s BBB (Better Business Bureau) page, request a report for information about their business credit and general financial standing (if they’re registered with Dun & Bradstreet), and even contact your state’s franchise authority for more information if you live in a state that regulates the sale of franchises.
Make it a priority to get in touch with other franchisees, as well. This is an excellent opportunity to get a sense of what it’s really like to own a franchise with a particular company.
6. Don’t forget your personal preferences
Finally, whatever franchise you choose to invest in has to work for your lifestyle. The reality of becoming a franchisee is similar to the reality of starting a business from scratch—it takes a lot of time, effort, and dedication to keep your operation going.
Pick an industry that excites you, whose hours suit your routine, and whose particular goals and objectives align with yours.
What is The Key to Successful Franchise Work?
The key to the success of a franchise is in the well-balanced business interest of the two partners. As a franchise buyer, you can use all the listed benefits, and it is in your partner’s interest to do business as well as possible because he earns through a percentage of your earned income(royalties).
Although the risk of doing business through the franchise model is significantly lower, you must be aware that each franchise is specific. Often some established franchises can work great in big cities or countries, but that does not mean that they will automatically succeed in some smaller places or in the international market.
Whether a franchise concept will succeed depends on several factors. How will your franchise work depends on location, competition; even the mentality and habits of consumers are important too.
Therefore, when you consider starting a franchise, you need to research the local market and see if a business idea is a perfect opportunity in your particular area.
At the moment, there are more than 770,000 franchise establishments in the United States, and most of them fall under Mcdonalds, Subway, KFC, etc. Also, except for the so-called mega-franchise brands like McDonald’s and KFC, thousands of other smaller franchisors are present on the market.
The franchise concept of doing business in the US and other countries in surroundings has become the norm. Some of the reasons for this situation lie in this that franchising business concept attracts entrepreneurs because it definitely works well and can make money for both parties.
Good franchise concepts are designed to be easy to learn, replicate, and implement. That is why franchising works well for everybody, and it is a good opportunity for self-employment.
The majority of franchises in the US market are related to businesses that require 100,000 to 500,000 + dollars of initial capital. But there are also available franchises that are less expensive, and they can work well for you if you don’t have too much start-up capital.
If you’ve decided that franchising is the right business opportunity for you, the next step is to formally evaluate each franchise.
Once you’re ready to apply with a particular company, they’ll send you a copy of their franchise disclosure document (FDD). The FDD discloses crucial information about the franchisor regarding their financial standing, history, capital requirements, and more.
That said, navigating a franchising agreement and FDD can be extremely complex, and therefore, we’d highly recommend working with an accountant or business attorney, especially one that specializes in franchise law, as you go through the process of comparing and applying to franchising opportunities.