Starting a Franchise: Everything You Need to Know
Starting a franchise is all about licensing. In the franchise business world and using franchise business models, business owners, known as the franchisees.8 min read
Starting a Franchise
At its heart, starting a franchise is all about licensing. In the franchise business world and using franchise business models, business owners, known as the franchisees, purchase a license to use any trademarked logos, names, and business structures or formats or systems of the franchise owner, all known as a franchisor.
Franchise expert, Joel Libava, offers his definition of a franchise: “a type of business that is owned and operated by individuals (franchisees) but that is branded and overseen by a much larger—usually national or multinational—company (the franchisor).”
Having and owning a franchise means a business owner is getting onto the back of an idea that is already proven and functional, and probably successful, although there are still challenges involved, not least of which include securing a location, hiring employees, managing and structuring the operation, and the logistics of day-to-day operations, even if the brand is already established, and the “path” set for business owners in advance.
Types of Franchises
There are two distinct, basic types of franchising available to business owners. The first is product/trade name franchising, wherein the franchisee obtains rights to sell and/or distribute products bearing the name of the franchise, including using the franchise’s logo and business format.
Package franchising is different, and there is an ongoing relationship between franchise owners and franchisees, wherein the franchisor provides any number of unique services to the franchisee.
There are well over 3,000 franchised brands in the United States today, and the most popular ones include:
- Entertainment and educational organizations
- Personal services
- Beauty and spa
- Fitness outlets, such as gyms
- And a number of other establishment types
Usually, restaurants that are part of a franchise have low failure rates and are relatively cheap to establish and operate compared to a “from the ground up” business. This, among many other factors, make them the most popular and sought-after type of franchise in the country.
The education and entertainment industries made Entrepreneur’s coveted list of top franchises in 2015.
Personal services, which revolve around selling a product or experience, are different in that the arrangement of the franchise relationship depends greatly on the employees and the hiring practices of the business.
Fitness outlets such as gyms, studios, and training facilities, and classes that emphasize fitness such as self-defense classes, Pilates, yoga, etc., are also popular franchise models. Forbes ranked these franchises as their fifth best franchise platform, given that most require a startup investment of a relatively low $150,000, which is much less than it would cost to run a gym or fitness operation from scratch.
The beauty and spa industry have a lot of unique services, including spa and massage treatments, facials, etc., and are also great franchising opportunities for would-be entrepreneurs.
What a prospective franchisee needs to know
The IFA, or the International Franchising Association, is the go-to industry trade association for franchising and offers a host of resources that a business owner can access in order to help themselves get started along the path of owning a franchise.
Starting a franchise is not an easy or “hands off” process whatsoever. Research on any given popular brand and finding a company with a great reputation for supporting their franchisees, is crucial for those looking to open a franchise.
Business owners would do well to research the net worth of the franchises they are considering. The businesses will tell any interested parties exactly what their platform costs, including franchising fees (which are prone to non-refund policies), and have a very thorough breakdown of the costs of initial inventory, logistics, materials, and royalties would be. Advertising and marketing are also often easily accessible, from a budget perspective.
Generally, franchisors are very helpful at helping franchisees understand the costs inherent to building and operating a franchise. Insurance, employment salaries, lease payments, and more are in need of consideration when buying a franchise.
Financially, a business owner looking to operate a franchise should have plenty of budgetary room to make a good go of the franchising efforts they undertake, as there can be difficulties that arise from logistical challenges and growing pains that any new business is prone to.
A good rule of thumb, should you be considering a franchise, is to have at least enough money on hand or in your accounts to cover living expenses for a year or two years (or more) until the franchise pays for itself, and starts turning a profit.
According to many current and former franchise owners, anyone who opens a franchise will enter into an ongoing business partnership with the franchisor for the entire duration of the franchise agreement. A complete list of both past and former franchisees should come as part of the Franchise Disclosure Agreement, which, by law, is required to be provided by the franchisor.
In most cases, the franchisor and the franchisee both undergo interviews with one another, usually taking place in the form of conference calls, personal visits or meetings at either party’s place of business, all taking place with the intent of covering all the bases and thoroughly exploring what it means to be a franchise operator. Both parties are interested in succeeding and turning a profit, so everyone ideally should be on the same page.
Those looking to operate a franchise should use this time and these opportunities to decide if a franchise is right for them.
The rights a business owner gets under the franchising agreement include:
- Rights to use the franchise name, logo, and trademark for business purposes
- Training assistance
- Assistance in implementing or procuring managerial support
- Use of the franchise’s business structure and/or system, which may include facility and property design, layout, marketing, and advertising templates, etc.
- Assurance that the franchisor doesn’t permit any other franchisees to operate within a geographically designated area that would incur competition between their franchisees. This means a franchisor cannot open two locations next to one another and allow business owners to operate competing franchises. The distance depends on the location, and some states have different laws pertaining to this distance.
Business owners should know their obligations and requirements under the terms of their franchising agreements. These agreements are likely more beneficial for the franchisor than the franchisee. However, the deals are legally required to be fair, and the agreement should thoroughly cover all sales quotas, or constrictions, or requirements to purchase equipment, products, services, etc. from the franchisor instead of third parties, even if another supplier provides the identical services or products for less money.
Business owners would do well to note how much the franchisors offer during the initial setup of the business. Whether or not they provide ongoing training is important to know before entering into an agreement with a franchisor.
Money Mailer, for example, uses a dedicated customer concierge to handle all of their advertising, marketing, creation, production, distribution, and digital platform management, including smartphone and social media processes for their franchisees.
Chicago venture capital firm PSP Capital Partners, which was founded by Penny Pritzker, serving in their capacity as United States Secretary of Commerce, did purchase a majority interest in the Money Mailer platform in April 2017.
A large consideration for both the franchisor and the franchisee in a given deal is the potential for profitability. Many documents pertaining to the actual franchise disclosure agreement, which are often in excess of 300 pages, and which franchisers must publish according to the law, are unclear as to how much profit is possible. That’s up to the business owners to set goals around.
A lot of information is readily available, however, such as the financial health of the parties interested in entering a business relationship. The performance of individual franchisees also operating under a given franchise name is not something a prospective franchisee has access to.
Usually, agreements of this sort come in five and ten year commitments. If all parties are satisfied with the arrangement, business owners can resign their licenses and continue operating the franchise.
Money Mailer claims, "We make our money on the production side of the business after the ads are sold.” As a result, Money Mailer has “every financial incentive to help the new franchisees become successful as quickly as possible.”
Statistics show that up to a third of franchisees have no considerable sales experience whatsoever, so work ethic and business savvy have become more heavily weighted in considerations such as these in recent years.
Requirements for starting a franchise
A UFOC, or Uniform Franchise Offering Circular, another standard disclosure document, is required by all companies by law, under the Federal Trade Commission, should they want to offer their franchises for sale anywhere inside the United States.
In fact, business owners must make copies of this document at least two weeks before they’re asked to sign any contracts or make payments of any kind to franchisors. This will help the franchisee in their research and investigative efforts.
However, former and current franchise owners advise that a better course of action would be to obtain these documents as soon as is legally possible, in order to best inform the decision-making process.
Franchise disclosure agreements should contain the following sections:
- Franchisor background
- Business and financial background
- Legal and litigative history
- Bankruptcy information
- Ongoing and initial costs
- Limitations of the franchise
- Any policies related to termination of employees, general, assignment, sales, training, assistance programs
- Marketing and/or advertising costs and current and former franchises.
Legally, requirements differ from state to state. It’s best to consult a franchise attorney who has a good reputation for being effective, efficient, and well-learned on franchising in the state a business owner wishes to operate a franchise in.
It’s also beneficial to business owners to obtain reviews of their entire Franchise Disclosure Document by a qualified attorney before they make their investments. This helps them be fully understand the costs, requirements, and obligations associated with starting the franchise.
An agreement should be reviewed by qualified attorneys on a low flat-fee basis, though many other agreements and payment structures exist.
An audited financial statement is usually required as part of a disclosure document. An experienced tax professional or accountant will be able to help a business owner review and properly process audited statements and can provide assistance on matters pertaining to how to best structure a business enterprise.
Business owners would do well to develop, document, and maintain the systems in which they are integrating into their operation. If all the pieces “fit together” as they typically do, as per the low failure rate of many franchises, the business will be successful to some degree and will turn a profit in good time.
A well-developed training regiment, marketing plan, and sales platform will help any franchisee successfully become a business operator and helps business owners draw in more clientele and business.
The rewards and satisfaction that comes along with building a successful company are widespread, but the price and initial costs of doing so are considerable. While low estimates on restaurant-type franchises can be as little as $150,000 for startup costs, many former and current owners will insist that $500,000 to $1,000,000 is more realistic.
Each franchise’s performance is tallied and judged on a number of variables. The franchise footprint and fees associated with starting up carry the most weight. Should a franchisor wish to change the arrangements or agreements he or she has with their franchisees, they would do well to remember that franchisees are not employees, and that interacting with them in a managerial capacity takes care. That’s why there are so many meetings and collaboration involved. It is an atypical business relationship that can be profitable for all involved parties.
If you’d like assistance or more information on starting a franchise, post your legal need to UpCounsel’s marketplace. Lawyers from UpCounsel consist of Harvard and Yale graduates, who have an average of 14 years of legal experience. They are top lawyers who have worked with the largest companies in the country, and are standing by to assist with your legal and business needs.