If you’re thinking about buying a franchise, you could be barking up the right tree. After seven straight years of growth, industry numbers showed that nearly three-quarters of a million franchises were slinging tacos, filing taxes, teaching kids and washing dogs in 2017.
It’s a proven business model with a good track record. But if you’ve heard that 90% of franchises make it, you’ve probably heard wrong.
Some franchises do have phenomenal success, but most independent experts say it’s nowhere near 90%. They think the overall franchise success rate is probably closer to that of independent start-ups.
For people with the drive and talent to run a business but not the will to give birth to it – or what Forbes calls the “patience, capital or guts to generate sales from scratch” -- the franchise route makes sense. It’s a turnkey operation.
You, the franchisee, buy and operate a prefab business with a recognizable brand name. In exchange, you adhere to brand guidelines and give the franchisor a cut of the sales.
Ohio franchise lawyer James Meaney describes the franchise business as “built around a well-known trademark, supported by experienced and knowledgeable individuals, with an emphasis on uniformity.”
Which sums it up pretty well.
Opening your doors with name recognition is huge. HUGE.
In the franchise system, you walk in with your brand established, your sales and accounting systems ready to go, and your possible locations vetted, and there are people who know what they’re doing waiting to show you how it all works.
Franchisors come in handy, especially early on, when you may have no idea what you’re doing.
They offer perks like:
And in exchange, they get to tell you what to do.
So if your plan is to buy a franchise and make your own decisions, rethink that: The franchisor gets both a piece of your profits and a good chunk of control over how, when, where, and for how much you do business.
Typically, the brand has the final word on:
And should the franchisor decide to change the font on the menus, you’ll get a bill for your share. After all, it’s your store.
What you can earn as a franchise owner varies wildly by industry. A 2016 survey found that owners of automotive franchises averaged $106,500 in pretax income, compared to $38,471 for travel and recreation. Retail came in at $60,405.
The real money is in multiples. But you gotta walk before you can run.
Really, at this point in your franchising career, “How much can I make?” may be less critical than “How much does it cost?”
When you hear you can buy a Subway restaurant for $15,000, that’s not the cost of your new business. It’s the “franchise fee,” which is more like the cost of the name.
The actual “initial investment” for a Subway ranges from $89,550 to $328,700, as of 2018, which covers the brand license and costs like real estate, construction, signage, insurance, and opening inventory.
Generally, the higher the franchise fee, the higher the initial investment. For a Hilton, the franchise fee is $75,000, and the initial investment is between about $29 million and $112 million.
The initial investment figure also includes what you’ll work and live on during the break-even period, before you turn a profit. Franchisors generally include three months of expenses.
Noting it could actually take up to a year to become profitable, experts advise including six months of business expenses and one year of living expenses when you run the numbers.
Finally, once your Subway is up and running, you’ll pay Subway Inc. 8% of your gross sales and 4.5% for advertising charges, along with equipment rental, leasing, licensing, and insurance fees, every month for the rest of your business’s life. (And possibly beyond – more on that later.)
Fees are all over the map. Hilton takes 5% in royalties and 4% for advertising. Jazzercise, which charges only $1,250 for the name and claims an initial investment starting at $2,400, takes 20% in royalties and doesn’t charge for ads.
All of this information is readily available. Check out industry websites, franchise handbooks, and local franchise expos (to avoid the hard sell, go for the booths, not the brokers).
In franchise shopping, the usual business rules apply:
Research the market, the industry, and the brand. The International Franchise Association (IFA) ranked the top US franchise industries by growth for 2018, putting personal services (like child care, home care, fitness centers) at the top, followed by quick-service restaurants, and retail food was dead last.
Look for company history, financial data, legal status, and statistics from groups like the Better Business Bureau, Federal Trade Commission, and financial reporting organizations.
And whatever else you do, says Meaney, contact current owners. You’ll find names in the franchise disclosure document, or FDD.
“The most important thing is to … call as many franchisees as possible with a list of questions to unlock their experience with the franchise system.”
Also important: Actually read the entire franchise disclosure document.
Read the franchise agreement, too.
You have to.
Between the contract and the FDD, you’re looking at hundreds of pages on the company’s financial status and legal history, how much you have to pay, how much they have to do, how much they’re allowed to do, and what happens if it doesn’t work out, among other matters.
Among the most critical, Meaney says, is the “Termination” section of the Franchise Agreement. Specifically, the part that answers: “If I fail, do you expect me to pay royalties after termination of the Franchise Agreement for the remaining balance of the term?”
You may have to pay fees to the franchisor for the duration of your contract even if your business closes before the contract ends.
Which is problematic.
If you’re not up to the challenge of 150 or so pages of needlessly complex legal minutiae -- and even if you are -- have a lawyer read it.
If you are a lawyer, have another lawyer read it. (Just to be safe. You’re obviously highly capable.)
Meaney says this guidance is essential. Preferably from a member of the American Bar Association Forum on Franchising.
“There must be a final review,” he notes, “and possibly negotiations,” before anyone signs a franchise contract.
James Meaney, franchise attorney, http://www.ohiofranchiselawyer.com/
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