Tips on Buying a Franchise
Last Verified:
2005-06-09
One option you may wish to consider when looking for a business to start is purchasing a franchise. Buying a franchise can be more expensive than starting a business "from scratch" but the success rate of franchises is generally higher than for startups, as you are investing in a product with a proven track record and the franchisor generally provides training, marketing, support and other services to the franchisee. On the other hand, if you have an established successful business, expanding it into a franchise may be one way to expand.
Summary
What is a Franchise?
A franchise is a legal agreement between a franchisor (seller) and the franchisee in which the franchisor grants the franchisee the right to distribute certain goods or services developed by the franchisor in a particular way, in a particular location and for a specified period of time. In return, the franchisee pays the franchisor various fees and royalties. There are several types of franchise arrangements.
A business format franchise is what most people think of when they hear the term "franchise." A franchisee buys the right to market and sell particular products or services. The franchisee buys those rights for a specific time and a defined area by paying the franchisor a franchise fee for the right to use the franchisor's trademarks and marketing plan. In some cases the franchisee buys an entire system - buildings, equipment, supplies, bookkeeping, uniforms, training, and so on. The franchisee can often walk in off the street, turn the key in the lock and start the business. This ready-made set-up is also known as a turnkey operation. Fast-food chains are good examples of this kind of franchise.
It should be noted that when you enter a franchise agreement, you are not really buying a business. You are only buying the rights to conduct the business under a franchise agreement for a limited time - usually for 10, 15, or 20 years - with renewal options.
Pros and Cons of Buying a Franchise
Pros
- Training. Most franchisors offers training to help you establish, run and expand your business. In general, it is very detailed, covering topics from hiring and training employees to record keeping. A good training will give you thorough knowledge of all aspects of the business without having had years of experience in the field.
- Supervision and consulting. Most franchisors will offer you ongoing advice and updated training, and in many cases they will be available for emergency problem solving.
- Proven products and methods. Good franchises can significantly reduce business risks because of their experience and know-how. In addition, you are able to build on the franchisor's image and reputation.
- Collective buying power. The franchisors achieve important economies of scale in purchasing, and are able to amass large amounts of money to fund national and regional advertising campaigns.
- Financing. In many cases, franchisors will make financing options available.
- Ongoing research and development. Most franchisors are constantly working on new products, new ideas and new systems. You enjoy the benefits produced by their R&D without having to invest yourself.
Cons
- Fees. Franchises are expensive to purchase and there are usually ongoing payments based on sales (royalties), to be paid to the franchisor. The royalty fee, combined with debt service on any financing, may put a drain on the cash flow of the business.
- Other costs. Franchisees will also be responsible for the cost of equipment, merchandise, supplies, rental and lease rates, and required participation in promotional and other support services.
- Loss of independence. It isn't your name or concept that you will be promoting through your business. Although as a franchisee you manage the day-to-day operations of your business, most franchisors have strict guidelines and regulations that must be adhered to, so in essence you are more a store manager than your own boss. These agreements tend to be quite restrictive, and if you encounter any problem with the franchisor, remember that you are legally bound by your contract to adhere to its operational guidelines.
- The franchisor's problems are also your problems. If the franchisor hits hard times, you'll most likely feel them as well. You are inevitably tied to the franchisor, not only by contract, but by concept, name, product, and services sold.
- Limited expansion possibilities. While many small retailers own multiple units of a particular franchise and/or multiple franchises, your ability to expand is limited by the franchisor.
- Work, work, work. Any retail business will require a significant commitment of time and effort, and franchising is certainly not unique in this respect. Some of your time will be devoted to activities related to the franchisor's requirements, such as special reporting or strict hours of operation.
Costs
Purchasing a franchise is not the cheapest way to start a new business. Many different fees are involved and some of them will have to be paid or gathered up-front, before you even start making money from your franchise. The Canadian Franchise Association provided us with the following list of the different types of fees (in Canadian dollars) which can be involved in a franchise agreement.
Note: These numbers are average fees. As franchises cover many different activities and sectors from home-based businesses to hotels and restaurants, they vary a lot depending on the type of franchise.
- Franchise fee (paid up-front on signing the franchise agreement): $23 000
- Equity investment (Investment of the franchisee needed to keep the franchise afloat, not only open your franchise, but to run it until such a time as it is profitable): $160 000
- Royalties on profits: 5 to 10% of the sales
- Other costs (share of the franchisor's costs benefitting its franchisees such as national campaigns of advertising, R&D, employees' training...)
Are you cut out to be a franchisee?
Before buying a franchise, ten important questions need to be carefully and thoughtfully answered:
- Are you ready to take on the responsibilities of starting and running your own business?
- Does your family accept your choice and are they ready to support you?
- Do you like the activity you are considering enough to make a commitment for 5, 10 or 15 years?
- Do you like dealing with people and are you good at it? - You will have to interact with your customers, your employees, the franchisor and other franchisees.
- Do you like the franchisor's staff / those people with whom you will be working?
- Are you willing to follow the franchisor's rules and system?
- Can you afford the franchise?
- Have you carefully studied the legal documents?
- Does the franchise you are considering have a track record of success?
- Are the other franchisees generally happy and successful?
Be aware of the risks involved
Rosy claims
Buyer beware! Franchising benefits from a largely unearned reputation of being a risk-free investment, attracting those who find safety in numbers. According to the CFA, Canada now boasts 76000 franchises establishments, with annual revenues of about $100 billion. Although, franchising's proponents claim that 90% of the franchises enjoy long-term survival, while independent businesses are more prone to fail, a survey by a professor at Wayne State University of Detroit and published in the Wall Street Journal found a failure rate of almost 35% among franchises, compared with a 28% among independents. And although another survey found that 80% of franchisees were breaking even, 62% were earning less than the franchisor promised, and about 40% reported that the franchiser had opened other franchises nearby cannibalizing their sales.
Frauds
The success of franchising has attracted a certain number of fraudulent promoters. However, certain clues and practices can give them away. The Better Business Bureau suggests that you be wary of franchisors that:
- Promise exorbitant profits with meager investments.
- Demand that you "act immediately" before investigating in order to "get in on the ground floor."
- Fail or are unable to provide vital statistics on franchise sales, profits, locations, etc.
- Promise "easy sale" of the franchises product or service.
- Fail to identify company officers or principals.
- Attempt to "trade you up" to a higher-than-advertised-price franchise.
- Promise profits through chain sales or pyramid schemes in which you make your money by selling other franchises or distributorships.
- Use names which sound like, but which are not connected with nationally known, reputable business firms.
- Promise large incomes from "work-at-home" or "spare-time" efforts.
Always check with the Better Business Bureau for information on a franchise firm before you begin to negotiate a franchise purchase. Also make use of mercantile reporting agencies, your local bank, and similar sources to check the up-to-date financial status of the franchisor.
Hidden costs
Some franchisors inflict different types of hidden costs on franchisees: they levy fines if the franchisee doesn't respect their rules, or negotiate exclusive contracts with suppliers to charge franchisees artificially high prices. If the training costs are part of the franchise fee in most cases, the franchisee will be responsible for his/her travel expenses while in training. The franchisee will also have to pay for licensing and insuring his/her business.
Poor site selection
The number one reason behind business failure or poor performance is the location of the business. A poor site selection can create a difference up to 200% in volumes of sales for identical stores from the same franchise. Before signing a lease or sublease of your franchisor, do your homework...
- Select a site before committing yourself to a business
- Take your time to find the perfect location
- Negotiate the best deal possible
- Choose better location over cheaper rent
- Study the area selected: size of the population, age, lifestyle, average earnings...
- If you cannot find what you are looking for, wait for the best location possible.
Evaluate a potential franchise
Purchasing a franchise is a major investment decision and not every franchise is ideal for every individual. To make sure you take the right decision, you should:
- Investigate the franchisor
- Talk to their franchisees
- Obtain disclosure documents
- Talk to a franchise lawyer
To help you with this process, the Canadian Franchise Association (CFA) has prepared a list of questions you should ask if you are considering purchasing a franchise:
Checklist to Evaluate a Potential Franchise
Links and resources
Canadian Franchise Association : http://www.cfa.ca
The Canadian Franchise Association represents over 350 franchise companies and the professionals who support this way of doing business.
Publication: Franchise Canada http://www.cfa.ca
International franchise association : http://www.franchise.org
IFA provides information and resources on franchising and the Virtual Franchise Opportunities Mall--one-stop-shopping place for obtaining your franchised business.
Buying a franchise in Alberta: http://www2.gov.ab.ca/gs/pdf/tipsheets/fran_buy.PDF
This consumer tip sheet on buying a franchise, is based on the Franchise act of Alberta
Information on franchising (Strategis) :
http://strategis.ic.gc.ca/epic/internet/indsib-fran.nsf/en/h_ov00004e.html
This World Wide Web information product is designed to help in the education process and provides a network of information sources on franchising including associations, professional and government services, trade shows and conferences, and publications.
Canadian Franchise DirectoryTM : http://www.franchisedirectory.ca
Canadian Franchise Directory profiles the main franchise opportunities available today in Canada and allow you to search the list by name, by category or by investment level. You can request brochures directly from the franchisors that interest you, send e-mails to their sales representatives or access their web site. This web site also offers information on franchising and useful links to help you choose the best franchise.
Franchises opportunities: http://franchiseopportunities.com and Canada Franchise Opportunities: http://canada.franchiseopportunities.com
Franchise Opportunities is the world's most comprehensive free directory of franchises and small business opportunities. Canada Franchise Opportunities is a licensee of Franchise Opportunity and offer current, local Canadian Franchise information.
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