May. 20, 2024
When investing in a franchise, you benefit from established brand recognition, training, and support. However, success is not guaranteed, as with any investment.
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The Federal Trade Commission has prepared this guide to help you determine if a franchise is right for you. It provides strategies for evaluating franchise opportunities and highlights crucial questions to ask before investing. The guide also explains how to use the disclosure document required by the FTC's Franchise Rule to investigate and evaluate franchise options.
A franchise allows you, the investor or franchisee, to run a business using a system developed by the franchisor. You pay a franchise fee for the right to use the franchisor’s name and benefit from their assistance, which may include location selection, initial training, an operating manual, and ongoing support through various channels like newsletters or workshops.
Owning a franchise involves specific costs, franchisor controls, and contractual obligations.
You'll pay for the right to use the franchisor's name and for their assistance, which includes various fees and expenses:
Initial Fees and Expenses
Your initial franchise fee can range from tens of thousands to several hundred thousand dollars and is often non-refundable. Other expenses may include renting, building, equipping the outlet, buying initial inventory, and even a 'grand opening' fee.
Royalty Payments
Expect to pay royalties based on your gross income, regardless of whether you’re profitable. These payments continue for the duration of your franchise agreement.
Advertising Fees
You may have to contribute to an advertising fund, with fees allocated to national advertising efforts rather than promoting your specific outlet.
To maintain uniformity, franchisors typically impose controls on how franchisees operate. These could include:
Site Approval
Franchisors may require approval of your chosen site, often conducting extensive studies to ensure it attracts customers.
Design and Appearance Standards
Uniform design standards may necessitate costly periodic renovations.
Restrictions on Goods and Services
You may be limited in what you can sell. For instance, a restaurant franchise might not allow any menu changes.
Operational Methods
Hours of operation, employee uniforms, and accounting methods may be dictated by the franchisor.
Protected Territories
Exclusive territories may be offered, but they don’t completely shield you from competition.
Franchise agreements last for a set number of years. Failing to meet the terms can result in losing your franchise. Terminations can happen for various reasons, and renewals are not guaranteed.
Termination
A franchisor can end your agreement for reasons like non-payment of royalties or failing to meet performance standards. Termination generally results in losing your entire investment.
Renewals
Agreements can last up to 20 years, but renewals may come with changes in terms, such as increased royalties or new design standards.
Evaluate your financial situation, abilities, and goals honestly before investing in a franchise.
There are various channels to research franchise opportunities, such as local outlets, franchise handbooks, expositions, and brokers.
Visit nearby franchised outlets and speak with the owners to understand their experiences with different franchisors.
Franchise opportunity handbooks list franchises by type and provide basic information. They are useful for finding suitable opportunities if you are unsure about the type of business you want.
Franchise expositions allow for comparison of multiple franchise opportunities. Prepare by researching suitable franchises and ask critical questions, such as initial fees, additional costs, and ongoing support offered by the franchisor.
Franchise brokers may be helpful but remember they often work for franchisors, getting paid only if a sale is made. Investigate their offerings and selection criteria. Be aware of how brokers are compensated and whether that influences their recommendations.
Choosing a franchise is a significant investment decision that involves risk. Consider demand, competition, franchisor support, and reputation.
Evaluate the demand for the franchisor’s products or services in your area. Consider factors like seasonal demand, whether the business relies on repeat customers, and how much market creation will be needed.
Analyze competition at local, regional, and national levels. Understand whether the franchise offers unique products or services and how well-established other competitors are in your area.
Consider what would happen if the franchisor goes out of business. Assess your capability to run the business independently, including access to suppliers and ongoing training.
The reputation of the franchisor’s brand can significantly affect customer draw. An established, respected brand will likely attract customers more easily than a lesser-known brand.
Check for complaints filed against the franchise or franchisor with regulatory bodies or consumer protection agencies. This information can offer insights into potential issues you might encounter.
Evaluate the franchisor’s training and support programs. Compare them with what is offered by competitors and consider feedback from current franchisees.
The franchisor’s experience in managing a franchise system is crucial. Determine how long they have been managing franchises and assess their expertise.
A growing franchise system can indicate strong brand recognition but rapid growth can sometimes lead to inadequate support. Investigate the franchisor’s financial health and resources to support new outlets.
Before you invest, obtain and review the Franchise Disclosure Document (FDD). FTC regulations require franchisors to provide the FDD at least 14 days before any contract signing or payment. The FDD is crucial for informed decisions.
Understand the franchisor's business tenure, competition, and any unique legal requirements like special licenses. This helps gauge the inherent costs and risks.
Assess the franchisor's executives and their experience levels in running a franchise system.
Discover any past legal issues involving the franchisor or its executives. Frequent claims may indicate systemic problems.
Check for any bankruptcy history associated with the franchisor or its affiliates. Review financial statements thoroughly, possibly with an accountant’s help.
Evaluate initial and ongoing costs, from non-refundable fees to operational expenses. These may include insurance, supplies, equipment, and employee salaries.
Understand any limitations on supplier choices, goods sold, and sales territories. This includes online sales restrictions.
Review summaries of advertising commitments and training programs. Ask the franchisor and current franchisees about these services.
Understand the conditions under which you can renew or terminate your franchise agreement. Post-termination obligations might include non-compete clauses.
Review any earnings claims made by the franchisor in Item 19. Make sure any income representations are documented and substantiated.
Examine data on franchise system growth and franchisee turnover. Contact current and former franchisees for practical insights.
Be cautious with any financial performance representations. Seek substantiation for any claims and consult an accountant to evaluate their legitimacy.
Check if earnings claims are typical across the franchise system. Averages can sometimes obscure disparities among different franchisees.
Understand the difference between gross sales and actual net profits. High gross sales do not necessarily mean profitability due to various overhead costs.
Earnings can vary by location. Ensure any financial claims consider geographic relevance to your chosen area.
Recognize that individual skill sets and education among franchisees will vary. One person's success doesn’t guarantee the same for another.
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Be mindful of any waivers or statements regarding financial performance representations. Document all claims provided during the franchise buying process to avoid waiving any rights.
Before signing, confirm if there have been updates to the franchisor’s disclosures. Updated information might include new lawsuits or changes in management.
Expert Consultation
Consulting an accountant and a lawyer can be invaluable. They can help you interpret the franchisor’s financial health and legal obligations.
Financial Institutions
If financing is needed, your bank might provide useful insights into the franchisor’s financial profile. However, bank approval doesn’t equate to a safe investment.
Better Business Bureau
Check for complaints against the franchisor’s products or personnel with local BBB offices.
Government Information
Various states have laws regulating franchise sales. Check with state consumer protection agencies for relevant information not included in the FDD.
The FTC aims to prevent fraudulent and unfair business practices and offers resources to help businesses comply with the law. To file a complaint or get consumer information, visit ftc.gov or call 1-877-FTC-HELP.
The FTC’s Business Center provides tools to help businesses understand and fulfill compliance responsibilities. Visit business.ftc.gov for more information.
Small businesses can share feedback about federal compliance activities with the National Small Business Ombudsman and 10 Regional Fairness Boards. These comments are evaluated annually to assess federal agency responsiveness to small businesses. To comment, call 1-888-REGFAIR or visit www.sba.gov/ombudsman.
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