Want to Learn More?
WHAT IS FRANCHISING?
A franchise is a legal and commercial relationship between the owner of a trademark, service mark, trade name or advertising symbol and an individual or group seeking the right to use that identification in a business. The franchise agreement governs the method for conducting business between the two parties. Although forms of franchising have been used since the Civil War, enormous growth has occurred more recently. Industries that rely on franchised businesses to distribute their products and services touch every aspect of life, from automobile sales and real estate to fast food and tax preparation.
In its simplest form, a franchisor owns the right to a name or trademark and sells that right to a franchisee. This is known as product/trade name franchising. The franchisor can provide a full range of services, including:
- Site selection
- Product supply
- Marketing plans
Generally, a franchisee sells goods or services that are supplied by the franchisor or that meet the franchisor’s quality standards.
WHAT ARE SOME OF THE BENEFITS AND RESPONSIBILITIES OF FRANCHISE OWNERSHIP?
There are a number of aspects to the franchising method that appeal to prospective business owners such as:
- Easy access to an established product.
- A proven method of operating a business.
- Reduced risk of opening a business.
In fact, statistics from the U.S. Small Business Administration and the U.S. Department of Commerce show a significantly lower failure rate for franchised businesses than for other business start-ups. The franchisee purchases not only a trademark, but also the experience and expertise of the franchisor’s organization. However, a franchise does not ensure easy success. If you are not prepared for the total commitment of time, energy and financial resources that any business requires, you should stop and reconsider your decision to enter the franchise business.
A franchise typically enables you, the investor or “franchisee,” to operate a business. By paying a franchise fee, which may cost several thousand dollars, you are given through a format or system developed by the company (“franchisor”), assistance from the franchisor as well as the right to use the franchisor’s name for a limited time. For example, the franchisor may help you find a location for your outlet; provide initial training and an operating manual; and advise you on management, marketing or operations. Some franchisors offer ongoing support such as monthly newsletters, a toll free phone number for technical assistance, and periodic workshops or seminars.
WHAT FACTORS SHOULD I CONSIDER WHEN SELECTING A FRANCHISE?
Like any other investment, purchasing a franchise is a risk. When selecting a franchise, you should carefully consider a number of factors, such as the demand for the products or services, likely competition, the franchisor’s background, and the level of support you will receive.
Is there a demand for the franchisor’s products or services in your community? Is the demand seasonal? For example, lawn and garden care or swimming pool maintenance may be profitable only in the spring or summer. Is there likely to be a continuing demand for the products or services in the future? Is the demand likely to be temporary, such as selling a fad food item? Does the product or service generate repeat business?
What is the level of competition, nationally and in your community? How many franchise- and company-owned outlets does the franchisor have in your area? How many competing companies sell the same or similar products or services? Are these competing companies well established, with wide name recognition in your community? Do they offer the same goods and services at the same or lower price?
Your Ability to Operate the Business
Sometimes, franchise systems fail. Will you be able to operate your outlet even if the franchisor goes out of business? Will you need the franchisor’s ongoing training, advertising or other assistance to succeed? Will you have access to the same or other suppliers? Could you conduct the business alone if you must lay off personnel to cut costs?
A primary reason for purchasing a franchise is the right to associate with the company’s name. The more widely recognized the name, the more likely it will draw customers who know its products or services. Therefore, before purchasing a franchise, consider:
- The company’s name and how widely recognized it is.
- If it has a registered trademark.
- How long the franchisor has been in operation.
- If the company has a reputation for quality products or services.
- If consumers have filed complaints against the franchise with the Better Business Bureau or a local consumer protection agency.
- Training and support services.
Another reason for purchasing a franchise is to obtain support from the franchisor. What training and ongoing support does the franchisor provide? How does their training compare to the training for typical workers in the industry? Could you compete with others who have more formal training? What backgrounds do the current franchise owners have? Do they have prior technical backgrounds or special training that helps them succeed? Do you have a similar background?
Many franchisors operate well-established companies with years of experience both in selling goods or services and in managing a franchise system. Some franchisors started by operating their own business. There is no guarantee, however, that a successful entrepreneur can successfully manage a franchise system.
Carefully consider how long the franchisor has managed a franchise system. Do you feel comfortable with the franchisor’s expertise? If franchisors have little experience in managing a chain of franchises, their promises of guidance, training and other support may be unreliable.
A growing franchise system increases the franchisor’s name recognition and may enable you to attract customers. Growth alone does not ensure successful franchisees; a company that grows too quickly may not be able to support its franchisees with all the promised support services. Make sure the franchisor has sufficient financial assets and staff to support the franchisees.
HOW CAN I FIND A LAWYER WHO SPECIALIZES IN FRANCHISING?
Entrepreneurs in search of a franchise lawyer can start by checking with their state bar association. Many state bar associations allow member lawyers to identify the areas of practice in which they specialize, and franchise or distribution law is a recognized specialty in an increasing number of states.
The American Bar Association also publishes a Membership Directory of the Forum Committee on Franchising. The Directory, which is organized by state and city, lists the names, addresses and telephone numbers of attorneys who are members of the Forum Committee. You can obtain a copy of the Directory from:
American Bar Association Service Center 750 North Lake Shore Dr. Chicago, IL 60611 (312) 988-5522
WHAT IS THE DISCLOSURE DOCUMENT?
The Federal Trade Commission (FTC) requires sellers of franchises and other business opportunity ventures to provide prospective investors with the information they need to make an informed investment decision. It also requires that all earnings claims be documented, that the information investors receive be complete and accurate, and that investors have adequate time to consider and evaluate the disclosures before making any final purchase commitment. All required information is given to prospective investors in the form of a franchise disclosure document, which must be furnished at least 14 days before any purchase may occur. This document includes 20 important items of information, such as…
- Names, addresses and telephone numbers of other franchisees.
- A fully audited financial statement of the seller.
- The cost required to start and maintain the business.
- The responsibilities you and the seller will share once you buy a franchise.
- Litigation involving the company or its officers, if any.
Again, use your professional support to examine all of these issues. Some of the contract terms may be negotiable. Find out before you sign; otherwise, it will be too late.
HOW CAN I EVALUATE MY POTENTIAL TO BECOME A SUCCESSFUL FRANCHISEE?
Perhaps your most important step in evaluating a franchise opportunity is examining your own skills, abilities and experience. The ideal franchisee is a creative, outgoing person who is eager to succeed, but not so independent that he or she resents other people’s advice. You must be able to balance your entrepreneurial initiative with a willingness to comply with the business formulas used by the franchisor. Remember, a successful partnership between franchisee and franchisor involves a mutual understanding of each other’s values and achievements.
Determine exactly what you want out of life and what you are willing to sacrifice to achieve your goals. Be honest, rigorous and specific. Ask yourself: Am I qualified for this field…
- By experience?
- By education?
- By learning capacity?
Ask yourself how this decision will affect your family. Do they understand the risks and sacrifices required, and will they support your efforts? Beginning a franchise is a major decision that does not ensure easy success. However, an informed commitment of time, energy and money by you and your family can lead to an exciting and profitable venture.
HOW CAN I PREPARE PRIOR TO SHOPPING AT A FRANCHISE EXPOSITION?
Attending a franchise exposition allows you to view and compare a variety of franchise possibilities. Keep in mind that exhibitors at the exposition primarily want to sell their franchise systems. Be cautious of salespersons that are interested in selling a franchise that you are not interested in. Before you attend, research what type of franchise best suits your investment limitations, experience and goals. Then, comparison shop for the opportunity that best suits your needs, and ask questions.
Know How Much You Can Invest
An exhibitor may tell you how much you can afford to invest or that you can’t afford to pass up this opportunity. Before beginning to explore investment options, consider the amount you feel comfortable investing and the maximum amount you can afford.
Know What Type of Business is Right for You
An exhibitor may attempt to convince you that an opportunity is perfect for you. Only you can make that determination. Consider the industry that interests you before selecting a specific franchise system. Ask yourself the following questions:
- Have you considered working in that industry before?
- Can you see yourself engaged in that line of work for the next 20 years?
- Do you have the necessary background or skills?
If the industry does not appeal to you or you are not suited to work in that industry, do not allow an exhibitor to convince you otherwise. Spend your time focusing on those industries that offer a more realistic opportunity.
Visit several franchise exhibitors engaged in the type of industry that appeals to you. Listen to the exhibitors’ presentations and discussions with other interested consumers. Get answers to the following questions:
- How long has the franchisor been in business?
- How many franchised outlets currently exist?
- Where are they located?
- How much is the initial franchise fee and what are the additional start-up costs, if any?
- Are there any continuing royalty payments? How much?
- What management, technical and ongoing assistance does the franchisor offer?
- What controls does the franchisor impose?
Exhibitors may offer you prizes, free samples or free dinners if you attend a promotional meeting later that day or the next week to discuss the franchise in greater detail. Do not feel compelled to attend. Rather, consider these meetings as one way to acquire more information and to ask additional questions. Be prepared to walk away from any promotion if the franchise does not suit your needs.
Get Substantiation for Any Earnings Representations
Some franchisors may tell you how much you can earn if you invest in their franchise system or how current franchisees in their system are performing. Be careful. The Federal Trade Commission (FTC) requires that franchisors that make such claims provide you with written substantiation. Make sure you ask for and obtain written substantiation for any income projections, or income or profit claims. If the franchisor does not have the required substantiation, or refuses to provide it to you, consider the claims to be suspect.
It may be difficult to remember each franchise exhibit. Bring a pad and pen to take notes. Get promotional literature that you can review. Take the exhibitors’ business cards so you can contact them later with any additional questions.
Avoid High Pressure Sales Tactics
You may be told that the franchisor’s offering is limited, that there is only one territory left, or that this is a one-time reduced franchise sales price. Do not feel pressured to make any commitment. Legitimate franchisors expect you to comparison shop and to investigate their offering. A good deal today should be available tomorrow.
Study the Franchisor’s Offering
Do not sign any contract or make any payment until you have the opportunity to investigate the franchisor’s offering thoroughly. As will be explained further in the next section, the FTC’s Franchise Rule requires the franchisor to provide you with a disclosure document containing important information about the franchise system.
Study the Disclosure Document
Take time to speak with current and former franchisees about their experiences. Because investing in a franchise can entail a significant investment, you should have an attorney review the disclosure document and franchise contract. You also should have an accountant review the company’s financial disclosures.
ARE THERE ADDITIONAL SOURCES OF INFORMATION?
Before you invest in a franchise system, you should investigate the franchisor thoroughly. In addition to reading the company’s disclosure document and speaking with current and former franchisees, you should speak with the following:
- Accountant – Investing in a franchise is costly. An accountant can help you understand the company’s financial statements, develop a business plan, and assess any earnings projections and the assumptions upon which they are based. An accountant can help you pick a franchise system that is best suited to your investment resources and your goals.
- Lawyer – Franchise contracts are usually long and complex. A contract problem that arises after you have signed the contract may be impossible or very expensive to fix. A lawyer will help you understand your obligations under the contract, so you will not be surprised later. Choose a lawyer who is experienced in franchise matters. It is best to rely upon your own lawyer or accountant, rather than those of the franchisor.
- Banks and Other Financial Institutions – These organizations may provide an unbiased view of the franchise opportunity you are considering. Your banker should be able to get a Dun and Bradstreet report or similar reports on the franchisor.
- Better Business Bureau – Check with the local Better Business Bureau (BBB) in the cities where the franchisor has its headquarters. Ask if any consumers have complained about the company’s products, services or personnel.
- Government Departments – Several states regulate the sale of franchises. Check with your state Division of Securities or Office of Attorney General for more information about your rights as a franchise owner in your state.
- Federal Trade Commission (FTC) – The FTC publishes information that may be of interest to you, including business guides. Visit http://www.ftc.gov for more information.