A franchise purchase is a long-term, complex investment. If you’re like most franchise buyers, it will be one of the largest investments of your entire life. It is important to make the right decisions during the purchase process. This starts with choosing the franchise opportunity that you wish to pursue.
There are many options. Franchising.com reports that there are over 3,000 franchisees in the United States and “an average 300 new brands start franchising every year.” However, not all options will be relevant for you. Once you have decided what type of franchise you want, you can start to look at geographic availability. You will soon find that you are trying to choose between two or three franchise systems.
While narrowing your options down from over 3,000 is simple, it’s not easy to narrow down from just two or three options to the final one. Franchise systems can be different. While franchisees may own their businesses, the success of franchisees also depends on their franchisors.
Many of the business decisions made by franchisors have an impact on the franchisees’ businesses. This includes everything from the fees they collect to advertising spending and how aggressively they protect their brands. If you don’t make informed decisions, it is possible to struggle as a franchisee.
7 factors to consider when choosing between franchise opportunities
All of this being said, how can you make an informed decision when purchasing a franchise? These are seven things to keep in mind when narrowing down your options to just two or three, or perhaps five, franchise opportunities.
1. Initial investment
The initial investment is the amount you spend to open your franchise. There are many types of franchises that require different initial investments. Opening a restaurant or fitness center can require a large initial investment. However, you might be able to start a mobile franchise with a cost of between $30,000 and $40,000.
How to compare initial investments
You can compare initial investments by reviewing Item 7 in each franchisor’s Franchise disclosure document (FDD). You may be able to find information about initial investments online depending on which franchises you want to compare. There are several factors to consider when comparing the Item 7 disclosures of franchisors.
- The Franchisors’ Items 7 numbers are only estimates and you will need an independent assessment of your franchise costs.
- Different franchisors may not include the same costs in Item 7 disclosures. Consider line items that are only found in one franchisor’s FDD when comparing initial investments.
- The “Additional Funds line item” makes up a significant part of Item 7 initial investments estimate. This amount is to pay for expenses in the initial phase of your franchise before it becomes profitable. To determine the period that this line item covers, you will need to refer to the footnotes in the Item 7 table.
2. Royalties and marketing fees
After you open your business, you will have to pay royalty and marketing fees on an ongoing basis to your franchisor. Most franchisors base their royalties or marketing fees on gross revenue. Franchisees are required to pay them monthly. There are exceptions to this rule, so you should carefully read Item 6 of FDD to find out the ongoing fees for each franchise opportunity.
There are no set standards for marketing fees and royalties, but franchisors can charge what they think their franchisees will pay. A few franchisors also charge minimum fees. This means you have to pay a fixed dollar amount, regardless of how much your franchise makes each month. Some franchisors also require franchisees to pay “lost future royalty,” which means that even if your franchise is unsuccessful, you will still have to pay the amount you would have paid if it was successful.
3. Territorial rights
Many franchises include some type of territory. The terms of the franchise agreement will define what it means to be granted territory as a franchisee. Some franchisors offer exclusive territories where only their franchisees can sell their products or services. However, franchisors usually reserve the right not to sell in franchisees’ territory from company-owned locations. Some franchisees are restricted in the geographical area they can spend their marketing money.
You can refer to Item 12 of your FDD to find out what type of territory a franchisor offers. It is important to also review the terms of the franchise agreement, as the summary in Item 12 may not adequately describe franchisees’ territorial rights.
4. Renewals and the initial term
Your rights do not expire when you purchase a franchise. The initial term of your franchise agreement will be specified. It will also include a list containing conditions you must meet to renew your agreement after the initial term ends.
You don’t want to work for two to three years to build your business and then start making a decent living, only to have your franchisor cancel your franchise agreement. You might not even have earned back your initial investment. It is better to have a longer-term than a shorter one, but you should also avoid getting locked into a long-term agreement that leaves no exit route if the franchise is not profitable.
5. Operational restrictions and support
What are you paying for when you purchase a franchise? You are usually paying for two things when you buy a franchise: (i) the rights to use the franchisor’s trademarks; (ii) access to the franchisor’s business system and operational support as a franchisor. If you don’t receive the support you require, you will not be satisfied and may wish you had chosen another franchise.
You should also consider the restrictions placed on franchisees by each franchisor. This can be viewed in the FDD at Items 8 and 11, as well as spoken to former and current franchisees. You want to be sure your franchisor will set and enforce system-wide standards to foster customer loyalty and establish uniformity. However, you must also ensure that you have the flexibility to manage a profitable business.
6. System size and growth
Although bigger is not always better when franchising, it is possible for a franchisor to create and manage a national system that has hundreds of franchisees that are (mostly), able to stay in business for many years. There are also benefits to joining a newly established franchise system. However, the franchisor must have the financial and personnel resources to ensure that the system grows well.
It is a good idea to spend some time looking at Item 20 in each franchisor’s FDD when comparing franchise opportunities. Multiple tables with footnotes are included in Item 20 that detail franchisee signings, closings, openings, and terminations. You can also find a list of states with projected openings in item 20. Each franchisor representative can help you determine if they are meeting or exceeding their projections.
7. Covenants after termination
As a potential franchisee, you should be aware of any post-termination covenants that may apply to your franchise agreement. These may vary from one franchise system or another, so make sure you carefully read the franchise agreement’s termination provisions for each opportunity.
While non-solicitation and non-competition covenants are fairly common, some franchisors may impose more strict restrictions than others. It is possible to expect that you will have to cease using the trademarks and system of franchisors immediately, but there may be some temporary leeway.
Do your due diligence
This is not an exhaustive list. Before you sign a franchise agreement or choose a franchise, do your research thoroughly and make a decision based on your belief in your abilities to succeed. To help you make the right decision, create a business plan.
Disclaimer. The opinions and views expressed in this article are the authors Andrew Napolitano.
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